author: HaRRON :

text:
    Margaret R. Phipps, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83863.
    Promulgated June 28, 1940.

      David A. Beed, Esq., for the petitioner.

      Angus B. Shannon, Jr., Esq., for the respondent.
   OPINION.

HaRRON :

The main question is whether, in the taxable years, petitioner was taxable on the entire net income of a funded insurance irust which was created by petitioner for the purposes of paying the annual premiums on three policies of insurance on the life of her husband, and of using the proceeds of the policies after her husband’s death to pay the inheritance and estate taxes on her share of his estate.

The facts show that in the taxable years part of the income of the irust was used to pay the premiums on the policies of insurance on the life of petitioner’s husband and the excess of the net income of the trust was added to the corpus of the trust.

Respondent determined that in the taxable years the entire net income of the trust was taxable to petitioner. To support his determination respondent relies, both in the deficiency notice and in his brief, on section 1C7 (a) (1) of the Revenue Acts of 1932 and 1934, the pertinent provisions of which are set forth in the margin.

While the excess of net trust income which was added to trust corpus clearly was accumulated within the meaning of section 167 (a) (1), petitioner contends that the trust income which was used to pay the premiums on the policies of insurance on the life of petitioner’s husband was not accwnvulated within the meaning of that section. Petitioner contends that the Board’s decisions in Lucy A. Blumenthal, 30 B. T. A. 591; appealed and reversed on another issue, 76 Fed. (2d) 507; reversed per curiam, 296 U. S. 552; Gail H. Baldwin, 36 B. T. A. 364; and Sophia P. O. Morton, 38 B. T. A. 419, are controlling. However, the BVamenthal and Baldwin cases are distinguishable because in each of those cases none of the proceeds of the collection of the policies was to be distributed to or for the direct benefit of the grantor at any time, and the Board’s decision in the Morton case recently has been reversed by the Circuit Court in Commissioner v. Morton, 108 Fed. (2d) 1005. It should be noted that respondent has submitted for his brief here a copy of the brief submitted by him to the Circuit Court in the Morton case.

While the facts in Commissioner v. Morton, supra, are somewhat different from the facts here, the Circuit Court’s decision in the Morton case is, in our opinion, controlling. In the Morton case the taxpayer created two funded insurance trusts to pay the premiums on policies of insurance on the life of her husband. The taxpayer was named as the beneficiary in the policies held in the first trust, and the trustee was named as the beneficiary in the policy held in the second trust and was directed to pay the proceeds of the collection of the policies on the death of the taxpayer’s husband to the taxpayer or to her daughter if the taxpayer predeceased her husband. In the policies held in the first trust the taxpayer retained the right to change the beneficiary and the right to the cash surrender or loan value, and in the policy held in the second trust the right to change the beneficiary and the right to the cash surrender or loan value were reserved in the taxpayer and/or her husband. The Circuit Court held that the taxpayer was taxable on the income of the two trusts which was used to pay the premiums on the policies of insurance, under section 167 of the Revenue Act of 1934.

In its decision in the Morton case the Circuit Court relied to a great extent upon the decision of the Supreme Court in Douglas v. Willcuts, 296 U. S. 1, and stated in part as follows:

* * * Looking to the practical facts, we find that here the bulk of the income did remain, in contemplation of law, in substance, that of the grantor, used to purchase property for herself. We think it could hardly be argued, in view of the teaching of the Willcuts 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.

In our opinion, the same reasoning applies here. To be sure, petitioner was under no contractual obligation to pay the premiums on the policies of insurance, which she had taken out on her husband’s life and on which she had paid the first annual premiums. However, the use of the income of the trust to pay the premiums maintained the policies during the life of petitioner’s husband, and on his death the trust assets, including the proceeds of the collection of the policies, were to be used to pay the inheritance and estate taxes on petitioner’s share of her husband’s estate. The reasonable inference is, in the absence of any evidence to the contrary, that the maintenance of the policies through the use of trust income resulted in a substantial economic benefit to petitioner. Moreover, one year after the death of petitioner’s husband, the trust assets remaining after the payment of the inheritance atid estate taxes on her share of her husband’s estate were to be transferred to petitioner absolutely. Through the use of the income of the trust to pay the premiums on the policies of insurance, petitioner enjoyed such a substantial economic benefit that it is both reasonable and just to treat her as the owner of the trust corpus for purposes of income taxation, as was concluded by the court in the Morton case. Cf. Douglas v. Willcuts, supra; Burnet v. Wells, 289 U. S. 670; Helvering v. Clifford, 309 U. S. 331.

Furthermore, it should be1 pointed out that the payment of the annual premium on a policy of life insurance ordinarily results in an increase in the surrender value of the policy. Here this would mean an increase in the value of the trust corpus and, in substance, would produce the same result as if the trust income had been added directly to the corpus of the trust. It should be pointed out, also, that an insurance company sets aside and accumulates a portion of the annual premiums paid on a policy of insurance as a reserve fund for the policy. “Common sense interpretation” has been stated to be the safest rule to follow in the administration of the income tax laws, Rhodes v. Commissioner, 100 Fed. (2d) 966, 969; and, in our opinion, the trust income which was used to pay the premiums on the policies of insurance on the life of petitioner’s husband clearly was wcwnulated within the meaning of section 167 (a) (1).

Petitioner contends further that the trust income which was used to pay the premiums on the policies of life insurance and the excess of net income which was added to trust corpus were not accumulated for future distribution to the grantor within the meaning of section 167 (a) (1). There is no merit in petitioner’s contention. The trust agreement contains definite provisions for future distribution to the petitioner of the trust assets, including the proceeds of the policies of life insurance and the excess of the net income of the trust which was added to trust corpus. Cf. William E. Boeing, 37 B. T. A. 178, 185; appealed and reversed on another issue, 106 Fed. (2d) 305. 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 Avere 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. Moreover, the trust assets remaining after payment of the estate and inheritance taxes on petitioner’s shai'e of her husband’s estate were to be transferred to petitioner absolutely one year after the date of her husband’s death. While it is true that the trust assets would not be used for petitioner’s benefit if she predeceased her husband, the fact remains that, in the taxable years, under the definite provisions of the trust agreement the trust income which was used to pay premiums on the policies of life insurance and the excess of the net trust income which was added to trust corpus were accumulated for future distribution to the petitioner within the meaning of section 167 (a) (1) of the Revenue Acts of 1932 and 1934. Cf. Everett D. Graff, 40 B. T. A. 920; Lolita S. Armour, 41 B. T. A. 777.

The cases cited by petitioner in support of her conteixtion that the trust income which was used to pay premiums on the policies of life insurance and the excess of net trust income which was added to trust corpus were not accumulated for future distribution to her are distinguishable. In John Edward Rovensky, 37 B. T. A. 702, it was held that a “power” to revest was not vested in the grantor within the meaning of section 166 of the Revenue Act of 1934. In William E. Boeing, supra, there was no definite provision for future distribution to the grantor of the accumulated trust income and there was only a bare possibility that the accumulated trust income might revert to the grantor. In Fanny M. Dravo et al., Executors, 34 B. T. A. 190, there was no provision for future distribution to the grantor of any of the accumulated trust income. In Preston R. Bassett, 33 B. T. A. 182, and in Arthur J. Morris, 33 B. T. A. 241, capital gains from the sale of trust assets, which were added to trust corpus by operation of law, and not by the exercise of the grantor’s discretion as trustee, were held not to be income taxable to the grantor under section 167 of the Revenue Act of 1928, which was different in several material respects from section 167 of the Revenue Acts of 1932 and 1934.

Therefore, respondent’s determination that, in the taxable years, petitioner was taxable on the entire net income of the trust is sustained.

Reviewed by the Board.

Decision will be entered for the respondent.

Mobdock dissents.

       SEC. 167. INCOME FOR BENEFIT OP GRANTOR.
      (a) Where any part of the income of a trust—
      (3) 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; * * *
      *******
      then such part of the income of the trust shall be included in computing; the net income of the grantor.

       Vance, Handbook on the Law of Insurance, 2d ed. (1930), pp. 200, 261.

       Bogert, Funded Insurance Trusts and tbe Rule Against A ccumulations, 9 Cornell Daw Quarterly (1924) 113, 129.

       Vance, Handbook of the Law of Insurance, 2d ed. (1930), pp. 27, 50, 54. Jarmon, Wills, 6th ed. (1893), vol. I, pp. 311, 314.

       The Report of the Ways and Means Committee on the Revenue Bill of 1924, 68th Cong., 1st sess., H. Kept. 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.]


source: Caselaw Access Project

author: Leeoix :

license: Public Domain

text:
    H. Cecil and Ruth Carroll Sharp, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 97425, 97426.
    Promulgated July 12, 1940.

      Brooks Potter, Esq., and John Bane, Jr., Esq., for the petitioners.

      Charles P. Reilly, Esq., for the respondent.
   OPINION.

