author: Keen:

text:
    Trust A, #3586, for the Benefit of Sarah Estelle Knapp Russell and Louise Russell, Under Deed and Agreement Dated May 10, 1922, by Louise Savage Knapp, Deceased, Central Hanover Bank and Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Trust B, #3587, for the Benefit of Sarah Estelle Knapp Russell and Phebe Russell, Under Deed and Agreement Dated May 10, 1922, by Louise Savage Knapp, Deceased, Central Hanover Bank and Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Trust C, #3588, for the Benefit of Sarah Estelle Knapp Russell and Isabel Russell, Under Deed and Agreement Dated May 10, 1922, by Louise Savage Knapp, Deceased, Central Hanover Bank and Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket Nos. 101753, 101754, 101755.
    Promulgated April 7, 1942.

      Charles W. Crawford, Esq., for the petitioners.

      Clay C. Holmes, Esq., for the respondent.
   OPINION.

Keen:

Respondent argues that the decision of the state court reforming the deed of George O. Knapp dated June 29, 1923, is not binding on this Board or the Federal courts when applying a Federal tax statute. We do not agree with this contention. The record discloses an action between adverse parties and a hearing on its merits. It is well settled that the decision of a state court of competent jurisdiction upon property rights, rendered in an adversary proceeding after a hearing upon the merits, is conclusive upon the Federal courts until it is reversed or overruled. Freuler v. Helvering, 291 U. S. 35; Blair v. Commissioner, 300 U. S. 5; Susan B. Armstrong, 38 B. T. A. 658.

That the decision of the state court in the reformation proceeding involved herein is a decision coming within the rule above stated is settled by Hugh D. Rhodes et al., Administrators, 41 B. T. A. 62; affd., 117 Fed. (2d) 509, and George N. Spiva, 43 B. T. A. 1174. The court decided that there had existed at all times since the execution of George Knapp’s instrument in 1928 six separate trusts, not three. We consider ourselves bound to honor this decree.

Respondent argues ingeniously that, .even accepting the state court’s decree and recognizing the existence of six trusts, nevertheless, there were only three taxable entities. With such an argument he is attempting to bring this case within the exception recognized in cases such as Estate of Arthur D. Forst, 40 B. T. A. 876, and Lewis Spencer Morris, Trustee, 40 B. T. A. 988, where this Board refused to give application to the state court’s decree solely because Congress had established its own criterion as to what claims and expenses are properly deductible for Federal tax purposes. We do not believe that Congress has ever established its own criteria for trusts to the extent of excluding as a separate taxable entity any relationship declared by state law to constitute a true trust. Consequently, the rationale of the Forst and Morris cases, supra, has no application whatsoever to the present controversy.

Respondent, foreseeing the possibility of the conclusions at which we have already arrived, has advanced a further argument which, if accepted, would have the effect of disallowing in part the petitioner’s claims of overpayments. Respondent asserts that the evidence is not sufficient to show that two-thirds of the gain derived from sales by the trustee of the Union Carbide stock resulted from sales of shares held as a result of the original contribution of 2,000 shares made by George Knapp, pointing out that there is no proof before us to distinguish which of the shares sold was a part of those physically transferred under the 1922 instrument and which was a part of those transferred under the 1923 instrument. Inasmuch as the burden of proof lies with the petitioner in a claim such as this, respondent contends that we must hold that the sales were made out of the corpus of the trusts set up by Louise Knapp in 1922. Where evidence on behalf of the taxpayer is lacking, we would be forced to this conclusion. In the present proceedings this would mean that all of the corpora of the original trusts was sold, since those trusts contained a total of 9,233 shares, and 11,100 shares were sold. Consequently, 9233/11100 of the gain from the sales would be taxable in equal proportions to the three original trusts, instead of alb the gains from all the shares sold.

This position of respondent is predicated on the proposition that we can not consider those facts found by the Supreme Court of New York in its decree entered in the accounting action brought by the trustee against the beneficiaries of the six trusts.

We would be impressed with this argument of respondent if the accounts in question were mere formal accounts rendered in a court administering a running trust and the court’s approval was entered ex parte. See Edgar M. Carnick, 21 B. T. A. 12, 21. In the instant proceeding, however, the trusts were not testamentary trusts and thus administered under the jurisdiction of the Surrogate’s Court; it was necessary for the trustee to bring an action in the Supreme Court of New York to have its accounts taken as stated and its acts and proceedings as trustee ratified and confirmed. This was not a routine formality, for the trustee was faced with the unusual situation of having administered in the form of three trusts what had been judicially determined to have been six trusts. This it had done in good faith but, as the event proved, in error; and, since the restrictions upon the powers of the trustee with regard to investments differed in the George Knapp trusts from those in the Louise Knapp trusts, it was a matter of great importance to the trustee and the beneficiaries to have definitely determined by court action what constituted the corpus of each trust in view of the actions of the .trustee' in regard thereto over the many years before the decree in the reformation action, and to have determined the question whether the trustee had acted correctly in reconstructing his accounts to show two-ninths of the stock sold from each of the George Knapp trusts and one-ninth from each of the Louise Knapp trusts. Accordingly, the trustee brought the action in the Supreme Court and made the beneficiaries parties defendant. After the service of summonses a guardian ad litem was appointed for the infant defendants, who subsequently filed a report. Upon the verified complaint and accounts of the trustee and the report of the guardian ad litem, the Supreme Court entered its decree approving and confirming the trustee’s accounts, which, among other things, found that two-ninths of the Union Carbide & Carbon stock had been sold by the trustee from each of the George Knapp trusts.

