author: Murdock:

text:
    Estate of Cyrus H. K. Curtis, Deceased, John C. Martin and Mary Louise Curtis Bok, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86613.
    Promulgated November 17, 1937.

      Hugh Satterlee, Esq., Alfred S. Weill, Esq., Albert S. Lisenby, Esq., and Philip Zimet, Esq., for the petitioners.

      Brooks Fullerton, Esq., for the respondent.
   OPINION.

Murdock:

Section 23 (c) of the Revenue Act of 1932 allowed the estate of a deceased person, in computing its income tax liability, to deduct estate, inheritance, legacy, and succession taxes. The Revenue Act of 1934 changed this provision and allowed no such deduction. See section 23 (c) (3) of the Revenue Act of 1934. The Revenue Act of 1934 applies “only to taxable years beginning after December 31,1933” and does not affect taxes “for taxable years beginning prior to January 1, 1934”, except as it amends prior acts. See section 1 of the Revenue Act of 1934. The estate, which is the petitioner before the Board, paid Federal estate taxes and state inheritance taxes in large amounts on May 28, 1934. If the estate was entitled to use the fiscal year basis for reporting its income, these payments were made within the first fiscal year following the death of the decedent, and the estate is entitled to a deduction of the total amount of the taxes paid. But if the estate is required to report its income on the calendar year basis, then it is not entitled to the deduction because the payment was made during a taxable year beginning after December 31, 1933, which makes applicable the Revenue Act of 1934. Thus the question for decision is, Is this taxpayer entitled to report its income on the basis of a taxable year beginning at the date of the decedent’s death and ending approximately twelve months thereafter? If it is, then the calendar year 1934 was not a taxable year of this taxpayer and the Commissioner erred in determining a deficiency for that period. The Commissioner has not determined a deficiency for a fiscal year. There is no question before the Board of the petitioner’s tax liability for a fiscal year and the Board has no jurisdiction to determine any such question in this proceeding. If the Board decides in the petitioner’s favor,- it can' express its decision only by holding that there is no deficiency for the calendar year 1934.

An estate is, of course, a taxpayer under both acts. It could properly select as its first taxable year, the period beginning at the date of death of the decedent and ending on the last day of the eleventh succeeding month. In order to do that it would have to place its accounts on the basis of such a fiscal year. Both statutes provide that “the- net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer.” Sec. 41. Both acts also provide that the income shall be computed on the basis of a calendar year in cases where no books were kept, in cases where the taxpayer had no annual accounting period, and in cases where the taxpayer’s annual accounting period was other than a fiscal year. Sec. 41. A fiscal year is defined as an accounting period of 12 months ending on the last day of any month other than December. A taxable year means a calendar year or a fiscal year, upon the basis of which the net income is computed and includes, in the case of a return properly made for a fractional part of a year, the period for which the return was made. Sec. 48. A taxpayer may choose whether or not it will keep books, and, may further choose whether it will keep them on a calendar year basis or on a fiscal year basis. It has no choice in filing its returns, but must file in accordance with the method used in keeping its books.

The essential facts have been set forth above in findings, but a discussion of some of the evidence may be appropriate. The executors met shortly after the decedent’s death and agreed unconditionally to adopt as the accounting period for the estate a fiscal year ending May 31. The record leaves no doubt about that. This action was taken upon the advice of counsel. The executors knew that they would have to pay the Federal estate tax and the state inheritance tax within one year of the decedent’s death, securities of the estate would have to be sold for that purpose, the sales would probably be made at a considerable profit, and the market at that time was uncertain. They wanted as long a period as possible within which to make the sales. Counsel explained to the executors that, all things considered, and in order that the deduction for the taxes could be used to offset the profit from the sales in reporting the income of the estate, it would be desirable to select a fiscal year ending May 31, 1934. The executors and also the trustees who met with them, understood all of these considerations at the time in June 1933 when the fiscal year was agreed upon. Before December 31,1933, the attorneys for the estate realized that there might be further justification for the period which had been selected; that is, they knew that there were proposals before Congress to eliminate the deduction for Federal estate and state inheritance taxes which, under the Revenue Act of 1932, had been allowed an estate in computing its income tax. Neither the executors nor any others connected with the estate ever had any reason to want to change the decision reached in June adopting the fiscal year basis. This was true despite fluctuations in the market value of the securities of the estate. The circumstances of the filing of the return for the period ended December 31, 1933, have been set forth in the findings. That return was presented to Martin by one unfamiliar with the decision of the executors to place the accounts upon a fiscal year basis. Just because it was placed before him, Martin thoughtlessly executed it. He did not consider whether or not it would be a proper return for the estate nor did he consider its possible effect upon the fiscal year basis. Had he been thinking of these things, he would not have filed the return, for he had no intention to abandon the earlier decision to place the accounts of the estate upon a fiscal year basis. His coexecutor had never authorized him to file such a return. The execution and filing of the return was a mistake upon his part. In the latter part of May one of the attorneys, in going over the expenditures of the estate, discovered the check used to pay taxes on the return for the period ended December 31, 1933, and his inquiry disclosed the filing of the return for that period. All persons connected with the estate, when they heard about the filing, recognized that a mistake had been made. The Commissioner was notified to disregard it. Books of account upon the fiscal year basis were already in the process of preparation. The books were completed and closed before the end of the fiscal year. Those books were proper and adequate books and placed the accounts of the estate definitely upon a fiscal year basis. Thereafter, they were regularly kept on that basis and returns for that first fiscal year, as well as for subsequent fiscal years, were prepared and filed in accordance with those books of account.

The respondent contends that the acts of the executors up to and including March 15, 1934, were insufficient to establish a fiscal year ending May 31,1934, as the accounting period of the estate; the executors merely expressed an intention to adopt a fiscal year; they did not adhere to or carry out that intention; they had no books of account at December 31,1933, or on March 15,1934, and this failure was tantamount to an adoption of the calendar basis or, at least, required the filing of a return upon a calendar year basis; the return filed for the period ended December 31,1933, was a proper return and, thereafter, binding, upon the executors; and the ruling down of the books on May 31,1934, was not a keeping of books under a recognized method of accounting regularly employed.

The informal records kept by the secretary prior to April 24,1934, were not regular books of account and did not establish a fiscal year basis. H. L. Scales, 10 B. T. A. 1024; Max H. Stryker, 36 B. T. A. 326. Although the executors definitely and unconditionally decided to keep their accounts upon a fiscal year basis and never thereafter considered any different basis, mere intention is not enough. Iron Mountain Oil Co. v. Alexander, 37 Fed. (2d) 231. Failure to currently record daily transactions in formal books is not necessarily inconsistent with the petitioner’s contention in this case. The words “regularly employed” used in section 41 do not require that the bookkeeping method be uniform throughout every day of the taxable year. The action of these executors in waiting as long as they did to open their formal books was not unreasonable under the circumstances. The informal records which they kept from the beginning were not inconsistent with the establishment of a fiscal year basis, as is shown by the fact that regular books of account were later drawn up from those very records. The executors did adhere to and finally carry out their original intention to place their accounts upon the fiscal year basis. This taxpayer, before the end of the fiscal year, was regularly keeping its books upon the basis of a fiscal year ended May 31, 1934, within the meaning of section 41.

The respondent cites no authority for his contention that the failure to have regular books on December 31, 1938, or on March 15, 1934, precludes a taxpayer from using a fiscal year basis. His rulings are to the contrary and require only that the books be kept upon the selected basis before the close of the first fiscal year. O. D. 404, 2 C. B. 67, published in 1920 and still in effect, is in part as follows:

A newly organized corporation may file its * * * returns on a fiscal year basis without applying to the Commissioner for permission to do so, provided such basis is definitely established and the books are kept in accordance therewith prior to the close of the first fiscal year.

The essentials mentioned in the regulations promulgated under the Revenue Acts of 1932 and 1934 are that before the close of the fiscal year the accounting period must be established and the books must be kept in accordance therewith. Regulations 77, article 324 and Regulations 86, article 41-4, provide:

No fiscal year will, however, be recognized unless before its close it was definitely established as an accounting period by the taxpayer and the books of such taxpayer were kept in accordance therewith.

The present petitioner has met the requirements of these rulings and regulations.