Leeoix :

As regards the Nancy Carroll Draper trust, respondent argues that three-fourths of the net income, exclusive of capital gains, is taxable to petitioner on the ground that the trust discharged petitioner’s duty to support her daughter, legal or contractual. Douglas v. Willcuts, 296 U. S. 1. He raises no issue as to the applicability of section 166, and it is noted that no such question could be successfully raised, since the power to revoke exists in petitioner only in conjunction with Draper, who holds a substantial adverse interest. See Paul W. Litchfield, 39 B. T. A. 1017.

Respondent’s contention that petitioner is under a duty to support her daughter rests first upon an invocation of the doctrine that the Commissioner’s determination in this regard is presumptively correct. He says that petitioner’s duty to her daughter is controlled by the laws of France and that he must prevail because petitioner has introduced no proof of French law.

The decree of the French court awarded custody of Nancy Carroll Draper to petitioner and left the matter of the child’s support to the parties, refraining entirely from passing on the latter question. Thereafter petitioner and the child established a legal domicile in the State of New York, as was their right and privilege. Restatement of the Law of Conflicts of Law, sec. 32; 1 Beale, Conflicts of Law, 215; Toledo Traction Co. v. Cameron, 137 Fed. 48. Draper, the ex-husband of petitioner and father of the child, returned to and retained his residence in Massachusetts.

Under the laws of New York, the duty of Draper to support the child survived the French divorce because the foreigji court failed to pass upon the question and made no provision therefor in its decree. Laumeier v. Laumeier, 237 N. Y. 357; 143 N. E. 219; Manice v. Randolph, 221 App. Div. 570; 224 N. Y. S. 496.

Under the laws of Massachusetts, if suit were brought against Draper there and the child were then a resident of that state, the proper probate court could have compelled the father to support the child, regardless of what a foreign court might or might not have done in the premises, and even though the child remained in the custody of its mother. Mass. G. L. (Ter. ed.) ch. 208, § 29; Durfee v. Durfee, 293 Mass. 472; 200 N. E. 395.

On the instant facts, moreover, the case of Yarborough v. Yarborough, 290 U. S. 202, which holds that the forum granting the divorce has sole jurisdiction over the question of support of children, does not require a holding that French law is controlling, since in the Yarborough case the court which granted the divorce provided for support in its decree, whereas here that was not done. See 50 Harvard Law Review 1197.

We conclude, therefore, that the question of petitioner’s obligations to her child is not controlled by the laws of France, and that under either Massachusetts or New York law, Draper’s duties to support the child remained. It follows that the trust discharged his legal obligation, but not petitioner’s, since she had none, and that she, therefore, is not taxable on any of the income of the Nancy Carroll Draper trust. Commissioner v. Yeiser, 75 Fed. (2d) 956; Martin F. Tiernan, Trustee, 37 B. T. A. 1048. See also Lolita S. Armour, 41 B. T. A. 777.

Respondent’s further contention, that petitioner was under a contractual duty to support her daughter because Draper had given her money on the understanding it would be used for the benefit of the family and she had used part of it to create the trust, is untenable, for a father can not by contract rid himself of his duty to support his minor child. Helvering v. Leonard, 105 Fed. (2d) 900; reversed on other grounds, 310 U. S. 80.

The second issue is whether petitioner is taxable upon the capital gains realized in the taxable years by the Ruth Carroll Draper trust. These were not distributed to her but were added to principal.

It is true that under the law of Massachusetts, capital gains normally are to be credited to principal, rather than to income. Theodore R. Plunkett, 41 B. T. A. 700. But here the trustees were given discretion to determine which receipts were capital and which were income. Under section 167 (a) (2) of the Revenue Acts of 1934 and 1936, a grantor of a trust is taxable on such of the income of a trust as 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. A trustee is not a person having a substantial adverse interest within the meaning of the statute. Reinecke v. Smith, 289 U. S. 172; Sterling Morton, 38 B. T. A. 1283; affd., 109 Fed. (2d) 47. There was, in consequence, nothing to prevent the trustees here from exercising their discretion and distributing the capital gains to petitioner. She is therefore taxable in respect of these capital gains under section 167 (a) (2), supra. Malcolm W. Greenough, 29 B. T. A. 315; affd., 74 Fed. (2d) 25.

In view of this conclusion, it will not be necessary to pass on respondent’s remaining contentions.

We find that petitioners overpaid their 1936 tax to the extent it was imposed in respect of one-third of the ordinary income of the Nancy Carroll Draper trust.

Decision will he entered wider Rule 50.


author: OrrER:

text:
    Pembroke Realty & Securities Corporation (in Liquidation), Petitioner, v. Commissioner of Internal Revenue, Respondent. Arthur M. Loew, Petitioner, v. Commissioner of Internal Revenue, Respondent. City Bank Farmers Trust Company, Trustee under a Certain Trust Created in Favor of A. M. Loew, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. City Bank Farmers Trust Company, Trustee under a Certain Trust Created in Favor of Jane C. Loew, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94218, 95837, 95838, 95839.
    Promulgated July 12, 1940.

      Maurice Henry Blimken, Esq., for the petitioners.

      DeWitt M. Evans, Esq., J. M. Morawshi, Esq., E. O. Hanson, Esq., and Harold D. Thomas, Esq., for the respondent.
   OPINION.

OrrER:

The corporate petitioner is a personal holding company within the meaning of section 351 of the Eevenue Act of 1934. It has claimed deductions from its “adjusted net income” under that section on account of certain amounts assertedly distributed as dividends, and for others as being “used or set aside to retire indebtedness incurred prior to January 1, 1934.” In this proceeding it contests the disallowance of these deductions.

It appears that, the distributions to the corporation’s stockholders are not “dividends” within the meaning of the applicable section for two reasons. There were no accumulated earnings or profits. Foley Securities Corporation, 38 B. T. A. 1036; affd., 106 Fed. (2d) 731 (C. C. A., 8th Cir.). And the distributions were in liquidation. Gaston & Co., 39 B. T. A. 640. Petitioners seek to distinguish the corporation’s position from the circumstances there appearing on the ground that, since distribution of its assets was complete, it had no “undistributed net income.” But/ we think this contention results from a misapprehension of the purport of the provision. Income is “distributed” for the purpose of section 351 only to the extent that it falls within the exceptions there defined. And it is clear that the reference to “dividends” as one of such exceptions does not reach the corporate petitioner’s distribution. Neither the plain language of the section nor its fundamental design to tax income to the corporation if its shareholders escape tax, permit the acceptance of petitioners’ contention. Foley Securities Corporation, supra; Gaston & Co., supra.

The “indebtedness” for the payment of which credit is claimed was in each case a running account having its inception long before the beginning of 1934: But respondent contends that the amount remaining unpaid' in- the tax year was contracted subsequent to the significant date, and therefore is not such “indebtedness” as the statute describes.

It seems reasonable to assume that Congress intended the reference to indebtedness to designate debts which under applicable law would be so regarded as between debtor and creditor. See Haffenreffer Brewing Co., 41 B. T. A. 443. Similarly, we may assume that “indebtedness incurred prior to January 1,1934” was intended to refer to debts which, under the local law governing the relations of debtor and creditor, would be treated as having been incurred prior to that date. See Freuler v. Helvering, 291 U. S. 35.

In the courts of New York, as well as under the common law generally, it is the settled rule that on running accounts payments will ordinarily be applied to the earliest indebtedness “so that the credits are to be deemed payments pro tanto of the debts antecedently due.” United States v. Kirkpatrick, 22 U. S. 318, 326; Carson v. Federal Reserve Bank of New York, 254 N. Y. 218; In re Stacy, Wolf Hat Co., 99 Fed. (2d) 793 (C. C. A., 2d Cir.). There are, of course, exceptions, but “* * * the formula is expressive of a rule that must prevail in the absence of persuasive reasons for qualification or exception.” Carson v. Federal Reserve Bank of New York, supra. And nothing is shown here to suggest that this case would fall within any of such qualifications.

The record shows that in the account of one creditor the balance due on December 31, 1933, was $65,616.98. Prior to October 1, 1935, the beginning of the tax year under consideration, $115,680.73 was repaid. Applying the legal formula just noted, it seems evident that during the tax year no part of the indebtedness incurred prior to 1934 remained unpaid, and hence none could have been “retired.” The same applies to the other account, where the balance at the end of 1933 was $55,104.50 and repayments prior to the beginning of the tax year were $107,502.36. The result is that the corporation’s claim for a deduction on this ground must also be disallowed.

There is apparently no present dispute between the parties as to the existence or amount of transferee liability imposed upon the remaining petitioners. Accordingly,

Decision will be entered for the. respondent in Docket Nos. 9J$18, 95838, and 95839, and under Rule 50 in Docket No. 95837.

       SEC. 351.. surtax ON PERSONA!, HORDING COMPANIES.
      * ******
      (b) Definitions. — As used in this title—
      **'■•** * * *
      (2) The term “undistributed adjusted net income” means the adjusted net income minus the-sum of:
      * * * * * * $•
      (B) Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness; and
      (C) Dividends paid during the taxable -year.
      * * * * * - * *

       See footnote 1, supra.


author: Muiídock :

text:
    Maine Central Transportation Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97221.
    Promulgated July 12, 1940.

