author: Black: OkpeR,

text:
    Frances S. Willson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99980.
    Promulgated May 27, 1941.

      Harry G. Gault, Esq., for the petitioner.

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

Black:

The Commissioner, in including the net income of the Frances S. Willson trust as a part of petitioner’s net income for each of the years in question, relies upon section 167 (a) of the Revenue Act of 1936, printed in the margin.

Petitioner, in contending that the income of the trust is not taxable to her, relies upon two propositions as follows:

(1) That the part of the trust income used in 1936 and 1937 to pay premiums on insurance policies insuring the life of petitioner’s husband, George C. Willson, which policies were payable to the trustee, was not taxable to petitioner as grantor of the trust which produced the income.
(2) That the part of the 1936 and 1937 trust income which remained after the payment of insurance premiums and was accumulated and added to trust corpus was not taxable to petitioner as grantor of the trust which produced the income.

We shall take up and discuss these two propositions in their order.

(1) To sustain her first proposition, petitioner cites Lucy A. Blumenthal, 30 B. T. A. 591; Gail H. Baldwin, 36 B. T. A. 364. These cases support petitioner.

In the Blumenthal case the policies of insurance were not taken out on the life of the settlor of the trust but on the life of her husband. The policies were payable to the trustee, who was to collect the proceeds upon the death of the insured and use the money as a trust fund, the income from which was to be paid to the settlor and her children. Under such circumstances we held that portion of the income of the wife’s trust which was to pay the insurance premiums on the policies of insurance taken out on the life of Sidney Blumenthal, Lucy’s husband, was not taxable to her. On the other hand, we held that the portion of the income of the trust which was used to discharge the liability of Lucy to the Guaranty Trust Co. of New York on a collateral note for money borrowed was taxable to her. Our decision on this latter point was affirmed by the Supreme Court per curiam in Helvering v. Blumenthal, 296 U. S. 552, following Douglas v. Willcuts, 296 U. S. 1. No appeal was taken by the Commissioner from our decision on the first point.

It should be noted that the income of the trust in the instant case was not to be used to discharge any legal obligation of the settlor, as was the case in Douglas v. Willcuts, supra, or the $31,500 indebtedness of Lucy A. Blumenthal in the Blumenthal case.

On authority of Lucy A. Blumenthal, supra, and Gail H. Baldwin, supra, we sustain petitioner on this point.

(2) In support of her second proposition, petitioner cites Fanny M. Dravo et al., Executors, 34 B. T. A. 190. In the Drmo case, under the terms of the trust indenture, the income could be accumulated and added to corpus and the income only on the aggregate corpus was distributable to the grantor, upon his wife’s death. Under these conditions we held that the income of the trust for the taxable year which was to be accumulated and become a part of the corpus of the trust and was never to be distributed to the grantor was not taxable to the grantor under section 167 of the Eevenue Act of 1928. In stating our conclusions we said, among other things:

It is true that the caption of section 167 of the Revenue Act of 1928 reads “income fob benefit of grantor.” But the section provides that the only-income taxable to the grantor of the trust under this section is income which “may * * * be distributed to the grantor or be held or accumulated for future distribution to him * * The explicit and definite wording of this provision affords no justification for .extending its boundaries to include income which, under the terms of the trust instrument or as a result of the exercise of a reserved power, never can be “distributed” to the grantor. Helvering v. City Bank Farmers Trust Co., 296 U. S. 85. The fact that he may receive income produced from the investment of the accumulations does not make such accumulations distributable to him. * * *

Following Fanny M. Dravo et al., Executors, supra, we hold that the income of the trust in each of the taxable years which was accumulated and added to the corpus of the trust is not taxable to petitioner.

The Commissioner, in support of his position, relies principally upon Commissioner v. Morton, 108 Fed. (2d) 1005, and Margaret B. Phipps, 42 B. T. A. 829.

We think these cases are distinguishable on their facts. For example, in the Morton case, in the first trust therein involved, the grantor was originally and continued to remain beneficiary of all eight life insurance policies, which were retained by grantor and were never assigned to the trustee. Also grantor was originally and continued to remain the owner of the loan and cash surrender values and of the right to change the beneficiary. In the second trust involved in the Morton case, the grantor and/or her husband, the insured, owned the loan and cash surrender values and the right to assign the policy and to change the beneficiary. Also the trust could be terminated by grantor’s husband, the insured, whereupon grantor’s husband would receive accumulated income and the grantor, if living, would receive the remainder of the property. The aforementioned features which were present in the Morton trusts are not present in the instant case.

In the trust indenture involved in the Phipps case it was provided that the trustee should collect the insurance upon the death of the grantor’s husband and should use the proceeds and any other trust property to pay inheritance and similar taxes which might be payable on grantor’s share of the estate of her husband, the insured. Also it was provided that one year after the death of the grantor’s husband, the insured, the trustee was bound to transfer to grantor, if living, the trust assets remaining after payment of taxes on grantor’s share of her husband’s estate. No such provisions are contained in the trust indenture involved in the instant case.

Because of the aforementioned differences and others which we might mention, we think the instant case is distinguishable from the Morton case and the Phipps case.

The case of White v. Wiggins, 116 Fed. (2d) 312, was decided by the First Circuit subsequent to the filing of briefs in the instant case. Therefore, it was not cited by either party. We have not overlooked that case, however, in connection with the question we have here to decide and we find that the facts involved have a striking similarity to those present in the Morton case. The decision of the First Circuit in White v. Higgins was in favor of the Government, following the decision of the Supreme Court in Helvering v. Clifford, 309 U. S. 331. For the same reasons that we have distinguished the Morton case, we distinguish White v. Higgins and hold that it is not controlling on the question we have here ,to decide.

Is the income of the trust taxable to petitioner because of that provision which reads: “In case the said net income from such new Trust Fund shall in the judgment of the Trustee be insufficient to properly maintain and support the Settlor in the manner in which she is accustomed to live, then the Trustee is authorized to use such part of the principal of the Trust Estate as shall be necessary so to maintain and support the Settlor” ? We think not.

There is a distinction between a trustee’s absolute and unconditional power to surrender to the grantor a part of the trust corpus, on the one hand, and a fiduciary’s duty to make a determination of conditions the existence of which would justify the trustee in surrendering to the grantor a part of the trust corpus, including accumulated income added thereto.

Because of the restrictions on the trustee’s right to distribute trust corpus, including accumulated income, in the instant case the right to invade corpus under restricted conditions does not render the trust income taxable to -the grantor. Cf. Katharine Boyd Morehead, 42 B. T. A. 851; Lewis Hunt Mills, Administrator, 39 B. T. A. 798.

Reviewed by the Board.

Decision will loe entered for petitioner.

Disney concurs only in the result.

OkpeR,

dissenting: Instead of justifying the limited scope accorded it here, I should have thought that Douglas v. Willcuts, 296 U. S. 1, was merely the occasion for applying to a comparatively narrow category of circumstances a doctrine which is infinitely more fundamental. It and its companion cases deal with situations where the pecuniary benefit of a trust is obtained through the discharge of the beneficiary’s legal obligation. It is not difficult to postulate more primary instances of the creation of benefits no less direct. To mention only one, a trust created for the purpose of buying food or clothes for the beneficiary might fall outside the particular facts of the Douglas case, but only by ignoring the reasoning there employed could it be placed beyond the underlying concept, of which there are not lacking both prior and subsequent authoritative recognitions. Thus, in Corliss v. Bowers, 281 U. S. 376, which of course considered specifically the forerunner of section 167, it was assumed that “If a man directed his bank to pay over income as received to a servant or friend, until further orders, no one would doubt that he could be taxed upon the amounts so paid.” And cf. Helvering v. Horst, 311 U. S. 112.

It may be that the unwillingness to consider these accumulations as part of the grantor’s income is attributable primarily to the assumption that the various judicial and legislative landmarks in this area are separate structures instead of parts of a single unit. This attitude, I recognize, is unfortunately encouraged by a limited view of the purely procedural results reached in such cases as Helvering v. Wood, 309 U. S. 344, and Hormel v. Helvering, 312 U. S. 552. But the problem is a single problem and I can not believe that either Congress or the courts intended to have us treat sections 166 and 167, Douglas v. Willcuts, supra, and Helvering v. Clifford, 309 U. S. 331, as isolated towers between which the beckoning fields of tax avoidance can readily be discerned. Cf. Paul, Studies in Federal Taxation, 3d Series, 211.

I can not, therefore, bring myself to believe that it may be possible, without undergoing the logical tax consequence, for a grantor, as in this case, to secure the pecuniary benefits of trust accumulations not by any such indirect device as provisions limited to the payment to a stranger of the grantor’s obligation to him, but by the simple process of securing to the grantor himself the economic benefit which accrues from the investment of the fund in income-producing property—a benefit which he can use for his unrestricted purposes. It is difficult to suppose that a principle which carries so far as to include the secondary consequences of Douglas v. Willcuts is impotent where the rewards to the grantor are as clear as in the present case. It should not be necessary to hesitate over nomenclature. The conclusion would be right, and it would be the same, whether we attributed it to the Douglas case alone, to section 167, to section 22 (a),.or to any combination of them, if, as I think, one is merely intended to fill a gap which might otherwise be left by another; and it seems to me it would be amply supported by authority.