Taxpayers are required to make a number of elections under the revenue acts. For example, a husband and wife must elect whether they will file a joint return or separate returns; affiliated corporations must elect between a consolidated return and separate returns; and installment sellers may elect to take the benefit of reporting their profits on the installment basis. The statutes do not expressly provide that an election, once made, is binding. But the Board and the courts have held under some circumstances that once a taxpayer has made an election, he may not thereafter change to the other position. Rose v. Grant, 39 Fed. (2d) 340; certiorari dismissed, 283 U. S. 867; Lucas v. St. Louis Baseball Club, 42 Fed. (2d) 984; certiorari denied, 282 U. S. 883; Levi Strauss Realty Co. v. United States, 41 Fed. (2d) 55; certiorari denied, 282 U. S. 868; Alameda Investment Co. v. McLaughlin, 33 Fed. (2d) 120; Commissioner v. Moore, 48 Fed. (2d) 526; certiorari denied, 284 U. S. 620; Sylvia S. Strauss, 33 B. T. A. 855, affirmed without opinion; Liberty Really Corporation, 26 B. T. A. 1119; Radiant Glass Co., 16 B. T. A. 610; affd., 54 Fed. (2d) 718; Kay Manufacturing Co., 18 B. T. A. 753; affd., 53 Fed. (2d) 1083. Those decisions were justified on the ground of administrative necessity, that is, that changing back and forth by taxpayers would unduly inconvenience the Commissioner in the orderly administration of the revenue acts. There have been cases in which the original election was not held binding. See the excellent discussion in McIntosh v. Wilkinson, 36 Fed. (2d) 807. See also Lucas v. Sterling Oil & Gas Co., 62 Fed. (2d) 951. Hobson’s Choice in Federal Taxation, vol. 48, Harvard Law Review, p. 1281, is also interesting.

The present taxpayer had an election, but the election was not between two returns, calendar or fiscal year returns. The election which the petitioner had under the statute was whether its annual accounting period and its method of accounting would be upon the basis of a fiscal year or upon the basis of a calendar year. It made that election in June 1933, and never departed from it. Not only does it not seek to avoid the effect of its election, but, on the contrary, argues that it was a binding election. In accordance with its election and before the end of the fiscal year, it completed its books of account upon that basis and forever after regularly employed the same basis and method of accounting in keeping its books. The filing of a return for the period ended December 31, 1933, by a taxpayer which kept only informal records, would ordinarily indicate that it had no intention of placing its books upon a fiscal year basis and that any earlier decision to place its accounts upon a fiscal year basis had been abandoned. But in this case the filing of that return has been explained and the evidence is clear that by filing that return the. taxpayer had no intention of abandoning its earlier decision to place its accounts upon a fiscal year basis. In Great West Printing Co. v. Commissioner, 60 Fed. (2d) 749, the court said:

The test is the year (fiscal or calendar) actually used in the business and shown by the books, and not the possibility of the use of some other annual period. Nor has the filing of a tax return any significance because the statute leaves no option as to that to the taxpayer if his books are kept on a particular annual basis. The taxpayer might have based his accounting period upon any annual period, closing with the end of any month, but it is upon this method actually so selected by the taxpayer that the statute automatically operates.

See also Helvering v. Brooklyn City Railroad, Co., 72 Fed. (2d) 274.

Thus the filing of the return for the period ended December 31, 1933, did not constitute an election permitted or required by the statute. That return, as later events conclusively demonstrated, was not in accordance with the method of accounting regularly employed in keeping the books of the taxpayer. The fiscal year return was in accordance with the method of accounting regularly employed in keeping the books of the taxpayer. The statute requires that the net income shall be computed upon the basis of the taxpayer’s annual accounting period. In this case that period was a fiscal year ended May 31, 1934. The return filed for the short period was a mistake. It does not appear that the Commissioner was in any way inconvenienced by that mistake, however, and there is no good reason to hold the taxpayer to a calendar year basis. There is no indication that the orderly administration of the revenue acts would be at all affected by permitting this taxpayer to wait until near the close of the first 12 months of its existence before actually preparing a formal set of books upon a fiscal year basis. The Commissioner does not contend that the method employed does not clearly reflect the income of the taxpayer. Since the books were prepared upon the fiscal year basis prior to the close of the fiscal year and within a time which seems reasonable under the circumstances, the filing of a return for the fiscal year was required under the law.

Reviewed by the Board.

Decision will be entered for the petitioner.


source: Caselaw Access Project

author: Smith: Hill,

license: Public Domain

text:
    Hazleton Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61954.
    Promulgated November 23, 1937.

      Robert A. Young, Esq., and John G. Altman, Esq., for the petitioner.

      Dean P. Kimball, Esq., and Dewey L. Shepherd, Esq., for the respondent.
   OPINION.

Smith:

In this proceeding the petitioner contends that the dividends of $611,825.76 and $5,547.50 received by it from the Delaware corporation on June 1 and June 6, 1928, respectively, constituted “taxable dividends” received by it from the Delaware corporation, within the meaning of section 112 (c) (2) of the Revenue Act of 1928, which it is entitled to deduct from its gross income under section 23 (p). It also contends that any gain realized by it from the exchange of shares of stock of the Delaware corporation for shares of stock of the Nevada corporation on June 6 is not to be recognized for tax purposes in accordance with section 112 (b) (3) of the Revenue Act of 1928. We shall first consider the reorganization issue.

The petitioner submits:

(1) There was a statutory “reorganization [of the Delaware corporation]”;
(2) There was an exchange by petitioner of stock of old United [Delaware corporation] for stock of new United [Nevada corporation] in pursuance of a plan of reorganization which exempted such exchange from taxation under the provisions of Section 112 (b) (8).
(3) The distributions of cash and accounts receivable were made in pursuance of the plan of reorganization and had the effect of the distribution of a taxable dividend within the meaning of Section 112 (c) (2).

The basis for the respondent’s objection to the petitioner’s contentions is that there was no reorganization of the Delaware corporation ; that it was contemplated prior to May 11,1928, that the Nevada corporation would be organized and that the Delaware corporation and the California corporation would transfer assets to the Nevada corporation in exchange for shares of stock to be issued by that corporation; that such reorganization was not completed until on or about June 21,1928, at which time neither the Delaware corporation nor its shareholders had control of the Nevada corporation.

Section 112 (i) of the Revenue Act of 1928 provides as follows:

(i) Definition of reorganization.—As used in this section and sections 113 and 115—
(1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred * * *
(2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.

We think that the evidence clearly shows that there was a reorganization of the Delaware corporation within the meaning of both clause (A) and clause (B) of section 112 (i). The Delaware corporation transferred all of its operative assets to the Nevada corporation in exchange for all of the shares of stock of the Nevada corporation. Neither the California corporation nor the Oliver interests were parties to the reorganization. The Delaware corporation remained in control of the Nevada corporation until it was dissolved, when the control passed to the petitioner, which then remained in control until June 27, 1928. This constituted a reorganization of the Delaware corporation under both clause (A) and clause (B). See Gross v. Commissioner, 88 Fed. (2d) 567; Helvering v. Minnesota Tea Co., 296 U. S. 378; Nelson Co. v. Helvering, 296 U. S. 374; Helvering v. Watts, 296 U. S. 387; Helvering v. Winston Brothers Co., 76 Fed. (2d) 381; J. M. Harrison, Inc., 30 B. T. A. 455.

Under the plan of reorganization the Delaware corporation was to distribute all of its assets to its stockholders. In pursuance of that plan it declared a dividend on May 17 of $64.96 per share payable to its stockholders of record on June 1. After such distribution it had only a small amount of cash on hand. It also, pursuant to the plan of reorganization, distributed its remaining cash and turned over to its stockholders all of the shares of stock of the Nevada corporation in exchange for the outstanding shares of its own stock.

The petitioner is a foreign corporation. Under the reorganization provisions of the Revenue Act of 1928, a foreign corporation is not to be treated differently from a domestic corporation. The dividends paid by the Delaware corporation and received by the petitioner in the amounts of $611,825.76 on June 1, and $5,547.50 on June 6, 1928, wore paid out of the accumulated earnings of the Delaware corporation. Such dividends constitute distributions which have the effect of taxable dividends received by it under section 112 (c) (2). Being dividends, they are deductible from the gross income of the petitioner under section 23 (p) of the taxing statute.

The respondent objects to this conclusion, contending that the dividends received by the petitioner from the Delaware corporation are not “taxable dividends” within the meaning of section 112 (c) (2). He takes the position that inasmuch as a corporation is entitled to deduct from gross income dividends received by it from domestic corporations it is not taxable upon them and hence that they do not constitute “taxable” dividends to it.

This argument of the respondent is directly opposed to Commissioner v. Forhan Realty Corporation (C. C. A., 2d Cir.), 75 Fed. (2d) 268; and Rose v. Little Investment Co. (C. C. A., 5th Cir.), 86 Fed. (2d) 50, which we think correctly construe the statute. In the last named case the court stated:

* * * The phrase “a taxable dividend” means only that the distribution is . of profits and not of capital, and of profits accumulated since February 28, 1913. and thus in nature and in history subject to income tax. * * *

To the same effect see Commissioner v. Owens (C. C. A., 5th Cir.), 69 Fed. (2d) 597; and George Woodward, 23 B. T. A. 1259.

The respondent submits that “the two cash distributions made to petitioner by United Filters Corporation [Delaware corporation] were payments in liquidation of its stock and are taxable as liquidating dividends.”