      O. B. Folsom-Jones, Esq., for the petitioner.

      J. T. Haslam, Esq., for the respondent.
   OPINION.

Muiídock :

The petitioner claims the right to a deduction equal to the amount which it paid Bailroad in each year under the contract of December 1, 1933. These payments, it says, are ordinary and necessary expenses paid during each taxable year in carrying on its business. Sec. 23 (a), Revenue Acts of 1934 and 1936. The payments were made pursuant to the contract of December 1, 1933, and the circumstances under which that contract was entered into, as well as the terms of the contract, may show whether the payments were ordinary and necessary expenses of carrying on the business of the petitioner.

All of the capital stock of the petitioner was owned by a subsidiary of Bailroad at the time the petitioner took over the motor lines. Later, Bailroad itself became the owner of all of the stock of the petitioner. Thus, the petitioner was at all times entirely under the control of Bailroad. The terms of the contract of December 1, 1933, were not agreed to by parties with adverse interests dealing at arm’s length but were just what Bailroad wanted them to be. The record does not show that the payments were necessary to the operation of the business of the petitioner or that they were reasonable compensation to Bailroad for services rendered to the petitioner. Moxa Building Co., 31 B. T. A. 457; affd., 79 Fed. (2d) 1004; Traylor Engineering & Mfg. Co. v. Lederer, 271 Fed. 399; certiorari denied, 257 U. S. 638. The contract appears to be merely a means adopted by Bailroad to secure distribution to it of the profits of the petitioner. Those profits were earned by the petitioner. They were not earned by Bailroad. Bailroad could not relieve the petitioner from tax by merely taking over the earnings of the petitioner.

Bailroad received compensation in the form of interest for the money it advanced to the petitioner. It also allowed the petitioner to use its terminal, traffic, and ticket office facilities free of charge. If the petitioner had been required to pay for the use of those facilities and the amount paid had been shown and claimed as a deduction, the decision in this case might be different. But it has not been shown that any part of the profits paid to Bailroad were in payment for the use of facilities of Bailroad. The two businesses complemented one another. Benefits flowed both ways. The business of the petitioner reduced the expenses of Railroad. The contract stated that, in recognition of those savings, Railroad agreed to advance the funds for equipment. Even though Railroad may have deserved some compensation for the risk it took in regard to possible losses of the petitioner, nevertheless the entire earnings of the petitioner were not required as reasonable compensation for the assumption of that risk. The record does not justify the allocation of any part of the profits as compensation for that risk.

The Commissioner, in his determination of the deficiency, mentioned section 45 of the Revenue Act of 1934, which deals with the allocation of income and deductions and authorizes the Commissioner, in the case of two organizations owned or controlled directly or indirectly by the same interests, to distribute, apportion, or allocate gross income or deductions between them if he deems it necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization. Thus, even if the petitioner were otherwise entitled to the deduction which it claims, the action of the Commissioner in allocating the gross income and deductions of this petitioner so that its income may be clearly reflected, seems entirely proper under section 45.

The next contention of the petitioner is that it is entitled to have its income tax liability for each year computed upon the basis of a consolidated return as an affiliate of Railroad. Section 141 (d) (3) excludes a corporation which is not a common carrier by railroad and operates a business other than that of a common carrier by railroad from an affiliated group of common carriers by railroad. The petitioner is not a common carrier by railroad within the meaning of that section. Norfolk Southern Bus Corporation, 39 B. T. A. 472; affd., 107 Fed. (2d) 304. Thus by the express terms of the statute, the petitioner is excluded from any affiliated group, including Railroad. Furthermore, the Commissioner, in accordance with authority delegated to him in the act, has promulgated Regulations 89, containing article 10 (a) (1), which provides that the privilege of making a consolidated return must be exercised at the time of making the return of the common parent corporation and under no circumstances thereafter. Article 12 (b) requires that each subsidiary prepare duplicate originals on form 1122 consenting to the regulations and authorizing the common parent corporation to make a consolidated return on its behalf. No consolidated returns were filed on behalf of the petitioner for the taxable years, the petitioner did not consent to the filing of such returns, and, on the contrary, the petitioner filed separate returns for each of the years. The first alternative contention of the petitioner is denied.

The second alternative contention made by the petitioner is that it should be permitted to amend the declared value of its capital stock reported in its capital sLock tax returns for the years ended June SO, 1984, 19S5, and 1936. It desires to increase those values so that it will have no excess profits tax to pay after taking into account the adjustments to its net income which result from our decision of the first issue. The parties are in agreement as to an adjustment under section 701 (f) of the Revenue Act of 1934 of the return for the year ended June 30, 1935. The petitioner did not file amended capital stock tax returns for any of the years within the time allowed for filing such returns. Its original returns were not incorrect. Haggar Co. v. Helvering, 308 U. S. 389, and Flomot Gin Co., 40 B. T. A. 689, are not in point. The Board distinguished the Haggar case in William B. Scaife & Sons Co., 41 B. T. A. 278, and held that a valuation declared in the original capital stock tax return may not be changed after the expiration of the period for filing the return has expired. That decision is controlling here and it follows that the second alternative contention of the petitioner must be denied. We assume that the petitioner has abandoned its contention that it would be unconstitutional to impose the excess profits taxes upon its net income, as now determined, without a revision or adequate increase in the adjusted declared value of its capital stock. This point was the subject of an amendment to the petition, but it is not mentioned by the petitioner in its brief.

Decision will be entered for the respondent.


author: Smith:

text:
    Keystone Automobile Club Casualty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Keystone Automobile Club Fire Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 90931, 90932, 91484, 91486.
    Promulgated July 16, 1940.

      R. Lester Moore, Esq., for the petitioners.

      Lloyd W. Greason, Esq., for the respondent.
   SUPPLEMENTAL OPINION.

Smith:

These proceedings are before the Board on petitioners’ motion for a reconsideration of its opinion promulgated July 27, 1939, and published at 40 B. T. A. 291. The Board’s final decisions entered J uly 29, 1939, were vacated by orders dated August 11, 1939, and reargument was heard on October 4, 1939.

In its promulgated opinion the Board referred to article 1014 of Regulations 74 and 77, promulgated under the Revenue Acts of 1928 and 1932, and at page 307, 40 B. T. A., quoted therefrom as follows:

* ⅜ * A slock fire insurance company, operated on the mutual plan to the (•stent of paying dividends to certain classes of policyholders, may make a return on the same basis as a mutual fire insurance company with respect, to its business conducted on the mutual plan. fArt. 1014.]

Following this quotation it was said that “No similar provision is found in Regulations 86, promulgated under the provisions of the Revenue Act of 1934.” This statement was in error, since by Treasury Decision 4697, approved September 22, 1936, article 207-1 of Regulations 86, Cumulative Bulletin XV-2, p. 167, was amended and the above quoted provision of the earlier regulations, which was omitted in Regulations 86 as originally promulgated, was reinstated. (See article 207-5 of amended regulations set out below.)

Assuming that the regulation is valid, what are the rights that it confers upon the petitioners? Only one of the petitioners, the Fire Co., is “a stock fire insurance company” and therefore within the letter of the regulation. No reference is made in the regulation to casualty companies.

The Fire Co. paid dividends not to “certain classes of policyholders” but to all of its policyholders. All and not just a part of its business was conducted, to that extent, on a mutual basis. Computing its income “on the same basis as a mutual fire insurance company” it would bo entitled to all of the deductions granted to “mutual insurance companies other than life and marine” under section 207 (c) of the Revenue Act of 1934 (section 208 (c) of the Revenue Acts of 1928 and 1932), which, so far as here material, are “the amount of premium deposits returned to their policyholders and the amount of premium deposits retained for the payment of losses, expenses, and reinsurance reserves.”

In his determination of the deficiencies herein the respondent has allowed both of the petitioners the deduction of the amounts of premium deposits returned to the policyholders, and does not in these proceedings question the correctness of the allowance, but has not allowed any deduction on account of the premium deposits retained by the companies.

We found, in our promulgated opinion, 40 B. T. A., at pages 307 and 308, that the evidence did not show that the amounts of premium deposits retained by the petitioners at the end of the taxable years involved, which were included in petitioners’ taxable income by the respondent, were retained for “the payment of losses, expenses, and reinsurance reserves”, within the meaning of the statute, as interpreted in article 207-1 of Regulations 86, the provisions of which are in part as follows:

In addition to the deductions and credits to which corporations generally are entitled as defined and limited under sections 23, 24, and 26, insurance companies of this type [mutual insurance companies other than life and marine] are entitled to deduct from gross income:
*$&«***
(2) The amount of premium deposits retained at the end of the taxable year for the payment of losses, expenses and reinsurance reserves. As used in this article the term “losses” means incurred losses; the term “expenses” means accrued expenses and the term “reinsurance reserves” means the amount necessary to reinsure outstanding policies for their unexpired terms.

