author: Smith:

text:
    Samuel Insull, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret A. Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent. Samuel Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 68001-68003, 68503-68505.
    Promulgated February 14, 1935.

      Laurence Graves, Esq., and E. J. Quirm, Esq., for the petitioners.

      Allin H. Pierce, Esq., and Irvmg M. Tuller, Esq., for the respondent.
   opinion.

Smith:

These proceedings, consolidated for hearing, involve income tax deficiencies as follows:

The petitions filed for the year 1929 raise but one issue and that is whether capital net gains realized by each of the petitioners should be excluded from net income in computing the 15 percent deduction allowable for charitable contributions under section 23 (n) of the Revenue Act of 1928.

For the year 1930, the question of the treatment of capital net gains in computing the deduction for charitable contributions is raised in the appeals of Samuel Insull and Samuel Insull, Jr. Otherwise the issues raised by the petitions filed for the year 1930 are the same in the case of each of the petitioners. They are:

(1) The determination by the respondent that the profits realized by the petitioners from the sale of shares of stock of Insull Utility Investments, Inc., acquired through the exercise of rights to subscribe for such shares should be taxed as ordinary gain or profit rather than as capital net gain.
(2) The determination by the respondent that the profit realized from the sale or exchange of stock subscription rights received on stock acquired by the exercise of stock subscription rights should be taxed as ordinary gain or profit rather than as capital net gain.
(3) The determination by the respondent that no portion of the basis of the stock with respect to which stock subscription rights were received and sold or exchanged on September 13, 1930, may be allocated against the sales price in determining the gain or profit realized from the sale.

By amended answers filed at the hearing of these proceedings the respondent alleged that he had erred in his determination of the deficiencies as follows:

(a) In determining that the transaction by which the three petitioners and a fourth individual had exchanged in January, 1929, certain securities owned by them for shares of stock of Insull Utility Investments, Inc., was a nontaxable exchange.
(b) In determining that a portion of the profit realized from the sale of stock subscription rights issued on stock of the Insull Utility Investments, Inc., received in exchange for securities transferred to said corporation, should be treated as capital net gain.

The petitioners and one Martin J. Insull were the owners of substantial blocks of stocks of public utility companies operating in the city of Chicago and its immediate vicinity. They also owned a large amount of stock in Middle West Utilities Co., a public utility holding company. It was decided that their stockholdings should be placed in a corporation. Plans for the formation of such a corporation and the transfer of the petitioners’ stock interests thereto were discussed in the summer of 1928 and they assumed active form in October 1928. In that month Waldo F. Tobey began work on the organization of a corporation which thereafter became Insull Utility Investments, Inc. The entire plan of organization was worked out by Samuel Insull, Waldo F. Tobey, who handled the legal side of the transaction, and H. L. Stuart of Halsey, Stuart & Co., who handled the financial side of the transaction. The plan contemplated the issuance by the proposed corporation of common stock, preferred stock, first series, prior preferred stock, and debentures. The plan also contemplated the method of issuance and disposal of such securities. An informal agreement was made between the petitioners and H. L. Stuart for the purchase of the debentures and the prior preferred stock by Halsey, Stuart & Co., and for the delivery of 57,000 shares of common stock of Insull Utility Investments, Inc., to Halsey, Stuart & Co. by members of the Insull family, composed of the petitioners herein and Martin J. Insull, as consideration for the services of Halsey, Stuart & Co.

Under date of December 27, 1928, a charter for the new corporation, Insull Utility Investments, Inc., was obtained under the laws of the State of Illinois. It had an authorized capital stock consisting of 250,000 shares of prior preferred, 250,000 shares of preferred, first series, and 3,000,000 shares of common stock without par value. After the incorporation a meeting of the board of directors was held on January 4, 1929. On the same date Insull Utility Investments, Inc., executed four separate agreements with Samuel Insull, Samuel Insull, Jr., Margaret A. Insull, and Martin J. Insull. By the terms of these agreements the petitioners received stock of Insull Utility Investments, Inc., as consideration for securities transferred to that company by them and they on their part agreed to deliver to Halsey, Stuart & Co. an aggregate of 57,000 shares of the common stock of Insull Utility Investments, Inc., which they were to receive in the transaction.

A condensed statement with respect to the securities transferred on January 4, 1929, to Insull Utility Investments, Inc., by the petitioners showing the stock received by each of the petitioners in accordance with the foregoing agreement, the original cost to. the petitioners, and the values at which the same were placed upon the books of the corporation, is as follows:

On January 11, 1929, in return for the foregoing securities, Samuel Insull received 25,456 shares of preferred stock, first series, of Insull Utility Investments, Inc., without par value, at an agreed exchange value of $100 per share; and 486,176 shares of common stock, also without par value, at an agreed exchange value of $7,547 per share.
On January 11, 1929, in return for the foregoing securities, Samuel Insull, Jr., received 5,928 shares of preferred stock, first series, of Insull Utility Investments, Inc., without par value, at an agreed exchange value of $100 per share, and also 113,241 shares of common stock, also without par value, at an agreed exchange value of $7,547 per share.
On January 11, 1929, in return for the foregoing securities, Margaret Insull received 3,692 shares of preferred stock, first series, of Insull Utility Investments, Inc., without par value, at an agreed exchange value of $100 per share, and also 70,461 shares of common stock, also without par value, at an agreed exchange value of $7,547 per share.

On January 17, 1929, Insull Utility Investments, Inc., executed a joint agreement with the petitioners herein and Martin J. Insull by the terms of which each of these parties was given an option to purchase within two years five shares of the common stock of the corporation at $15 per share for each share of preferred stock, first series. These options had no value at the time received by the petitioners.

On January 18, 1929, Insull Utility Investments, Inc., executed a written agreement with Halsey, Stuart & Co. whereby the former agreed to sell and the latter agreed to purchase $6,000,000 of its 5 percent gold debentures, series A, and 60,000 shares of the $5.50 prior preferred stock. The debentures and prior preferred stock were delivered to Halsey, Stuart & Co. on the same date, January 18,1929, and tbe consideration was likewise received by Insull Utility Investments, Inc., on that date. Also on tbe same date, January 18, 1929, Halsey, Stuart & Co. sold tbe prior preferred stock to the Utility Securities Co., which proceeded to sell the same to the public; Halsey, Stuart & Co. sold the debentures to the public. Both the debentures and the prior preferred stock carried nondetachable warrants for common stock at $15 per share before June 80, 1929. Because of the quick rise in prices of the common stock many of these warrants were exercised by the holders of the debentures and prior preferred stock who had bought their securities from the distributors.

The foregoing transactions with Halsey, Stuart & Co. were entered in the journal of Insull Utility Investments, Inc., as of January 17, 1929, and the accrued interest on the debentures and the accrued dividends on the prior preferred stock were adjusted to show transfer of said securities as of that date. The common stock which was delivered to Halsey, Stuart & Co. for its services in accordance with the agreements of January 4, 1929, actually was delivered to Halsey, Stuart & Co. by the petitioners herein on January 21,1929.

All of the foregoing transactions were carried out in accordance with the general plan of procedure which was determined and agreed upon as aforesaid prior to the organization of Insull Utility Investments, Inc., in December 1928. All of the written agreements above described and referred to were prepared in the office of Waldo F. Tobey at or about the same time to reflect the general plan of procedure agreed upon. They were dated on the respective dates when they were fully executed by the parties thereto.

On December 17, 1929, a 6 percent stock dividend was declared by Insull Utility Investments, Inc., on its common stock, payable 1 y2 percent on January 15, 1930, 1y2 percent on April 15, 1930, iy2 percent on July 15, 1930, and 1 y2 percent on October 15, 1930, to the stockholders of record on December 31, 1929, March 31, 1930, June 30, 1930, and September 30, 1930.

On December 31, 1929, Samuel Insull exercised a portion of the option acquired by him and thereby purchased 126,030 shares of common stock of Insull Utility Investments, Inc., at $15 per share. On the same date Margaret A. Insull and Samuel Insull, Jr., exercised the options which they had acquired and thereby purchased common stock in the amounts of 18,460 shares and 29,640 shares, respectively.

On December 31, 1929, the common capital stock of Insull Utility Investments, Inc., was traded in on the Chicago Stock Exchange at the following prices:

High— 58% per share
Low_ 57% per share
Closing. 58% per share
The sales on that day on the Chicago Stock Exchange amounted to 8,200 shares. On the same day this same class of stock sold on the New York Curb Exchange at a high of 59% per share and a low of 56% per share. The sales on that day on the New York Curb Exchange amounted to 900 shares.
On January 6, 1930, the petitioners sold shares of common stock of Insull Utility Investments, Inc., which they had acquired on December 31, 1929, by exercising the option contained in the agreement of January 17, 1929, as follows: Samuel Insull, 42,816 shares for $1,712,640; Margaret A. Insull, 6,923 shares for $276,920; and Samuel Insull, Jr., 11,415 shares for $449,100.
In filing their Federal income tax returns for 1930, the petitioners reported profits on the foregoing sales as follows:
Samuel Insull_$1,079, 891.24
Margaret A. Insull_ 174, 609. 66
Samuel Insull, Jr- 280, 550. 81

The petitioners treated these amounts as capital net gain, while the respondent in determining the deficiencies held that they should be taxed as ordinary gains or profits.