Section 115 (c) of the Revenue Act of 1928 provides:

(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. * * *

It will be noted that the gain or loss to the distributee resulting from distributions in liquidation “shall be recognized only to the extent provided in section 112.” We think it a fair inference from the evidence of record that the cash distributions made by the Delaware corporation were distributions in liquidation of that corporation. At the meeting of the board of directors of that corporation on May 17, 1928, a dividend of $64.96 per share payable to the stockholders of record on June 1, 1928, was declared. Immediately thereafter the board of directors adopted a plan of reorganization which provided for the dissolution of the Delaware corporation. We have found as a fact that there was a reorganization of the Delaware corporation within the purview of section 112 (i) of the taxing statute. The declaration of the dividend on May 17 was incident to such reorganization. It was a part of the plan of reorganization. Likewise, the distribution of the remaining cash voted by the former directors of the Delaware corporation on June 5 and received by the petitioner on June 6 was a part of the plan of reorganization.

We think it is clear that it was the purpose of Congress to treat as taxable dividends to the recipients dividends paid by a liquidating corporation, a party to a reorganization, out of earnings which had been accumulated subsequent to February 28, 1913. Since the two dividends received by the petitioner on June 1 and June 6 in the amounts of $611,825.76 and $5,547.50, respectively, were taxable dividends to it, they constitute legal deductions from the gross income of the petitioner under section 23 (p).

The contentions of the petitioner with respect (1) to the dividends received by it from the Delaware corporation, and (2) to its claim that the gain realized by it from the exchange of shares of stock of the Delaware corporation for shares of stock of the Nevada corporation is not recognized for tax purposes under section 112 (b) (3), are sustained.

The remaining question for consideration is whether the petitioner derived taxable gain from the sale by it on June 27, 1928, of shares of stock of the Nevada corporation. Admittedly the petitioner realized a gain from the sale. The petitioner contends, however, that the sale was made outside the United States and that the gain is not subject to United States income tax.

Upon this point it is to be noted that the petitioner is a foreign corporation. The shares of stock of the Nevada corporation owned by it were personal property. A foreign corporation is liable to income tax upon income derived from sources within the United States. Section 119 of the Revenue Act of 1928 provides in part:

(e) Income from sources partly within and, partly without United States.— * * * Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property without and its sale within the United States, shall he treated as derived entirely from sources within the country in which sold, * * *
(f) Definitions.—As used in this section the words “sale” or “sold” include “exchange” or “exchanged”; * * *

The rule is well established that title to property passes at the place of sale where the final act of the seller making effective the sale takes place. Compania General v. Collector, 279 U. S. 306. In East Coast Oil Co., S. A., 31 B. T. A. 558, 561; affd., 85 Fed. (2d) 322, the Board said: “the place of sale is where the final act of the seller, causing title to pass, was done.”

The petitioner contends that it sold 46,858 shares of A stock and 42,058 shares of B stock of the Nevada corporation to the Bank of Montreal, which in turn sold the shares to the bankers in San Francisco. The respondent strenuously contends that this was not a bona fide sale and that the transfer of the shares to the bank of Montreal was for accommodation only. In its brief the petitioner argues that it is immaterial whether the Bank of Montreal be considered as principal or as agent in effecting the sale to the bankers; that in any event the sale to the bankers was made in Canada on June 27. From a consideration of the entire record, we are of the opinion that the Bank of Montreal should be regarded only as agent of the petitioner in effecting the sale to the bankers, although the evidence shows the payment of transfer taxes in Canada upon the transfer of the shares from the petitioner to the Bank of Montreal.

Up to the time of the sale by the petitioner of 46,858 shares of A stock and 42,058 shares of B stock of the Nevada corporation the petitioner was clearly the owner of those shares. Certificates for all of the holdings of the petitioner in the Nevada corporation were on deposit with the Bank of Montreal, Montreal, Canada. The petitioner through R. A. Young, its attorney, negotiated the sale of these shares to bankers in San Francisco. He made it very clear to them, however, that the sale must take place in Canada and not in the United States. The bankers made the Royal Trust Co. of Montreal, Canada, their agent for the purchase of them. They authorized the Royal Trust Co. as their agent to purchase the shares for them. They sent to the Ottawa branch of the Royal Trust Co. funds with which to acquire the shares. The Royal Trust Co. paid the money to the Bank of Montreal at Ottawa for the purchase of the shares and the Bank of Montreal turned over to the Royal Trust Co. at Ottawa certificates for the shares. The Royal Trust Co. had been given authority by the Nevada corporation to write the word “cancelled” across the face of each of the certificates and to advise the proper parties in San Francisco as soon as it had made the purchase. It advised the proper parties in San Francisco of the purchase of the shares and of its action in canceling the certificates and immediately thereafter the Nevada corporation caused new certificates to be issued to take the place of those purchased by the Royal Trust Co. and canceled pursuant to the authority given.

The respondent contends that by reason of the fact that the bankers were to receive the reissued certificates in San Francisco the actual sale was made within the United States.

We think it is clear from the evidence that it was the intention of all parties concerned that the petitioner should part with all of its right, title and interest in and to the shares of the Nevada corporation in question by the delivery of the certificates for the shares to the Royal Trust Co. The rule is well established that in the case of a sale of corporate stock title passes with the delivery of certificates for the shares to the purchaser, where that is the intention of the contracting parties. Johnston v. Laflin, 103 U. S. 800; Early v. Richardson, 280 U. S. 496. In Powers v. Pacific Diesel Engine Co., 206 Cal. 334; 274 Pac. 512, it is stated:

It is common knowledge that, as between the parties to the transaction, the property in shares of stock customarily passes in the ordinary and regular course of trade by delivery of the certificates indorsed in blank by the person to whom the certificate purports on its face to have been issued. * * *

To the same effect is McNeil v. Tenth National Bank, 46 N. Y. 325.

The subsequent reissuance of certificates for the shares by the Nevada corporation in San Francisco was solely for the purpose of enabling the bankers to get immediate possession of certificates for the shares, and had nothing to do with effecting the sale. Neither was it material that the Bank of Montreal made it a condition of its acting as intermediary that the purchase price of the securities should not be released to the petitioner until it had been advised by the bankers that they had received the reissued certificates.

Since the evidence clearly establishes that the petitioner sold its shares of stock in the Nevada corporation in Canada, and not in the United States, the profit realized from the sale is not subject to Federal income tax.

In the drafting of the bill which later became the Revenue Act of 1932, Congress realized that a very “serious loophole for avoidance of taxes” existed under the Revenue Act of 1928. This is clearly apparent from the report of the Ways and Means Committee to the House of Representatives accompanying the bill which later became the Revenue Act of 1932. In this report (Rept. No. 798, 77th Cong., 1st sess., p. 20) it is stated:

Property may be transferred to foreign corporations without recognition of gain under the exchange and reorganization sections of the existing law. This constitutes a serious loophole for avoidance of taxes. Taxpayers having large unrealized profits in securities may transfer such securities to corporations organized in countries imposing no tax upon the sale of capital assets. Then, by subsequent sale of these assets in the foreign country, the entire tax upon the capital gain is avoided. For example, A, an American citizen, owns 100,000 shares of stock in corporation X, a domestic corporation, which originally cost him $1,000,000 but now has a market value of $10,000,000. Instead of selling the stock outright A organizes a corporation under the laws of Canada to which he transfers the 100,000 shares of stock in exchange for the entire capital stock of the Canadian company. This transaction is a nontaxable exchange. The Canadian corporation sells the stock of corporation X for $10,000,000 in cash. The latter transaction is exempt from tax under the Canadian law and is not taxable as United States income under the present law. The Canadian corporation organizes corporation Y under the laws of the United States and transfers the $10,000,000 cash received from the sale of corporation X’s stock in exchange for the entire capital stock of Y. The Canadian corporation then distributes the stock of Y to A in connection with a reorganization. By this series of transactions, A has had the stock of X converted into cash and now has it in complete control. [Italics supplied.]

Subsection (k) of section 112 of the Revenue Act of 1932 was designed to cure the defect in the earlier statute. It reads as follows:

SEC. 112. RECOGNITION OF GAIN OR LOSS.
*******
(k) Foreign Corporations.—In determining the extent to which gain shall lie recognized in the ease of any of the exchanges or distributions (made after the date of the enactment of this Act) described in subsection (b) (3), (4), or (5), or described in so much of subsection (e) as refers to subsection (b) (3) or (5), or described in subsection (d) or (g), a foreign corporation shall not be considered as a corporation unless, prior to such exchange or distribution, it has been established to the satisfaction of the Commissioner that such exchange or distribution is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

It will be noted that the amendment made by the Revenue Act of 1932 was effective from the date of the enactment of that act. It was never designed to be applied retroactively.

A case bearing some resemblance to the proceeding at bar is Kaspare Cohn Co., Ltd., 35 B. T. A. 646. There a Canadian corporation had been formed for the purpose of effecting a sale of securities of domestic corporations. The respondent held both the Canadian corporation and a domestic corporation taxable upon the profit realized upon the sale. Upon the evidence before it the Board held that the Canadian corporation was a mere agency or instrumentality of the real owner of the stock, and that the domestic corporation, and not the Canadian corporation, was taxable upon the profit realized from the sale. The Panama corporation, the petitioner in the proceeding at bar, was not a mere agency of the Delaware corporation and its stockholders.