Article 207-1 of Regulations 86, as amended by Treasury Decision 4697, is in part as follows:

Akt.-207-5. Special deductions allowed mutual insurance companies. — Mutual insurance companies (including interinsurers and reciprocal underwriters, but not including mutual life and mutual marine insurance companies), which require their members to make premium deposits to provide for losses and expenses are allowed to deduct from gross income the aggregate amount of premium deposits returned to their policyholders or retained for the payment of losses, expenses, and reinsurance reserves. In determining the amount of premium deposits retained by a mutual fire or mutual casualty insurance company for the payment of losses, expenses, and reinsurance reserves, it will be presumed that losses and expenses have been paid out of earnings and profits other than premiums to the extent of such earnings and profits. If, however, any portion of such amount is applied during the taxable year to the payment of losses, expenses, or reinsurance reserves, for which a separate allowance is taken, then such portion is not deductible; and if any portion of such amount for which an allowance is taken is subsequently applied to the payment of expenses, losses, or reinsurance reserves, then such payment can not be separately deducted. The amount of premium deposits retained for the payment of expenses and losses, and the amount of such expenses and losses, may not both be deducted. A company which invests part of the premium deposits so retained by it in interest-bearing securities may nevertheless deduct such part, hut not the interest received on such securities. * * *

It will be noted that the amended regulations do not carry forward the definition given for the statutory terms “losses”, “expenses”, and “reinsurance reserves” contained in the revoked regulations, to which we referred in our promulgated opinion. This change in the regulations, however, does not affect the result previously reached, that the premium deposits on hand at the end of the taxable years are not shown to have been retained for the payment of losses, expenses, and reinsurance reserves.

The petitioners’ balance sheets for the years involved show among their liabilities a few small items such as “Estimated expenses of investigation”, “Commissions, brokerage, etc.”, “Reinsurance”, “Losses and claims”, and other items that might fall within the statutory terms “losses”, “expenses”, and “reinsurance reserves”, but in the determination of tbe deficiencies the respondent has allowed the deduction of these accrued items by including in the net incomes, only the increases in surplus year by year, less the nontaxable income.

As we pointed out in our promulgated opinion, the premium deposits retained by both the Fire Co. and the Casualty Co. at the end of the taxable years fell into the accumulated surplus of those companies and, for all that the evidence shows, were available for dividend distribution to the sole stockholder.

We adhere to our prior ruling that the petitioners are not entitled to any additional deductions for the years involved.

The petitioners in their reargument renew their principal contention that they are mutual insurance companies and exempt from tax under the provisions of section 103 (11) of the Revenue Act of 1928 and the corresponding sections of the 1932 and 1934 Acts, and urge that the Board erred in determining otherwise.

Our determination that the petitioners are not mutual insurance companies was reached after a careful consideration of that question and the reargument advances no convincing reason for changing our ruling.

Since the promulgation of our opinion the United States Circuit Court of Appeals for the Third Circuit has handed down its decision in Driscoll v. Washington County Fire Ins. Co., 110 Fed. (2d) 485, holding that a fire insurance company organized under the laws of the Commonwealth of Pennsylvania, which operated in part on a mutual basis but whose policyholders were not all “members” who participated in the conduct of the business, was not a mutual company entitled to exemption under the income tax laws. The case supports our prior determination, which we now affirm, that the petitioners herein are not exempt from tax as mutual insurance companies.

Reviewed by the Board.

Decisions will he entered for the respondent.


author: Opper :

text:
    Jamaica Water Supply Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94503.
    Promulgated July 19, 1940.

      Arthur McCauley, Esq., and Louis D. Blum, C. P. A., for the petitioner.

      Alim T. Akin, Esq., for the respondent.
   OPINION.

Issue 1.

Opper :

Whether petitioner is taxable upon the contested income in the tax year in which the controversy concerning it was settled appears to depend upon whether that income was properly accruable at some previous time; for, if it was, respondent having expressly waived the defense of estoppel, there would be no reason for taxing it now. On the other hand, the income wag unqualifiedly recognized as owing in the year before us. Accordingly, if it was not properly accruable in prior years there can be little doubt that it was then chargeable to petitioner.

The point of time when income becomes sufficiently definite and certain to be the proper subject of accrual is a question which has been the subject of extensive litigation. As a result, the principles involved have by now become reasonably clear and this proceeding appears to present a not particularly complicated subject for the application of such principles.

The income in question is the amount of rentals which petitioner sought to collect from the city of New York for water supplied to its hydrants during the years 1923¡-1928, inclusive. During all this time an annual rental of $18 per hydrant was accrued as income on petitioner’s books, and apparently conceded by the city to be due. The difference between that amount and $45 per hydrant was claimed by petitioner and contested by the city. This difference remained the subject of controversy until December 1933, within the tax year before ns, when litigation involving it was settled for an amount which was actually received a few months later. It is the inclusion of this amount in petitioner’s income for the year of settlement which it contests.

We think it clear that the disputed parts of the hydrant rentals were not properly, accruable in the years when the services were performed. Not only the amount but the existence of liability was contingent and doubtful at that time. See Kentucky & Indiana Terminal Railroad Co., 19 B. T. A. 969; affd., 54 Fed. (2d) 738 (C. C. A., 6th Cir.); certiorari denied, 286 U. S. 557. The only amount concerning which there was no dispute was that which petitioner actually did accrue contemporaneously. With respect to all of the excess over that amount, the city of New York denied any liability whatever, so that it was possible that an adjudication of the controversy would result in no recovery by petitioner-or in a recovery the amount of which might be anything between the undisputed liability of the city and the rental which petitioner claimed. Under these circumstances it seems clear that no proper basis for the accrual of any part of the contested rent existed prior to the time when the parties agreed upon a settlement of the pending litigation. United States v. Anderson, 269 U. S. 422; Lucas v. American Code Co., 280 U. S. 445. Of course, the same applies to the interest on the disputed rentals. McGuirl, Inc. v. Commissioner, 74 Fed. (2d) 729 (C. C. A., 2d Cir.).

Petitioner relies principally upon the case of Brooklyn Union Gas Co., 22 B. T. A. 507; affd., 62 Fed. (2d) 505 (C. C. A., 2d Cir.). But the distinction from the present situation is readily apparent from the opinion of the Circuit Court of Appeals in that case. There the court took the view that the disputed amounts were paid or made available currently to the taxpayer, with the proviso that they be subject to return upon an adverse determination. The dissenting judge, it is true, was of the opinion that some of the payments did not fall into that category, but that merely emphasizes the basis upon which the court’s decision rests. Since it was the liability to return which was contingent and not the right to receive, it was only the latter liability which could not be the subject of an accrual until it became definite. See Commissioner v. Thatcher & Son, 76 Fed. (2d) 900 (C. C. A., 2d Cir.). Here, of course, the situation is reversed. Petitioner did not receive payment of any amounts in excess of the rentals conceded by the city to be due. It had no liability to return any amounts and it was the receipt by petitioner and not the disbursement by it which was so uncertain as to preclude accrual.

Similarly, in Illinois Terminal Co., 5 B. T. A. 15, also relied upon by petitioner, the income in question, or substantially all of it, was available to the taxpayer in the years when it was earned. Furthermore, while not actually accepted, its amount was readily ascertainable, at least with approximate correctness, and there was apparently no dispute as to liability. The opinion states (p. 22) :

* * * The fall amount of just compensation, as measured by the so-called standard return, was known both to the Government and to the taxpayer during all of the years 1918, 3919, and 1920, and all of that amount definitely accrued by virtue of tbe Federal Control Act of March 21, 1918, and that amount or, in the absence of agreement no less than 90 per cent thereof, was payable to the taxpayer in convenient installments throughout that period. * * *

The complete dissimilarity between that situation and the one now before us, where the entire claim was in dispute and no possible method existed whereby the amount ultimately to be awarded could be even roughly approximated, calls for no further elaboration.

Petitioner assails the action taken by respondent on the ground that its income will be distorted as a result of the accrual in previous years of expenses attributable to the service supplied, so that income will be charged to it in the present year without the corresponding deductions. But that is a situation which is bound to occur where deductions are definite and ascertainable and receipts are indefinite and contingent. See Commissioner v. Thatcher & Son, supra. Moreover, there seems no way to avoid the conclusion that a determination in favor of petitioner would result in an equal or greater distortion of the previous year’s income in its own favor. This would be attributable to the action of petitioner itself in failing to accrue the amounts in question as income in the previous years. It was, of course, justified in that action if its situation was that described in Kentucky & Indiana Terminal Railroad Co. v. Commissioner, supra:

* * * It did not place these items upon its books or return them as accrued income in the Federal Control years. This omission was not the result of oversight. It arose from the uncertainty petitioner entertained as to its duty to return the items for those years.