On July 30, 1930, Insull Utility Investments, Inc., issued rights to its common and preferred stockholders of record on August 30, 1930, to subscribe for its common stock at $50 per share on and prior to September 15, 1930. In accordance with this action the petitioners herein received rights on stock held by them as follows:

Samuel Insull- 440, 568n%00
Margaret A. Insull_ 68,016
Samuel Insull, Jr_ 135, 221

On September 13, 1930, the petitioners exchanged the rights so received by them for common stock of the Corporation Securities Co., which at that date had a value of $23 per share.

As a result of this exchange the petitioners received shares of Corporation Securities Co. common as follows:

Samuel Insull_21, 272
Margaret A. Insull_ 3, 289
Samuel Insull, Jr_ 6,578

The petitioners reported the entire amounts so realized in their income tax returns. They regarded, however, a portion thereof as having been realized from the exchange of rights received on stock considered by them as capital assets and reported such amounts as capital gain, while the remainder was reported as ordinary gain. In his deficiency notice the respondent determined the amount so reported as capital gain by each of the petitioners to be excessive.

During the years 1929 and 19S0 each of the petitioners made contributions for gifts to organizations falling within the provisions of section 23 (n) of the Revenue Act of 1928 as follows:

In the determination of the deficiencies the respondent has excluded all capital gains from the income upon which the limitation of 15 percent for the deduction of charitable contributions is based.

1. One of the issues in these proceedings is whether capital net gains realized by each of the petitioners in 1929 and 1930 should be excluded from net income in computing the 15 percent deduction allowable as charitable contributions under section 23 (n) of the Revenue Act of 1928. This issue is decided in favor of the petitioners, upon the authority of Helvering v. Bliss, 293 U. S. 144.

2. Although the respondent, in the computation of the deficiencies for 1929, held that the transaction by which the three' petitioners and a fourth individual, Martin J. Insull, in January 1929 exchanged certain securities for shares of stock of Insull Utility Investments, Inc., was. a nontaxable exchange, he now contends that he was in error in so doing and that the transaction should be treated as a taxable exchange and that the deficiencies for the year 1929 should be increased accordingly.

Section 112 (b) (5) of the Revenue Act of 1928 reads as follows:

(b) Eaolimges solely in hi/nd.—
*******
(5) Transfer to corporation controlled by transferor, — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

Section 112 (j) of the same act provides:

(j) Definition of control. — 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.

It is the respondent’s contention that immediately after the exchange by the petitioners of securities for shares of capital stock of Insull Utility Investments, Inc., the petitioners and Martin J. Insull were not in control of the newly organized corporation; that the plan of the organization of Insull Utility Investments, Inc., contemplated that the petitioners should contribute 57,000 shares of the common stock to Halsey, Stuart & Co., as an inducement to it to purchase from the newly organized corporation 60,000 shares of its prior preferred stock and $6,000,000 of its gold debentures; that after all of these steps had been taken the petitioners and their associate did not control Insull Utility Investments, Inc., since they did not own any of the prior preferred stock of that corporation.

It has been stipulated that prior to the organization of Insull Utility Investments, Inc., an informal agreement had been reached between the petitioners and H. L. Stuart that Halsey, Stuart & Co. should purchase certain gold debentures and the prior preferred stock issued by Insull Utility Investments, Inc., and that the petitioners and Martin J. Insull would contribute 57,000 shares of the common stock as consideration for the services of Halsey, Stuart & Co. Upon the basis of this stipulation the respondent contends that all of the steps contemplated in the exchange transaction were not completed until after Halsey, Stuart & Co. had acquired the debentures, the prior preferred stock, and the 57,000 shares of common stock.

Although the transactions above referred to were contemplated by the petitioners prior to the organization of Insull Utility Investments, Inc., it can not be said that they in any wise affected the exchange transaction by which the petitioners transferred securities to Insull Utility Investments, Inc., and received the issued preferred stock, first series, and all the common stock in exchange therefor. The petitioners received their shares of stock on January 11, 1929. The exchange transaction was completed on that date. The petitioners, with Martin J. Insull, were the owners of all of the issued capital stock of Insull Utility Investments, Inc.

On January 18,1929, Insull Utility Investments, Inc., entered into a written contract with Halsey, Stuart & Co. for the purchase by the latter of $6,000,000 gold debentures and 60,000 shares of prior preferred stock. The agreement provided, “As a commission to the Purchaser the Company agrees to' issue, or to cause to be issued and transferred to the Purchaser fifty-seven thousand (57,000) shares of the company’s common stock without par value.” The agreement further provided:

4. The obligations of the parties hereto are subject to the following:
(a) Approval by counsel for the Purchaser as to the form and legality of issue of said Debentures and' said Stock;
(b) The qualification of the securities to be purchased under the Securities Law of the State of Illinois either by direct action of the State authorities or by listing upon a stock exchange and thereby excusing such approval;
(c) Delivery of and payment for said Debentures and Stock shall be made within ten (10) days of the date hereof.

From the above facts it is clear that the agreement by which Halsey, Stuart & Co. was to acquire the debentures and the prior preferred stock of Insull Utility Investments, Inc., was no part of the exchange transaction or contract by which the petitioners and Martin J. Insull transferred their shares of stock to Insull Utility Investments, Inc. Clearly, “ immediately after the exchange ” the transferors were in control of Insull Utility Investments, Inc., and remained in control of it until after January 18, 1929. What happened on and after that date has no bearing upon the question in issue. Our opinion in Federal Grain Corporation, 18 B. T. A. 242, is apposite. The facts in that case were that certain individuals transferred property to the Federal Grain Corporation on May 1, 1924, in exchange for its entire capital stock. Prior to the exchange these individuals entered into two agreements regarding the stock to be received. One was a trust agreement under which the stock was to be held in trust for a period of five years, and the second was an agreement to sell such stock at certain prices per share over a period of five years. In our opinion we said:

* * * In our opinion, there is no question that the transferors had ownership and control of the petitioner’s capital stock for some period of time, even if only momentary, which the petitioner concedes would be sufficient to meet the provisions of the statute. The creation of the trusteeship transferred to Klein the legal title to the shares of stock and the transferors retained their equitable interests. "Without already having had complete ownership, therefore, at some time no interest whatsoever could have been transferred to Klein by the transferors. They did have complete legal and equitable ownership within the meaning of the statute, although it may have been for only a short time. * * *

Our opinion in Federal Grain Corporation, supra, was cited with approval in Evans Products Co., 29 B. T. A. 992, in which we said:

The question then is whether E. S. Evans remained in control of the petitioner immediately after the transfer of the property from E. S. Evans & Oo. to it It is not essential that Evans should retain control for any length of time. It is sufficient that he was momentarily in control. Federal Oram Oorp., 18 B. T. A. 242.
* * * ‡ sjs sjs *
In our opinion immediately after the transfer of the property of E. S. Evans & Co. to petitioner, E. S. Evans, who owned all the stock of the transferor, was in control of the petitioner, and the determination of the respondent in this respect is approved. (Schmieg, Hungate & Kotzian, Inc., 27 B. T. A. 337.) West Texas Refining & Development Co., 25 B. T. A. 1254, on which the petitioner relies, is not in point. There the corporations involved were parties to the reorganization.

This rule was adopted in American Compress & Warehouse Co. v. Bender, 70 Fed. (2d) 655, cited by the Board in Ared Corporation, 30 B. T. A. 1080. That case involved the interpretation of section 208 (b) (4) of the Revenue Act of 1924, which contains the same language as section 112 (b) (5) of the Revenue Act of 1928, herein involved. The court said:

* * * It is not material that at a time subsequent to the consummation of the exchange of property solely for corporate stock the transferor corporations ceased to be in control of the transferee corporation.

The contentions of the respondent upon this point are not sustained.

3. In exchange for the securities transferred to Insull Utility Investments, Inc., in January 1929, the petitioners received rights to purchase within a period of two years at $15 per share five additional shares of common stock for each share of preferred stock owned by them. It is stipulated that these rights “ had no value at the time received by the said petitioners.” The rights became very valuable, however, prior to the close of 1929, and a portion of such rights owned by Samuel Insull, and all of the rights owned by Margaret A. Insull and Samuel Insull, Jr., were exercised on December 31, 1929, by the purchase of common stock at $15 per share. Six days thereafter, or on January 6, 1930, a portion of the stock thus acquired was sold at great profit. The only contention of the petitioners upon this point is that these profits are taxable at capital net gain rates. They were so returned by the petitioners. The capital net gain from this source reported by Samuel Insull was $1,079,891.24, by Margaret A. Insull, $174,609.66, and by Samuel Insull, Jr., $280,550.81. These profits were computed after making a slight adjustment in the basis for a stock dividend declared on December 17, 1929, and payable January 15, 1930. The correct amounts of the profits based upon the cost to the petitioners ($15 per share) were $1,070,400, $173,075, and $277,-875, respectively.