Under the peculiar facts of this case we can not feel justified in disregarding this decree. As we have shown above, it was entered in an accounting action specially brought, adversary in nature, and involving important property rights, and after a thorough investigation by the guardian ad litem appointed by the court. In addition we may point out that the trustee is of necessity subject to the jurisdiction of the state courts in the administration of the various trusts. Those courts have determined that there were six trusts during the taxable year and that the securities sold were properly allocable one-ninth to each of the three petitioner trusts, and two-ninths to each of three other trusts. Unless these determinations are recognized by us, the trustee faces a situation not only in the taxable year, but also in all later years, whereby it is bound by the state court decrees to administer a certain corpus in a certain trust, and yet with regard to its Federal tax liability as to ■ each trust it is subject to the uncertainty of the respondent’s determination, for it is apparent that a physical identification of each share that went into the several trusts is impossible. After the transfers of the stock to the trustee by both settlors the stock was divided three for one and new certificates necessarily issued, and a considerable-number of shares was acquired pursuant to “rights.” Under .these circumstances, if the respondent determined, for example, that all of certain stock which the trustee purported to sell from each of the six trusts was, in reality, a part of the corpus of two trusts created by George Knapp, the trustee would not be able to overcome this determination by tracing back into each trust the certificates which were sold.

It is apparent to us that the state court in the accounting action gave a fair and equitable answer to the problems raised in the administration of the trusts by the decree in the reformation action. It is further apparent to us that, the decree in the accounting action being binding upon the trustee and the beneficiaries in the administration of the various trust properties, it should be accepted by the Federal taxing authorities as determining the interests of the various trusts subject to tax. This result, demanded by justice and public policy, may be reached by considering as evidence herein those facts found in the decree of the state court entered in the accounting action; and this we do for the reasons set forth above.

Accordingly, we hold that the petitioner trusts are each taxable on one-ninth of the gains derived from the sale of Union Carbide & Carbon Co. stock during the taxable year.

Decisions will be entered under Rule SO.


source: Caselaw Access Project

author: Black :

license: Public Domain

text:
    Banner Building Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105605.
    Promulgated April 7, 1942.

      Charles Roser, Esq., for the petitioner.

      Frcmk M. Ca/vanaugh, Esq., for the respondent.
   OPINION.

Black :

In support of its claim for exemption as a fraternal beneficiary society, the petitioner pleads specifically the benefits of paragraphs (3), (6), (9), and (14) of section 101 of the Revenue Act of 1936. Exemption is claimed under facts stated in the petition as follows:

(b) That the petitioner is a Fraternal beneficiary society, operating under the lodge system for the exclusive benefit of the members of Banner Council No. 39, Junior Order United American Mechanics, a fraternity itself operating under the lodge system; and the petitioner does operate indirectly through Banner Council No. 39 and does assist Banner Council in the payment of sick and death claims, and provides for other relief and assistance to its own members in addition to helping all other worthy public causes both private and governmental.
(c) That the petitioner does not operate for profit and no part of its net earnings is now, nor has it ever inured to the benefit of any member or individual. Nor has any person ever secured any profits from the petitioner and no one can receive any personal gain or profits in the future.

The paragraphs in section 101 of the Revenue Act of 1936 relied upon by petitioner are printed in the margin.

Considering first the petitioner’s contention that it is a fraternal beneficiary society within the meaning of paragraph (3), supra, it is obvious, we think, that the contention must be denied. The section is clear in limiting its benefits solely to societies “(A) operating under the lodge system or for the exclusive benefit of the members of a fraternity itself operating under the lodge system” and (B) “providing for the payment of life, sick, accident, or other benefits to the members of such society, order, or association or their dependents.” It seems clear of course that Banner Council No. 39 Jr. O. U. A. M. is a fraternal beneficiary society within the meaning of the above quoted law and is exempt from Federal taxation. The respondent concedes that is true, but Banner Council is not before us for taxation. Clearly, it is not the same entity as the Banner Building Co., which is the petitioner in the instant case, and it is futile, we think, under the showing which has been made to argue that the petitioner meets either of the requirements for exemption above named. First, its charter is that of a capital stock corporation operating under a board of directors, and not a fraternal organization operating under the lodge system. Stock of a par value of $10 per share was actually issued to stockholders who paid in the amounts which they subscribed for it. This stock is still outstanding, so far as the record shows, although some of it is in the hands of others than those to whom it was originally issued. The purposes for which the corporation was organized, as declared in its charter, are purely business purposes, which comprehend earning of profits. The bylaws anticipate the distribution of profits among the stockholders, and in section 21, after directing the directors to determine semiannually how much shall be set apart for a contingent loss fund, provide that the residue of the earning shall he divided among the shareholders. These provisions of the charter and bylaws are determinative of the petitioner’s true character as a corporation. National Association of Certified Public Accountants v. United States, 292 Fed. 668; American Surety Co. v. 14 Canal St., 276 Mass. 119; 176 N. E. 785; Wilson v. Louisville Trust Co., 242 Ky. 432; 46 S. W. (2d) 767; Northwestern Municipal Association Inc. v. United States, 99 Fed. (2d) 460; Sun-Herald Corporation v. Duggan, 73 Fed. (2d) 298. Under authority of these decisions we decide against the petitioner on the first point urged.