Thus it is now settled that “even though a literal interpretation of section 167 might tend to establish the immunity of the grantor from the tax, no such literal interpretation is to be accorded the section.” Commissioner v. Morton (C. C. A., 7th Cir.), 108 Fed. (2d) 1005, 1007. The actual physical distribution into the hands of the grantor is no longer considered to be a necessary condition for the application of the section, if it ever was. Commissioner v. Morton, supra; Altmaier v. Commissioner (C. C. A., 6th Cir.), 116 Fed. (2d) 162; Kaplan v. Commissioner (C. C. A., 1st Cir.), 66 Fed. (2d) 401; William Lea Taylor, 37 B. T. A. 875; Margaret B. Phipps, 42 B. T. A. 329. A similar result has been reached in construing the cognate provisions of section 302 (c) with respect to estate tax.

Literal compliance with the physical aspect of distribution being thus an unessential refinement, what can more nearly furnish that benefit which is its practical counterpart than an estate in the accumulations which the courts will treat as equitable title? To borrow language used in an entirely different connection:

* * * “Distribution to the taxpayer” is not necessarily restricted to situations where property is delivered to the taxpayer. It also aptly describes the case where property is delivered * * * to trustees in trust for the taxpayer.
[.Maguire v. Commissioner, 313 U. S. 1.]

It will be recalled that this trust indenture requires that:

* * * upon the death of * * * the husband of the settlor, the trustee shall collect the proceeds of any and all Insurance Policies * * * and shall hold the same * * * as a new Trust Fund * * *
A. The net income from said new Trust Fund * * * shall be paid to the settlor * * * during the balance of her life.

How can we say that the present grantor has not retained a beneficial interest sufficient to demonstrate that the accumulations are being held for her?

We should be closing our eyes to the motives for accumulating income if we did not recognize that no single purpose is more universal or more powerful than the desire to acquire a competence, the income from which may be used to sustain the owner. In this case that is the means which the grantor has selected for “the maintenance of effective benefit through the interposition of a subservient agency.”

In Commissioner v. Morton, supra, the court thought:

* * * it could hardly be argued, in view of the teaching of the Willmts case, that if the taxpayer created a trust for the purpose of paying installments provided for by contract on the purchase of a house or any other property, title to which was taken in the name of or for the benefit of the grantor, the income would not be taxable to the grantor. We see no difference in principle between the property rights involved in the house and in the insurance policies.

If we make the further assumption that the house, the title to which has been taken “for the benefit of the grantor”, remains an asset of the trust, but with all rights of use and occupancy reserved to the grantor, I think the case would be squarely parallel to the one being considered.

It is true, of course, that by force of the petitioner’s directions she was not to have the trust benefits until her husband’s death. But such postponement is no bar to the application of section 167. William Lea Taylor, supra; Margaret B. Phipps, supra; see Everett D. Graff, supra.

Lucy A. Blumenthal, 30 B. T. A. 591, and Gail H. Baldwin, 36 B. T. A. 364, have been deprived of all authority by Commissioner v. Morton, supra, reversing 38 B. T. A. 419, see particularly 424; and Fanny M. Dravo, 34 B. T. A. 190, is a lone and outworn precedent which was never subjected to the scrutiny of review by an appellate court and which in any event was decided prior to the change in the Commissioner’s regulations which were in effect when the section we are now considering became law. Cf. Helvering v. Reynolds Tobacco Co., 306 U. S. 110; Helvering v. Wilshire Oil Co., 308 U. S. 90. The Bramo case applied the literal interpretation which the Morton case, specifically, and the Graf, Altmaier, Mercantile-Commerce Bank c& Trust Co., and Griffiths cases, inferentially, have since rejected.

On the third point I see nothing to distinguish this case from Lewis Hunt Mills, Administrator, 39 B. T. A. 798, where the Board held the grantor taxable. No facts are shown here, as none were there, “to contradict the occurrence of the contingency upon which the exercise of the power” to pay accumulations to the grantor depends.

As the present result seems to me a retreat to the repudiated doctrines of legal formalism and economic unreality sometimes thought to have been inherent in the strict construction of tax statutes, I respectfully dissent.

       SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor ; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      (8) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23. (o), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.

       But cf. Helvering v. Coxey, 297 U. S. 694, reversing (C. C. A., 3d Cir.) 79 Fed. (2d) 661.

       Cf. Surrey, The Supreme Court and The Federal Income Tax, 35 Ill. Law Rev. 779, 799.

       Where the Board said :
      “* * * On the death of petitioner’s husband, the trust assets were to be used to pay the inheritance and estate taxes on petitioner’s share of her husband’s estate. If petitioner was required by law to pay any of the inheritance or estate taxes on her share of her husband's estate, sufficient cash funds to pay the taxes were to be distributed directly to petitioner. In any event, it is reasonable to infer that the use of the trust assets to pay the taxes would result in an economic benefit to petitioner, which would be, in substance, the equivalent of a distribution directly to her.” [At this point there is a footnote reading as follows :
      “The Report of the Ways and Means Committee on the Revenue Bill of 1924, 68th Cong., 1st sess., H. Rept. 179, p. 21, with respect to section 219 (h) (substantially the same for present purposes as section 167 of the Revenue Acts of 1932 and 1934) states in part as follows: ‘Trusts have been used to evade taxes by means of provisions allowing the distribution of the income to the grantor or its use for Ms benefit. The purpose of this subdivision of the bill is to stop this evasion.’ [Italics supplied].”

       “* * * The trust income is treated of as an entity distinct from the corpus and the liability to estate tax is made to depend on whether the decedent had retained or surrendered his right to it. The right referred to is a substantial right in respect to the income generally, not necessarily every incident of right originally vested in the decedent. It would strain the meaning to construe the section as though it read that the estate tax would only be applicable to property transferred by trust in the cases where the decedent had retained an absolute right to have paid to himself each and every dollar of the income from the property. * * *” Helvering v. Mercantile-Commerce Bank & Trust Co. (C. C. A., 8th Cir.), Ill Fed. (2d) 224; certiorari denied, 310 U. S. 654.

       In Blair v. Commissioner, 300 U. S. 5 : “* * * the right to income from the trust property was thought to be so identified with the equitable ownership of the property from which alone the beneficiary derived his right to receive the income and his power to command disposition of it that a gift of the income by the beneficiary became effective only as a gift of his ownership of the property producing it.” Helvering v. Horst, supra; cf. Harrison v. Schaffner, 312 U. S. 579.

       In Everett D. Graff, 40 B. T. A. 920, 923; add. (C. C. A. 7th Cir.), 117 Fed. (2d) 247, the Board said :
      “Section 167, unlike 166, deals with the interest of a grantor in trust income. Since, by definition, the act of creating the trust constitutes a severance from the grantor’s property of whatever is assigned to the trustees, the subject matter of 167 may otherwise be described as the taxation of certain retained interests of the grantor in the income of the trust. Prior to the transfer the grantor’s legal and beneficial right to receive income from the property was absolute. By the trust he parted with that interest to some extent. Whether section 167 comes into operation thus depends on whether the beneficial interest with which he parted was, as a matter of law, great enough so that it can be said that the aceumulatmns of income did not continue to be held for his benefit.”

       Cf. Huber v. Helvering (App. D. C.), 117 Fed. (2d) 782 :
      “Moreover, what happened to the monies assigned? They increased the corpus, and the corpus earns for the petitioner. He can now look forward to more income each year. * * *
      “Then after the petitioner has enjoyed for life the income producing capacity of the money assigned that money will earn for his wife and will benefit his children both by the income it produces and later by the division of the principal itself. He has made use of his power of disposition to procure a satisfaction ‘which he would otherwise procure only by the use of the money when received’.”

       cannot too often reiterate that ‘taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed—the actual benefit for which the tax is paid.’ Corliss v. Bowers, 281 U. S. 376, 378. And it makes no difference that such ‘command’ may be exercised through specific retention of legal title or the creation of a new equitable but controlled interest, or the maintenance of effective benefit through the interposition of a subservient agency. * * *” Griffiths v. Commissioner, 308 U. S. 355.

       * * the inclusion of any trust 'within the scope of section 167 is based on the fact that the grantor has retained an interest in the income therefrom by which he is, or may be enabled at some time, to receive its benefits. If the grantor strips himself permanently and definitively of every such interest retained by him the income of the trust realized after such divesting takes effect is not taxable to the grantor * * Regulations 86, art. 167- (¾).


source: Caselaw Access Project

author: HaRRON :

license: Public Domain

text:
    Estate of Elizabeth Felt, Raymond J. Koch, Conservator, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100713.
    Promulgated May 27, 1941.

      Albert E. Ford, Esq., for the petitioner.

      E. G. Sievers, Esq., for the respondent.
   OPINION.

HaRRON :

Petitioner contends that by reason of the fact that it is incumbent upon the conservator of the property of Elizabeth Felt to preserve, enhance, and manage her estate and to invest and reinvest the funds and income therefrom, under the laws of the state of Illinois, Illinois Rev. Stat., 1935, ch. 86, secs. 1 to 57, that the conservator, in carrying out his duties, is thereby carrying on a trade or business within the purview of section 23 (a) of the Revenue Act of 1936, and that he is entitled to deduct as ordinary and necessary business expenses the total fees paid in 1937 in the amount of $9,373.75. The contentions of the petitioner are twofold; first, that the duties of the conservator in administering the estate of his ward constitute the carrying on of a trade or business, and, second, that the activities of looking after the status of investments, reinvesting capital, and investing surplus funds constitute the carrying on of a trade or business.

Respondent contends that Elizabeth Felt, the taxpayer, was not engaged in a trade or business, through the conservator, but that she was a passive investor and that the management ’of the estate by the conservator, the incidental changing of investments, and the investment of surplus funds did not constitute carrying on a trade or business. Respondent relies on Van Wart v. Commissioner, 295 U. S. 112; Higgins v. Commissioner, 111 Fed. (2d) 795; affd., 312 U. S. 212; Foss v. Commissioner, 75 Fed. (2d) 326; Kane v. Commissioner, 100 Fed. (2d) 382.