Section 101 of the Revenue Act of 1928 deals with capital net gains and losses. It defines a “ capital gain ” as the taxable profit realized from the sale or exchange of capital assets. It then defines “ capital assets ” in subsection (c) (8), in so far as here material, as follows:

(8) “ Capital assets ” means, property lielcl by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business. For the purposes of this definition—
(A) In determining the period for which the taxpayer has held property received on an exchange there shall be included the period for which he held the property exchanged, if under the provisions of section 113, the property received has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as the property exchanged.

It is the contention of the petitioners that, inasmuch as the shares of stock sold on January 6, 1930, were''acquired through the exercise of rights issued on stock owned and held by them for a period of more than two years, they are entitled to return the profits realized from the sale of such stock as capital net gains. No support for such a contention can be found in the law. With respect to stock subscription rights the Supreme Court stated in Miles v. Safe Deposit & Trust Co. of Baltimore, 259 U. S. 247:

* * * It is evident, we think, that such a distribution [stock subscription rights] in and of itself constituted no division of any part of the accumulated profits or surplus of the company, or even of its capital; it was in effect an opportunity given to stockholders to share in contributing additional capital, not to participate in distribution. * * * This privilege of itself was not a fruit of stock ownership in the nature of a profit; nor was it a division of any part of the assets of the company.

It is clear that if the petitioners had not exercised their rights and purchased additional shares of stock they would not have had the profits which accrued to them from the sale of those shares on January 6, 1930. Those profits resulted from an investment on December 31, 1929, of additional capital in the stock of Insull Utility Investments, Inc. The shares were held by the petitioners for a period of only six days. Since they were held for a period of less than two years they were not “ capital assets ” within the meaning of section 101 (c) (8) of the Revenue Act of 1928 above quoted. The gains were therefore not capital net gains. Rodman E. Griscom, 22 B. T. A. 979; Ellen Ayer Wood, 29 B. T. A. 1050.

In Helvering v. New York Trust Co., 292 U. S. 455, the Supreme Court had before it the question whether donated property held by the donee for a period of less than two years was taxable as capital net gain where the time within which the donor and the donee held the property was more than two years. The Court held that the two periods should be added together for the purpose of determining the period during which it was held by the “ taxpayer.” From a careful consideration of that opinion and of the legislative history of the taxing statutes involving capital net gains and losses set forth therein, we find nothing which would warrant a modification of the principles invoked by the Board in Rodman E. Griscom, supra, and Ellen Ayer Wood, supra.

The contentions of the petitioners upon this point are not sustained. It should be noted, however, that the profits returned by the petitioners from the sales were in excess of the true profits, which were, in the case of Samuel Insull, $1,070,400; in the case of Margaret A. Insull, $173,075; and in the case of Samuel Insull, Jr., $277,875. In the recomputations under Rule 50 the deficiencies should be recomputed upon the basis that the taxable profits from the sales on January 6, 1930, were as above stated.

4. On July 30, 1930, Insull Utility Investments, Inc., issued rights to its common and preferred stockholders of record on August 30, 1930, to subscribe for additional shares of common stock at $50 per share. The petitioners never exercised those rights to subscribe. They did, however, on September 13,1930, exchange those rights for shares of common capital stock of the Corporation Securities Co., which at the time received had a value of $23 per share. The stock was valued by the petitioners in the computation of taxable gains from this source at $25 per share. The amounts returned by Samuel Insull, Margaret A. Insull, and Samuel Insull, Jr., were $533,524.09, $82,502.73, and $164,984.43, respectively. Small portions of these amounts were returned as taxable as ordinary income and the balance as taxable at capital net gain rates. In the audit of the returns the respondent determined the incomes of the petitioners from this source as follows:

The respondent by amended answers alleges that he erred in determining that a portion of the gains was taxable at capital net gain rates and that the entire amounts should be taxed as ordinary income.

On brief, the petitioners state:

In the returns filed the petitioners reported as income the entire amount realized from the sale of rights received in 1930 on stock of Insull Utility Investments, Inc. to subscribe for additional common stock. No attempt was made to apportion a part of the cost basis of the stock on which such rights were issued for the reason that under the respondent’s rulings then in existence practically all of such profit was taxable as capital net gain and little benefit would have resulted from such an apportionment. However, since the returns were filed the respondent has changed his rulings with respect to capital net gains, with the result that a large portion of the capital gain reported is now taxable as ordinary gain or profit.

The contention of the petitioners that they are entitled to allocate or apportion to the rights sold in 1930 a portion of the cost of stock on which such rights were issued is apparently predicated on article 58 of Regulations 74, which provides in part:

(1) If tlie shareholder does not exercise, but sells his rights to subscribe, the cost or other basis of the stock in respect of which the rights are issued shall be apportioned between the rights and the stock in proportion to the respective values thereof at the time the rights are issued, and the basis for determining gain or loss from the sale of a right on one hand or a share of stock on the other will be the quotient of the cost or other basis assigned to the rights or the stock, divided, as the case may be, by the number of rights issued or by the number of shares held.

Manifestly, under this regulation the petitioners would be entitled to the allocation referred to in the regulation, provided the rights had a value at the time they were issued, viz., August 30, 1930. The stipulated facts, however, contain no information upon this point. We can not, from the record, determine that any allocation should be made. The contention of the petitioners upon this point is therefore denied for lack of evidence.

The claim of the respondent that he erred in taxing a portion of the gain realized by the petitioners from the sale or exchange of the rights at capital net gain rates is sustained. The rights were held by the petitioners for less than a month from the date of issuance. They did not constitute “ capital assets ” within the meaning of the statute. Rodman E. Griscom, supra; Ellen Ayer Wood, supra. The motion for increased deficiencies in the correction of the errors is allowed.

Reviewed by the Board.

Judgment will be entered wnder Rule 50.

Goodeich dissents.

Arhhdell, Yah Fossan, and McMahon dissent on the second point.


source: Caselaw Access Project

author: Van Fossan :

license: Public Domain

text:
    Franklin J. Matchette, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40710.
    Promulgated February 14, 1935.

      Hugh 0. Bickford,, Esq., and William P. McGool, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for tlie respondent.
   OPINION.

Van Fossan :

This proceeding was heard upon stipulated facts and an opinion was promulgated on August 29, 1932 (26 B. T. A. 909). On application of the petitioner, concurred in by the respondent, rehearing was had, at which the parties filed a new stipulation of facts, modifying materially and enlarging the stipulation theretofore filed. The issues remain the same, namely, (1) whether or not under the following facts the petitioner was taxable on certain dividends, and (2) whether the dividend payable December 31,1924, but received by the petitioner on or after January 2, 1925, was taxable in former or latter year.

The facts are now stipulated substantially as follows:

In December 1912 the petitioner acquired 700 shares of preferred and 1,740 shares of common stock of Richmond Radiator Co. at a cost of $88.50 per share for the preferred and $20 per share for the common. The fair market price or value of such stock on March 1, 1918, was the same as petitioner’s cost. Petitioner sold said stock as follows:

In reporting gain or loss on account of these sales the petitioner used as his cost basis in every case $100 per share.

The petitioner, who was and is a citizen and resident of New York, New York, at all times material to this proceeding, kept his accounts for the years 1922, 1923, 1924, and 1925 and filed his Federal income tax returns for said years upon a cash receipts and disbursements basis as distinguished from an accrual basis.

From prior to January 23, 1923, and until February 3, 1923, the petitioner was the owner and holder of 7,555 shares of common stock of the Servidor Co. and 5,651 shares of common stock of the New York Hotel Statler Co. (hereinafter called the Hotel Co.), a corporation duly organized and existing under the laws of the State of New York.

On January 23, 1923, the Hotel Co. declared a dividend out of its surplus or net profits of $35 per share on its common stock, payable February 10, 1923, to stockholders of record on January 26, 1923.

On February 3,1923, the petitioner made a written offer to Match-ette Investment Co. (hereinafter called the Investment Co.), a corporation then duly organized and existing under the laws of the State of Delaware, a true copy of which is as follows:

February 3, 1923.
Matchette Investment Company.
Wilmington, Delano are.
Gentlemen : I, the undersigned, hereby subscribe ior and agree to take eleven thousand one hundred and ninety-five (11,195) shares of the capital stock of Matchette Investment Company, a corporation organized and existing under the laws of the State of Delaware, said stock being without nominal or par value, and I hereby agree to pay therefor and for the ten (10) shares of stock subscribed for by the Incorporators of this Company, by selling, assigning, transferring and setting over unto Matchette Investment Company the following shares of stock as follows, to wit:
7,555 shares of common stock without nominal or par value of The Servidor Company,
3,650 shares of common stock without nominal or par value of New York Hotel Statler Company, Inc., together with any dividends which may be paid hereafter upon said stock prior to the certificates therefor being transferred upon the books of said Company,
provided that the transfer of said shares of stock to the Company be accepted in full payment of eleven thousand two hundred and five (11,205) shares of its capital stock.
I further request that all the shares of stock of said Company be issued in my name except one (1) share which I direct to be issued in the name of Nellie S. Matchette and one (1) share to be issued in the name of Percival S. Kaufman.
Franklin J. Matchette.