Likewise, under the same authorities and under the same line of reasoning, without repeating it, petitioner is not exempt under section 101 (6) or (9). We hold against its contentions that it is exempt under these provisions.

The petitioner’s claim for classification as a holding corporation under paragraph (14) likewise can not be sustained. A holding company under this paragraph is one which has been organized for the exclusive purpose of holding title to property, collecting the income therefrom and turning over the entire amount, less expenses, to an exempt association. The petitioner has not shown that it was organized for any such purpose. Again we refer to its charter and bylaws for proof of its corporate form and purpose, which in neither respect are within the paragraph. The petitioner contends, however, notwithstanding its charter provisions, that it was organized to serve the purposes of a building holding company for Banner Council, and has so operated since its organization to and including the taxable year. It contends, that actual operations rather than corporate form are the test of its right to be exempted under the law. We need not discuss the law involved in this last claim, since the record fails to ■ show the petitioner’s compliance in respect to operations.- An essential requirement of a bolding company under tbe paragraph pleaded is that it turn over income from the property held, less expenses, to an exempt association. The petitioner has not shown that it was under any legal obligation to turn over any of its funds to Banner Council No. 39 Jr. O. U. A. M., nor has it shown that it did in fact pay over any of its said funds to Banner Council. The failure in this essential precludes its classification as an exempt corporation under this provision. Stanford University Bookstore, 29 B. T. A. 1280; affd., 83 Fed. (2d) 710. The petitioner is not sustained in this contention.

There remains to be considered whether or not the respondent erred in treating as part of petitioner’s gross income the net receipts from bingo parties, and picnics conducted by Banner Council and members and turned over to the petitioner during the taxable year. The petitioner contends that these payments were gifts or deposits from Banner Council and its members. The respondent stated his position respecting these payments in a paragraph of the deficiency notice as follows:

Respecting the various sums turned over to you by Banner Council No. 39, and claimed by you to be contributions or deposits, it is held that all such sums and monies were rental income to you paid by Banner Council No. 39 for use and occupancy by it of your premises.

Whether or not the respondent correctly classed these payments as rents, we need not decide. We think that, under the evidence in this proceeding, he correctly included them as part of the petitioner’s gross income and must be sustained. The petitioner contends that the payments were gifts from Banner Council and members to it. Gifts are defined as the voluntary transfer of property from one person to another, without any consideration, or compensation therefor. C. B. Wilcox, 27 B. T. A. 580; J. T. Lupton, 19 B. T. A. 166. To be without consideration means without obligation to the donee, as might be discharged or paid by the transfer. C. B. Wilcox, supra. In our opinion Banner Council and its members can not be said to be without obligation to the petitioner in this case. They enjoy at all times and without cost free use of .its building, rooms, club, and all other rental facilities. These facilities are used in conducting the money raising affairs here discussed. The petitioner’s committees and officers assist in conducting said parties and its treasurer receives the profits from all of them. The petitioner is a stock corporation operating for the purpose of earning income. It pays taxes on the property which it owns. For the taxable year in question it deducted for taxes $1,499.78.- It pays for repairs to its building. It pays interest on its bonded and other indebtedness. Obviously it must collect money for the use of its facilities to meet these and other expenses, and there appears to be no good reason why it should not collect from Banner Council No. 39. This it did in the form of net profits from bingo parties and picnics. The petitioner concedes that the parties are given for its exclusive benefit, the purpose being to supplement its revenues to meet deficiencies in its operating income. We think petitioner has failed to show that these payments were transfers of property made to it without motivating considerations and therefore in establishing that they constituted gifts. On this point the petitioner is not sustained.

Decision will be entered for the respondent.

       SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.
      The following 'organizations shall be exempt from taxation under this title—
      * * * . * * * *
      (3) Fraternal beneficiary societies, orders, or associations, (A) operating under the lodge system or for the exclusive benefit of the members of a fraternity itself- operating under the lodge system ; and (B) providing for the payment of life, sick, accident, or other benefits to the members of such society, order, or association or their dependents;
      *******
      (6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious; charitable^ scientific, literary, or'"'educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation;
      *******
      (9) Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder;
      *******
      (14) Corporations organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof, less expenses, to an organization which itself is exempt from the tax imposed by this title;


author: SternhageN :

text:
    Hortense A. Menefee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103431.
    Promulgated April 7, 1942.