We do not have before us in this proceeding either the Delaware corporation or its stockholders. Whether or not they might be liable to income tax upon profits realized from the sale by the petitioner to the bankers in San Francisco of the shares of stock of the Nevada corporation is a question likewise not before us. Since the respondent has not determined deficiencies against either the Delaware corporation or its stockholders, who might be considered the parties in interest, the opinion of the Board in Kaspare Cohn Co., Ltd., supra, is not controlling here.

Reviewed by the Board.

Judgment will be entered under Rule 50.

VAN Fossan dissents.

Hill,

dissenting: I can not agree with the finding and conclusion of the majority of the Board that petitioner sold the stock of United Filters, Inc. (the Nevada corporation) in Canada and that the profits thereon are nontaxable by the Government of the United States. I believe that the facts show that the sale was made in the United States and that a tax liability was incurred.

The whole purpose of the complicated scheme employed by the officers and stockholders of the Delaware corporation (the United Filters Corporation) to effect a sale of the assets and business of that corporation or of its capital stock to the Oliver Continuous Filter Co. (the California corporation) or to its stockholders was concededly to avoid the payment of taxes in the United States by the Delaware corporation or its stockholders on the profits of such sale.

The terms of the sale and the purchase price to be paid were in all essential respects agreed upon directly between the Delaware corporation and the California corporation before any plan was initiated by the seller to effectuate a tax-free transaction. Had the sale been consummated, as it was initiated, directly from the Delaware corporation to the California corporation, the Delaware corporation or its stockholders would have incurred large tax liabilities. The California corporation would not have incurred any tax liability through such purchase and its accession to the arrangement proposed by the seller was solely in the interest and for the accommodation of the latter. The officers and stockholders of the Delaware corporation organized the Nevada corporation and the petitioner. The Bank of Montreal and the Royal Trust Co. of Canada were selected by the petitioner as agencies to carry out its plan to give to the sale of the Nevada corporation stock the appearance of having been consummated in Canada. These institutions acted under the direction of petitioner and were its agents in effectuating this purpose.

The petitioner first designated the Bank of Montreal at Montreal to be the channel through which to transfer the Nevada corporation stock to the California purchaser and then, because of certain provincial taxes, changed the designation to the Bank of Montreal at Ottawa. It is apparent from the record that it was never the intention of the petitioner or the Bank of Montreal that the latter should be other than the channel through which petitioner should transfer 'title to the stock in question to the purchaser in California. The stock was registered in the name of two nominees of the Bank of Montreal as custodians thereof for petitioner. The stock was never registered in the name of the Bank of Montreal or its nominees as owner. The petitioner told the bankers of San Francisco, representing the California purchaser, to deal through the Royal Trust Co. of Montreal, Canada, in purchasing the stock. The Royal Trust Co. was an agency of the petitioner, not of the purchaser, and was part of the channel provided by petitioner through which to convey the stock to the California purchaser. There is nothing in the record to indicate that the Royal Trust Co. received any compensation from the purchaser for its services in connection with the transaction. The bankers of San Francisco did not select the Royal Trust Co. to act for them. They dealt with petitioner through it because petitioner told them to do so. Immediately upon receipt of the Nevada corporation stock from the Bank of Montreal, the Royal Trust Co. canceled it by authority of the Nevada corporation and advised the vice president of that corporation in San Francisco thereof by telegraph. Thereupon the vice president reissued the stock and delivered it to the bankers of San Francisco. When the Royal Trust Co. canceled the certificates received from petitioner through the nominees of the Bank of Montreal, petitioner’s custodian thereof, it acted as agent of the Nevada corporation, which was under the complete domination of petitioner. The Royal Trust Co. was the agent of petitioner, and its possession of the certificates of stock was the possession of petitioner and not of the bankers of San Francisco or of the California corporation.

The deal for the sale of the stock was not consummated and title thereto did not pass from petitioner until the reissued certificates of stock were delivered “in acceptable form” to the bankers of San Francisco. The petitioner agreed that the purchase money for the stock should not be released to it until the reissued stock certificates were so delivered and, in fact, the purchase money was not so released until the delivery of the stock was made (in acceptable form) in San Francisco, California. Not until the stock was so delivered and the purchase money released to petitioner was the sale consummated, for it could not be determined whether the stock was “in acceptable form” until the certificates were presented to the bankers of San Francisco. This was done in San Francisco. The Nevada corporation, through its vice president, delivered the stock in California and it was there that title thereto passed from petitioner to the purchaser.

The money that was paid to the petitioner for the stock was the money transmitted to Canada by the bankers of San Francisco for that purpose. This money remained the property of the bankers until it was released to the petitioner. The Royal Trust Co. never had title to that money. It was not for its protection, but for the protection of the bankers of San Francisco, that the money was not released to the petitioner until the reissued stock was delivered. The Royal Trust Co. was not recognized by petitioner as having any interest in the release of the money or the delivery of the stock. It is obvious from the record that neither the petitioner, the Bank of Montreal, the Royal Trust Co., nor the bankers of San Francisco intended that the Bank of Montreal or the Royal Trust Co. should become the owner of the stock, but that the sole purpose of all the parties connected with the transaction was to transfer title to the stock from petitioner to the bankers of San Francisco and that the Bank of Montreal and the Royal Trust Co. were brought into the deal only to give to the transaction the appearance of a sale by petitioner in Canada to avoid a tax liability in the United States. There was no substance in that arrangement.

The petitioner had placed in escrow with the Bank of Montreal of San Francisco 1,771 shares of class A stock and 117,777 shares of class B stock of the Nevada corporation, to be issued and delivered to the Oliver Continuous Filter Co. as soon as the bankers had paid for and secured title to the shares of stock being purchased from petitioner. The California corporation also placed with the Bank of Montreal (San Francisco) a bill of sale and deeds to all its properties to be delivered to the Nevada corporation as soon as the bankers had acquired the shares of the Nevada corporation from the petitioner.

Delivery was not made under this escrow agreement until after the reissued stock had been delivered to the bankers of San Francisco and the money therefor released to petitioner. Thus both the petitioner itself and the purchaser of the stock construed the deal for the stock as having been closed only when the reissued stock was delivered in San Francisco and the purchase money therefor released to petitioner.

I respectfully submit that the finding and conclusion should be that petitioner sold the stock in the United States and incurred a tax liability by reason of a gain realized thereon, represented by the difference between $1,966,000, the sale price, and $747,944.52, the statutory cost basis of the stock.

Mellott and Arnold agree with this dissent.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.

        ****** *

      (b) Exchanges solely in kind.—
      ****** *
      (3) Stock for stock on reorganization.—No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * * * * * * *
      (c) Gain from exchanges not solely in kind.—
      (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
      (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.


author: Smith :

text:
    Nellie S. Alexander, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78995.
    Promulgated November 23, 1937.

      R. M. Stroud, Esq., for the petitioner.

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

Smith :

This proceeding is for the redetermination of a deficiency of $1,183.76 in petitioner’s income tax for 1932. In her return for that year the petitioner reported a net income of $9,500.13, including $8,346.33 of “fiduciary income” from a trust of which she was life beneficiary. In determining the deficiency herein the respondent has increased the fiduciary income reported by the petitioner by the amount of $10,062.50, representing a loss which the trust sustained on the sale of capital assets. The correctness of that adjustment, that is, whether the capital loss of $10,062.50 should be taken into account in computing the distributable income of the trust, is the only question in issue in this proceeding.

The facts are stipulated. By a trust indenture dated December 31, 1929, the petitioner, a resident of Miami, Florida, created the “Nellie S. Alexander Trust,” transferring to her husband, John Alexander, trustee, her credit balance of $325,000 with the Marathon Investment Co., a Delaware corporation, whose stock was all owned by the Alexander family. The petitioner herself owned about 20 percent of the stock. The Marathon Investment Co. held the shares of stock of a number of lumber companies with which the Alexander family had been long identified and also a substantial amount of marketable securities.

The trust indenture provided in paragraph first that during the petitioner’s lifetime the trustee should “pay the income of said trust estate to her in annual, semi-annual or quarterly installments as may be most convenient for the due and careful management of the said Trust.” After the death of the petitioner the income of the trust was to be paid:

* * * in equal shares to her four children during their lives, or to the survivors of them if any child shall die without issue. If any child shall die leaving issue then the share of income which would have been payable to such child if living shall be divided equally between such issue.
Third : Upon the deaths of said children or any of them leaving issue, the said share of income shall be paid to such issue as aforesaid for a period of twenty-one years from the date of the death of last surviving child of the party of the first part, when and whereupon the corpus of said Trust Fund shall be distributed per stirpes in equal shares to the issue of said deceased children and this Trust shall then cease. Should there be no issue of any deceased child and issue of other deceased children then the share of income which would have gone to the deceased child in his or her lifetime shall be paid to the surviving brothers and sisters and the issue of deceased child or children in equal shares by representation and not per capita.