But, if so, that demonstrates that in the earlier years the items wore so doubtful and uncertain that accrual would have been unjustified, and that only when that doubt and uncertainty was removed by settlement or payment would the inclusion in income be proper. Petitioner’s own treatment of the disputed items in failing to accrue them on its books, or to include them in its return, is persuasive evidence of the correctness of respondent’s position. See Moran v. Commissioner, 67 Fed. (2d) 601 (C. C. A., 1st Cir.); S. Rossin & Sons, Inc., 40 B. T. A. 1274.

Petitioner strenuously opposes the admission of evidence of the manner in which it treated these items on its tax returns for the earlier years. The question was raised by petitioner’s objection to the materiality of the stipulated evidence and by motion to strike, on both of which, pursuant to agreement of counsel, decision was reserved. We now rule that the evidence was admissible for the reason suggested in the foregoing comment. The treatment accorded by petitioner is material since it bears upon the frame of mind of its responsible officers contemporaneously with the disputed transactions and suggests the plausibility of the view that the amounts in question were too doubtful of collection to be treated as taxable income at that time. We see no reason to assume that the disposition of the matter for income tax purposes was erroneous. S. Rossin & Sons, Inc., supra. That this evidence might also bear upon the issue of estoppel if it were in the case does not militate against its materiality in other connections.

Finally, petitioner contends that respondent is guilty of an inconsistency in charging it with income in the years before us to the full extent of the rentals claimed. But it is by no means clear that the situation in the present years was the same as that involving the rentals prior to 1929. And, of course, the absence of evidence on this point must be judged in respondent’s favor. Whether respondent is inconsistent is a matter we need not decide. For, if he was wrong with respect to the later rentals, that question is not in issue, and it seems to us he was clearly right in his treatment of the rentals relating to the earlier years.

On this issue respondent’s determination is sustained.

Issue 2.

No facts relating to petitioner’s method of handling the gross earnings tax reserve on its books are in evidence, nor does it appear whether petitioner, being on the accrual basis, accrued its liability for these taxes on the basis of estimated future amounts represented by the charges to reserve. It does appear that the payment made in January 1934 was for gross earnings tax for the year ended October 31, 1933. But whether or not that or any other amount was accrued as tax liability during that prior year is not shown. Respondent contends that, in fact, the disputed item constitutes the adjustment of a deduction claimed by petitioner for a prior year and, hence, that the transfer of the amount from reserve to surplus represents income made available to petitioner in the present year and that it is taxable as such. The facts, if they exist, which would be necessai’y to rebut the prima facie correctness of respondent’s determination have not been produced. For that reason this issue must be determined in favor of respondent.

Issues 3 and 5.

All of tbe evidence on these issues is contained in the following excerpts from the stipulation:

[Issue 3.] The loss of $3,499.68, claimed by tbe petitioner on its return as abandonment, was not charged to the profit and loss account on the books of the petitioner but was charged against depreciation reserve, in accordance with the uniform system of accounts described by the Public Service Commission of New York.
[Issue 5.J For the year 1934 the Commissioner disallowed depreciation claimed by the petitioner on its return in the amount of $1,583.19, which disallowance was arrived at as follows: [Here follow detailed computations showing the amount disallowed in the sum of $1,583.19.]
For the year 1935 the Commissioner disallowed depreciation claimed by the petitioner on its return in the amount of $1,670.90, which disallowance was arrived at as follows: [Here follow detailed computations showing the amount disallowed of $1,670.90.]

It seems manifest that the facts upon which a consideration of these issues could be predicated according to the principle of Illinois Pipe Line Co., 37 B. T. A. 1070, relied upon by the petitioner on the third issue, or of any other authority, have not been placed before us. Petitioner seeks to amplify the stipulation by reference to the deficiency letter. However, no authority exists for us to treat this as evidence of the facts contained therein or to use it to supply material otherwise absent from the record. Charles F. Ayer, 7 B. T. A. 324; affd., 26 Fed. (2d) 547 (App. D. C.). Consequently, no factual basis is furnished for overruling respondent’s determination and it must be sustained.

Issue ⅛.

Expenses paid or accrued in a prior year and properly deducted from income at that time which are subsequently adjusted and refunded are proper additions to income in the year of receipt. The cases claimed by petitioner to demonstrate a contrary view may be distinguished as were those in Estate of William H. Block, 39 B. T. A. 338, 341; affd., 111 Fed. (2d) 60 (C. C. A., 7th Cir.); where the Board said :

* * * The holding in each of those cases was that the deduction was erroneously allowed in the first place and, since the year before the Board was that in which the original deduction was taken that original deduction was reduced by the later recovery. Those cases may be distinguishable upon the fact that there the original deduction was not properly allowed under the statute, whereas here the original deductions were proper. Furthermore, the solution given in those cases is an impractical one in many instances because the tax liability for the prior year had been closed before the recovery by the taxpayer of the amount originally claimed as a deduction.
Income tax liability must be determined lor annual periods on tbe basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs. No other system would be practical in view of the statute of limitations, the obvious administrative difficulties involved, and the lack of finality in income tax liability, which would result. The foregoing principles, which have been established by the following cases, require that the refund here be included in the income of this estate for the year of recovery.

There is no claim here that the insurance premiums were not properly deducted in the previous years, and, particularly considering the petitioner’s accrual basis, it is difficult to see how there could be grounds for any such claim.

On the authority of Estate of William H. Block, supra, and similar cases, respondent’s determination that the refunds of insurance premiums previously paid and properly deducted were income when returned to petitioner was correct and must be approved.

Decision will be entered imder Buie 60.


author: I&RN:

text:
    The Texas-Empire Pipe Line Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78604.
    Promulgated July 19, 1940.

      B. JEl. Bartholow, Esqfor the petitioner.

      John E. Marshall, Esq., for the respondent.
   OPINION.

I&RN:

Since the second question, whether the dividend distributed on November 30, 1932, the day before the liquidation of petitioner’s subsidiary, was a liquidating dividend, as respondent contends, or an ordinary one does not require extended consideration, we shall dispose of it now. If we should find it a liquidating dividend, it must be treated like the distribution admittedly made in liquidation of the corporation on December 1,1932. Section L15 (a) and (c), Eeve-nut Act of 1932, set out in the margin, is here involved.

The petitioner coni ends that llie November dividend was paid in accordance with a long established practice of its subsidiary to pay out all its earnings and profits every, quarter or half year. The dates of payment of these dividends and the company’s minutes authorizing the payments have ben set out fully in the findings. The revenue agent thought that the regularity of distribution indicated a general practice and that this last dividend was herefore not taxable, and the Interstate Commerce Commission likewise treated it as an ordinary dividend.

Eespondent relies on the presumptive correctness of his determination and on the Fifth Circuit Court’s decision in Canal-Commercial Trust & Savings Bank v. Commissioner, 63 Fed. (2d) 619, affirming 22 B. T. A. 541. Needless to say, we are not bound by the revenue agent’s opinion or by the Interstate Commerce Commission’s treatment of the dividend. In the Canal-Commercial Trust & Savings Bank case, the taxpayer received from a national bank $1,000,000 ostensibly as an ordinary dividend on December 30,1920. On December 21 the directors of the taxpayer had voted to liquidate the national bank, and on December 30 they had authorized the purchase of all assets and the assumption of liabilities of the national bank. On December 31, the day after the dividend in question was voted and paid to the taxpayer, the directors of the national bank voted to liquidate by transferring all its assets to the taxpayer. The national bank had previously, in the same year, declared and paid dividends in July and December. The two banks had interlocking directorates and the taxpayer owned 95 percent of the stock of the national bank. The court pointed out that the fact that the distribution was wholly from surplus and not from capital was not decisive, but merely evidential. The distributions in Hellmich v. Hellman, 276 U. S. 233, and Tootle v. Commissioner, 58 Fed. (2d) 576, where they were wholly from profits were, nevertheless, held liquidating dividends., As was said by the Supreme Court in Hellmich v. Hellman, supra, an ordinary dividend is “a distribution made by a going corporation to its shareholders in the ordinary course of business”, and in the Canal-Commercial Trust & Savings Bank case the Circuit Court thought that a distribution by a national bank of its entire surplus, 200 percent, was hardly compatible with it continuing in business. The final convincing fact was the arrangement made by the national bank’s 95 percent shareholder, the taxpayer, to buy the bank’s assets and to liquidate its stock at the very same time that the national bank should declare and pay its dividend; a fact which, said the court, “leaves no doubt that it had been determined in advance, and that the $1,000,000 authorized to be turned over on December 30th was but a step in the final liquidation accomplished on December 31st.”

The facts in the instant case are strikingly similar. Petitioner’s insistence that its subsidiary was making a regular distribution of current earnings is unconvincing in the circumstances. Its distributions had all been made for the three years last past at the end of each quarter of the calendar year, so that if petitioner’s theory be allowed, it would not sustain the ordinary dividend character of a distribution on November 30 which -would normally have been made only on December 31. The petitioner contends that liquidation here followed the dividend of November 30, and so it did, but by only one day. There is nothing to indicate that the petitioner on November 30 intended to keep its subsidiary in operation and then changed its mind on the morrow; and, in the absence of such evidence, we must assume that dissolution was in contemplation on the eve of its being put into effect, and this assumption leads inevitably to the conclusion that dividend and dissolution were part and parcel of the same' plan. We think that the Canal-Commercial Trust & Savings Bank case is controlling here, and hold accordingly.