      Oharles E. McCulloch, Esq., and Thomas B. Stoel, Jr., Esq., for the petitioner.

      John EL. Pigg, Esq., for the respondent.
   OPINION.

SternhageN :

The petitioner contends that as to her no gain may be recognized in the receipt of the West Coast shares from the La Dee corporation, Eevenue Act of 1936, sec. 112 (b) (3). The respondent treats section 112 (b) (3) as irrelevant because petitioner’s shares in La Dee were not “exchanged * * * in pursuance of a plan of reorganization.”

The transaction whereby the two corporations exchanged property and shares was a statutory reorganization as defined in section 112 .(g) (1), and each of the two corporations was a party to such reorganization as defined in section 112 (g) (2). This is not in dispute. Eespondent says that the distribution by La Dee of the West Coast shares was not pursuant to the plan of reorganization but was separate; also that such distribution was not an exchange but was a dividend or a liquidation.

The respondent’s conception of what was done is of separate and unrelated acts, and he fortifies this conception by a fine regard for the intervals of time between them and by a disregard for the testimony of the witnesses that in truth all of the acts were related as parts of a single plan, that the consummation of all was contemplated when the first was commenced, and that none would have been permitted to occur if assurance had been lacking that as a whole the plan could be perfected without tax liability. The evidence is not doubtful that from the beginning a reorganization was contemplated which would amalgamate the business and operations of the two corporations and that the operations should thenceforth be conducted by the West Coast; La Dee should become inactive and should ultimately be dissolved. There was no thought of giving the shareholders a distribution of assets either in a dividend or in liquidation. Their part was merely to continue as the same shareholders of a newly arranged business. The entire plan was integrated and what was done was a series of steps in it to achieve the reorganization. It is not important whether the plan was written, so long as the evidence is clear that it existed, Edison Securities Corporation, 34 B. T. A. 1188; William H. Redfteld, 34 B. T. A. 967, and it is not important that its fulfillment was spread over two months instead of being accomplished simultaneously, so long as the steps were a consistent performance of the reorganization plan and purpose. Von's Investment Co. v. Commissioner, 92 Fed. (2d) 861; 111 Fed. (2d) 440; Starr v. Commissioner, 82 Fed. (2d) 964; D. W. Douglas, 37 B. T. A. 1122.

Eespondent emphasizes the fact that the La Dee shares were not turned back to the corporation contemporaneously with the distribution. He says that the distribution was therefore a dividend and not an exchange. The plan, however, from the time it was first considered, contemplated the reduction of La Dee’s capitalization to a small amount to cover the remaining assets after the transfer of the. principal assets to West Coast, and the distribution of the West Coast shares to La Dee shareholders. The La Dee shares were deposited in accordance with the plan. Even if the distribution were expressly in liquidation, it would be required by section 115 (c) to be treated as an exchange and gain or loss would be recognized only as provided in section 112. This depends on whether the actual or constructive exchange is in pursuance of the plan of reorganization. From the evidence there is no escape from the finding that it was, and the nonrecognition of gain is therefore imperative. The determination is reversed.

Decision will be entered under Bule SO.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      *******
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock fob 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.

       SEC. 115. distributions BY CORPORATIONS.
      * * * * * * •
      (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. * * *


author: Turner:

text:
    Mahlon D. Thatcher, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ada T. Huntzinger, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lydia T. Wheeler, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101598, 101599, 103219, 103220.
    Promulgated April 7, 1942.

      Richard F. Barrett, Esq., and Egbert Robertson, Esq., for the petitioners.

      Leonard A. Spalding, Jr., Esq., for the respondent.
   OPINION.

Turner:

The question raised by the first issue is whether there should be excluded from gross income of the petitioners the installment payments received by them under the insurance policies described in our findings. This is a question of law and involves the interpretation of sections 22 (b) (1) of the Revenue Acts of 1934, 1936, and 1938, which are identical and read as follows:

SEO. 22. GROSS INCOME.
*******
(b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title:
(1) Life insurance. — Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income).

Applying article 22 (b) (1)-1 of Regulations 86, the respondent, in determining the deficiencies here involved, has included in the income of the petitioners for the years before us the full amount of the installments received in those years under the insurance contracts above described. In support of such action, he states that these petitioners, prior to the years in question, had received in the aggregate amounts equal to or in excess of the amounts that would have been payable under contracts providing for the payment of insurance proceeds to beneficiaries in a lump sum at the death of the insured but in all other respects identical with the contracts before us, and that all amounts received in excess of the lump sum which would have been payable at the death of the insured had the contracts so provided constitute income. On brief, he makes an elaborate argument to the effect that since insurance companies, in arriving at the amount of the installments payable under contracts providing for such payment of the insurance proceeds, apply a percentage rate to the amount that would have been payable had the contract provided for payment in a lump sum at the death of the insured, therefore the pro rata part of each installment attributable to such percentage rate represents interest and the remainder principal. Regardless of such argument, however, he still contends for the conclusion that the full amount of the installments received by these petitioners in the years here involved is income.