A guardian or committee of an incompetent person is not a taxable person under the statute. William S. Lindermam,, Executor, 28 B. T. A. 113, 117. The conservator in this case serves in no really different capacity than as a guardian and it is only a matter of terminology that he is called a conservator. He is a fiduciary, required to file an income tax return and pay income tax for his ward, but the estate of the ward is not a taxable entity and the estate of the ward thereby differs from the estate of a trust or of a deceased person. Regulations 94, art. 161-1, p. 349; art. 1001-9, p. 469. The ■ incompetent person, the ward, is the taxpayer. For purposes of the issue here, the ward of a guardian or conservator has no different status than a minor under a guardianship. The rules, therefore, applying to deductions allowable to an individual taxpayer apply in the determination of whether an incompetent taxpayer under a guardianship or conservatorship is entitled to business expense deductions. The rationale of Van Wart v. Commissioner. supra, applies here. The question is whether or not the •ward, through the conservator, was engaged in carrying on a trade or business. In the Van Wart case the Court stated: “The ward was not engaged in any business. So far as appears, the same thing is true of the guardian.” The burden of proof upon the petitioner is to show that the ward or the guardian on her behalf was engaged in carrying on a trade or business. To meet that burden of proof the same type of proof must be presented as is required in the case of an ordinary individual who asserts that he is engaged in carrying on a trade or business.

It has been found that in 1925, under the Revenue Act of 1924, there was a ruling made by the Bureau of Internal Revenue, C. B. IV-2, I. T. 2238, p. 49, holding that fees, commissions, and other compensation of committees for incompetent persons and expenses properly incurred by such committees are allowable deductions, as business expenses, if paid or incurred with respect to the management or conservation of income-producing property belonging to the incompetent. As far as can be ascertained that ruling has not been revoked or revised. However, the Commissioner and the Secretary of the Treasury have never approved a regulation to the same effect as the above ruling. It may be that it has been the administrative practice in the past to allow as business expense deductions, to a taxpayer who is a ward of a guardian the fees and expenses of the guardian paid or incurred in managing the estate of the ward. But, since the ruling of the Bureau of Internal Revenue referred to was not promulgated by the Secretary of the Treasury, it is of little aid in interpreting the statute. Biddle v. Commissioner, 302 U. S. 573; Helvering v. New York Trust Co., 292 U. S. 455, 467, 468.

The first question is whether or not being a guardian or conservator, both terms meaning the same thing here, is doing a business, or whether the activities of the conservator in carrying out his duties . of managing and conserving the estate of his ward constitute carrying on a business of conserving and managing the estate. In the past several courts have taken the view that trustees, executors, or guardians, in carrying out their traditional duties of managing and' conserving the estate in their control in order to produce and conserve income and property for a beneficiary or a ward, were engaged in the business of doing all of those things. The court in Commissioner v. Wurts-Dundas, 54 Fed. (2d) 515, 516, allowed deductions of attorneys’ fees for legal services to a guardian of a minor because the expense paid was held “to enable it to perform those duties (of a guardian) in the furtherance of its business in domg its work as a guardian.” (Italics supplied.) The court regarded the necessity for the guardianship as making a business out of a guardianship. This view was apparently rejected by the Circuit Court of Appeals for the Fifth Circuit in Commissioner v. Van Wart, 69 Fed. (2d) 299, and because of conflict between these decision's the Supreme Court of the United States granted certiorari in the Van Wart case. The Supreme Court held that the ward of the guardian was not engaged in any business and said that it appeared that the same thing was true of the guardian. Van Wart v. Commissioner, supra . It is clear that the Supreme Court, in "the Van Wart case, rejected the view that being a guardian in itself constitutes doing a business. The Court of Claims, in Pyne v. United States, 35 Fed. Supp. 81, adopted the view that the executors of the estate were engaged “in the business of conserving the estate and protecting its income”, and allowed deductions as business expense attorney’s fees. In United States v. Pyne, 313 U. S. 127, the Supreme Court reversed the Court of Claims. The Supreme Court pointed out a technical feature, a lack of an ultimate finding of fact by the Court of Claims that the executors were engaged in carrying on a business, and the Court indicated thereby, we believe, that it must be proved and found as a fact that the fiduciary, be he an executor, trustee, or guardian, is carrying on a business in the sense that the statute prescribes by the clause “carrying on a trade or business”, in order that expenses may be deducted. And the Court clearly pointed out that such a finding can not be supported merely by a statement that a fiduciary is engaged “in the business of conserving the estate and protecting its income.” The Court said:

Such activities are the traditional duty of executors. Executors who engage actively in trade and business are the exception and not the rule. * * * But in the absence of evidence showing activities coming within the general acceptation of the concept of carrying on a trade or business, it cannot be said as a matter of law that an executor comes into this category merely because he conserves the estate by marshalling and gathering the assets as a mere conduit for ultimate distribution. * * *

See also, City Bank Farmers Trust Co. v. Helvering, 313 U. S. 121, affirming City Bank Farmers Trust Co. v. Commissioner, 112 Fed. (2d) 457, in which the Circuit Court of Appeals for the Second Circuit took the view that there is no rational ground for distinguishing the position of a trustee of a testamentary trust from that, of a guardian, custodian, or individual investor, in considering whether or not any of the above types of fiduciary is carrying on a business when doing no more than carrying out their respective, traditional duties. The Circuit Court pointed out that:

The natural and legal limitations of a trustee differ fundamentally from those of an active speculator and do not place such a fiduciary in the category of one carrying on a business. * * * The case of a ward * * * seems hard to distinguish from that of the petitioner * * *. Neither, we think, falls within the provisions of section 23 (a) because ward, guardian and trustee will under ordinary circumstances fail to establish that he is carrying on a trade or business.

From the above cases it appears to be established with a great degree of certainty that the carrying out of the ordinary duties of a conservator does not in itself constitute carrying on a business or that there is no “business” of being a conservator of an estate of a ward, as the term “business” is used in section 23 (a). Koch, conservator, was not engaged in a business solely because of his activities as conservator.

We come then to the second and real question. Was Koch, or was Elizabeth Felt through him, engaged in carrying on a business within the meaning of section 23 (a) ? His activities in making reports to and filing petitions with the Probate Court of Cook County, and in having income tax returns prepared and filed certainly did not amount to carrying on a business. Such activities were routine duties. Koch was on the board of directors of the Felt & Tarrant Manufacturing Co. because of his ward’s stockholdings in that company, but the record contains no information whatever as to what this service entailed. Koch did not have to collect interest and dividends, which was done by the Northern Trust Co. The only remaining point is whether or not Koch’s reinvestment of capital from redemptions of bonds and his investment of surplus funds constituted carrying on a trade or business. Koch testified that there were about 125 different issues of securities in the estate and that he watched the status of all and changed investments wherever it appeared that the investment was becoming doubtful or bad. He is limited by law to making investments in United States bonds or bonds of any state, county, city, or municipality, and certain kinds of loans, all subject to the approval of the Probate Court. Illinois Kev. Stat., 1935, ch. 86, sec. 18, p. 2037. He testified that the number and aggregate amount of the purchases of securities in 1937 was unusual because Liberty bonds in the face amount of about $96,700 were called in 1937. It appears that in each year there were surplus funds in a large amount to be invested because the annual costs of maintaining the ward were around $9,000 and income from dividends and interest probably was about $100,000, if the year 1937 may be taken to be a typical year. The guardian was required by law to keep all funds of his ward invested or out on interest under court approval. His investment activities were, of course, a part of his prescribed duties. In short, Koch, the guardian and conservator, as a fiduciary, did no more than invest and reinvest the funds of his ward within the prescribed legal limitations and these activities were no other than an individual ordinarily does in exercising reasonable care in preserving his investments and investing his money from an investment point of view. The only expenses involved were the fees paid in connection with the custodian’s collection of income, and the conservator’s fees and charges of an accountant in connection with preparation of the income tax return. These are not indicative of expenses of a “business.” The ward, Elizabeth Felt, obviously, was not engaged in any business.

It now is settled by a preponderance of authority that the investing and reinvesting of assets by an individual himself or by a fiduciary on behalf of an estate, under such facts as are present here, do not constitute carrying on a business. The authorities are cited here and are followed: Bedell v. Commissioner, 80 Fed. (2d) 622; Higgins v. Commissioner, supra; Foss v. Commissioner, supra; Kane v. Commissioner, supra; Miller v. Commissioner, 102 Fed. (2d) 476; White Trust v. Commissioner, 119 Fed. (2d) 619; City Bank Farmers Trust Co., Trustee, 39 B. T. A. 29; affd., 112 Fed. (2d) 457; affd., 313 U. S. 121.

It is held that neither the taxpayer nor the conservator was engaged in carrying on a business and that the expenses of the conservator are not deductible as business expenses under section 23 (a).

Decision will be entered for the respondent.

       In the Tan Wart case the expense In question was held' to be a personal expense. The court said (p. 300), “whether or not being a guardian Is doing business, it is unnecessary to decide.”


author: HaeRon :

text:
    Israel Silberman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101533.
    Promulgated May 29, 1941.

      Laurence Graves, Esq., for the petitioner.

      George B. Sherriff, Esq., for the respondent.
   OPINION.