The trustee was given “unrestricted power over the income and principal of said trust fund except as above” and was authorized to invest the trust fund without regard to legal restrictions. The .trustee was not permitted to make any advance payments to the beneficiaries of either income or principal.

Immediately upon the creation of the above described trust the Marathon Investment Co. transferred to the trustee out of its assets stocks and bonds of a then market value of $323,353.28 in complete satisfaction of the credit balance which the petitioner had transferred to the trustee.

During the first year of its operation, 1930, the trust realized a net profit from the sale of securities of $1,566.17 which was distributed to the petitioner and was reported by her as a part of her fiduciary income in her income tax return for that year. During the year 1931 the trust sustained a net loss from the sale of securities in the amount of $17,726.25. Its income from interest and other sources was $17,-850.83. After allowing for incidental expenses the operation of the trust for 1931 showed a net loss of $212.07. The trust made no distribution to the petitioner in that year.

During the taxable year 1932 the trust sustained a loss of $10,062.50 on the sale of bonds which it had held for more than two years and a further loss of $2,867 on the sale of bonds which it had held for less than two years. It received income from interest and other sources in the amount of $18,770.10 and its incidental expenses amounted to $361.27. The trustee determined that the distributable income of the trust in 1932 was $5,267.26, computed as follows:

Interest on bonds in trust fund_$18, 770.10
Deduct:
(a) Loss on bonds held more than two years_$10, 062. 50
(b) Loss on sale of bonds held less than two years- 2, 867.00
(c) Incidental expenses of Trust_ 361. 27
(d) Net loss applicable to 1931_ 212.07
- 13,502.84
Net amount actually paid to Nellie S. Alexander- 5,267. 26

Although the petitioner did not actually receive but $5,267.26 from the trust in 1932, she reported in her income tax return for that year $8,346.33, which was the amount shown as its net income by the trust in its fiduciary return for that year. In such return the trust reported the loss of $10,062.50 from the sale of bonds held for more than two years, but did not report the loss of $2,867 from the sale of bonds held for less than two years, or the $212.07 representing the net loss of the year 1931.

The amounts distributed by the trustee to the petitioner as income from the trust, as above set forth, have been tendered by the trustee and accepted by the petitioner as being in full compliance with the terms and purposes of the trust agreement.

In his deficiency notice the respondent has increased the petitioner’s taxable income for 1932 by $10,062.50, on the ground that the loss from the sale of securities held for more than two years constituted a charge against the corpus of the trust and was not a proper deduction in arriving at the amount of income distributable to the petitioner as beneficiary.

After the deficiency herein was asserted by the respondent the trustee and the petitioner executed an agreement in the form of an affidavit, which was submitted in evidence in this proceeding, wherein they set forth that the acts of the trustee in determining the distributable income of the trust and in paying such income to the petitioner in the years 1930 to 1932, inclusive, as set forth above, and also in similarly determining the amounts of income distributable to the petitioner in 1933 and 1934, “were in strict accord with the intent of affiants in creating the above mentioned trust, and in accord also with their purpose to set up and preserve intact as the principal of the trust the sum of $325,000.” The agreement further provides that:

This affidavit * * * shall nevertheless' he taken as an agreement between the said Nellie S. Alexander, as creator of the trust and beneficiary thereunder, and the said John Alexander, as trustee under said trust, in respect to the true intent of the parties in the execution of said Trust Indenture, and as an agreement between them in the settlement of the accounts between the said trustee and the said Nellie S. Alexander, as life beneficiary of said trust, for the years 1930 to 1934, inclusive.

It is the respondent’s position in this proceeding that under the terms of the trust agreement described above the petitioner is entitled to receive, and is therefore taxable on, all of the income derived from interest and dividends on the securities comprising the trust corpus, less the operating expenses of the trust, and that the gains or losses on the sale of capital assets should be credited or charged to corpus and not taken into account in determining distributable income.

We do not so construe the trust agreement. There is nothing in the wording of the agreement itself to indicate that the term “income” as used in paragraph first above refers only to dividend and interest income. In its ordinary meaning the “income” of the business is understood to include the gains from the sale or conversion of capital assets. Doyle v. Mitchell Brothers Co., 247 U. S. 179; Eisner v. Macomber, 252 U. S. 189. There is every indication that it was so used in the trust agreement here. In the first place, the parties themselves have construed the agreement as directing the distribution of the net income computed with the capital gains or losses taken into account and as requiring the corpus of the account to be kept intact. This harmonious construction of the trust agreement by the parties in interest is to be given great weight. See Grace Scripps Clark, 1 B. T. A. 491; E. L. E. Brenneman, 10 B. T. A. 544; Anna M. Chambers, 17 B. T. A. 820. The rule is more forceful here because the life beneficiary is the creator of the trust and is free to advise the trustee in his interpretation of the trust agreement. It was said by the Supreme Court in Insurance Co. v. Dutcher, 95 U. S. 269:

The practical interpretation of an agreement by a party to it is always a consideration of great weight. The construction of a contract is as much a part of it as anything else. There is no surer way to find out what parties meant, than to see what they have done. * * *

It is true, as the respondent points out, that the affidavit and agreement submitted by the parties in this proceeding manifesting their approval of the administration of the trust in prior years, as well as declaring a policy to be adhered to in the future, is not binding upon the Board in the question before us, but at the same time an agreement of this character must receive consideration in determining the intent of the parties.

The trust agreement must be construed in the light not only of the intention of the settlor, but of all the attendant circumstances. It is to be noted that here the trust corpus consisted entirely of stocks and bonds. The settlor must have contemplated that in the careful management of the trust fund it would be necessary for the trustee from time to time to sell some of the securities and purchase others. This was provided in paragraph sixth of the agreement. It might reasonably be that the gain from this trading in securities was expected to prove a material source of income to the trust. Investment trusts of such character are not uncommon.

It is to be noted, too, that the creator of the trust had four living children, who were designated as the recipients of the income of the trust after her death. It is reasonable to suppose that she intended the corpus of the trust to be kept intact for their benefit.

The facts here are similar to those in Lawrence Fox et al., Executors, 31 B. T. A. 1181, where we held that the beneficiary of a trust was taxable on the capital gain that was credited to her in the taxable year.

The respondent has not called our attention to any statute or prevailing rule of law of the State of Florida, where the settlor was resident, and we have not found any, which requires the capital gains and losses to be charged to corpus and not taken into account in determining distributable income, as in the State of Pennsylvania. Cf. Anna M, Chambers et al., Trustees, 33 B. T. A. 1125.

The respondent submits, citing Freuler v. Helvering, 291 U. S. 35, that the beneficiary of the trust is taxable on the income which she was entitled to receive and not just on what she actually received. This can not be disputed; but, aside from the construction of the trust agreement for which he contends, there is nothing to support the respondent’s contention that the petitioner was entitled to receive any more income than she actually received, or, at least, than she reported in her individual tax return. The petitioner is, of course, taxable on all of the income of the trust for the taxable year 1932, including the $212.07 which the trustee withheld from her to offset the 1931 loss. She does not contend otherwise.

In our opinion it was error for the respondent to increase the petitioner’s taxable income from the trust by the amount of $10,062.50, representing the loss to the trust on the sale of capital assets during the taxable year.

Judgment of no deficiency will be entered.


author: Hill:

text:
    Estate of George Herder, Deceased, Mary Herder, Alma Williams, Vida Allen, and George Herder, Jr., Executrices and Executor, Petitioners, v. Commissioner of Internal Revenue, Respondent. Mary Herder, Petitioner, v. Commissioner of Internal Revenue, Respondent. R. L. Williams, Petitioner, v. Commissioner of Internal Revenue, Respondent. Alma Williams, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 84000, 84001, 84051, 84052.
    Prmulgated November 24, 1937.

      Charles T. Byers, Esq., for the petitioners.

      Edward A. Tonjes, Esq., and Allen T. Akin, Esq., for the respondent.
   OPINION.

Hill:

We shall take up first the cases of R. L. Williams and his wife Alma Williams, Docket Nos. 84000 and 84001. One of the errors alleged by them was that the respondent erred in including in their income certain salary paid R. L. Williams. No evidence was taken on this issue and the finding of the respondent thereon is approved.

These petitioners next object to the determination of the respondent fixing the amount of the profit resulting from the burning of the rice mill, and the inclusion of R. L. Williams’ share of the proceeds as taxable profit or income. We agree that the findings of the respondent as to the cost of the mill and profit are correct, but we do not think the share of R. L. Williams is taxable. Williams collected his share of the insurance money in March 1934, and thereafter had the continuing purpose to reinvest it in similar property. Soon after the death of George Herder he endeavored to reinvest it in a mill at Eagle Lake. A flaw in the title caused a delay of six months, after which, with due diligence, Williams reinvested his part of the insurance money in the Gulf Coast Rice Mill on or about May 1, 1935. Under all the circumstances we think this was a reasonable time and hold that he made the reinvestment in similar property forthwith and in good faith. We hold, therefore, that under section 112 (f) of the Revenue Act of 1934 no gain should be recognized for tax purposes, notwithstanding no replacement fund was established and no permission for such fund was had from respondent under article 112 (f)-2 of Regulations 86.