This same question was considered by us in Sidney W. Winslow, Jr., 39 B. T. A. 373, and we there sustained the petitioner’s contention that annual installments of life insurance received by the beneficiary after the death of the insured were excluded from gross income by section 22 (b) (1), swpra. In the opinion of that case we reviewed the legislative and judicial history of the statute and concluded that the respondent’s interpretation thereof, as set forth in his regulation, could not be sustained. Our decision was affirmed by the United States Circuit Court of Appeals for the First Circuit, Commissioner v. Winslow, 113 Fed. (2d) 418. There the court likewise held that the respondent’s regulation above mentioned was contrary to the expressed intention of Congress and was invalid. Shortly thereafter the same conclusion was reached by the United States Circuit Court of Appeals for the Second Circuit, Commissioner v. Bartlett, 113 Fed. (2d) 766. To the same effect is Commissioner v. Buck, 120 Fed. (2d) 775, decided since the hearing in this proceeding.

The respondent concedes that in the cases above cited the taxpayers successfully challenged the validity of the regulation on which he relies, but argues that those cases are distinguishable and, further, that in so far as they deny his contentions they are erroneous. He fails to point out any material distinction, however, and, in view of the decisions cited above, further and extended discussion here seems to us unnecessary. We accordingly hold that the installment payments received by the petitioners under the seven insurance contracts are to be excluded from their gross income under section 22 (b) (1), supra. Cf. Equitable Life Assurance Society of the United States, 44 B. T. A. 293.

The question raised by the second issue is whether the exchanges by petitioners Thatcher and Huntzinger in 1929 and 1930 of their Washington stock for stock of the North American Co. were made in pursuance of a plan of reorganization and the stock exchanged and the stock received were the stock of corporations parties to the reorganization. If so, the basis of the North American stock in the hands of the petitioners was the same as the basis of their Washington stock. Sec. 113 (a) (6), Revenue Act of 1928. In section 112 (b) (3) it is provided that “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 m such corporation or m another corporation a party to the reorganization.” In section 112 (i) (1) (A) of the Eevenue Act of 1928 it is provided that the term “reorganization” means “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 * * *).” It is the contention of the petitioners that the transactions whereby they exchanged their Washington shares for North American shares was not an exchange within the meaning of section 112 (b) (3), but. was an exchange in respect of which the gain was recognized and that the basis of the North American stock to them for the purpose of determining gain or loss was therefore its fair market value when acquired.

The exchanges of the Washington stock for North American stock were made pursuant to the offer contained in the letter dated July 3, 1939, by North American to the common stockholders of Washington. At or prior to that date North American was the owner of 73,324% shares, or 48.8 percent of all the Washington stock outstanding, all of such outstanding stock being voting stock. Washington had nothing to do with the offer and was not a party thereto. No change in either Washington or North American or in their business operations other than the acquisition by North American of additional common stock of Washington was contemplated or made. As the result of the offer and in accordance with its terms, North American by August 17, 1929, had acquired 6,128 additional shares of common stock of Washington and it thereafter directly owned a majority of the voting stock and a majority of the total number’ of shares of all classes of Washington stock then outstanding.

It is the contention of the respondent that these facts make of the transaction a reorganization within the meaning of section 112 (i) (1) (A), supra, and bring the exchange by the petitioners of their Washington shares for North American shares within the provisions of section 112 (b) (3). He relies particularly on Rawco, Inc., Ltd., 37 B. T. A. 128, and Commissioner v. Dana, 103 Fed. (2d) 359. In the instant case the facts in our opinion not only fail to show the existence of a plan of reorganization, but to the contrary indicate the absence of one. North American was already the owner of 48.8 percent of the entire outstanding stock of Washington, which stock had been acquired by it for cash, and the only plan involved in the offer of July 3, 1929, was the plan to acquire such additional shares of Washington’s common stock as might be offered in exchange for North American common stock. Furthermore, even though it be assumed that a plan to acquire additional common shares of Washington, under the facts and circumstances outlined, did constitute a plan of reorganization within the meaning of section 112 (i) (1) (A),

supra, there is no basis of fact whatever for any conclusion that Washington was a party to such plan. The factual situations in Rawco, Inc., Ltd., supra, and Commissioner v. Dana, supra, are entirely different and amply distinguish those cases from the instant case. Cf. Cushman Motor Works, 44 B. T. A. 1288; Huey & Philp Hardware Co., 40 B. T. A. 781; and Robert A. Pulfer, 43 B. T. A. 677. We accordingly conclude that the exchange by the petitioners of their Washington shares for North American shares in 1929 and 1930 did not fall within the provisions of section 112 (b) (3), supra, and under the statute the gain realized from such exchange was recognizable.