The offer was duly accepted by the Investment Co. on the same date. The shares of stock of the Hotel Co. referred to in the agreement represent 3,650 shares of the 5,651 shares of the stock referred to above.

Pursuant to the agreement the 3,650 shares of common stock o,f the Hotel Co. and 7,555 shares of common stock of the Servidor Co. were thereupon assigned and delivered to the Investment Co. under the terms of the agreement and 11,205 shares of stock of the Investment Co. were issued to petitioner, Nellie S. Matchette, and Percival S. Kaufman. The shares of stock issued to Nellie S. Matchette and Percival S. Kaufman were held by them as nominees for the petitioner. The 11,205 shares of stock of the Investment Co. constituted the entire issue of stock of the company. The Investment Co. thereupon caused the shares of stock of the Hotel Co. to be delivered to the transfer agent hereinafter referred to, which, after the opening of the stock records of said company as hereinafter stated, transferred such shares on the records to the Investment Co. on February 13, 1923.

The bylaws of the Hotel Co., at all times during the year 1923, contained the following provisions:

Article I, par. 4. At each meeting of the stockholders, every stockholder having voting rights * * * shall have one vote for each share of stock standing registered in his name on the books of the corporation for ten days next preceding the date of such meeting. * * * Only the persons having voting rights and in whose names shares of stock stand on the books of the corporation for ten days preceding the date of such meeting * * * shall be entitled to vote. * * *
Article IV, par. 2. No transfer of stock shall be valid as against the corporation except on surrender and cancellation of the certificate therefor, accompanied by an assignment or transfer by the owner thereof. * * *
Article IV, par. 3. The Board of Directors shall have power and authority to make all such rules and regulations, not inconsistent herewith, as it may deem expedient, concerning the issue, transfer and registration of certificates for shares of the capital stock of the corporation.
Article IV, par. 4. The Board of Directors may appoint a transfer agent or agents and a registrar or registrars of transfers within the State of New York, and may require all stock certificates to bear the signature of a transfer agent and of a registrar of transfers.
Article IV, par. 5. The stock transfer books may be closed for the meeting of stockholders, and may be closed for the payment of dividends, during such periods, as, from time to time, may be fixed by the Board of Directors, and during such periods no stock shall be transferable.

At all times during 1923 the Marine Trust Co. of Buffalo was the duly authorized and designated transfer agent for the capital stock of the Hotel Co., duly designated as such by the board of directors of said company pursuant to the authority granted by the bylaws.

Pursuant to authority of the bylaws, the board of directors of the Hotel Co. duly directed that the transfer books be closed from January 26, 1923, to and including February 10, 1923, and during such interval no stock could be transferred of record.

On February 10, 1923, the Hotel Co. mailed to the petitioner, as record holder, a check representing the dividend on the entire 5,651 shares of stock hereinabove referred to, at the rate of $35 a share, or a total of $197,785, in accordance with the custom of the company to make dividend payment by check. The check was accompanied by a printed notice in the form following, which check and notice were received by petitioner in the usual course of the mail not later than February 12,1923:

New York Hotel Statler Company, Inc.
Operating Hotel Pennsylvania, New York City
Executive Offices, Buffalo, N. Y.
The Board of directors has declared an extra dividend of $35.00 per share on the Common Stock payable February 10, 1923.
A cheek is enclosed in payment of this extra dividend on shares of common stock held by you.
Please advise us promptly of any change in your post-office address.
F. A. McKo wne,
Treasurer.
February 10, 1923.

Because the said check included dividends on 2,001 shares other than the 3,650 shares referred to in the foregoing subscription agreement, the petitioner, on February 16, 1923, deposited the same to his order in the Irving-Bank-Columbia Trust Co., New York City, and on February 20,1923, drew his certified check to the order of Matchette Investment Co. for $121,150, representing the amount of the dividend on the 3,650 shares assigned to the company pursuant to the aforesaid subscription agreement of February 3, 1923. The check was thereupon delivered to the Investment Co. and was deposited by it in its bank account.

The following are the entries on the petitioner’s cash book reflecting these transactions:

1923
Feb.
16 Irving Bank Deposit
To N. Y. Hotel St Div. on 2,001 shares_$70, 035. 00
Match. Inv. Oo Div. on 3,650 shares_ 127, 750.00
20 Match. Inv. Oo-Due Investment Oo. for dividend on 3,650 shares of N. Y. Hotel Statler
Go. com. stock_ 127,750. 00

The Investment Co. included the dividend of $127,750 in its Federal income tax return for 1923.

In his notice of deficiency the respondent added such amount, $127,750, to the gross income of the petitioner for the year 1923.

From January 26, 1923, and until after January 7, 1925, the petitioner individually was the owner and holder of the remaining 2,001 shares of common .stock of the Hotel Co. not assigned to the Investment Co., as aforesaid.

On December 20, 1924, the Hotel Co. declared a dividend of $1.25 per share on its common stock, payable December 31, 1924, to stockholders of record on December 15,1924.

On December 81, 1924, the Hotel Co. put in the United States mail at Buffalo, blew York, where the company had its principal office, a postpaid wrapper addressed to the taxpayer in New York City, containing its check for $2,501.25, payable to the taxpayer, representing such dividend on the 2,001 shares owned by him. The check reached the petitioner in the ordinary course of mail on or after January 2,1925, but prior to January 7, 1925.

If the attributes of income were to acquire their character solely from the provisions of the agreement of February 3, 1923, it would seem that the dividends paid on February 10,1923, properly belonged to the Investment Co. and became income to it on that date. The phrase “ together with any dividends which may be paid hereafter upon such stock prior to the certificates therefor being transferred upon the books of said company ” apparently was intended to< cover the transfer of the dividends declared on January 23 and payable on February 10. At first glance, it also would appear that the provisions of section 201 (e) of the Revenue Act of 1921 apply to the situation before us.

However, a careful study of the facts and the law appropriate thereto is convincing that neither section 201 (e) nor the decision of the courts support that conclusion. Section 201 (e) fixes the time of the acquisition of income by the distributee, but does not determine who is the proper distributee on a certain date. Assuming, therefore, that either the petitioner or the Investment Co. is the proper distributee, that section merely directs that the gross income shall include the distribution (of dividend) as of the date when it is unqualifiedly made subject to the demands of the distributee. The dividend in the case at bar was not unqualifiedly made subject to the stockholder’s demands until February 10 and, therefore, could not be included in his or its income before that date. The question then still remains, How was the “shareholder or member” entitled to receive that distribution?

In order to answer this question correctly and completely we must consider the position of the petitioner and the Investment Co. with relation to the stock and to the prospective dividends thereon at the date of the agreement to sell, February 3, 1923. At that time the petitioner owned the Hotel Co. stock. He also owned the right to receive the dividends on that stock on February 10. He had acquired that right consequent upon the declaration of the dividend made by the Hotel Co. onl January 23 and by reason of his having been a stockholder of record on January 26. The dividend belonged to the petitioner as owner of the stock at the time of declaration, Fletcher Cyc. Corp., section 3700; Hopper v. Sage, 112 N. Y. 530; 20 N. E. 350; Ford v. Snook, 205 App. Div. (N. Y.) 194; 199 1ST. Y. S. 630; and the corporation was indebted to him in his proportionate share of the dividends declared by it on January 23. He became a creditor of the corporation, which was liable for the payment of that debt on and after February 10. Chesapeake & Delaware Canal Co. v. United States, 250 U. S. 123.

Therefore, he sold to the Investment Co. his stock and his right to receive the dividend thereon in exchange for certain shares of its capital stock. It must be presumed that those shares represented the value of both the shares of stock and the prospective dividends. The dividends, representing gain flowing to the petitioner through his ownership of the stock, were derived from the earnings of the corporation and as such constituted income.

The Hotel Co. made the dividends payable to the stockholders of record on January 26. On that date the petitioner was such a stockholder and, therefore, he, and he alone, could receive the dividend distribution whenever it was payable. It became subject to his demand on February 10. The Investment Co. could not have held the Hotel Co. liable for payment to it, but was compelled to look to the petitioner for a proper division of the dividend check paid pursuant to the action of the Hotel Co. taken on January 23. Such division was necessary by reason of the terms of the contract between the parties, but the tax incidence was not thereby fixed.

The petitioner cites Eugenia R. Jemison, 28 B. T. A. 514. The situation there considered involved the liability of the purchaser under a very different set of facts. Moreover, it involved different tax concepts. We find nothing in the cited case at variance with our holding here.