In the recent case of August Buckhardt, 32 B. T. A. 1272, we held that under the facts there the lapse of over two years between the conversion of taxpayer’s property and reinvestment in similar property without the permission of the Commissioner to establish a replacement fund under article 580 of Regulations 74 was within the provisions of section 112 (f) of the Revenue Act of 1928, and no gain should be recognized. Section 112 (f) of the Revenue Act of 1934 is the same as section 112 (f) of the Revenue Act of 1928. Article 112 (f)-2 of Regulations 86 is the same as article 580 of Regulations 74 in respect to the requirement of permission of the Commissioner to establish a replacement fund.

There is a sufficient parallelism between the facts of the instant case and those of August Buckhardt, supra, to justify our merely citing it in support of our holding here.

We have examined the cases of Eastern Steamship Lines, Inc., 17 B. T. A. 787, John J. Bliss, 27 B. T. A. 803, and Frishkorn Development Co., 30 B. T. A. 8, cited and relied upon by the respondent, but we do not think they are applicable or decisive of this case, as in those cases the evidence was unsatisfactory as to the disposition and reinvestment of the converted funds. In the instant cases the evidence is positive and uncontradicted that Williams deposited the money in bank and used it to reinvest in the new mill.

The alleged gain on the insurance fund is not taxable to R. L. Williams or his wife, Alma Williams.

As there was no reinvestment of the insurance funds collected by George Herder, his share of the insurance fund is taxable as ordinary income for the period January 1 to March 29, 1934. Section 117 (a) provides: “In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income.” We hold that the involuntary conversion of the rice mill by its destruction by fire was not a sale or exchange. John H. Watson, Jr., 27 B. T. A. 463; Arthur E. Braun, Trustee, 29 B. T. A. 1161; M. P. Sturdivant, 23 B. T. A. 1385; Echols v. Commissioner, 61 Fed. (2d) 191, and the profit derived therefrom is taxable as ordinary income.

Deductions for bad debts are claimed in Docket Nos. 84051 and 84052 in the cases, respectively, of George Herder,' deceased, and Mary Herder. The debts claimed as deductible are set forth in the findings of fact and total $29,975.56. One-half of this amount, or $14,987.78, is claimed as such deduction by each petitioner. However, at the hearing petitioners abandoned such claim as to the debt of J. W. Gates (dairy farm) for the amount of $1,861.22. Accordingly, the claim of deduction for the amount of this debt will be disallowed.

The evidence shows that the other debts in question were worthless. The debtor, Emil Herder, died in 1932 or 1933, leaving no estate. Jackson Brothers were hopelessly insolvent in 1932 and their financial condition grew worse after that time. They had been rice farmers, but prior to 1934 had given up farming and moved away. These debts were unquestionably worthless prior to 1934 and are, therefore, not deductible within the taxable periods here involved. The debtors Wilbur Webb, Matthews Brothers, L. P. Bunge, Mrs. J. N. Frazar, and W. R. Terrell were farmers who for many years had been financed in their operations by the decedent and to whom they were each indebted far beyond the value of their assets. There was some basis for believing that these debts would be paid in whole or in part provided the debtors could continue to produce crops. They could not continue their farming operations without the extension, of credit for groceries and supplies and other financial support. Such credit had been furnished by George Herder up to the time of his death. He was their only source of credit and financial backing. Upon his death these debtors became hopelessly insolvent and the debts then became worthless.

The applicable provisions of the statute for deduction of bad debts is section 23 (k) of the Revenue Act of 1934, and is as follows:

(k) Bad Debts.—Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

The statute is silent as to how and where or in what manner bad debts are to be charged off. However, as was said by the court (C. C. A., 6th Cir.) in Fairless v. Commissioner, 67 Fed. (2d) 475:

It was clearly the purpose of the Congress to condition allowance of deduction for bad debts upon the perpetuation of evidence that they were ascertained to be worthless within the taxable year, and upon some specific act of the taxpayer clearly indicating their abandonment as assets.

In line with this expressed view of the court we adhere to our holding in Carl G. Stifel, Trustee, 7 B. T. A. 1060, that:

The charging off of bad debts should, in the case of a taxpayer keeping regular books of account, be evidenced by such book entries as will effectually eliminate the amount of the bad debt from the book assets of the taxpayer.

See also Britton Lumber Co., 20 B. T. A. 583.

The debts in question were never charged off on the books of the petitioners, but are still carried as assets thereon. The deduction of the debts on the income tax returns of petitioners did not constitute a charge-off. Such deduction could only be allowable as the result of a previous ascertainment of the worthlessness of the debts and a charge-off thereof within the taxable period. The mere ascertainment of worthlessness is not sufficient to authorize the deduction. We hold that the debts were never charged off and that the claim of deductions for bad debts must be disallowed.

There was interest in the amount of $5,518.01 earned, but unpaid, on debts owing the community of George Herder and Mary Herder, his wife, at the time of the death of the former. Respondent added one-half of this amount to the income of decedent in determining the deficiency against him under the following provision of section 34 of the Revenue Act of 1934: “In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.”

A list of the debtors, the debts on which the interest accrued, and the amounts of the interest so accrued is set forth in the findings of fact herein.

Petitioners claim that respondent erred in adding the amount of interest in question to decedent’s income for the reason, as they contend, that the interest so accrued was not collectible. The evidence shows that E. R. and Anna Frnka owed Herder two notes—one for $5,073.57 and the other for $4,460.38. The first note had collateral security consisting of 50 shares of stock in the Garwood Lumber Co. of a par and book value of $5,000. The second note mentioned was unsecured. R. L. Williams testified that the interest accrued on these notes was uncollectible. No effort had been made, however, to subject the collateral security to the payment of the interest on the note it secured. Considering the substantial value of the security in comparison with the amount of the note, we can not find that there was not a reasonable expectation that the interest on that note would be paid. We hold, therefore, that one-half of the interest accrued thereon up to the time of the death of decedent should be added to his income. As to the other and unsecured Frnka note the evidence is that there were no assets out of which payment of the interest accrued thereon could be made and that the debtors were unable to pay it. We think it clearly appears from the evidence that there was no reasonable expectation that such interest would ever be paid.

The evidence shows that the debtors W. J. Wright, Matthews Brothers, E. P. Schilling, and Mrs. J. U. Frazar had no available assets out of which payment of the interest accrued on their debts could be realized and that the debtors were unable to pay such interest. It appears from the evidence that it was reasonably certain that such interest would never be paid. We hold, therefore, that the interest accrued, but unpaid, on these debts and on the unsecured Frnka note did not constitute income to George Herder and should not be so considered in determining the deficiency against him. There can be no accrual of income where there is no income. Corn Exchange Bank v. United States, 37 Fed. (2d) 34; Turners Falls Power & Electric Co., 15 B. T. A. 983; Great Northern Railway Co., 8 B. T. A. 225.

The agreement of the parties hereto at the hearing that Mary Herder realized a capital gain of $1,498.50 in the sale of mineral lands will be given effect in the redetermination of the deficiency against her.

Judgment will be entered wider Rule 50.


author: Disney:

text:
    Schoenfeld Bros. Inc., a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80772.
    Promulgated November 24, 1937

      R. J. Venables, Esq., and Donald G. Graham, Esq., for the petitioner.

      Harold D. Thomas, Esq., for the respondent.
   OPINION.

Disney:

After careful consideration of the voluminous transcript of the testimony given at the hearing herein and the numerous exhibits admitted in evidence, we have found the facts as heretofore set forth, which make the applicable law thereto not very difficult.

The record shows that Schoenfeld Bros. Inc., the petitioner herein, was a going corporation and had been such since its organization in 1914. The facts do not show exceptional circumstances— although all its stockholders were members of the same family— that would, in our opinion, warrant us in disregarding the petitioner’s claim that it and its stockholders are separate taxable entities. Such, in our opinion, they were.

It is definitely settled by numerous decisions of this Board and of the courts that separate taxable entities generally do exist between a corporation and its stockholders, and, when such is the case, losses when arising from bona fide sales or exchanges between them may be allowed to either. See Corrado & Galiardi, Inc., 22 B. T. A. 847; Edward Securities Corporation, 30 B. T. A. 918; affd., 83 Fed. (2d) 1007; A. S. Eldridge, 30 B. T. A. 1322; affd., 79 Fed. (2d) 629; A. R. Glancy, Inc., 31 B. T. A. 236; Marjory Taylor Hardwick, 33 B. T. A. 249; Ralph Hochstetter, 34 B. T. A. 791; Commissioner v. McCreery, 83 Fed. (2d) 817; Jones v. Helvering, 71 Fed. (2d) 214; certiorari denied, 293 U. S. 583.