HaeRon :

Petitioner was engaged in the occupation of making, registering, and recording bets on horse races at duly licensed race tracks in New York State. He rented booths at various tracks, for the use of which he paid fees. He employed persons to register bets and assist him in these booths and in his activities and paid them salaries for their services. At these booths he kept books and records for the purpose of recording bets and he received bets and paid bets. The aggregate amounts paid in the taxable year for fees for booths and salaries for assistants was $12,683.50. Petitioner claims that he is entitled to deduct these amounts as ordinary and necessary business expense or as losses under section 23 (a) or section 23 (e). Petitioner did not realize any gain or income from betting transactions in the taxable year, so that, obviously, he does not claim that he is entitled to offset the above expenditures against income from betting transactions. Petitioner did receive income in the taxable year from legal sources, from dividends on securities and from a paint and varnish company as “salaries, wages, commissions or fees”, the nature of the services for such compensation not being shown, and petitioner seeks to reduce income received from legal business interests by deducting therefrom expenditures made in connection with illegal business activities. Respondent disallowed the deduction and, in our opinion, respondent’s determination is correct. The following discussion relates to the status of betting and receiving of bets at race tracks in New York under the law of the State in 1936, prior to the amendment of Art. 1, par. 9 of the Constitution, November 7, 1939, and the enactment of the Pari-Mutuel Revenue Law, effective March 31, 1940.

Petitioner’s gambling operations were illegal in New York by statutory prohibition, as was betting on races. Betting at race tracks was illegal in New York State, being forbidden by the state constitution and penal laws, the offense being punishable by a civil forfeiture. (1936) Op. Atty. Gen. 331. Beach v. Queen's County Jockey Club, 164 Misc. 363; 298 N. Y. S. 777. Bookmaking or the receiving and registering of bets upon a race at a race track is “gaming” or “gambling” and was illegal, and it has been held that the lightness of the penalty imposed by the legislature, namely, forfeiture of money wagered to be recovered in a civil action, did not make these activities legal. Chapin v. Austin, 165 Misc. 414; 300 N. Y. S. 932. See McKinney’s Consolidated Laws of New York Annotated, Book 2, Constitution, pp. 480-483; Art. 1, sec. 9 of the Constitution; Book 39, Penal Law, sec. 986, at p. 496, and sec. 991, at p. 506; Book 65, Unconsolidated Laws, par. 1141, sec. 17, at p. 172.

In section 986 of the Penal Law of New York, supra, it is provided that it is a misdemeanor except when another penalty is provided by law, for any person who is the owner, lessee, or occupant of a booth on any grounds in the state to knowingly permit the same to be used or occupied for receiving, registering, or recording bets, and for any person to aid or assist in receiving or recording bets, all of which are forbidden. Section 986 makes it illegal to permit another person to use a booth to receive and register bets and to aid another in receiving and registering bets.

Petitioner’s gambling operations were illegal and the amounts he expended for fees and salaries were expenditures made to obtain occupancy and services which were illegal. Petitioner contends that the gambling activities were not “illegal” because they were not “criminally punishable”, or that they ’were “illegal” only in the sense that they were “ultra vires.” The argument is without merit and is confused in many respects. It is wholly immaterial here that the statutory offense involved is malum prohibitum rather than makum in se. Petitioner’s argument in essence is that his gambling operations were only “a little bit” illegal because the penalty of forfeiture of a bet received if a civil action is brought to recover the bet is only a light penalty. The only merit of the argument is its humor. We must proceed here with recognition that without any doubt betting, receiving, and recording bets, letting a booth be used for the same, and assisting anyone in doing the same, all were illegal under New York statutes.

Section 23 (g) of the Bevenue Act of 1986 allows as deductions from gross income “losses from wagering transactions * * * only to the extent of the gains from such transactions.” Since petitioner realized no gains from wagering transactions in the taxable year the deduction which he claims is not allowable under section 23 (g).

If the expenditures in question may be treated as loss from gambling transactions they are not deductible under section 23 (e), because gambling transactions were illegal in New York. Mitchell M. Frey, Jr., et al., Executors, 1 B. T. A. 338; M. Rea Gano, 19 B. T. A. 518, 529; E. F. Simms, 28 B. T. A. 988, 1034.

There remains only the question whether or not the expenditures may be deducted under section 23 (a), as ordinary and necessary business expenses, under such facts as are present in this case. We do not find a reported case involving this particular question under facts similar to the facts present in this case. In our opinion the expenditures are not deductible as ordinary and necessary business expense.

It is true that if petitioner had realized income or gains from his illegal gambling transactions such gain would be subject to income tax because of the broad definition of gross income set forth in section 22 (a), which covers gains or profits and income derived from any source whatever. United States v. Sullivan, 274 U. S. 259; United States v. Yuginovich, 256 U. S. 450; Steinberg v. United States, 14 Fed. (2d) 564. In spite of the seeming inconsistency, even though income derived from an illegal business is subject to tax, expenditures made in the carrying on of activities which in themselves are in contravention of law and illegal have been held to be not deductible as business expenses on grounds of public policy. Great Northern Railway Co. v. Commissioner, 40 Fed. (2d) 372; certiorari denied, 282 U. S. 855. In that case expenditures for the payment of fines for violating Federal statutes were said to have been made as a result of unlawful operations, prohibited specifically by statutes, and the court said, “It cannot be that Congress intended the carrier should have the advantage, directly or indirectly, of any reduction, directly or indirectly, of these penalties.” Of course, the Great Northern case differs from this case, principally because the business of the taxpayer was a legal business in general and the infractions of law involved were only incidents in the conduct of business which generally was conducted in a lawful way. Here there are stronger reasons from the standpoint of public policy for denying petitioner business expense deductions for the sums expended for fees for the use of booths and for salaries for assistants. First, under section 986 of the Penal Law of New York it is illegal to let a booth be used for receiving or recording bets and it is illegal to assist in the receiving or recording of bets. The expenditures in the nature of rent and salaries were made for illegal occupancy and illegal services, as well as being made in the conduct of illegal gambling activities. Second, the petitioner in claiming deduction for these expenditures seeks to offset such expenditures against income from lawful sources received from other legal business activities, and to thereby obtain reduction of tax upon that income. Such claim differs from a claim that the income to be taxed from an illegal business is the net income received therefrom. Cf. James P. McKenna, 1 B. T. A. 326. In reality petitioner sustained loss from his illegal business activities and he seeks deduction for part of the loss in the guise of a claim for a deduction for business expenses. Under the rule of Mitchell M. Frey, Jr., et al., Executors, supra, losses sustained in illegal gambling operations are .not deductible. Furthermore, as has been stated in the Great Northern Railway case, sufra, it is not conceivable that Congress intended that section 23 (a), allowing deductions for business expenses, should be a medium for giving the benefits thereof directly or indirectly where the expenditures arise not only from unlawful activities but where the expenditures are made to others in compensation to them for unlawful activities. In United States v. Sullivan, sufra, the taxpayer argued that income from an unlawful business is exempt from tax and that he did not have to file income tax returns. There was an allusion to the problem of expenditures made in pursuit of the unlawful business and, commenting on that, Justice Holmes said:

It is urged that if a return were made the defendant would be entitled to deduct illegal expenses such as bribery. This by no means follows but it will be time enough to consider the question when a taxpayer has the temerity to raise it.

There is indication from the provisions of section 986 of the Penal Law of New York that the expenditures in question were illegal. They were, at the least, expenditures which are not deductible from taxable income on grounds of public policy. New Orleans Tractor Co., 35 B. T. A. 218; and H. S. Anderson, 35 B. T. A. 10, 11, where it was said that, “It is now well established without any conflicting decisions that the illegality of the occupation or the transactions in which the taxpayer engages deprives him of any claim to the use of losses or expenses in reducing his taxable income.”

It is held that petitioner is not entitled to deduction for the expenditures either as losses under section 23 (e) or as business expense under section 23 (a). It is immaterial whether the deduction is classified as a loss or as a business expense. Lawrence A. Wagner, 30 B. T. A. 1099, 1106.

Decision will he entered for the respondent.

       See amendment of Art. 1, par. 9, of the New York State Constitution as amended and approved November 7, 1939, effective January 1, 1940, which excepts from the provisions of Art. 1, par. 9, pari-mutuel betting on horse races as may be prescribed by the legislature. See also McXCinney’s Consolidated Laws of New York Annotated, book 65, Unconsolidated Laws, see. 1939, in the Supplement. Effective March 31, 1940, the legislature enacted a new law which prescribes the conditions under which the pari-mutuel method of betting on horse races shall be lawful.


author: Murdock :

text:
    C. A. Roberts Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102438.
    Promulgated May 29, 1941.

      H. A. Mihills, C. P. A., and Lee J. Shoner, C. P. A., for the petitioner.

      E. G. Sievers, Esq., for the respondent.
   OPINION.

Murdock :

The petitioner claims credits under section 26 (c) (2) of the Revenue Act of 1936. That provision, which is headed, “Disposition op PROFITS of taxable ye Ait”, allows a credit of “An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt * ⅛ * to the extent that such amount has been so paid * * *.” The petitioner claims that the provision of the notes quoted in the findings of fact brings this case within section 26 (c) (2). The notes require that payments of $16,000 be made annually on account of principal before any dividends are paid on the common stock from surplus or net profits. We shall pass the question of whether or not the restriction on the payment of dividends might properly be described as one which “expressly deals with the disposition of earnings and profits of the taxable year” because it restricts distributions from those earnings just as it restricts distributions from prior earnings. The claim for credit must fail in any event, since the provisions of the notes do not require that any portion of the earnings and profits of the taxable year be paid in discharge of a debt. Payments will comply with the provisions of the notes regardless of the source from which the payments are made. Thus, the petitioner could have made payments on the notes from any source whatsoever and could have distributed all of its earnings of the taxable years without in any way violating provisions of the notes. “The basic intent of Congress seems to have been to include in the provision only contracts which inevitably require in their performance a drawing on current earnings, thus removing current earnings as a source of dividend payments.” G. B. R. Oil Corporation, 40 B. T. A. 738, 744. Since the facts in the case of this taxpayer do not meet the precise provisions of the statute, no credit is allowable. Cf. Hub Clothing House, Ltd., 39 B. T. A. 900; Belle-Vue Manufacturing Co., 43 B. T. A. 12; Brockway Glass Co., 43 B. T. A. 267; Lafayette Hotel Co., 43 B. T. A. 426.