We turn now to the question whether petitioner realized a gain, as respondent contends, or suffered a loss on the liquidation of its Illinois subsidiary. The essential question of the case, since the cost of the subsidiary’s assets is stipulated, is the fair market value of the assets on distribution to petitioner. There is a preliminary legal question, however, which we must dispose of first, for if petitioner’s contention with regard to it is sound, we need not proceed further.

Petitioner contends that its relation to its wholly owned subsidiary was substantially that subsisting between the taxpayer and its wholly owned subsidiary in Southern Pacific Railroad Co. v. Lowe, 247 U. S. 330, and that in determining the tax consequences of the transactions between it and its subsidiary the separate corporate entity of the latter must be ignored and disregarded. In that case, where a large surplus had been accumulated by the subsidiary before March 1, 1913, the first effective date of the new Federal income tax, and the parent corporation caused its subsidiary to declare a dividend from this surplus and to pay it by a credit against the taxpayer’s indebtedness to the subsidiary, the Supreme Court held that the dividend was not taxable to the parent corporation, basing its conclusion upon the fact that the income “in mere form only, bore the appearance of income accruing after that date [March 1, 1913], while, in truth and in substance, it accrued before; and upon the fact that the Central Pacific and the Southern Pacific were in substance identical because of the complete ownership and control which the latter possessed over the former, as stockholder and in other capacities.” The matter was treated as a “paper transaction”; and, so far as the dividends represented surplus of the Central Pacific accumulated before January 1, 1913, “They were not taxable as income of the Southern Pacific within the intent and meaning of the Act of 1913.” The Court was careful to point out in conclusion that “the case turns upon its very peculiar facts, and is distinguishable from others in which the identity of a controlling stockholder with his corporation has been raised. Pullman Car Co. v. Missouri Pacific Co., 155 U. S. 587; Peterson v. Chicago, Rock Island & Pacific Ry., 205 U. S. 364, 391.” Again, six months later, in December 1918, the Supreme Court reaffirmed in somewhat similar circumstances the same principle in Gulf Oil Corporation v. Lewellyn, 248 U. S. 71. There the taxpayer was a holding company owning substantially all the stock in the other corporations concerned, and decided in January 1913 to take over the previously accumulated earnings and surplus. The subsidiaries had invested their earnings in property necessary for the business and owed certain debts inter sese. The taxpayer by the transfer became the creditor of the subsidiaries and also the recipient of their earnings. The Court noted that the taxpayer did not itself do the business of its subsidiaries and have possession of their property, as in the Southern Pacific case, but thought that its principle must be taken to cover this case, saying “that the debts were all enterprise debts due to members, and that the dividends represented earnings that had been made in former years and that practically had been converted into capital.”

It will be observed that in both these cases a factor which weighed heavily with the Court and which is not present here was that the dividends distributed were from earnings accumulated before the effective date of the first income tax act.

After its decisions in the Southern Pacific & Gulf Oil Co. cases the Supreme Court has taken occasion in several later cases to limit expressly their effect to the special facts presented therein. Lynch v. Hornby, 247 U. S. 339; Burnet v. Commonwealth Improvement Co., 287 U. S. 415. In the latter case the Court said: “Southern Pacific Co. v. Lowe, supra, and Gulf Oil Corporation v. Lewellyn, supra (the latter covered in principle by the first), can not be regarded as laying down any general rule authorizing disregard of corporate entity in respect of taxation. These cases presented peculiar situations, and were determined upon consideration of them * * In view of these repeated and expressed limitations placed by the Supreme Court upon its decisions in these cases, we take it that they will only be applied to other cases having identical facts. From an examination of Burnet v. Commonwealth Improvement Co., supra, in the light of the recent decision of the Supreme Court in Higgins v. Smith, 308 U. S. 473, we consider the general rule to be that, if a taxpayer creates a corporation for its own purposes and enjoys advantages from the corporate life which it has created, then it must accept the tax consequences and the corporate entities will not be disregarded in order to save it from such consequences. It is our opinion that the instant proceeding should be governed by the general rule and is not subject to the narrow exception limited to the facts of Southern Pacific Railroad Co. v. Lowe, supra, and Gulf Oil Corporation v. Lewellyn, supra.

It need scarcely be pointed out that petitioner’s claim of a loss on the liquidating distribution of its subsidiary’s assets is at complete variance with its contention that parent and offspring were one for tax purposes. On its own theory, therefore, we could not allow the refund claimed. On the theory which we believe to be the correct one in the circumstances, that parent and subsidiary were distinct corporate entities for tax purposes, whether there was a gain or loss will depend upon the value of the assets of the subsidiary distributed in the taxable year. Serious consideration need not be given to the petitioner’s argument that there was here a de faoto merger of the subsidiary into the taxpayer such as happened in Helvering v. Metropolitan Edison Co., 306 U. S. 522, for the facts here will not sustain such a claim.

We turn, then, to the valuation question. There is no dispute over the basis for the computation, but only upon the correct method to be applied. Eespondent urges that the fair market value of the assets of the subsidiary as a going concern when distributed to petitioner on December 1, 1932, was $11,100,000. Two expert witnesses were put on the stand to sustain this contention. We shall examine later the method employed. ^Petitioner, on the other hand, argues (1) that its pipe line system as a whole (including the Illinois and Indiana assets received upon liquidation of its subsidiary) bad at the end of 1934, after the system had been thoroughly established, as its only intangible asset a going concern value of not more than $497,435; and that if it be assumed that a part of this intangible value could be attributed to the Illinois and Indiana assets on the basis of relative investments, the intangible value attributable to the Illinois and Indiana assets was not more than $203,948. This figure is reached by taking the Interstate Commerce Commission value for all of petitioner’s assets determined for 1934 of $14,503,918 (see Exhibit C) as the ultimate total, and computing going concern value (that is, as petitioner used the term, the element of intangible value derived solely from the operation of the subsidiary as a going concern and not this intangible value plus the value of the physical assets) by averaging original cost and reproduction cost, deducting depreciation, and deducting a further $75,000 for working capital. The petitioner next contends (2) that the physical assets received by petitioner on liquidation had no greater value than the cost of reproduction less depreciation, which it puts at $5,100,000; that (3) on the basis of sales of comparable assets within a short time of the period of liquidation, the assets received by petitioner were not worth more than $5,186,210.80. Finally (4) petitioner argues that if any intangible asset was received by petitioner on liquidation, it had no fair market value which could be determined and hence that no gain was realized. We shall examine these contentions more precisely after reviewing the respondent’s arguments, and need add only that petitioner denies that A. R. M. 34, C. B. 2, p. 31 (1920), or Hoskold’s formula has any application in the premises.

This great discrepancy in the calculation of fair market value on the basic date is accounted for wholly by respondent’s contention that the subsidiary’s assets had a going concern value on that date which would more than double their reproduction cost. There appears to be no material dispute on reproduction cost. This contention rests on the theory that there was an intangible value to be determined from the subsidiary’s earnings, which are set out in full in the stipulated findings.

Summarized, these findings show an average annual number of barrels of oil transported by the subsidiary in the 3 years next preceding the basic date of from 15 to 19% millions, the highest point being reached in 1931; and of these, an average number of barrels transported for others having no interest in either the subsidiary or petitioner of from 5% to 8% millions. The subsidiary’s net income, before deduction of Federal income taxes, in the same period ran from 11/2 to 2% million dollars. A detailed statement of its gross income and net income in those years may be found in the findings and need not be set out here. It is agreed that the pipe line had a daily capacity of 70,000 barrels, and a probable life of 20 years more, on an annual average of operation of not more than three-fourths of its maximum capacity.

The respondent urges that the Interstate Commerce Commission’s tentative report, agreed by the parties to be treated as final, as of December 31, 1934, which was, of course, made for rate-making purposes, does not measure the fair market value as of the basic date. The Interstate Commerce Commission valuation was $14,503,918 for all of petitioner’s assets, including the Illinois and Indiana assets of the subsidiary here in question. Eespondent points out that the petitioner made a protest against the lowness of this valuation, and petitioner responds that the protest was fro forma and merely to save to itself any rights in the future. The following paragraphs of petitioner’s protest are those relied on by respondent:

(4) Finding op Going-Concern Value Erroneously Omitted. — The carrier protests that the Commission while stating that it has given consideration to going-eoncern value, has failed to mate any finding of such value or to show to what extent, if at all, such value was taten into account in the determination of the final value found. Thus the Commission failed to give recognition to the requirement of law that there is an element of value in the assembled and established plant of this carrier, which was and is doing business and earning money, over one not thus advanced, and that such value should be separately shown and explained. It has by such error, greatly reduced the sum which it should find as the final value of the carrier’s property.
⅜ ⅜ * * * ⅛ *
(6) Final Value Erroneously Found. — The carrier protests that the Commission has erroneously found final value oí the carrier’s property in that: (a) such final value which it has determined is based, among other things, upon the erroneous findings and improper methods hereinabove described, and (b) such final value has been determined without reporting separately other values and elements of value, and an analysis of the methods of valuation employed, together with the reasons for the differences between such value and each of the cost values which the Commission has found. Thus the Commission has found final value of the carrier’s properties to be much less than their true value. More specifically the Commission (Page 7) has failed to show how much it has allowed for appreciation, depreciation, and going-concern value, in determining the final value found. It has likewise failed to state what is meant by “all other matters” which it refers to as having been considered. It attempts no explanation as to why its final value of property owned and used is $14,500,000 while its findings of original cost, cost of reproduction new, and cost of reproduction new less depreciation are different. The Commission further errs in restricting its finding of final value to final value for “rate-making purposes”, and thus fails to make the findings required by law. [Stipulation, Exhibit D, pp. 6-8.]