All the sales in question herein were consummated prior to the enactment of the Revenue Act of 1934 and, therefore, at a time when the full amount of losses resulting from such sales were allowable, provided the sales were bona fide. A. S. Eldridge, supra.

The record shows that prior to the aforesaid sales the petitioner was the owner of the securities in question, which securities had been purchased for it with its funds through the instrumentality of its stockholders, in whose names certificates of stock were at times issued and held in trust for petitioner, but only for the purpose of facilitating and expediting trading therein, the real ownership thereof being in the petitioner.

The record further shows that petitioner by proper resolutions of its stockholders (termed trustees) definitely decided to sell at the then market price certain designated securities and by said resolutions the stockholders were given the option of buying the designated securities at said market prices.

The evidence, in our opinion, further, shows that Max and Theodore Schoenfeld purchased from petitioner the securities involved herein, described and set forth in our findings of fact, at the prevailing market prices for the same existing on the dates the resolutions authorizing their sale were passed. The manner in which the sales in question were effected is set out fully in our findings of fact, and it is not necessary to repeat it here.

The record shows there were several mistakes or errors made in the matter of entering on the books of the petitioner and of Max and Theodore Schoenfeld proper credits and debits resulting from the various transactions described in our findings of fact, which errors, in our opinion, are satisfactorily explained and show that there was no attempt made thereby to defraud the United States or evade the payment of any income tax due the United States from the petitioner.

Because of the error of use of the figure $40 instead of $575 as sale price of the Tri-Continental shares, petitioner’s loss is to be reduced by $585.

Counsel for respondent say in their brief:

The important question is not whether the stockholders ever came into ownership of the securities but whether the alleged sales took place within the taxable years. If they did not take place within the taxable years then the losses claimed thereon are not deductible and the taxes are due. If no valid sales wore ever made, or if a subsequent sale was made and the losses were put on the returns with the knowledge on the part of the corporation that no such sales occurred within the taxable years, then the fraud penalties are likewise due.

In the light of the facts and circumstances disclosed by the record and the law of the State of Washington, we are of the opinion and hold that the sales in question were bona fide and that the title to the securities involved herein was intended to pass and did pass from the petitioner to Max and Theodore Schoenfeld in the taxable years, as claimed by the petitioner. We are further of the opinion and hold, in the circumstances shown, that the fact of the securities not being endorsed and having thereon no transfer revenue stamps did not invalidate the sale. The pertinent law of the State of Washington is, as set forth in Remington’s Revised Statutes, as follows:'

Section 5836-18. Property in specific goods passes when parties so intend.
(1) Where there is a contract to sell specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred.
(2) For the purpose of ascertaining the intentions of the parties, regard shall be had to the terms of the contract, the conduct of the parties, usages of trade and the circumstances of the case.
Section 5836-19. Rules for ascertaining intention.
Unless a different intention appears, the following are rules for ascertaining the intention of the parties as to the time at which the property in the goods is to pass to the buyer:
Rule 1. Where there is an unconditional contract to sell specific goods, in a deliverable state, the property in the goods passes to the buyer when the contract is made, and it is immaterial whether the time of payment, or the time of delivery, or both, be postponed.
Rule 2. Where there is a contract to sell specific goods and the seller is bound to do something to the goods for the purpose of putting them into a deliverable state, the property does not pass until such thing be done.

With respect to respondent’s insistence that petitioner is or may be subject to the 50 percent penalty as prescribed in section 298 (b) of the Revenue Act of 1932, it is well and definitely settled that fruad is never presumed. “Not only is it never presumed, but the ordinary preponderance of evidence is not sufficient to establish such a charge. It must be proved by clear and convincing evidence.” Henry S. Kerbaugh, 29 B. T. A. 1014; affd., 74 Fed. (2d) 749.

The burden of proving fraud is upon the respondent and his proof must be clear and convincing. James Nicholson, 32 B. T. A. 977, 989; affd., 90 Fed. (2d) 978; Charles E. Mitchell, 32 B. T. A. 1093, 1129, 1137; Oscar G. Joseph, 32 B. T. A. 1192, 1204; Harry Feldman, 34 B. T. A. 517, 520.

In view of our findings of fact, there is, in our opinion and we so hold, no sufficient evidence in the record on which to base the imposition of any penalty, and imposition thereof is disapproved.

Decision will be entered under Rule 50.


text:
    Isidor Kahn, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rosa Schlesinger, Petitioner, v. Commissioner of Internal Revenue, Respondent. Max Einhorn, Petitioner, v. Commissioner of Internal Revenue, Respondent. Leonora Kahn, Petitioner, v. Commissioner of Internal Revenue, Respondent. Bella Kahn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 73891, 73892, 73893, 73894, 73895.
    Promulgated November 26, 1937.

      Henry Waldmam,, Esq., for the petitioners.

      J. E. Marshall, Esq., and T. G. Histon, Esq., for the respondent.
   OPINION.

Disney:

The following deficiencies in income tax for 1929, the subject of redetermination herein, resulted, in part, from a ruling of the respondent that there was a liquidation of the Vulcan Insurance Co., and not a nontaxable reorganization as contended by the petitioners.

Which of these theories is correct is the sole question presented for decision. All of the facts were stipulated and only so much thereof is set forth as is necessary for consideration of the problem.

The Vulcan Insurance Co. was a New York corporation engaged in the fire insurance business, with a capital stock of 2,000 shares of common stock of the par value of $200,000. The stock was owned by members of one family group which included the petitioners.

The Vulcan Insurance Co. owned all of the 2,500 shares of common stock, par value $100 each, of the 134 William Street Co., a New York corporation engaged in the real estate and investment business.

The Vulcan Insurance Co. ceased to operate as a fire insurance company, with the result that during the early part of 1929 the Superintendent of Insurance for the State of New York instituted a proceeding to dissolve the corporation under section 63 of the Insurance Law of New York, and thereafter ordered the liquidation of the corporation. The stockholders of the corporation applied to the same court for a voluntary dissolution under section 170 of the General Corporation Law. On March 28, 1929, the court denied the petition of the Superintendent of Insurance and granted the petition filed by the stockholders of the Vulcan Insurance Co. On April 10, 1929, the court made an order to show cause why the corporation should not be dissolved.

Thereafter in 1929, pursuant to resolutions adopted by the directors and stockholders of the respective corporations, the Vulcan Insurance Co., after discharging its liabilities, transferred all of its securities, except stock of the 134 William Street Co., to the 134 William Street Co., and then distributed the stock it retained of the 134 William Street Co. and $50,000 in cash proportionately to its stockholders in exchange for Vulcan Insurance Co. stock. The Vulcan Insurance Co. was formally dissolved by court order entered February 8, 1934, in which the court directed that the remaining assets of the corporation, amounting to $299.24, be distributed ratably among its stockholders.

The petitioners reported no taxable gain from the exchange. In his determination of the deficiencies the respondent treated the transaction as an ordinary liquidation of the Vulcan Insurance Co. resulting in capital gain to the petitioners, measured by the difference between the cost of their stock and the amount of cash and other property received by them in exchange for their stock.

Section 112 (i) (1) (B) of the Revenue Act of 1928 defines a reorganization as “a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets were transferred.” Subsection (b) (3) provides for the nonrecognition of gain or loss “if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.”

The respondent, in contending that the transaction was merely a liquidation of the Vulcan Insurance Co., with the usual tax result to the petitioners, and not a reorganization within the meaning of the revenue act, relies upon the opinion of the court, in which the court said that the stockholders of the corporation could divide the corporate assets among themselves, and resolutions of the respective corporations in which the terms “liquidation” and “liquidate” were used in connection with the transaction, and also argues that the transfer had no relation to the business of either corporation.

The issue is not to be determined solely from the terminology used by the superintendent of insurance or the directors and stockholders of the respective corporations in referring to the transaction. San Joaquin Fruit & Investment Co., 28 B. T. A. 395; Ballwood Co., 30 B. T. A. 644. Taxation must be determined from what is actually done rather than from the declarations of the parties to the transaction. Weiss v. Steam, 265 U. S. 242. The act makes no distinction between a voluntary and an involuntary reorganization. De Blois v. Commissioner, 36 Fed. (2d) 11, affirming 12 B. T. A. 1138; C. H. Mead Coal Co. v. Commissioner, 72 Fed. (2d) 22. The stockholders of the Vulcan Insurance Co. desired to dissolve the corporation without the intervention of the superintendent of insurance, and sought and obtained court authority to accomplish their purpose. We find nothing in the opinion rendered by the court on March 28, 1929, requiring the Vulcan Insurance Co. to dissolve by a distribution of its net assets directly to its stockholders. The final decree of dissolution was rendered after the transfer and exchanges in question had been made and in the light of the report of a referee appointed by the court to hear complaints under an order requiring persons interested in the Vulcan Insurance Co. to show cause why the corporation should not be dissolved. Obviously, if the transfer to the 134 William Street Co. had been made contrary to the court’s opinion, the court would have taken notice of it. Its failure to do so supports the idea that the transfer was not opposed to any prior instructions given in the proceeding. The terms “liquidation” and “liquidate” used in the resolutions have reference to the terms used in the original application by the superintendent of insurance to the court— which as already seen was denied. The resolutions refer to “complete the intercompany transactions” and to transfer of bonds and securities of the Vulcan Insurance Co. to the 134 William Street Co. simultaneously with surrender of the Vulcan Insurance Co. stock and “in consideration thereof,” and a motion to do so was carried— all demonstrating that the plan was to reorganize with the 134 William Street Co. We conclude that the plan was one of statutory

reorganization.