The respondent pleads, however, that in any event petitioners are estopped to claim as the basis for the North American stock its fair market value at the time of acquisition. On brief, he states that he is not contending that petitioners are estopped within the usual confines of the doctrine of estoppel, but is contending, citing Stearns Co. v. United States, 291 U. S. 54, that petitioners, having taken the position in the earlier years that the exchanges of their Washington stock for .North American stock were nontaxable, may not now change their position to the detriment of the revenue. He admits that there was no misrepresentation or deception practiced upon him, but contends that this matter was not brought to his attention prior to the running of the statute of limitations on the years in which the exchanges were made.

This latter contention of the respondent seems contrary to the stipulated facts. It has been stipulated that in 1931 an examining agent of the Commissioner made an examination of the books and records of petitioner Thatcher for the year 1929 and “in his examination checked the North American Company common stock ledger account of the petitioner” in connection with a sale of such stock in 1929, and in his report dated May 12,1931, stated that “He maintains a complete set of books which were checked.” In computing his gain on the 1929 sale of North American stock petitioner Thatcher used as a basis therefor his cost of the Washington stock which had been exchanged therefor. It is also stipulated that in 1932 the same examining agent made an examination of the books and records of petitioner Huntzinger for the year 1930, the year in which she acquired the North American stock, and she was later notified that, subject to approval in Washington, her return for 1930 was being accepted as correct. We do not know the details of the respondent’s examination, but it can not now be said that the transactions in the prior years were not called to his attention.

The question of estoppel was considered and discussed at some length in Tide Water Oil Co., 29 B. T. A. 1208, and American Light & Traction Co., 42 B. T. A. 1121; affd., 125 Fed. (2d) 365. In the latter case the respondent advanced without success the same contentions which he now advances in the instant case. We do not think that case can be satisfactorily distinguished from the instant case. Since the respondent had knowledge of the transactions in the prior years and concedes that no misrepresentation or deception was practiced upon him, we find no basis for his plea of estoppel.

Petitioner Thatcher mailed his Washington stock certificates to the depository on July IB, 1929, and petitioner Huntzinger mailed her certificates on July 19, 1930. The North American certificates were received by Thatcher on August 6, 1929, and by petitioner Hunt-zinger on August 2, 1930. The petitioners contend that the basic dates, for purposes of valuing the North American stock, were the respective dates on which they received their stock certificates. We do not think so. The basic dates for valuing the stock were the dates on which they were entitled to receive the stock and not the dates on which the certificates were delivered to them. Anita Owens Hoffer, 24 B. T. A. 22. Stanton v. Commissioner, 98 Fed. (2d) 739, relied on by petitioners, is clearly distinguishable. On the basis of the record here, we conclude that they were entitled to receive such stock on the dates that they accepted the offer made by North American, that is, the dates on which they mailed their Washington stock certificates to the depository.

The question raised by the last issue is whether the transaction whereby petitioners Thatcher and Huntzinger exchanged their stock in the American-La France & Foamite Corporation for stock and warrants in American-La France-Foamite Corporation, Inc., was a reorganization within the meaning of section 112 (g) of the Revenue Act of 1936. The respondent contends that the transaction was a reorganization within the meaning of section 112 (g) (1) (C) and under section 112 (b) (3) of the act, the loss sustained by reason of such exchange is not to be recognized.

Petitioners contend that, since immediately after the transfer neither the transferor corporation nor its stockholders were in “control”, section 112 (h) , of the new corporation, it was not a reorganization within the meaning of the act and that they are accordingly entitled to deduct the losses sustained.

Since the filing of briefs in this case, the Supreme Court has decided that bondholders of a transferring corporation can not, for the purpose of satisfying the 80 percent control provision, be regarded as “stockholders”. Helvering v. Southwest Consolidated Corporation, 315 U. S. 194. But, argues the respondent, here 2,500 shares of the new corporation were issued to noteholders of the old corporation who were also stockholders of the old corporation and when these 2,500 shares are added to those acquired by the other stockholders, then the 80 percent control requirement will be satisfied. The error in this argument is that such noteholders acquired the 2,500 shares of stock of the new corporation by exchanging their notes and not by reason of the fact that they also happened to be stockholders. This fact, in our opinion, is fatal to the respondent’s contention. We hold that the transaction was not a reorganization within the meaning of the act and that petitioners are entitled to deduct the-losses claimed.

Petitioner Thatcher now concedes that in 1935 and 1936 he received dividends on Northwestern Mutual Life Insurance policy No. 163,896 in the respective amounts of $156.31 and $52.32 and that, such amounts being in excess of the guaranteed installments payable under the poL icy, are includible in his taxable income for those years. Petitioner Huntzinger concedes that she similarly received during the years 1935, 1936, and 1937 the respective amounts of $156.44, $52.32, and $39.32 and that those amounts are includible in her taxable income for those years. Petitioner Wheeler also concedes that for the years 1936, 1937, and 1938 she received under the same policy payment of dividends in excess of the guaranteed installments payable thereunder and that such dividends are includible in her taxable income for said years.