The authorities relied on by respondent to support this point will be discussed later.

The respondent then launches into the positive evidence adduced to sustain his theories. He put on the stand two expert witnesses. The first testified to a fair market value of $12,300,000, reached by disregarding 1929 and 1930 earnings on the ground that the pipe line was then not in full operation and did not become so until the new pumping stations were installed on November 1, 1930. He considered earnings for 1931 and 1932, deducted an estimated Federal tax at the rate of 13% percent (in force in 1932) and a further amount for expenses as a going concern, since all of the subsidiary’s operating expenses were paid by petitioner, and arrived at an average annual rate of $2,050,000, to which he applied a time-earning factor of 6. This factor was determined by consideration of market conditions on December 1, 1932, such as the yield of bonds of various classes and other factors relating to commercial paper, the earnings of companies which paid dividends without reduction in those years, and the market on which the company’s stock would have had to be sold if it had been an independent going concern at the time. This computation resulted in a time-earning factor of 8, for which he conservatively substituted 6.

The other witness testified to a fair market value of $11,100,000. He took stipulated net income for the eleven months of 1932, and on it computed average annual earnings for 1931 and 1932, which he found to be, before deduction for Federal taxes, $2,429,343. He took the average operating»capacity of 73⅜ percent in prior years, and the stipulated life of 20 years, based on a 75 percent maximum capacity operation, and concluded on these data that the average earnings for 1931 and 1932 Avere conservatively representative of the stipulated expectancy of the system. The next question was segregation of the subsidiary from petitioner’s system, one of the results of which would be a probable demand by the western line, by reason of its strategical situation in relation to the origin of shipments, of 20 percent of the tariff as a fee, with a consequent reduction of income; or in result that an average annual transportation revenue of $3,064,-025 would be reduced by $612,805. A further alloAvance of $50,000 Avas made for executive officers of the independent company, and an allowance for Federal taxes, and the final figure of $1,523,639 emerged as a reasonable expectation of future annual net earnings. Taking this figure, he applied Hoskold’s formula to obtain present worth. He stated that: “Therefore, on the basis of an economic life of 20 years, as stipulated, I have taken 20 times the anticipated income of $1,523,639, which amounts to $30,472,780 over a period of 20 years. Applying the factor for compound discount at 10 percent, sinking fund accumulation, and 3 percent compound interest over a period of 20 years of income at the same level, or the factor .36439, I have as a product indicating the present value of this business $11,103,976 * * jje summarized his final determination as follows:

That means this: Assuming that we have a willing buyer and a willing seller, the seller, that is, the parent company, is selling for $11,000,000 assets which it contends are worth $5,000,000, and having made that handsome profit, also will for the next 20 years receive commissions for business originated and delivered to this line annually of some $600,000.
So, it does not look like a disastrously bad deal for tbe seller.
On behalf of the buyer, it means he has expended $11,000,000 upon which he should receive annually earnings of $1,100,000 for a period of 20 years and still have left his $11,000,000 which does not seem like a bad deal for the buyer.

The respondent’s witnesses appeared to be fully qualified professionally to give expert testimony in such matters. The only fact raised by petitioner in derogation of their competence was that neither had even been engaged in the pipe line business.

The testimony of petitioner’s witnesses may be briefly summarized. J. L. Culbertson, petitioner’s chief engineer, testified solely as to replacement cost, and stated that he had never heard of any pipe line company paying more for a part of a pipe line system than its replacement cost in the condition at the time. C. M. Scott, chief engineer for another pipe line company, testified to the same general effect; and so did J. N. Hunter, general superintendent for another oil company. The petitioner’s evidence stops here, but in argument it raises the question of comparable sales of pipe line assets at about the same time, the only evidence of which is drawn from the Interstate Commerce Commission’s valuation reports put in evidence by petitioner solely to establish the valuation which the commission put upon the assets of petitioner’s subsidiary. Regardless of the admissibility of these reports for this purpose, however, we think that the data to be drawn from these reports are entirely insufficient to sustain any argument of “sales of comparable assets.” While the reports are competent evidence of the market value of such assets, if properly presented, the sales therein mentioned lose all significance unless all the vital factors, many of which are lacking, are known; and hence we do not stop to discuss them.

The whole question narrows down, therefore, to whether reproduction cost or going concern value is the proper method of determining the value of the subsidiary’s assets on the basic date. If the former is proper, the Interstate Commerce Commission’s valuation is of great importance; if the latter rate is proper, we think that respondent has fairly made his case.

There can be no doubt that, on the authorities, going concern value of the business as an organic whole, as opposed to the inert value of its several assets, and independent of franchises or good will, is recognized as real. Omaha v. Omaha Water Co., 218 U. S. 180; Des Moines Gas Co. v. Des Moines, 238 U. S. 153; McCardle v. Indianapolis Water Co., 272 U. S. 400; Los Angeles Gas Co. v. R. R. Commission, 289 U. S. 287. This is true for tax purposes as well as for rate-making purposes. The principle, as there applied in the case of a state direct property tax on a corporation doing an interstate business, was succinctly stated by Holmes, J., in Fargo v. Hart, 193 U. S. 490:

* * * On the other hand, it can tax property permanently within its jurisdiction although belonging to persons domiciled elsewhere and used in commerce among the States. And when that propei-ty is part of a system and has its actual uses only in connection with other parts of the system, that fact may be considered by the State in taxing, even though the other parts of the system are outside of the State. The sleepers and rails of a railroad, or the posts and wires of a telegraph company, are worth more than the prepared wood and the bars of steel or coils of wire, from their organic connection with other rails of wires and the rest of the apparatus of a working whole. This being clear, it is held reasonable and constitutional to get at the worth of such a line in the absence of anything more special, by a mileage proportion. The tax is a tax on property; not on the privilege of doing the business, but it is intended to reach the intangible value due to what we have called the organic relation of the property in the State to the whole system. Western Union Telegraph Company v. Taggart, 163 U. S. 1, 21, 22. * * *

Somewhat later the same great judge said, in Galveston, Harrisburg &c Ry. Co. v. Texas, 210 U. S. 217, 225, 227, which involves a state gross receipts tax:

* » * As the property of companies engaged in such commerce inay be taxed, Pullman’s Palace Car Co. v. Pennsylvania, 141 U. S. 18, and may be taxed at its value as it is, in its organic relations, and not merely as a congeries of unrelated items, taxes on such property have been sustained that took account of the augmentation of value from the commerce in which it was engaged. Adams Empress Co. v. Ohio State Auditor, 165 U. S. 194; S. C., 166 U. S. 171; Fargo v. Hart, 193 U. S. 490, 499. So it has been held that a tax on the property ahd business of a railroad operated within the State might be estimated prima facie by gross income, computed by adding to the income derived from business within the State the proportion of interstate business equal to the proportion between the road over which the business was carried within the State to the total length of the road over which it was carried. Wisconsin & Michigan Ry. Co. v. Powers, 191 U. S. 379.
* * * * * * *
* * * The State must be allowed to tax the property and to tax it at its actual value as a going concern. * * *

In the instant case petitioner collected the charges for transportation of crude oil at rates set out in published tariffs filed with the Interstate Commerce Commission and apportioned these charges between itself and its subsidiary on a pro rata mileage basis, with a credit on its books to the subsidiary for the share apportioned to it. These tariffs were substantially the same as other tariffs filed by other crude oil pipe line carriers in the Middle West area, the tariffs of railroad carriers being about 50 percent higher. The respondent points out that binding contracts for the transportation of oil were in effect on December 1, 1932, the basic date. On its contracts and under the tariffs in effect for the four years of its existence which ended on that day, the subsidiary had cleared operating profits of over $5,500,000. With these facts before him, the Commissioner emphasizes the necessity of applying the words of the statute, “fair market value,” and argues that earnings constituted an important element in that value. In so far as the petitioner’s argument that the value of the intangible interest, if any, was impossible to determine, it relies on what was said by Learned Hand, J., in Helvering v. Walbridge, 70 Fed. (2d) 683. We agree with respondent that any comfort to be taken from this decision was largely dissipated by the same learned judge a month later in Houghton v. Commissioner, 71 Fed. (2d) 656. The discussion of other cases cited we think idle, since, for the reasons already given, we regard the method used by the respondent as proper if it is applicable here.