Decision will be entered for the respondent


author: Kern :

text:
    Union Telephone Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99820, 102494.
    Promulgated May 29, 1941.

      Luden L. Dimbar, Esq., and Merlin M. Dunbar, Esq., for the petitioner.

      Sidney U. Hihen, Esq., for tbe respondent.
   OPINION.

Kern :

To be eligible for a credit created for the benefit of taxpayers, strict'compliance with the terms of the section granting the credit must be shown. New Colonial lee Co. v. Helvering, 292 U. S. 435; Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46; Boeckler Lumber Co., 43 B. T. A. 804.

In the instant proceeding petitioner claims the benefit of section 26 (c) (1) and (2) of the Revenue Act of 1936. Both subsections (1) and (2) have several essential requirements in common— i. e., there must exist a written contract executed by the corporation prior to May 1, 1936, a provision of which expressly deals with the payment of dividends and the disposition of earnings and profits of the taxable year.

Here we have a written contract executed prior to May 1, 1936, expressly dealing with dividends and earnings. Two questions then arise', however: First, whether this contract dealt expressly with petitioner’s dividends and earnings, and, second, whether the contract was executed by petitioner. If either of these elements is found to be lacking in our present situation, then the taxpayer is ineligible to claim the credit offered by section 26.

Neither the contract of January 22, 1935, nor the supplemental agreement was executed by petitioner. On each there were but three executing parties: Detchon, the United Telephone & Telegraph Corporation, and the United Telephone & Electric Co. Petitioner asserts that, notwithstanding the fact that the written contract was not executed formally by petitioner, nevertheless, it was executed on behalf of the petitioner by the United Telephone & Telegraph Corporation and, therefore, was binding on petitioner as if petitioner had formally executed the instrument.

Evidence was introduced by petitioner to show that it was a customary practice for United Telephone & Telegraph Corporation to enter into agreements for the whole group of United corporations; but it appears that there never was any written power of attorney executed by the subsidiaries or any other formal agency agreement. Furthermore, no agency is disclosed in the contract. On the contrary, the contract itself states that all the parties thereto were holders of the preferred stock of the United Telephone Investment Corporation, and it appears that they executed the contract as such and not as agents for any corporation. Petitioner was not a holder of any of this preferred stock.

We must conclude that the contract was not executed by the petitioner, within the meaning of section 26. There is no written instrument executed by petitioner granting authority to any other corporation to act as its agent and in no contract in writing does the petitioner appear as a party to be bound. The evidence merely discloses a custom on the part of the United Telephone & Telegraph Corporation to act in contractual matters on behalf of its subsidiaries which acquiesced in such action.

This customary course of conduct may be explained by reason of the fact that United Telephone & Telegraph Corporation owned all o.f the common stock of the corporation which owned practically all the common stock of petitioner. However, a contract signed even by a corporation’s immediate stockholders is not a contract of the corporation binding upon it. American Preservers’ Co. v. Norris, 43 Fed. 711. It has even been held that a contract executed by a corporation’s directors restricting the payment of dividends does not come within the purview of the pertinent section of the act. Thibaut & Walker Co., 42 B. T. A. 29. The testimony to the effect that an officer of petitioner who was also an officer of the several holding companies considered that petitioner was bound by the contract to which it was not a party, is in no way controlling.

Petitioner has failed to show strict compliance with the terms of section 26 (c) (1) or (2), and we, therefore, uphold the validity of respondent’s determination.

Decision will be entered wnder Bule 50.


author: Hill :

text:
    Healy River Coal Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99698.
    Promulgated May 29, 1941.

      Edward F. Medley, Esq., and E. B. Hanley, Esq., for the petitioner.

      B. H. Neblett, Esq., for the respondent.
   OPINION.

Hill :

The only issue before us is whether or not petitioner is entitled to a deduction for depletion computed on the percentage basis as provided by section 114 (b) (4) of the Revenue Act of 1936.

Section 114 (b) (4) of the Revenue Act of 1934, which first allowed the percentage method of depletion deduction, required the taxpayer to elect in his first return whether or not the depletion allowance should be computed with or without regard to percentage depletion and is identical in language with section 114 (b) (4) of the Revenue Act of 1936, excluding the last sentence^of the latter section.

The instant proceeding is controlled by Riley Investment Co. v. Commissioner, 311 U. S. 55. There, upon facts substantially like those in the present case, the Supreme Court held that an amended return filed after the period within which an original return might be filed was not a “First Return” as required by section 114 (b) (4) of the Revenue Act of 1934.

We are of the opinion that the “First Return” filed by petitioner was the “Definitive Return” filed on May 24,1935. lío statement was made by petitioner in the “Definitive Return” regarding a claim for depletion allowance of any kind. The amended return in which petitioner first claimed an allowance for percentage depletion was not filed earlier than December 31, 1935. Since petitioner first claimed in its amended return an allowance for depletion computed on percentage basis, such claim came too late to entitle it to such allowance. The amended return was not filed within the time fixed by statute nor within such extended time as is authorized by statute. Revenue Act of 1934, sec. 53 (a) (1) and (2). Subdivision (a) (1) of section 53 required petitioner’s income tax return for the year 1934 to be filed on or before March 15, 1935. However, respondent had the power under the provisions of subdivision (a) (2) of that section to grant a reasonable extension of time (not exceeding six months) for filing such return. The definitive return filed May 24, 1935, was made within the allowable extension of time for filing the first return under the Revenue Act of 1934. The amended return filed December 31, 1935, was not filed within such allowable extension of time. Petitioner, therefore, was precluded from using the percentage method of depletion deduction. The statute clearly provides that if no statement of election is made upon filing the first return the depletion allowance of the taxpayer must be computed without reference to percentage depletion. The statute further provides that the method used in computing depletion allowance for the taxable years shall be used for all future taxable years in which the property is in the hands of the taxpayer. Finally, section 114 (b) (4) of the Revenue Act of 1936 specifically denies to a taxpayer a new right of election in cases where no right would be granted under the similar section in the Revenue Act of 1934. Tonopah Minina Co. of Nevada, 44 B. T. A. 165.

Petitioner argues that denial of an allowance based upon percentage depletion will work great hardship on petitioner, since it has no cost basis for other depletion allowance. In the Riley Investment Go. case, the taxpayer had exhausted its cost basis and, because it was denied the percentage depletion allowance, was deprived of any depletion deduction. Here petitioner never had a cost basis. In both cases a hardship is imposed because of the failure of the taxpayers to comply with the law. However, we can not exempt petitioner from the binding effect of the statute. Respondent’s determination is sustained.

Decision will ~be entered for respondent.

       (b) Basis for Depletion.—
      *******
      (4) Percentage depletion for coal and metal mines and sulphur.—The allowance for depletion under section 23 (m) shall be, in the ease of coal mines, 5 per centum, in the case of metal mines, 15 per centum, and, in the case of sulphur mines or deposits, 23 per centum, of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property. A taxpayer making his first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section. The above right of election shall be subject to the qualification that this paragraph shall, for the purpose of determining whether the method of computing the depletion allowance follows the property, be considered a continuation of section 114 (b) (4) of the Revenue Act of 1934, and as giving no new election in cases where such section would, if applied, give no new election.

       SEC. 53. TIME AND PLACE FOR FILING RETURNS.
      (a) Time for Filing.—
      (1) General rule.—Returns made on the basis of the calendar year shall be made on or before the 15th day of March following the close of the calendar year. Returns made on the basis of a fiscal year shall be made on or before the 15th day of the third month following the close of the fiscal year.
      (2) Extension op time.—The Commissioner may grant a reasonable extension of time for filing returns, under such rules and regulations as he shall prescribe with the approval of the Secretary. Except in the case of taxpayers who are abroad, no such extension shall be for more than six months.


author: MuRdock:

text:
    Cambridge Apartment Building Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102205.
    Promulgated May 29, 1941.

      D. A. Busby, G. P. A., for the petitioner.

      Devoid Altman, Esq., for the respondent.
   OPINION.

MuRdock:

The Commissioner determined deficiencies as follows:

The only issue for decision is whether or not amounts assessed upon and collected from stockholder-tenants in excess of operating expenses and for the purpose of retiring the bonded indebtedness were income or contributions of capital. The Board adopts the stipulation as its findings of fact.

The petitioner was organized under the laws of Illinois in 1927. It owned and operated an apartment building which was occupied' by its stockholders. The bylaws provided that all expenses for taxes, mortgage indebtedness, maintenance, and operation of the building should be met by assessments against the stockholders in proportion to their holdings. The capital stock consisted of 21,430 shares of a par value of $10 each. The petitioner acquired the building subject to an issue of mortgage bonds in the amount of $325,000, due June 1, 1934, with interest. The stockholders elected a board of directors, who determined annually the amount of the assessment necessary to cover the operating expenses, bond interest, and amortization of bonded indebtedness. They included this information in an annual budget.