As to the second issue, our decision is controlled by Avery v. Commissioner, 292 U. S. 210. See also Edward S. Harkness, 31 B. T. A. 1100.

Reviewed by the Board.

Decision will he entered under Rule 50.

Trammell dissents.

       Sec. 201 (e). For the purposes of this Act, a taxable distribution made by a corporation to its shareholders or members shall be included in the gross Income of the distributees as of. the date when the cash or other property is unqualifiedly made subject to their demands.


author: Black:

text:
    The Pittsburgh & West Virginia Railway Company, as Successor to West Side Belt Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. The Pittsburgh & West Virginia Railway Company, as Successor to Wabash-Pittsburgh Terminal Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 72157, 72158.
    Promulgated February 14, 1935.

      O. F. Tallin, Esq., and Leo H. Hoffman, Esq., for the petitioner.

      Allin H. Fierce, Esq., and Irving M. Tidlar, Esq., for the respondent.
   OPINION.

Black:

This is a reconsideration of our Division report promulgated May 31, 1934 (30 B. T. A. 843), which involved proceedings that grew out of proceedings originally commenced at Docket No. 8349. The caption of the petition in Docket No. 8349 was “Appeal of The Pittsburgh & West Virginia Railway Company and Affiliated Companies Hereinafter Mentioned ”, and in the opening paragraph the petition recited in part as follows :

The above named taxpayer, The Pittsburgh & West Virginia Railway Company, its predecessor company, the Wabash Pittsburgh Terminal Railway Company, and its affiliated companies, the Pittsburgh Terminal Coal Corporation (formerly Pittsburgh Terminal Coal Company, and prior thereto Pittsburgh Terminal Railroad & Coal Company), West Side Belt Railroad Company, Mutual Supply Company, Pittsburgh Terminal Clay Manufacturing Company, and Pittsburgh Terminal Land Company, hereby appeal from the determination of the Commissioner of Internal Revenue set forth in his deficiency letters * * * dated August 26, 1925 * * *.

The Commissioner determined deficiencies as follows:

Period, January 1, 1917, to March 31, 1917.
Wabash-Pittsburgh Terminal Railway Co_$2,199. 57 Income tax only
West Side Belt Railroad Co- 1, 789.48 Income tax only
Mutual Supply Co- 103. 24 Income tax only
Pittsburgh Terminal Railroad & Coal Co_ 59, 034. 70 Income and excess profits taxes
Period April 1,1917, to December SI, 1917.
Pittsburgh Terminal Railroad & Coal Co_$228, 923. 63 Income and excess profits taxes

The respondent in arriving at the above mentioned deficiencies had determined that the Wabash-Pittsburgh Terminal Railway Co. (hereinafter called the Wabash Co.) was the parent company of the affiliated group for the three-month period and that the petitioner, the Pittsburgh & West Virginia Railway Co., was the parent company of the affiliated group for the nine-month period, the petitionei having taken over the major properties of the Wabash Co. at midnight on March 31,1917. In his determinations of August 26, 1925, the respondent allocated to the Pittsburgh Terminal Railroad & Coal Co. all of the excess profits taxes due on the consolidated net income of the two affiliated groups.

On March 20, 1931, a report was promulgated (see 22 B. T. A. 876) holding that an order should be entered dismissing the petition “ as to the Pittsburgh Terminal Coal Corporation ” for lack of jurisdiction, on the ground that the Pittsburgh Terminal Coal Corporation was an entirely separate and distinct corporate entity from the Pittsburgh Terminal Railroad & Coal Co.

On September 19, 1931, the respondent filed in Docket No. 8349 a petition for review in the United States Circuit Court of Appeals as a result of our report promulgated and published at 22 B. T. A. 876, supra. This appeal was dismissed by the Third Circuit on April 19, 1933.

On April 11, 1933, an order was entered in Docket No. 8349, reading in part as follows :

After due consideration permission is hereby granted to Pittsburgh & West Virginia Railway Company, as successor to the Wabash-Pittsburgh Terminal Railway Company, to West Side Belt Railroad Company, and to the Mutual Supply Company, each, to file on or before May 10, 1933, at a new docket number, a separate amended petition based upon the notice of deficiency received by it, for the period January 1, to March 31, 1917, in accordance with the Revenue Acts and the Board’s Rules of Practice. If any petitioner fails to take proper or timely advantage of the permission thus granted, the respondent may move for dismissal or for such relief as he deems appropriate. If proper amended petitions are timely filed, the respondent may have the usual time within which to answer or otherwise move with respect thereto.

On April 18,1933, a written stipulation was entered into in Docket No. 8349, paragraph 2 of which is as follows:

That the Board may determine a deficiency against the Mutual Supply Company for the fiscal period January 1, 1917, to March 31, 1917, in the amount of $103.24; and that it may dismiss the proceeding so far as it relates to the Mutual Supply Company for the period April 1, 1917, to December 31, 1917, for the reason that no deficiency was asserted against said' company for that period, and that the Board, therefore, is without jurisdiction.

On April 25, 1933, we entered a decision in Docket No. 8349 in accordance with the stipulation referred to in the preceding paragraph. Thus there was left for our further consideration and determination only the tax liabilities of the Wabash Co. and the West Side Belt Railroad Co. (hereinafter referred to as the West Side Belt) for the period January 1 to March 31, 1917. In accordance with our order entered April 11, 1933, petitioner, on May 9, 1933, filed a separate petition for itself “ as successor to ” each of these two remaining companies, which petitions were docketed as Nos. 72157 and 72158.

Subsequent to the Board’s dismissal of the proceeding against the Pittsburgh Terminal Coal Corporation, already ref erred to herein, the tax liability of the Pittsburgh Terminal Railroad & Coal Co. was settled for an amount less than the deficiencies originally determined. As has already been pointed out, respondent, in his determination of deficiencies for the taxable periods, allocated all excess profits taxes to the Pittsburgh Terminal Railroad & Coal Co.

However, in his amended answers filed in Docket Nos. 72157 and 72158, respondent affirmatively pleaded that there was no inter-company agreement requiring that all the escess profits tas should be allocated to Pittsburgh Terminal Railroad & Coal Co. and that in conformity with the law this escess profits tas should be allocated to each member of the affiliated group in proportion to its net income, and he moved to increase the deficiencies against petitioner in the respective amounts of $3,269.29 and $4,018.53 on account of escess profits tas properly allocable to petitioner.

These issues raised in Docket Nos. 72157 and 72158 were made the subject of our division report promulgated May 31,1934 (30 B. T. A. 843), and it is this report we now have under reconsideration.

Petitioner’s motion for reconsideration challenges our division report promulgated May 31, 1934, on eight separate grounds. For reasons which will appear later in this opinion it will be necessary for us to consider only two of such grounds, which, as stated by petitioner, are as follows:

A. The Board of Tax Appeals does not have jurisdiction where the deficiency letters cover the fractional portion of the year, namely, from January 1, 1917, to March 31, 1917, inclusive, instead of the whole year 1917. Therefore, since the letters cover the improper period, orders of no deficiency should be entered.
* * * * * * *
D. Assuming that affiliation were proper, the determination of invested capital for the period January 1, 1917, to March 31, 1917, inclusive, was incorrect in the following particulars:
*******
3. Refusal to allow the full average invested capital of the alleged affiliated group for the three-month period begun January 1, 1917, and ended March 31, 1917.

Under assignment of error (A) petitioner contends that if any one of the corporations included in the affiliation for the period January 1 to March 31,1917, was in existence beyond March 31,1917, the deficiency notice in question, being for only a three-month period, as to it, would be for an improper period; and that the Board would be deprived of jurisdiction of any period beyond March 31,1917, citing Sweets Co. of America, Inc., 12 B. T. A. 1285, after our first decision (entered July 17,1928) in that case had been reversed and remanded by the Second Circuit in Sweets Co. of America, Inc. v. Commissioner, 40 Fed. (2d) 436.

In the Sweets Go. case the respondent had determined a deficiency against the petitioners for the six-month period ending June 30, 1919, which deficiency we originally approved. Upon appeal the Second Circuit held that the correct taxable period was a ten-month period ending October 31, 1919, and remanded the cause for further proceedings. Further proceedings were had pursuant to the court’s decree, and in our final decision we decided that there was no deficiency for the period January 1 to June 30, 1919 (the only period before us), and that the Board never acquired jurisdiction over the four months from July 1 to October 31, 1919, because no deficiency had been determined for that period.

Under section 240 of the Revenue Act of 1918, corporations which were affiliated were required to file consolidated returns “ for the purposes of this title and Title III”, that is, for “Income Tax” purposes and also for “ War-Profits and Excess-Profits Tax ” purposes. Under the Revenue Acts of 1916 and 1917, corporations, whether or not affiliated, were required to file separate returns for income tax purposes, and, if affiliated, were required, by virtue of section 1331 of the Revenue Act of 1921, relating to consolidated returns for the year 1917, to file a consolidated return only for the purposes of the war excess profits tax. See Trustees for Ohio & Big Sandy Coal Co., 15 B. T. A. 273; Clinchfield Navigation Co. v. United States, 66 Ct. Cls. 589.