Decisions will be entered under Rule 50.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      *#***♦♦
      (g) Definition of Reorganization. — As used in this section and section 113—
      (1) The term “reorganization” means * * * (C) 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 * * *.

       (h) Definition of Control. — As used in this section the term “control” means the ownership of stock possessing at least 80 percentum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.


author: Smith:

text:
    Constance C. Frackelton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106474.
    Promulgated April 7, 1942.

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

      Thomas F. Callahan, Esq., for the respondent.
   OPINION.

Smith:

The principal question presented by this proceeding is whether the petitioner is liable to income tax upon the difference between the cost to her of two 15-year endowment policies on the life of her husband and their maturity value in 1938.

The respondent gives as his reason for including in the petitioner’s gross income for 1938 the amount of $51,179.85 representing the difference between the alleged cost of the policies and their value at maturity, that the amount is taxable under the provisions of section 22 (a) of the Revenue Act of 1938, which requires the inclusion in gross income of “gains or profits and income derived from any source whatever.” Certain exclusions from gross income, however, are provided for by section 22 (b). That section reads in part as follows:

(b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation-under this title:
(1) Life insurance. — Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income) ;
(2) Annuities, etc. — Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation under paragraph (1) or this paragraph.

Under section 22 (b) (2) above tbe petitioner would be taxable in 1938 on tbe excess of tbe maturity value of the policies over tbe aggregate premiums paid only if she “received” tbe proceeds in that year. While admittedly petitioner actually received no money payment under tbe policies in 1988 except the interest and dividends and the $85.64 referred to above under tbe policy issued by the State Mutual Life Assurance Co., respondent’s contention is that she “constructively” received the entire amount of the proceeds of both the policies on the dates of their maturity.

The test for applying the doctrine of constructive receipt is the availability of the income for the taxpayer’s use and enjoyment in the taxable year. “The income that is subject to a man’s unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not.” Corliss v. Bowers, 281 U. S. 376. See also Loose v. United States, 74 Fed. (2d) 147, and cases there cited. Taxpayers are not permitted to shift the receipt of income from one year to another and to select the year when the income is to be taxed “by the simple expedient of withholding volition” to accept it when it is made available for their use. Harry B. Hurd, 12 B. T. A. 368. See also Avery v. Commissioner, 292 U. S. 210; Foley v. Commissioner, 94 Fed. (2d) 958; Security First National Bank of Los Angeles et al., Executors, 28 B. T. A. 289; Alexander Zolotoff, 41 B. T. A. 991.

An examination of the various Bureau rulings shows that the Commissioner has consistently treated the proceeds of matured life insurance or endowment policies which, in accordance with option settlement agreements, are to be paid out in installments over a period of years, not as taxable to the beneficiaries at the date of maturity under the constructive receipt theory or otherwise, but as taxable in each year as the installment payments are actually received. I. T. 3202, C. B. 1938-2, p. 138; G. C. M. 21666, C. B. 1940-1, p. 116; I. T. 3402, C. B. 1940-2, p. 57; I. T. 3413, C. B. 1940-2. p. 58: G. C. M. 22519, C. B. 1941-1, p. 330.

We consider first the policy issued by the New England Mutual Life Insurance Co. This policy was applied for by petitioner’s husband. In making his application he named the petitioner as beneficiary and stated that he did not retain the right to change the beneficiary. The dividends apportioned to the policy were to be applied in acquiring paid-up additional insurance. The policy provided that if both the insured and the petitioner were living at the date of the maturity of the policy the petitioner was thereafter to receive income equal to 3 percent per annum of the value of the policy, which annual payment was to be increased by such share of “surplus interest” as may be apportioned thereto and upon the death of the beneficiary the principal sum and any accrued interest thereon were to be paid to her estate. At the maturity of the policy, February 5, 1938, both the insured and the beneficiary were living and the insured had not made any attempt to change the policy in any way. The petitioner received no payment on the policy in 1938, the first annual payment not being due until one year after the maturity of the policy.

On brief the respondent states:

With regard to the New England policy it is noted that the premium was paid by the petitioner and that the insured, by specific provision, did not reserve the right to change the beneficiary. Accordingly, it should be held that the petitioner was the real owner of the policy and the petitioner should be considered as the real applicant, rather than her husband who signed the application. This being so, it is believed that the terms of the policy should be construed to hold that petitioner has the rights which the insured would otherwise have, including the right to change or revoke any election as to the manner of payment of proceeds. Therefore, it is believed that under the circumstances the petitioner had the right at the date of maturity of this policy to draw down the proceeds thereof.