Payments of principal on the mortgage became in default and a petition under section 77B of the Bankruptcy Act was filed on June 14, 1935. A plan of reorganization was completed and approved by the court on September 17, 1935, whereby the date of the bond issue was extended to June 1, 1943, in consideration of the corporation agreeing to pay, during the extension, all amounts collected in excess of the current operating expenses and agreeing, further, that the assessment on the stockholders would not be reduced during the period of extension. The plan approved by the court further provided that all funds coming into the hands of the depositary, after payment of interest, should be used to purchase and retire bonds of the petitioner at the lowest price obtainable.

The budget was discontinued after the corporation was reorganized under section 77B of the Bankruptcy Act. The assessments immediately prior to the court order had been $1.63 per share per annum. The court provided that assessments of not less than $1.63 per share per annum should be made during the period of the extension of the bonds. Assessments in that amount were made for 1936 and all years thereafter.

There was an excess of assessments and rents over operating expenses for each of the taxable years, and in each year a larger amount was paid to retire bonds of the corporation.

The petitioner contends that the: actual amount of the excess of assessments collected from stockholders over operating expenses and used to retire bonds was a capital contribution to the corporation and not income of the corporation. It cites Paducah & Illinois Railroad Co., 2 B. T. A. 1001, and 874 Park Avenue Corporation, 23 B. T. A. 400. Two railroads, in the Paducah case, had organized a bridge corporation to provide bridge facilities across the Ohio River, and agreed to make payments to the company to cover its expenses and to provide a sinking fund for the retirement of its bonds. These contributions were to be in proportion to the use of the bridge and the bridge company was to issue its preferred stock to the railroads in return for payments which went to retire bonds. The Board said that the contributions, in so far as they were to be used for the retirement of debt, were contributions of capital for which stock was to be issued, and it was immaterial whether or not stock was actually issued at the time. The Board said in the 874 Park Avenue Corporation case:

The only issue is whether the assessments paid to the petitioner by stockholder-tenants pursuant to the terms of their leases to be used by the petitioner for the amortization of mortgages on the apartment house and so used constitute paid-in surplus capital to the petitioner or income in the nature of rent. We are of the opinion that the assessments so made and employed were contributions of capital to the petitioner and as such are nontaxable.

Counsel for the respondent attempts to distinguish the latter case on the ground that there was an understanding in that case prior to the time the assessments were made that they would be used to retire indebtedness, whereas here, he says, there was no such agreement. The cases are not distinguishable on this basis. The stockholders in the present case had an understanding in prior years, as indicated by budgets, that a part of the assessments would be used to retire indebtedness. Although the budget was abandoned after the reorganization under section 77B, nevertheless, the plan of reorganization approved by the court expressly provided that all amounts collected by assessment which were not needed to defray operating expenses would be used to retire bonds. The amounts here in question were collected by assessment pursuant to this order of the court and were used to retire bonds. Therefore, following the above cited cases, we hold on this point for the petitioner.

Decision will be entered, wider Bule 50.


author: Leech :

text:
    Estate of George W. Wickersham, Cornelius W. Wickersham, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100630.
    Promulgated May 29, 1941.

      G. Forrest Butterworth, Jr., Esq., and Clarence Castimore, Esq., for the petitioner.

      J. R. Johnston, Esq., for the respondent.
   OPINION.

Leech :

Respondent has determined a deficiency of $63,820.90 in income tax of the decedent, George W. Wickersham, for the period January 1,1936, to the date of his death on January 25,1936. This deficiency arises through the action of respondent in including in taxable income of the decedent, as accruable under section 42 of the Reveune Act of 1936, an amount as constituting decedent’s portion of the uncollected partnership profits of the law firm of which he was a member, as earned to the date of his death and distributable to his estate under the terms of the partnership agreement, and an amount as commissions earned to date of decedent’s death for services by him individually as guardian and trustee. The amount included in each instance was the value at which these two items had been returned for estate tax purposes.

Certain of the facts involved are formally stipulated and this stipulation we include by reference. Briefly, the stipulated facts are summarized as follows.

George W. Wickersham died a resident of the County and State of New York on January 26, 1936. At all times material here he had kept his accounts and made his returns on a cash receipts and disbursements basis. The accounts of the petitioner herein and its returns have also been kept and made on such basis.

On or about May 15, 1937, the petitioner filed in the office of the collector of internal revenue for the second district of New York the income tax return for the decedent for the year 1936, in which was reported a tax liability of $6,490.91, which amount was paid, together with interest thereon of $16.23. On November 8,1940, petitioner, under protest, paid on account of the deficiency here in question the sum of $41,022.84, together with interest thereon of $8,977.16.

At the time of his death, George W. Wickersham was the duly qualified and acting guardian of the property of Gloria Laura Morgan Vanderbilt, an infant. Subsequent to his death, and on or about May 15,1936, his executor, together'with the other guardian of the property of the infant, petitioned the Surrogate’s Court of New York County for judicial settlement of the accounts and for allowance of the commissions due the decedent for services rendered up to the date of his death. No request had been made theretofore for any allowance for such services and the amount of the commissions requested for allowance in the sum of $34,668.81 was allowed by the surrogate and paid to petitioner on August 6, 1936. Of this sum, $34,121.80 was commissions on principal and $547.01 was commissions on income. The commissions allowed on income were included as accrued at the time of death in the original return filed for the decedent and petitioner concedes that they are taxable here. The amount of the commissions on principal was disclosed in a rider attached.to that return but the sum was not included as income accrued prior to death. However, the right or claim to the commissions, both on principal and income, was reported as an asset of the estate of the decedent in the estate tax return filed at a value of $34,668.81. This value was accepted by respondent upon audit of that return.

The decedent at the time of his death was a partner in the law firm of Cadwalader, Wickersham & Taft, 14 Wall Street, New York City, under articles of copartnership effective for two years from January 1, 1936. For a number of years prior to the formation of the particular firm existing on January 25, 1936, decedent had been a member of several similar preceding organizations of the same name but which from time to time had been affected by death or retirement of members. These several organizations thus affected were designated by numbers on the books of account of the firm, these being numbers 4 to 12, inclusive. The organization in effect at the time of decedent’s death was designated as number 13.

The books of account of partnership number 13 and those of all the predecessor partnerships were at all times kept on the cash receipts and disbursements basis of accounting. The income of the partnership of which decedent was a member at the time of his death, computed on a cash basis, was made up principally of fees and commissions paid by clients of various kinds for legal services. Some of these fees consisted of periodic retainers and there were others in specific matters for which an agreement as to the amount to be paid for such services existed at or before the date of decedent’s death.

In the income tax return filed for the decedent for the year 1936 the sum of $47,120.53 was included in item 7 as income from the copartnership. This was explained in a rider attached to such return as decedent’s share of fees and disbursements where the amounts were fixed and determined prior to his death, estimated to be in that amount. Of this amount petitioner now concedes that the sum of $12,307.68, only, which had been collected' and which petitioner concedes was distributable, is taxable here.

Upon the death of the decedent the surviving partners continued to operate under the partnership agreement, which provides for such a contingency, and distributions were made to petitioner as collection of fees were effected. These distributions were in the amdunt determined by the surviving partners as the proportion of such fees due the decedent for services rendered by him up to the date of his death. The amounts so paid were as follows:

Jan. 26 to Dec. 31, 1936_$75,321. 73
1937 _ 40,823.70
1938 _ 5, 530.73
1939 _ 7,528.65
Total_ 129,204.81

In addition to the payments made as aforesaid to petitioner, there is a probability of further collections in which the proportion due the decedent’s estate will not exceed $1,000.

The interest of decedent in the profits of the copartnership of Cad-walader, Wickersham & Taft under the articles of partnership was reported as an. asset of the estate upon its Federal estate tax return filed on or about April 22, 1937, at an estimated value of $132,000. Upon audit of the return respondent accepted this value.

On or about June 28, 1938, the New York State Tax Commission assessed an additional state income tax of $9,554.98 on account of accrued income of the decedent as determined by that commission for the period January 1 through January 25,1936, as follows:

Commissions on principal as general guardian-$34,121. 80
Commissions as trustee_ 436. 04
Additional partnership income_ 84, 879. 47
Total_ 119,437.31

The “additional partnership income” was in addition to $47,120.53 originally returned as estimated accrued income to date of decedent’s death.

The additional state income tax was paid by the petitioner to the New York State Tax Commission about July 1,1938. Application for revision and claim for refund have been filed in accordance with the statutes of the State of New York. The application and claim for refund had not been finally acted upon, but it is mutually agreed that this item may be considered upon Rule 50 settlement in accordance with its status at that time to be determined by agreement of counsel.

In the partnership return of Cadwalader, Wickersham & Taft for the calendar year 1936, the year of decedent’s death, decedent’s distributable portion of the total partnership income collected for that calendar year and representing compensation for services by him to the date of his death on January 25,1936, less expenses allocable thereto to that date, was stated as $75,321.73. No separate partnership return was made for the period January 1 to January 25, 1936, inclusive, or for the period January 26 to December 31,1936, inclusive.

In addition to the stipulated facts summarized above we find, upon the basis of evidence submitted at the hearing, the following facts.

Although the law of New York State does not specifically provide for the determination of the amount of compensation allowable to the estate of a deceased fiduciary for services performed up to the date of his death when that event occurs prior to his distribution of the trust estate; the uniform practice for many years has been, in cases' where the services were well and truly performed, to allow such estate the same commissions as would have been' allowable to the decedent under the law had he lived. Under these conditions it was possible to determine with, accuracy the amount which would be allowed by the surrogate to petitioner upon his application for an accounting of commissions due his decedent up to the time of his death as guardian of the estate of Gloria Laura Morgan Vanderbilt.