In the first case mentioned two corporations, the Ohio & Big Sandy Coal Co. and the United Thacker Coal Co., were aifiliated from April 30 to December 20, 1917. The Ohio & Big Sandy Coal Co. kept its books and made its returns on the basis of a fiscal year ended April 30 and was dissolved on or about December 29, 1917. The United Thacker Coal Co. kept its books and made its returns on the basis of a fiscal year ended June 30, and continued in existence after the close of its fiscal year ended June 30,1918. In holding that two separate tax periods existed, that is, one for the purposes of the income tax and one for the purposes of the war excess profits tax, we said:

* * * In this case, the Ohio & Big Sandy and the United Thacker were held to be affiliated for excess-profits-tax purposes for the period April 30, 1917, to December 20, 1917, and, accordingly, a consolidated return for such purpose and for such period was required. That it comprehended a period less than 12 months, or that it did not coincide with the fiscal year of the United Thacker is immaterial; a separate tax status for excess-profits-tax purposes existed for this period. The action of the Commissioner in computing an excess-profits tax on the basis of a period of 7 months and 20 days is accordingly sustained.
The Commissioner, however, determined not only the excess-profits tax on the basis of 7 months and 20 days, hut also the income tax for both the Ohio & Big Sandy and the United Thacker for the same period. No great objection is made to this action in so far as Ohio & Big Sandy is concerned, since the end of the affiliation period was likewise the approximate end of its corporate existence, hut ohjection is made in so far as United Thaclcer is concerned, amd as to this we are of the •opinion that the Commissioner was in error. It it true, as pointed out by the Commissioner, that the income tax for the United Thacker was computed on its separate income for the period of 7 months and 20 days, and not on the consolidated net income, but wherein lies authority for the compu tation of income tax to this company on the basis of such a period? We think no authority to do so exists. The affiliation in 1317 is recognized, for excess-profits tax only, and whatever separate taw stains arose on account of the affiliation w,as for this purpose and no other. The income tax must he computed as if this affiliation never existed. In the case of the United Thacker, its taxable period, for income-tax purposes, did not begin on April SO, 1917, nor did it end on December 20, 1917; its income tax would be computed on the basis of a fiscal year ended June 30.
In view of the foregoing, we are of the opinion that to the extent that the deficiency in the case of the United Thacker arises from the determination of an income tax for the period April 30,1917, to December 20,1917, such deficiency is in error. That is, the correct deficiency for this period, in so far as it pertains to United Thacker, is the difference between the excess-profits-tax liability as determined hereunder and the excess-profits tax as paid, if any, for the same period on account of returns previously filed. [Italics supplied.]

The Ohio & Big Sandy case was taken to the Fourth Circuit, but not on this point. See Trustees For Ohio & Big Sandy Coal Co. v. Commissioner, 43 Fed. (2d) 782.

In Clinchfield Navigation Co. v. United States, supra, the plaintiff and another corporation were affiliated. The plaintiff kept its books on a calendar year basis and filed a return for “ income tax ” purposes for the calendar year 1917. The parent corporation kept its books on the basis of a fiscal year ending June 30, and filed a consolidated return for “ war excess profits tax ” purposes for the period January 1 to June 30,1917. The Commissioner did not question the correctness of filing a consolidated war excess profits tax return for the six-month period ending June 30,1917, but required plaintiff to make its income tax return and pay its income taxes on a six-month period ending June 30,1917, to conform with the same period for which the consolidated war excess profits tax return was filed. The Court of Claims held that the Commissioner erred in such requirement, giving substantially the same reasons for its conclusion as the Board gave in the Ohio do Big Sandy case, supra.

In the instant proceedings the West Side Belt was organized in 1902 and continued in existence until it was merged with the petitioner on December 31,1928. On or about April 30,1918, it filed with the collector at Pittsburgh a return of annual net income for the calendar year 1917. The respondent determined that in place of the one return for the calendar year 1917 the West Side Belt should have filed two returns for “ income tax ” purposes, one for the three-month period ended March 31, 1917, and one for the nine-month period ended December 31, 1917. On this basis the respondent determined a deficiency in income tax of $1,789.48 against the West Side Belt for the three-month period ended March 31,1917.

We believe this determination to be erroneous. It is our opinion that the income tax liability of the West Side Belt should have been determined on the basis of the full calendar year 1917. Trustees for Ohio & Big Sandy Coal Co., supra; Clinchfield Navigation Co. v. United States, supra. The respondent did not determine a deficiency against the West Side Belt for the nine-month period ended December 31, 1917. Therefore, we never acquired jurisdiction over this latter period, and, since the three-month period is an improper period for the purpose of determining the income tax liability of the West Side Belt, a decision of no deficiency in income tax for this period will be entered. Elgin Compress Co., 31 B. T. A. 273; Sweets Co. of America, Inc., supra. Whether there is a deficiency in war excess profits tax against the West Side Belt for the period January 1 to March 31,1917, will be discussed later in this opinion.

Although a slightly different situation exists in the case of the Wabash Co., we believe that the same result must be reached as to the deficiency of $2,199.57 in income tax determined against that company for the three-month period ended March 31, 1917, as was reached in the case of the West Side Belt for the same period. The Wabash Co. was organized in 1901. In 1916 its properties were sold at a judicial sale and were purchased by the corporation’s creditors, who in turn incorporated two new companies, namely, the Pittsburgh & West Virginia Railway Co. of West Virginia and the Pittsburgh & West Virginia Railway Co. of Pennsylvania. On January 29, 1917, these two new corporations were consolidated into a new corporation, the petitioner herein. At midnight on March 31, 1917, the petitioner took over the major portion of the properties of the Wabash Co. The Wabash Co. was not dissolved during 1917, but continued in a state of liquidation until at least March 30, 1921. It did no business as a going concern after March 31,1917. The record does not show definitely what kind of returns, if any, were filed by or on behalf of the Wabash Co. for the year 1917.

It is our opinion however that since the Wabash Co. was actually in existence during the entire calendar year 1917, it should have filed a return for income tax purposes for the full calendar year. In the case of Mrs. Grant Smith, 26 B. T. A. 1178, a corporation was actually dissolved on January 12, 1925, but its affairs remained in the hands of liquidating trustees for the remainder of the year. We held that the Commissioner erred in determining a deficiency against the corporation for the 12-day period.

In G. C. M. 2080, C. B. VI-2-288, it is stated in part:

In a case where a corporation liquidates and dissolves or comes into existence, other than at the beginning or end of the corporation’s taxable year, the return required is not a return for a fractional part of a year but a return for a full taxable year of 12 months, regardless of the fact that the period during which income is received or earned is less than a full year. Bankers Trust Co. v. Bowers, 295 Fed. 89; Louis Symel Planting and Mfg. Co., 5 B. T. A. 910; I. T. 2239—C. B. IV-2, 58.

Since the Wabash Co. was not dissolved during the year 1917, but actually continued in existence for purposes of complete liquidation, cf. Burnet v. Aluminum Goods Manufacturing Co., 287 U. S. 544, it would seem that as strong a reason existed for requiring a return for the full calendar year as existed in the Mrs. Grant Smith case, supra.

We hold therefore that the income tax liability of the Wabash Co. should have been determined on the basis of the full calendar year 1917; that since the respondent did not determine a deficiency against this company for the nine-month period ended December 31, 1917, we have no jurisdiction over this latter period; and that since the three-month period is an improper period for the purpose of determining the income tax liability, a decision of no deficiency in income tax for the period January 1 to March 31, 1917, will be entered.

We will now consider petitioner’s ground D (3). We have no doubt but that the respondent was correct in requiring a separate consolidated return for war excess profits tax purposes for the three-month period ended March 31, 1917, since the Wabash Co. ceased to be the parent company on that date. Cf. Marvel Equipment Co. v. Commissioner, 67 Fed. (2d) 354. Our question here is whether the respondent erred in not allowing the full average invested capital of the affiliated group for the three-month period instead of one fourth thereof. At page 851 of our report now under reconsideration, published at 30 B. T. A. 843, we said:

Petitioners contend that the respondent has erroneously computed the invested capital of the affiliated group in the taxable period. They argue that their entire invested capital should be used as an element in the computation of the excess profits deduction for the three-month period under review, instead of one-fourth thereof. It is perfectly clear that the method contended for by the petitioner would result in a computation applicable to income for an entire year. As the capital here involved was used for only three months, the deduction is only one-fourth of what it would be for an entire year.