We think that further discussion of a method of valuation so long accepted by the highest court as proper, or the multiplication of citations to support so well established a rule, is entirely unnecessary. Undoubtedly going concern value, determined by reference to earnings, is the proper method to be applied here unless the situation of the taxpayer and its parent corporation is so peculiar as to take it out of the operation of the general rule. Respondent’s method of valuation approved, we must also accept his computation of value; so that our sole question is whether circumstances justify the exception claimed. There is one point, however, upon which petitioner relies which must be disposed of before we proceed to the final question.

Petitioner throughout insists that the determination of the valuation of its entire assets by the Interstate Commerce Commission is binding on us. Its method of computation of the separate value of its subsidiary’s assets by apportionment of this total value has already been set out in our summary of its argument, including its treatment of a so-called “going concern value” which is radically different in nature from that to which respondent in argument addresses himself, and, by the same token, different from the measure used in numerous cases decided by the Supreme Court. We have already pointed out in our resume of the arguments that petitioner itself had strenuously objected to the Interstate Commerce Commission’s finding of value as insufficient, which objection it now says was merely pro forma. Whether it was so or not we need not now determine, for we have already concluded that the respondent’s method of using “going concern value” is to be preferred to reproduction value, which appears to be the basis of Interstate Commerce Commission value; and it remains only to say that that commission’s determination of value for rate-making purposes can not bind us in fixing value for tax purposes. Although the Interstate Commerce Commission and this Board are coordinate branches of the same Government, it does not need argument to show that the difference in our functions would not render wholly disparate valuation figures arrived at by widely distinct methods, in themselves contradictory. As we said in James Couzens, 11 B. T. A. 1040, 1161:

In any case such as this, requiring the determination under the income tax laws of value of property on March 1, 1913, the problem of valuation is ap-proaclied with little or no restriction arising from the purpose of the litigation. It is, for example, unlike a proceeding to determine the value in respect of which an interstate carrier or local utility is to have its rates regulated, the theory of valuation in such a case being considered in the light of its effect upon the more important ulterior problem of public rate regulation. Under section 202 of the revenue laws, the value to be ascertained is, in terms, absolute, the only purpose being to measure the tax by the gain above the value on March 1, 3913. * * *

To state petitioner’s argument in its proper perspective it is necessary once more to glance at the origins of petitioner and its subsidiary. In 1928 the Texas Corporation and the Empire Gas & Fuel Co., two corporations whose subsidiaries were producers of crude oil in the Mid-Continent belt, agreed to cooperate in the construction of a pipe line system, mainly to meet the requirements of their subsidiaries. On October 31 of that year they accordingly organized the petitioner, whose stock they halved between them and thereafter controlled, in order to carry out this purpose. The subsidiary of petitioner here in question was brought into being as an Illinois corporation on November 17, 1928, to act as a pipe line carrier in that state, the petitioner not having the legal power under Illinois law to exercise the right of eminent domain. Construction of a pipe line in Illinois and Indiana was accordingly started late in 1928 and finished in October 1929. The petitioner’s subsidiary owned, therefore, a portion of a much larger pipe line system, its own pipes beginning east of the center of the Mississippi River and extending into Illinois and Indiana, with six pumping stations in the former state, and tankage and general equipment in both states. These facts, petitioner contends, constitute the subsidiary’s system only a “plant facility”, a link in the greater system, which extended from Oklahoma to Illinois and Indiana, and was controlled by petitioner and petitioner’s corporate overlords. Petitioner’s subsidiary’s business was only what the subsidiary got from these overlords; it “originated no business, entered into no contracts for the transportation of crude oil, and had no contacts whatever with the public.” It did, indeed, have contracts with others, but these, petitioner says, were negotiated and controlled by petitioner. The Interstate Commerce Commission fixed tariffs for its carriage of oil, but this, petitioner says, was a mere bookkeeping matter, not a gauge or limitation on profits to the subsidiary. Its earnings, therefore, while taxable to it as income, were, so petitioner urges, merely the result of a more or less arbitrary apportionment on a straight mileage basis by its corporate owners, were returned to those owners as dividends, and in no way represented an intangible asset to the subsidiary. These earnings, since the subsidiary had no independent commercial existence, could add nothing to the value of the subsidiary’s physical assets. The capitalization of earnings as an intangible asset, it is said, can be made only where there is a reasonable expectation that those earnings will continue for a reasonably certain time, which is here fixed by the respondent as 20 years of the physical life of the assets. And, the argument continues, even if the future earnings could be accurately forecast, the assets of the subsidiary could not have been sold at a going concern value for the reason that future earnings, as past-earnings, would be derived solely from the subsidiary’s corporate owners. No purchaser could be found, in other words, to pay more than the reproduction value of the physical assets less depreciation, for he could not reasonably expect a return on his investment greater than the present value of the physical assets at the prevailing interest rate. Any attempt by the new owner, it is finally said, to extort higher rates from petitioner and its allied corporations, the sole users of the system, would be met, it is safe to conjecture, by the petitioner’s replacement of the old carrier by a new system.

This contention leaves out of account, it should be pointed out, the very important fact that for petitioner to have the advantage of reproduction cost in respect of its subsidiary, it must be assumed that it could have obtained the issuance by the Illinois Commerce Commission of a certificate of public necessity and convenience to build a new pipe line which could perform its own carriage contracts and thus avoid the extortionate demands of the purchaser of its old pipe line in that state. But petitioner has not shown that such a certificate would issue to it on demand. True, there is no evidence that it would not issue, but in matters involving a state’s public policy, where the act sought is discretionary and not ministerial, we may not lightly assume, without positive evidence, that any application will be granted. In view of respondent’s determination, the burden of presenting such evidence is upon petitioner. This it has failed to do. We do not rest our decision, however, on this ground alone, for a much more fundamental principle is here involved.

We have already indicated in our discussion of petitioner’s contention that the subsidiary’s liquidating dividend was to be treated as falling within the principle of Southern Pacific Railway v. Lowe, supra, that a basic principle of tax law, as declared in Burnet v. Commonwealth Improvement Co., supra, is that a corporation and its sole shareholder are to be treated as distinct entities. See Archibald R. Watson, 42 B. T. A. 52. Upon this rule we now have engrafted the doctrine of Higgins v. Smith, supra, that, where a natural person or a corporation has created or acquired control of another distinct tax entity, it may not avail itself of the legal separateness of personality of its creature from itself to save itself from the incidence of taxation. The Supreme Court said in that case:

The taxpayer cites Burnet v. Commonwealth Co. [287 U. S. 415] as a precedent for treating the taxpayer and his solely owned corporation as separate entities. In that case the corporation sold stock to the sole stockholder, the estate of P. A. B. Widener. The transaction showed a hook profit and the corporation sought a ruling that a sale to its sole stockholder could not result in a taxable profit. This Court concluded otherwise and held the identity of corporation and taxpayer distinct for purposes of taxation. In the Commonwealth Improvement Co. case, the taxpayer, for reasons satisfactory to itself voluntarily had chosen to employ the corporation in its operations. A taxpayer is free to adopt such organization for his affairs as he may choose and having elected to do some business as a corporation, he must accept the tax disadvantages.
On the other hand, the Government may not be required to acquiesce in the taxpayer’s election of that form for doing business which is most advantageous to him. The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.

We are of the opinion that that principle applies here; that the petitioner, having organized the subsidiary for its own purposes and presumably for its own advantage, may not plead the latter’s substantial identity with petitioner, the parent corporation, but must endure the tax consequences which flow from the existence of the two separate corporations. Having set up a pipe line company for its own purposes, regulated by tariffs approved by the Interstate Commerce Commission and sufficiently high to prevent rival producers from availing themselves of the new facility, but which in fact earned substantial revenue from outside contracts, petitioner may not be heard now to complain that the respondent regards its pipe line company, as it has chosen to treat it itself, as a distinct taxable entity, whose value must be determined according to the recognized method of valuing assets of corporations and not by an exceptional rule invoked at the parent corporation’s pleasure. No hardship, in fact, results from such a recognition of actualities and the revenue is saved from what would otherwise constitute an imposition.

We have therefore found as an ultimate fact that the assets of petitioner’s subsidiary had a fair market value of $11,100,000 on their distribution in liquidation to petitioner.

Eeviewed by the Board.

Decision will be entered under Rule 50.

Murdock and Mejxott concur only in the result.

AiruNDEnn did not participate in the consideration of or decision in this report.

       SECTION 115. DISTRIBUTION BY CORPORATIONS.
      (a) Definition of Dividend. — The term “dividend” when used in this title (except in section 203 (a) (4) and section 208 (e) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
      * ⅛ * ⅜ + * *
      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of section 112 (h) of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.