Of the total amount received by petitioner from the firm of Cad-walader, Wickersham & Taft out of collections from January 26 through December 31, 1936, made by the successor firms, the sum of $30,811.35 constituted the decedent’s share as estimated in matters in connection with which no agreement with the client as to the amount of compensation existed at the time of decedent’s death, and no other facts existed at that time from which it was possible to ascertain definitely the amount of the fee which would be charged or collected. Of the amounts received by petitioner in 1937, 1938, and 1939, from the firm, $47,923.31 was decedent’s share in matters where the conditions were similar and the amount ultimately to be realized impossible of accurate determination at the time of decedent’s death. These payments constituted decedent’s portion of fees not yet due the partnership on the date of decedent’s death for the reason that they were to be paid in connection with legal matters which were in various stages of completion on that date and were completed by the successor firms. They were not billed until after the date of decedent’s death. In some cases the amounts of the fee was fixed only after consultation with the client. Some were court allowances, some depended upon the outcome of the matter involved, and some were heavy cases where bills rendered were later reduced and a lesser amount accepted in settlement. Some items were for services extending over a long period of time. No agreements existed with clients as to the fee in any of these matters and there were no amounts on the books of account of the firm at the date of decedent’s death from which allocations of any definite amount as representing the proportionate share which it would ultimately receive could be made to the estate of decedent.

At the time this proceeding was heard and when briefed by counsel, the correct answers to the questions presented upon the above facts were in considerable doubt, since there was conflict in the decisions of the courts upon cases arising under section 42, supra. However, that doubt has been resolved by the recent decision of the Supreme Court in Helvering v. Enright, 312 U. S. 636, which we think concludes petitioner upon the issues here raised.

In the Enright case, as here, the decedent was a member of a New York law partnership and under a substantially similar partnership agreement in that case, as here, the Commissioner had included in taxable income the decedent’s interest in the partnership accounts at the same value at which that interest had been returned for estate tax.

In sustaining that action the Court clearly laid down the rule that the accrual of income required by section 42, supra, is not a system of accrual which might be applicable in other situations under accepted accounting practices, but requires the accrual of the value of decedent’s interest in unfinished business of the firm approximated at date of death and representing compensation for the services rendered by him even though the compensation to be received ultimately in individual matters is not then determinable because dependent upon the final outcome of matters still in progress. The Court stated the rule thus:

* * * Accrued income under § 42 for uncompleted operations includes the value of the services rendered by the decedent, capable of approximate valuation whether based on the agreed compensation or on quantum meruit. The requirement of valuation comprehends the elements of collectibility. * * *

This rule is controlling not only as to the amount included by respondent as representing decedent’s interest in the firm accounts but also the item representing commissions for services rendered by him, individually, as guardian and trustee. As to the latter item, see also Helvering v. McGlue, 119 Fed. (2d) 167. Respondent’s action is accordingly sustained, but, in view of the stipulation of counsel for adjustment of the deficiency by reason of additional state taxes paid,

Decision will be entered wider Bule 60.

       SEC. 42. PERIOD IN WHICH ITEMS OP GROSS INCOME INCLUDED.
      * * * In the case of the death of a taxpayer there shall be Included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.


author: Smith:

text:
    Quintana Petroleum Company, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 100314—100321.
    Promulgated June 3, 1941.

      Whitfield E. Marshall, Esq., for the petitioners.

      Donald P. Moyers, Esq., and Frank B. Sohlosser, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: H. R. Cullen, Transferee, Docket No. 100315 ; H. R. Cullen, Trustee, Transferee, Docket No. 100316; H. R. Cullen, Successor Trustee, Transferee, Docket No. 100317; H. R. Cullen, Guardian, Transferee, Docket No. 100318; Katherine T. Cullen, Transferee, Docket No. 100310; Estate of Harry Holmes, deceased, Lucy B. Holmes, Executrix, Docket No. 100320; Harry Holmes, Jr., John B. Holmes and Thomas J. Holmes, Successor Trustees, Docket No. 100321.

   OPINION.

Smith:

The first question for decision is whether petitioner is entitled to deduct from the gross income of 1937, $7,142.28 representing the total of profit-sharing payments paid to the Gulf Oil Corporation in connection with the operation of an oil and gas lease. The petitioner contends that the amount is deductible from gross income either (a) as rentals or royalties, or (b) as other ordinary and necessary business expenses. The respondent contends that the amount represents a part of the cost to it of ¿he Duval County Eanch lease; that under the statute the petitioner is entitled to deduct for depletion 27½ percent of the production from the lease; that that amount was intended by Congress to return to the taxpayer its capital investment; and that the $7,142.28 here in question did not constitute an expense deductible from gross income.

We think it clear that Gulf did not during the year 1937 have an investment in the Duval County Eanch Co. lease which is subject to depletion. See Helvering v. Elbe Oil Land Development Co., 303 U. S. 372; Commissioner v. O'Donnell, 303 U. S. 370; Anderson v. Helvering, 310 U. S. 404; Blankenship v. United States, 95 Fed. (2d) 507; Marrs McLean, 41 B. T. A. 565. As stated in Anderson v. Helvering, supra:

* * * A. share in the net profits derived from development and operation, * * * does not entitle the holder of such interest to a depletion allowance even though continued production is essential to the realization of such profits. * * *

It is quite clear that if the payment of the $7,142.28 here in question constituted a part of the consideration for the Duval County Ranch Co. lease it did not constitute an expense payment. This is the position taken by the respondent, and we think that it is correct. In Murphy Oil Co. v. Burnet (C. C. A., 9th Cir.), 55 Fed. (2d) 17, it was held that the payment of legal fees incurred in the defense of a claim against oil properties represented capital expenditures or additional cost of the property and wa s not to be allowed as an expense deduction. In North American Oil Consolidated, 12 B. T. A. 68; appealed and reversed on other issues, 286 U. S. 417, the Board held that the payments of 4 percent of the proceeds from the sale of oil to attorneys for services in defending title to and securing land patents on the oil-producing property were capital expenditures, recoverable by way of depletion. In our opinion the respondent properly disallowed the deduction of the $7,142.28 in question.

The second question for decision is whether the petitioner is entitled to compute the depletion allowance upon other leases than Duval County Ranch Co. lease upon the full amount of the production from those leases, or upon such amount reduced by the portion of the bonus payments paid in prior years which are allocable to the production of the taxable year. Such allocable portion is in the amount of $915.42.

Section 114 (b) (3) of the Revenue Act of 1936 provides that the basis for depletion shall be as follows:

(3) Percentage depletion for oil and gas wells.—In tlie ease of oil and gas wells the allowance for depletion under section 23 (m) shall be 27½ per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. * * *

Regulations 94, article 23 (m)-l(p) provides in part:

In all cases there shall be excluded in determining the “gross income from the property” an amount equal to any rents or royalties which were paid or incurred by the taxpayer in respect of the property and are not otherwise excluded from the “gross income from the property.” If royalties in the form of bonus payments or advanced royalties (see article 23 (m)-10) have been paid in respect of the property in the taxable year or in prior years, the amount excluded from “gross income from the property” for the taxable year on account of such payments shall be an amount equal to that part of such payments which is allocable to the products sold during the taxable year.

It is well settled that advance bonus payments or advance royalties are depletable interests to the recipient. Burnet v. Harmel, 287 U. S. 108; Bankers' Pocahontas Coal Co. v. Burnet, 287 U. S. 308; Herring v. Commissioner, 293 U. S. 322; Marrs McLean, supra. Such items are not depletable interests both to the lessor and lessee. In Alice G. K. Kleberg, 43 B. T. A. 277, the Board said: “Two separate and distinct taxpayers are not entitled to receive depletion deductions as to the same oil interest.”

In Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312, the lessee-taxpayer was obligated to pay the lessor royalties of one-fourth of gross production. In that case, as in the instant proceedings, the lessee claimed that it was entitled to a depletion allowance based upon the gross production. The Commissioner determined that its depletion deduction should be limited to 27½ percent of the gross production less the one-fourth royalties paid to the lessor, and his determination was sustained- by the courts.

We think it clear that the petitioner is not entitled to a depletion allowance in respect of bonus payment as to which the lessor is entitled to a depletion allowance. The action of the respondent with respect to this issue is approved.

Reviewed by the Board.

Decisions will be entered under Buie 50.

       Dissent. See p. 1318.


author: HaeRON :

text:
    Baltimore Steam Packet Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102559.
    Promulgated June 5, 1941.

      Robert G. Vincent, Esq., for the petitioner.

      B. M. Brodsky, Esq., for the respondent.
   OPINION.

HaeRON :

In the computation of the surtax imposed by section 14 of the 1936 Act on its income tax return for the taxable year petitioner took a credit “for contracts restricting dividend payments” in the amount of $25,490.23. In the statement attached to the deficiency notice respondent disallowed the credit in full.

The sole question before the Board for determination is whether in the computation of the surtax imposed by section 14 petitioner is entitled to a credit of $25,490.23 under section 26 (c) (2), the provisions of Which are as follows:

SEO. 26. CREDITS OP CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
*******
(e) Contracts Restricting Payment of Dividends.—
*******
(2)' Disposition of Profits of Taxable Year.—An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt; or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30,1936.