The respondent, under sections 201, 203, and 207 of the Revenue Act of October 3, 1917, has determined that the consolidated war excess profits tax of the affiliated group in question for the period January 1 to March 31, 1917, amounted to $42,442.38, which, according to the schedules attached to his deficiency notice, he computed as follows:

Schedule 6 — Invested Capital
Invested capital disclosed by Bureau letter of Feb. 9, 1923- $2,503,750.00
As corrected_ 2, 503,750.00
No change
Schedule 7 — Proof of Invested Capital
Capital stock_$10,015,000.00
Surplus_None
Total, corrected balance sheet beginning of year-$10,015,000.00
Reductions to reduce to (3) months period Jan. 1, 1917, to March 31, 1917, % of $10,015,000.00_ 7, 511, 250.00
As shown on Schedule No. 6___ $2, 503, 750.00
Schedule 8 — Computation of Excess Profits Tax
Consolidated invested capital (Schedule 6)_$2,503,750.00
Consolidated net income (Schedule 5)_ 385,692.00
Income Tax
Deduction 7%, $175,262.50 plus $750.00_$176, 012.50
Taxable at 20%_ 199, 550.00 39,910.00
Taxable at 25%_ 10,129.50 2, 532.38
$385, 692.00 $42,442.38

Petitioner contends tRat during the entire three-month period the affiliated group actually operated upon an invested capital of $10,015,000; that no authority can be found in section 207 of the Eevenue Act of October 3, 1917, for reducing the capital of $10,-015,000 actually invested in the business to $2,503,750 merely because the taxable period in question is a three-month period rather than a twelve-month period; that no authority can be found in section 203 of the same act for prorating likewise the specific exemption of $3,000 provided for therein; that under section 203, swprco, the credit shall be at least 7 percent of $10,015,000, plus $3,000, or $704,050, rather than 7 percent of $2,503,750, plus $750, or $176,012.50, as determined by the respondent; and that since the credit of $704,050 is in excess of the consolidated net income of $385,692, there is no war excess profits tax due under section 201 of the act of October 3, 1917.

In support of the above contentions petitioner relies upon Strong, Hewat & Co. v. United States, 62 Ct. Cls. 67; Trustees for Ohio & Big Sandy Coal Co., 15 B. T. A. 273, 292-293; and T. D. 3848, Cumulative Bulletin V-l, p. 290.

Treasury Decision 3848 was approved subsequent to the decision by the Court of Claims in Strong, Hewat & Co., supra, and reads as follows:

Treasury Decision 2689, approved April 1, 1918, is hereby revoked, and article 26 of Regulations 41 is hereby amended to read as follows:
Art. 20. Computation of tax for period of less than 1% months. — If a corporation or partnership at any time, either because it has just designated a fiscal year as provided in sections 8 or 13 of the Act of September 8, 1916 (see Income Tax Regulations, arts. 31 and 211), or for any other reason [italics here supplied], makes a return for a period of less than 12 months, the deduction will be the full amount allowable for a period of 12 months, i. e., the deductions shall not he prorated in the proportion that the number of months for which the return is made bears to 12 months.

To the same effect is G. C. M. 2080, Cumulative Bulletin VI-2, p. 288.

In H. B. Mallinson <& Oo., 14 B. T. A. 1124, we said:

Respondent has determined the excess-profits-tax liability of the petitioners for the one-month period ended December 31, 1917, upon the basis of a consolidated net income of $35,705.69, a consolidated invested capital of $152,294.45, and a specific deduction of $500. The invested capital of $152,294.45 is but one-twelfth of the full consolidated invested capital, as determined by the respondent, and the specific deduction of $500 is but one-twelfth of the specific deduction of $6,000 allowed domestic partnerships by section 203 (b) of the Revenue Act of 1917.
Petitioner partnership was dissolved on June 1, 1918, and succeeded by a corporation. Such fact brings this case squarely within the decision of the United States Co.urt of Claims in the case of Strong, Hewat & Co. v. United States, supra, which was followed by this Board in Louis Hymel Planting & Manufacturing Co., 5 B. T. A. 910, and within the provisions of Treasury Decision No. 3848. The excess-profits-tax liability should be recomputed upon the basis of the full invested capital and the full specific deduction allowed by section 203 of the Revenue Act of 1917.

The respondent, in Trustees for Ohio & Big Bandy Coal Co., supra, conceded “ * * * that his action in both instances was in error and that no reduction should be made either in invested capital or the specific exemption on account of this determination in 1917 for a period less than 12 months.” (15 B. T. A. 273, 293.)

The same rule does not prevail under the subsequent revenue acts wherein Congress made special provision for prorating in case the return was for a period of less than 12 months. In this connection see Trorlicht-Duncker Carget Co., 22 B. T. A. 466, 473.

Section 203 of the Bevenue Act of October 3,1917, provides in part as follows:

Sec. 203. That for the purposes of this title the deduction shall be as follows, except as otherwise in this title provided—
(a) In the case of a domestic corporation, the sum of (1) an amount equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the pre-war period was of the invested capital for the pre-war period (but not less than seven or more than nine per centum of the invested capital for the taxable year), and (2) $3,000 * * *. [Italics supplied.]

We therefore sustain petitioner in this assignment of error. Since the consolidated net income of $385,692 determined by respondent is less than the credit to which petitioner is entitled under section 203 of the Bevenue Act of 1917, it appears that there will be no war excess profits tax liability of the affiliated group for the period January 1 to March 31, 1917. Strong, Hewat & Co., supra; T. D. 3848, supra; H. R. Mallinson & Co., supra.

Our holding in our former report sustaining the Commissioner in his disallowance of depreciation claimed by petitioner is affirmed.

Reviewed by the Board.

Decision will be entered under Rule 50.


author: Mtjedock:

text:
    Royal Marcher, Petitioner, v. Commissioner of Internal Revenue, Respondent. Quill, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 67800, 67808.
    Promulgated February 19, 1935.

      Lowis Salami, Esq., and Loms F. Gosswevn, O. P. A., for the petitioners.

      Harold Alien, Esq., and 8. L. Yowng, Esq., for the respondent.
   OPINION.

Mtjedock:

The Commissioner determined a deficiency of $35,-204.27 in the income tax of Royal Marcher for the calendar year 1929. Royal Marcher assigns as error the recognition for tax purposes by the Commissioner of a gain of $168,332.50 from the receipt by him of 750 shares of the stock of Quill, Inc. The Commissioner conceded at the hearing that he erred in failing to tax this gain as a capital net gain.

The Commissioner determined a deficiency of $18,403.72 in the income tax of Quill, Inc., for the fiscal year ended May 31,1930. There is but one issue involved as to Quill, Inc. — whether the basis for gain or loss to Quill, Inc., on 150 shares of the stock of Cohn & Rosenberger, Inc., is the basis which the stock had in the hands of Marcher and Grandee, Inc., as determined by the Commissioner, or whether the basis is cost to Quill, Inc., as the latter contends. The facts were stipulated in each proceeding and may be summarized as follows:

Royal Marcher, an individual residing in the city of New York, was the owner in June 1929 of 150 shares of Cohn &' Rosenberger, Inc., stock which he had acquired in 1910. The value of this stock on March 1, 1913, was $3,800, which was greater than its cost. The value of this stock on June 15, 1929, was $171,747.75. Marcher desired to dispose of the stock and, at the same time, to avoid the imposition of income tax which would result from a direct sale of the stock to the prospective purchaser. He incorporated two corporations under the laws of New Jersey on June 13, 1929. One of these, named Quill, Inc., had authorized capital of 1,000 shares of no par value. The other, named Grandee, Inc., had authorized capital of 100 shares of no par value. On June 13, 1929, he transferred his Cohn & Rosenberger, Inc., stock to Grandee, Inc., in exchange for all of its capital stock and had his wife transfer to Quill, Inc., some stock belonging to her (not Cohn & Rosenberger, Inc., stock), having a value at that time of $57,249.25, in exchange for 250 shares of Quill, Inc., stock. Two days later, on June 15, 1929, he had Grandee, Inc., transfer the Cohn & Rosenberger, Inc., stock to Quill, Inc., in exchange for 750 shares of Quill, Inc., stock, which latter shares were issued directly to Marcher. Grandee, Inc., thereafter had no assets, but was not dissolved. Marcher did not surrender his Grandee, Inc., stock. Grandee, Inc., never had books of account and has never had another transaction. Quill, Inc., sold the Cohn & Rosenberger, Inc., stock on June 24, 1929, for $172,260. Thereafter Quill, Inc., engaged in the business of investing in and selling securities. Marcher owed Quill, Inc., $57,128.53 at the close of its fiscal year May 31, 1930. The Commissioner determined that Marcher realized a taxable profit of $168,332.50 when he received the 750 shares of Quill, Inc., stock and that Quill, Inc., realized a taxable profit on the sale of the Cohn & Rosenberger, Inc., stock of the difference between $3,800 and $172,260, the amount realized from the sale.