The plan of reorganization, in general, provided for a transfer by the Vulcan Insurance Co. of part of its assets to the 134 William Street Co. and a distribution of a portion of its remaining assets, consisting of stock of the 134 William Street Co. and cash, ratably among its stockholders in liquidation proceedings. The plan of reorganization was carried out, with the result that immediately after the transfer the stockholders of the Vulcan Insurance Co. controlled the transferee directly instead of indirectly through the transferor. The court directed that the small amount of assets on hand in 1934 after the Vulcan Insurance Co. had satisfied all of its obligations be distributed among the corporation’s stockholders in proportion to their interests in the assets.

Similar facts were involved in H. B. Leary, Sr., 34 B. T. A. 1206. There the General Baking Corporation, a Maryland corporation owning practically all of the common stock and in excess of 80 percent of all of the voting stock of the General Baking' Co., a New York corporation, transferred part of its assets to the New York corporation. Thereafter, as part of the plan of reorganization, the stockholders of the Maryland corporation surrendered their stock in that corporation and in exchange therefor received stock and bonds of the New York corporation and a small amount of cash. After this exchange the Maryland corporation was dissolved and its former stockholders owned in excess of 80 percent of the" voting stock of the New York corporation. In holding that the transaction involved a nontaxable reorganization, and was not simply a distribution of a liquidating dividend as the Commissioner had determined, we said:

But if there is any doubt about'the application of (A) [section 112 (i) (1) (A), 1928 Act], it seems clear that (B) applies. There was a transfer by the Maryland corporation of all or a part of its assets to the New York corporation and immediately after the transfer the stockholders of the transferor were in control of the New York company.

The exchange by the petitioners, and other stockholders of the Vulcan Insurance Co., of their stock of the Vulcan Insurance Co. for stock of the 134 William Street Co. and cash at the rate of $25 per share, was made pursuant to the. plan of reorganization. The exchange of stock for stock did, not result in a realization of taxable gain. H. B. Leary, Sr., supra; Jacob F. Schoellkopf, Jr., 35 B. T. A. 855; Helvering v. Winston Bros. Co., 76 Fed. (2d) 381. The amount of cash received by the petitioners in the exchange is taxable to the extent that it does not exceed gain computed under the provisions of section 112 (c) of the Revenue Act of 1928.

Reviewed by the Board.

Decision will be entered under Rule 50.


author: Arnold:

text:
    Mason Securities Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78559.
    Promulgated November 26, 1937.

      William M. Fitch, Esq., for the petitioner.

      S. B. Anderson, Esq., for the respondent.
   OPINION.

Arnold:

The only question presented for our decision is whether the amount of $4,449.85, representing 10 percent of gross sales of cemetery lots during the taxable year, should be excluded from gross income.

Petitioner argues that it was under a contractual obligation to pay 10 percent of its gross receipts from sales of cemetery lots to the Hiram Cemetery Association to establish a fund for the perpetual care of the cemetery, which amount was set up on its books as a reserve, and should not be included in income.

The respondent argues that since no amount was ever set aside to meet this reserve, but an informal agreement was entered into between the parties under which petitioner assumed the care of the, cemetery and retained the amount it was supposed to pay the Hiram Cemetery Association'and used it in its business, it is not entitled to have the amounts placed in reserve on its books excluded from gross income or deducted.

Petitioner contends that the decisions of the Supreme Court of the United States in United States v. Anderson, 269 U. S. 422, and American National Co. v. United States, 274 U. S. 99, are direct authority under the facts of this case for the accrual of the amounts in question and authorize the deduction by petitioner of the 10 percent fund from its taxable income.

These cases arose under sections 12 (a) and 13 (d) of the Revenue Act of 1916. In the American National Co. case the Court quoted from the decision in the Anderson case in part as follows:

* * * * consideration of the difficulties involved in the preparation of an income account on a strict basis of receipts and disbursements . . . indicates with no uncertainty the purpose of §§ 12 (a) and 13 (d) ... to enable taxpayers to beep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred and properly attributable to the process of earning income during that period * * *.

The American National Co. reported as income the total amount paid on certain five-year notes received during the year and accrued and deducted the total amount of certain bonuses which it was obligated to pay over a period of five years at 1 percent of the balance of each note remaining unpaid during each year. Later, if it did not have to pay all the bonus which had been accrued, it reported the unpaid portion as income. The Court approved the method used as clearly reflecting the company’s income.

In the instant case the petitioner, after entering into an agreement to pay to Hiram 10 percent of its receipts from the sale of lots for a perpetual care fund, set up a reserve on its books in that amount. Thereafter it did not carry out this agreement, but on the contrary entered into an oral agreement with Hiram under which petitioner assumed the care of the cemetery lots and used the total amount of the receipts from sales in its business, and, although it continued to set up on its books 10 percent of its receipts from sales, it never paid any money to Hiram and so far as the record shows this arrangement may continue indefinitely. Under these facts we do not think that this case is controlled by the decisions in the Anderson and the American National Go. cases.

Where a cemetery association is obligated to set apart a certain portion of its receipts from sales of lots for the purpose of establishing a fund for the perpetual care of such lots and has in fact not only accrued such amounts on its books but set them aside or paid them into a trust fund for that purpose, the Board and the courts have recognized the accrual of such amounts as clearly reflecting income and have either excluded them from gross income or allowed their deduction. Los Angeles Cemetery Association, 2 B. T. A. 495; Greenwood Cemetery Association, 2 B. T. A. 910; Inglewood Park Cemetery Association, 6 B. T. A. 386; Evergreen Cemetery Association of Chicago, 21 B. T. A. 1194; Mountain View Cemetery Association, 35 B. T. A. 893. Cf. American Cemetery Co. v. United States, 28 Fed. (2d) 918; Portland Cremation Association v. Commissioner, 31 Fed. (2d) 843; Woodlawn Cemetery Association, 28 B. T. A. 882. But where there is only a general obligation to maintain the cemetery or where there is an accrual and a reserve set up for a perpetual maintenance fund and no money has actually been paid into the fund, the amount has been included in income and only a deduction of the actual expense of maintenance allowed. Parkview Memorial Association, 34 B. T. A. 406; Cedar Park Cemetery Association, Inc. v. Commissioner, 67 Fed. (2d) 699; certiorari denied, 292 U. S. 639; Acacia Park Cemetery Association, Inc. v. Commissioner, 67 Fed. (2d) 700. Cf. Mt. Plymouth Corporation, 25 B. T. A. 1201; Union Paving Co., 6 B. T. A. 527.

In Parkview Memorial Association, supra, the Board said:

* * * A mere appropriation to a reserve set up by a taxpayer to provide for Ills contractual obligations does not serve to lessen bis taxable net income either by way of exclusion from gross or by way of deduction, irrespective of whether the accounting system be a cash system or an accrual system. If, however, there is a trust which the law recognizes, whether express or implied, and a prescribed part of the contract price received for a lot can be said to be received in trust, such part is excluded from gross income; or if, although not received in trust, a part is necessarily immediately turned over to an established trust, such part is deductible. * * *

In Acacia Park Cemetery Association, supra, the Circuit Court of Appeals said:

* * * The law permitted petitioner to keep its books on the accrual basis, which as it well states, implies that the books shall immediately reflect obligations and expenses definitely incurred and income definitely earned; and we think it further implies that the actions of the taxpayer shall be consistent with its books of account.
The rulings of the Board are consistent in permitting deductions for accrued liabilities where the books of account are kept according to the accrual method, and that permission has never been denied, in cases of trusts such as the one before us, where the money received has actually been paid into the trust fund. The Board’s ruling in such eases requires the actual payment of the money into the trust fund as a prerequisite to its deduction as an accrued liability, and we think that ruling is proper. * * *

Here petitioner’s obligation was contractual and no amount of the receipts from sales was turned over to an established trust. Petitioner has at all times treated the entire receipts from sales as income by using it for purposes not contemplated by the original agreement with Hiram on which it relies and has failed to pay over any amounts due under that agreement. The exact terms of the oral agreement are not clear, but the term is so indefinite that it can not be said when if ever petitioner will pay over any money to Hiram.

From the facts before us we think that the amount in controversy should be included in income for the taxable year, and only the actual expense of maintenance should be deducted from income. The record does not disclose what this actual expense is, and we can not, from the facts before us, agree with petitioner’s argument that 10 percent of the receipts from sales should be considered expense of maintenance.

Decision will be entered under Rule 50.