Petitioner bases its claim to a credit under section 26 (c) (2) on the provision contained in each of the three contracts entered into by it with the three banks on July 31, 1935, requiring that beginning with January 1, 1936, “any net income after deductions for depreciation (as the term net income is now defined in the accounting regulations and reports of the Interstate Commerce Commission) of [petitioner] * * * from its operations, as reported in its annual reports to the Interstate Commerce Commission” be applied to the reduction of the loans from the three banks. The parties apparently agree that the provision in question was contained in written contracts executed by petitioner prior to May 1,1936, (see Sutcliffe Co., 41 B. T. A. 1009) and that the debts referred to in the provision in question were incurred before April 30,1936.

Respondent contends, first, that the provision in question did not deal expressly with the disposition of earnings and profits of the taxable year, as required by section 26 (c) (2). He seeks to support this contention by reliance on excerpts from the opinion of the Supreme Court in Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46.

This contention, in our opinion, is without merit. Article 26-2 (c) of Regulations 94 itself provides in part as follows: “A contractual provision, however, shall not be considered as not expressly dealing with the disposition of earnings and profits of the taxable year merely because it deals with such earnings and profits in terms of ‘net income’, ‘net earnings’, or ‘net profits.’ ” The Board has held that section 26 (c) (2) does not require that the contractual provision specifically refer in so many words to “earnings and profits of the taxable year.” G. B. R. Oil Corporation, 40 B. T. A. 738; Michigan Silica Co., 41 B. T. A. 511; Joell Co., 41 B. T. A. 825. In the C. B. B. Oil Corporation case the contractual provision required that “all sums of money of every character whatsoever” from certain oil leases owned by the taxpayer be paid in discharge of a debt. In the Michigan Silica Co. case the contractual provision required that “on or before the 10th of each month * * * twenty-five cents (25⅞⅞) for each ton of sand produced and sold by” the taxpayer during the previous month be irrevocably set aside for the discharge of a debt. In the Joell Co. case the contractual provision required that rents from certain leases owned by the taxpayer be paid in discharge of a debt. The Board held in each of the above cases that the contractual provision expressly dealt with the disposition of earnings and profits of the taxable year.

In the present case the provision in question did not refer specifically in so many words to “earnings and profits of the taxable year.” However, it did deal expressly with the disposition of “net income after deductions for depreciation (as the term net income is now defined in the accounting regulations and reports of the Interstate Commerce Commission).” The record shows that such net income after deductions for depreciation was equivalent to earnings and profits. Moreover, the provision in question dealt expressly with such net income after deductions for depreciation “as reported in its annual reports to the Interstate Commerce Commission.” And by its very terms the provision was to become effective January 1, 1936, the beginning of the taxable year. The conclusion is inescapable that the provision in question dealt expressly with the disposition of earnings and profits of the taxable year within the meaning of section 26 (c) (2). G. B. R. Oil Corporation, supra; Michigan Silica Co., supra Joell Co., supra.

There is nothing in the opinion of the Supreme Court in Helvering v. Northwest Steel Rolling Mills, Inc., supra, which supports respondent’s contention. In that case the Supreme Court held that a corporation which was prohibited by state law from distributing as dividends its profits of the taxable year because of a previously existing deficit was not entitled to a credit under section 26 (c) (1). The Court stated that a provision of the corporation’s charter that it should obey state law, including the statutory prohibition against distributing dividends, was not a provision of a written contract executed by the corporation and thus did not meet the requirements of section 26 (c) (1). The Court’s general statement, “that provisions granting special tax exemptions are to be strictly construed,” does not compel the conclusion in the present case that the provision in question did not deal expressly with the earnings and profits of the taxable year.

Respondent contends, next, that the provision in question did not require petitioner’s earnings and profits of the taxable year “to be paid within the taxable year” or “to be irrevocably set aside within the taxable year,” as required by section 26 (c) (2). In support of this contention he cites Moloney Electric Co., 42 B. T. A. 78, and relies on excerpts from the opinion of the Supreme Court in Helvering v. Northwest Steel Rolling Mills, Inc., supra.

In our opinion, there is no merit in this contention. The basic situation in the present case is not unlike that in Strong Manufacturing Co., 41 B. T. A. 1278. In that case on January 1, 1936, the taxpayer was indebted to a bank in the amount of $47,000. The debt was evidenced by a note and secured by a mortgage. Under a provision of the mortgage the taxpayer was required to pay to the bank “forty percentum (40%) per annum of its net earnings for any calendar year” to be applied on the debt. Such payment was to be made to the bank “not later than April 15th of the succeeding year.” At the end of September 1936 it appeared that the taxpayer’s net earnings for 1936 would be such that 40 percent thereof would be in excess of the amount required to discharge the debt in full. Therefore, on October 15, 1936, the taxpayer made a payment to the bank which discharged the debt in full. It would not have been possible on January 1, 1937, to determine the net earnings of the taxpayer for 1936 with complete accuracy. The Board held that the taxpayer was entitled to a credit under section 26 (c) (2) in the amount of the payment made by it to the bank on October 15, 1936, in full discharge of the debt. With respect to the question as to whether or not the contractual provision required that 40 percent of the taxpayer’s earnings and profits of the taxable year “be paid or irrevocably set- aside within the taxable year,” the Board stated in part as follows:

* * * We are of the opinion that the “application” to the indebtedness of the designated portion of the earnings may, for present purposes, he considered to be called for by the contract “as of” the taxable year, MicMgm. Silica, Co., 41 B. T. A. 511, 515, and therefore to constitute the irrevocable setting aside contemplated by the statute.

The basic situation in the present case also resembles that in Michigan Silica Co., supra. In that case the taxpayer on January 1, 1936, had bonds outstanding which were secured by a trust indenture. Under a provision of the trust indenture the taxpayer was required to pay to the trustee on or before the tenth of each month 25 cents for each ton of sand produced and sold by it during the previous month. In case the taxpayer had not received payment for sand so sold, it might defer payment to the trustee of the sum of 25 cents per ton until it had received payment, but not for more than 60 days after such sale. The sums so paid were to be placed by the trustee in a sinking fund for the purchase or retirement of the bonds. The amounts which the taxpayer was obligated to pay into the sinking fund for sand produced and sold during the 12 months of 1936, and which were paid in the months from February 1936 to January 1937, inclusive, totaled $26,828.88. The Board held that the taxpayer was entitled to a credit in the amount of $26,828.88 under section 26 (c) (2). The Board stated in part as follows:

Since it would be impossible to compute any monthly payment due the sinking fund here until after the close of the month, the contested credit shall include the payment for sand sold during December of the taxable year, 1936, even though that payment was not physically made until January 1937. This seems proper on the theory that such payment was made as of December 1936. Cf. Mason Machine Works Co., 3 B. T. A. 745. Moreover, respondent makes no issue as to the amount of the credit.

The application of the principles set forth in the Strong Manufacturing Co. case and the Michigan Silica Oo. case to the facts present here compels the conclusion that the provision in question required petitioner’s net income (after deductions for depreciation) of the taxable year to be paid or irrevocably set aside “as of the taxable year”, and thus “within the taxable year” within the meaning of section 26 (c) (2).

Moloney Electric Co., supra, which is cited by respondent in his brief, is distinguishable. In that case, under a provision of a trust agreement securing its bonds, the taxpayer was required to pay to the trustee as a sinking fund on the first day of June of every year, so long as the bonds were outstanding, 20 percent of its net earnings for the next preceding year in excess of $320,000. The Board held that this provision of the trust agreement did not require a portion of the taxpayer’s earnings and profits of the taxable year to be paid or irrevocably set aside within the taxable year and that the taxpayer was not entitled to a credit under section 26 (c) (2) with respect to this provision of the trust agreement. The Board distinguished the Strong Manufacturing Co. case on the ground that in the Strong case “the taxpayer recognized that under its contract its creditor had an equitable lien, during the taxable year, upon 40 percent of its net earnings” while in the Moloney case “the creditor had no equitable lien upon [taxpayer’s] earnings until and unless they should be in excess of $320,000.”

It should be pointed out that the record in the present case clearly indicates that petitioner recognized that under the provision in question the three banks had an equitable lien during the taxable year upon its net income (after deduction for depreciation) of that year. The testimony of petitioner’s general auditor indicates that petitioner understood that its net income of the taxable year “belonged to” the three banks; -that the three banks had “an equitable lien” on its net income of the taxable year; and that it was obligated to pay its net income of the taxable year to the three banks at the end of that year. In accordance with this understanding petitioner, about the middle of December of the taxable year, estimated that its net income of the taxable year would be approximately $25,000 and on December 23 of the taxable year paid a total of $25,000 to the three banks. Its net income of the taxable year, as finally determined after the close of that year, amounted to $25,490.23; and on March 13, 1937, it paid the balance of $490.23 to the three banks.

Lafayette Hotel Co., 43 B. T. A. 426, and Belle-Vue Manufacturing Co., 43 B. T. A. 12, which are cited by respondent in his brief, are not in point. For reasons already set forth above, the opinion of the Supreme Court in Helvering v. Northwest Steel Rolling Mills, Inc., supra, does not support respondent’s contention.

Under section 26 (c) (2) the credit allowable is limited to the amount which was actually paid or irrevocably set aside within the taxable year under the provision in question. Petitioner paid to the three banks a total of $25,000 on December 23, 1936, and a total of $490.23 on March 13, 1937, under the provision in question. The payment of $490.23 may be considered as made “as of” the taxable year. Michigan Silica Co., supra. Respondent makes no issue as to the amount of the credit allowable.

Accordingly, it is held that, in the computation of the surtax imposed by section 14 of the Revenue Act of 1936, petitioner is entitled to a credit in the amount of $25,490.23 under section 26 (c) (2). Respondent is reversed.

Decision will be entered under Rule 50.