Marcher admits that all of these steps were part of one purpose— to avoid or at least reduce taxes upon the disposition of his Cohn & Rosenberger, Inc., stock. But he claims that his plan was patterned after the statute and accomplished his purpose. His transfer of Cohn & Rosenberger, Inc., stock to Grandee, Inc., in exchange for all of its stock, left him in complete control of that corporation so that no gain was recognized from that transaction. Sec. 112 (b) (5) Revenue Act of 1928. He argues that the transfer of the Cohn & Rosenberger, Inc., stock by Grandee, Inc., to Quill, Inc., was a reorganization within the meaning of section 112 (i) (1) (A); the distribution of the Quill, Inc., stock to him was in complete liquidation of Grandee, Inc.; and no gain to him is recognized since both corporations were parties to a reorganization and he, as a shareholder in one, received stock of another pursuant to the plan of reorganization, without surrender of his Grandee, Inc., shares. See secs. 115 (c) and 112 (g).

Although a transaction otherwise within the nonrecognition provisions of the taxing statute does not result in taxable gain merely because it results in an avoidance of tax (United States v. Isham, 17 Wall. 496, 506; Bullen v. Wisconsin, 240 U. S. 625), nevertheless to accomplish its purpose the transaction must be the kind of a transaction that Congress intended to relieve of tax. The Circuit Court of Appeals for the Second Circuit, in deciding the case of Commissioner v. Gregory, 69 Fed. (2d) 809, said, “ it does not follow that Congress meant to cover such a transaction, not even though the facts answer the dictionary definitions of each term used in the statutory definition.” It further said:

* * * But the underlying presupposition is plain that the readjustment shall be undertaken for reasons germane to the conduct of the venture in hand, not as an ephemeral incident egregious to its prosecution. To dodge the shareholders’ taxes is not one of the transactions contemplated as corporate “ reorganizations ”.
* * * All these steps were real, and their only defect was that they were not what the statute means by a “ reorganization ” because the transactions were no part of the conduct of the business of either or both companies; so viewed they were a sham, though all the proceedings had their usual effect.

The Supreme Court of the United States, in affirming the decision of the Circuit Court in the Gregory case, said that the words “ in pursuance of a plan of reorganization ” mean in pursuance of a plan of reorganization of the corporate business and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either. It further said, “ The reasoning of the court below in justification of a negative answer leaves little to be said.” It held that the transaction there in question upon its face lay outside the plain intent of the statute, and concluded its opinion with these words, ‘£ To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.”

The facts in the Gregory case differ from those in the present case and there 112 (i) (1) (B) was involved instead of (A), but, despite these differences, the remarks of the courts apply with equal force to the transactions in the present case. Although here, as there, no step lacked legality and none may be disregarded, nevertheless, the artificiality of this tax-dodging scheme and its consequent failure to come within the purpose of the reorganization provisions of the statute is obvious. The transfer of the Cohn & Rosenberger, Inc., stock from Grandee, Inc., to Quill, Inc., for the latter’s stock, was not a reorganization within the meaning of section 112 (i) (1) (A), since it was no part of the conduct of the business of either corporation, but was an added gesture made in a vain effort to save taxes.

There may be other reasons why the transfer of the stock of Cohn & Rosenberger, Inc., to Quill, Inc., by Grandee, Inc., was not a reorganization within the meaning of section 112 (i) (1) (A). Cf. Alfred R. L. Dohme, 31 B. T. A. 671. However, further discussion seems unnecessary in view of the decisions in the Gregory case, upon which this present decision is based.

Marcher does not claim that section 112 (b) (5) applies to prevent recognition of his gain upon the receipt of the Quill, Inc., stock. We agree that it does not apply, since he did not transfer any property to Quill, Inc., and, consequently, did not transfer property to it in exchange for its stock. He received the Quill, Inc., stock as a stockholder of Grandee, Inc., and not in exchange for property which he transferred to Quill, Inc.

Since Marcher’s entire scheme was outside the purpose of the reorganization provisions of the statute, there is no occasion to attempt to stretch the wording of the act to include the transfer in question. The result is that the reorganization provisions do not apply and the various steps are tax-free or taxable, depending upon other provisions of the statute. The fact that Marcher realized a profit of $168,332.50 has been conceded. This profit to Marcher was taxable, since it does not come within any of the exceptions contained in section 112 and the general rule of (a) applies.

Quill, Inc., does not get a stepped-up basis for gain or loss on the Cohn & Eosenberger, Inc., stock, as Marcher had anticipated, despite the fact that Marcher’s profit has now been held taxable to him. The general rule of section 113(a) of the Eevenue Act of 1928 is that the basis for determining gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property. If that general rule applies here, it follows that the Commissioner erred and the contention of Quill, Inc., is correct. However, there are certain exceptions to that rule, and, as the respondent contends, this case falls within one of the exceptions, i. e., under subsection (8), which is as follows:

(8) Same — Corfobation controlled by transferor. — If the property was acquired after December 81, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112(b) (5) * * *, then the basis shall be the same as it would be in the bands of the transferor, increased in the amount of gain * * * recognized to the trans-feror upon such transfer under the law applicable to the year in which the transfer was made.

The transfer of 150 shares of the stock of Cohn & Eosenberger, Inc., by Eoyal Marcher to Grandee, Inc., comes precisely within the provisions of sections 112 (b) (5) and 113 (a) (8), supra. Therefore, the basis for gain or loss which the stock had in the hands of Grandee, Inc., was the same as it had had in the hands of Marcher, to wit, $3,800. Mrs. Marcher transferred some of her property to Quill, Inc., and Grandee, Inc., also transferred some property to Quill, Inc. Although these transfers were in one sense separate, they were, nevertheless, a part of one general plan. Thus, the two previous owners, Grandee, Inc., and Mrs. Marcher, transferred their property to a corporation (Quill, Inc.) solely in exchange for stock in such corporation ; immediately after the exchange the two transferors were in control of the corporation; and the amount of stock received by each was substantially in proportion to the interest of that one in the property prior to the exchange. Grandee, Inc., was entitled to receive 150 shares of the stock of Quill, Inc., in exchange for the stock of Cohn & Eosenberger, Inc., which it transferred to Quill, Inc. The fact that it permitted these 150 shares of stock of Quill, Inc., to go directly to its sole stockholder does not serve to take this transaction outside of section 112 (b) (5). The facts in the case of Ared Corporation, 30 B. T. A. 1080, were substantially similar and in that case the Board held that, under sections 203 (i), 203 (b) (4), and 204 (a) (8) of the Revenue Act of 1926, which sections are counterparts of the above quoted sections of the Revenue Act of 1928, the basis in the hands of the transferee was the same as it would be in the hands of the transferors. Here the transferor of the property consisting of the 150 shares of stock of Cohn & Rosenberger, Inc., was Grandee, Inc. No gain or loss to it was recognized in the transaction and, therefore, the property in the hands of Quill, Inc., takes the same basis for gain or loss which it had in the hands of Grandee, Inc. Ared Corporation, supra; American Compress & Warehouse Co. v. Bender, 70 Fed. (2d) 655. The basis which this property had in the hands of Grandee, Inc., was $3,800, as previously demonstrated. Quill, Inc., sold the stock for $172,260. The difference between these two figures represents the gain realized by Quill, Inc., in the taxable year. The Commissioner, in determining the deficiency, computed the profit in this way.

The stock of Cohn & Rosenberger, Inc., was the only asset which Grandee, Inc., had. The transfer of this asset by Grandee, Inc., to Quill, Inc., was in exchange for 750 shares of the stock of Quill, Inc. Grandee, Inc., was entitled to receive these shares in consideration of its transfer to Quill, Inc. Instead of receiving the 750 shares of stock of Quill, Inc., Grandee, Inc., permitted these shares to be issued directly to Marcher. This amounted to a liquidating dividend from Grandee, Inc., to its sole stockholder. This distribution to Marcher resulted in a gain to him of the excess of the value of the 750 shares of stock of Quill, Inc., over $3,800, the basis to him of his Grandee, Inc., stock. Yet the recognition of this gain to him does not serve to increase the basis which the stock of Cohn & Rosenberger, Inc., had in the hands of Quill, Inc., since Marcher did not transfer that property to Quill, Inc. Grandee, Inc., was the transferor within the meaning of section 113 (a) (8) and no gain to it was recognized upon the transfer. Grandee, Inc., was actually and legally created. The stock of Cohn & Rosenberger, Inc., was actually transferred to it, and it, in turn, transferred this property to Quill, Inc. None of these steps can be disregarded for, as the Circuit Court¡ of Appeals said in the Gregory case, supra, “All these steps were real * * *. * * * all the proceedings had their usual effect.” Thus, Marcher’s scheme by which he intended to avoid tax not only failed in its purpose, but resulted in two taxable transactions where only one taxable transaction would have resulted from a direct sale by him of the stock of Cohn & Rosen-berger, Inc. Like a boomerang, it was a dangerous thing to launch, but since Marcher deliberately used this involved method of disposing of his stock of Cohn & Rosenberger, Inc., the taxing statutes must be applied to the transfers which were actually made.

Keviewed by the Board.

Decision •will he entered, under Rule 50 at Docket No. €7808. Decision will he entered for the respondent at Docket No. 67800.

       Sec. 112 (i) (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 of the properties of another corporation) * * *.

       Sec. 112 (b) (5). Transfer to Corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.