We do not subscribe to these views. A life insurance policy is a contract between the insurance company and the party who makes application for the policy. The application here was made by petitioner’s husband. The laws of the Commonwealth of Massachusetts require the application to be attached to the policy and when so attached the policy and the application together constitute the entire contract between the parties. See ch. 175, secs. 131 and 132-3, General Laws of Massachusetts (Annotated Laws of Massachusetts, vol. 5, pp. 666, 667). Section 132-3, chapter 175, provides in part that:

§ 132. Life, Annuity, etc., Policies, Approval and Contents. — No policy of life or endowment insurance and no annuity or pure endowment policy sliall be issued or delivered in tbe commonwealth * * * unless it contains in substance the following:
v ***** *
3. A provision that the policy and the application therefor shall constitute the entire contract between the parties, and that no statement made by the Insured or on his behalf shall be used in defence to a claim under the policy unless it is contained in a written application, and a copy of such application is endorsed upon or attached to the policy when issued.

The policy here in question conformed to the requirements of the statute, stating upon its face that “This Policy and the application constitute the entire contract between the parties hereto.” The application is signed only by “Robert James Frackelton, Applicant.” It states that the amount of the policy is to be “payable at death or after maturity of the endowment period under option four in monthly instalments” to the petitioner, and the question “Do you reserve the right to change the Beneficiary?” is answered “No.”

The policy on its face acknowledges payment of the single premium by the petitioner and states that in the event of the maturity of the policy as an endowment the company “in lieu of paying One hundred thousand (100,000) dollars in one sum, will pay annual payments in accordance with the provisions of the Fourth Option of this policy, in equivalent monthly instalments, to said Constance Chandler Frackelton, if living.” Option fourth, as set out above, provides only for payments to petitioner for life of interest of 3 percent annually, plus dividends.

We find no provisions anywhere in the contract that permitted the petitioner as beneficiary to receive the principal amount of the policy at the maturity date or at any time during the taxable year 1938. The fact that petitioner paid the premium on the policy gave her no rights outside of those expressly contained in the contract. In Millard v. Brayton, 117 Mass. 533; 59 N. E. 436, it was said:

* * * ^he payment of the premiums, whether before or after the death of the wife, did not affect the nature or construction of the contract, did not make him a party to it, nor the policy his property. Swan v. Snow, 11 Allen, 224; Baker v. Insurance Co., 43 N. Y. 283; Whitehead v. Insurance Co., 102 N. Y. 151; 6 N. E. 267. * * *

The policy here provides that the “insured” alone should have the right to select the option settlement and that “In case such election is made by the Insured, the Payee shall have no right to assign, alienate or commute any of the instalments so payable, unless the Insured has otherwise directed.” The payee (petitioner) was to have the right of election only upon failure of the insured to exercise such right prior to his decease. The fact is that the election was made, presumably by the insured, at the time the policy was issued and was never changed by the insured or any one else. In the absence of any provision to the contrary in the contract, we think that the rights of the petitioner in the proceeds of the policy became fixed upon the maturity of the policy as an endowment. Thereafter, she had no right under the contract to anything more than the interest and dividends.

We do not agree with respondent’s contention that the petitioner should be considered the “real applicant” of the policy as well as the “real owner.” The application reads: “I, Robert J. Frackelton, of Cleveland, Ohio, hereby apply”, etc. It is signed only by “Robert James Frackelton, Applicant.” The questions in the application are directed solely to the insured and are all answered by him.

In Millard v. Brayton, supra, the Supreme Court of Massachusetts had under consideration the question of the respective rights of husband and wife, or persons claiming under them, in an insurance policy on the husband’s life. On facts which in some respects resemble those in the instant case but in others were notably different, as pointed out below, the court decided that the policy was a contract between the insurance company and the wife. A distinction, which was emphasized by the court, is that the application there was executed by and signed by both the husband and wife, the wife being referred to therein as the “applicant” and the husband as the “insured.” In its opinion the court said:

* * * It appears, therefore, from the application and policy, constituting together the contract, that the wife, having an insurable interest in the life of her husband to the amount of $10,000, wished to insure that interest, and applied to the company for such insurance; that upon such application the policy was issued; that the basis of the contract or the thing insured was the interest of the wife in the life of her husband, as stated in the application, and not the interest of the husband in his own life; that the consideration for the contract was recognized by all parties as coming from the wife; that the promise by the insurance company, although not made in express terms to the wife, was, by fair and reasonable implication and in law, a promise to the wife; that it was a promise to pay the wife, and was made upon certain express conditions, which were to be accepted by the assured, namely, the wife, and by no one else. It follows, as a necessary consequence, that the contract was in law between the company and the wife. It was a contract by which she was insured upon her interest in the life of her husband, and not a contract by which he was insured upon his interest in his own life. In Whitehead v. Insurance Co., 102 N. Y. 143, 150, 6 N. E. 267, where each of three policies in the life of the husband recited that the consideration was paid by the wife, and the money was to be paid to her, the court said: “These contracts purport upon their face to be contracts with the wife as the party assured, and not at all with the husband, who stands in the policy as simply the life insured; his conduct and death furnishing the contingencies upon which the liability of the insurer is made to depend. As was tersely expressed in the argument, the contract was about the husband, and not with him.” * * *

Further in its opinion the court distinguished Fuller v. Linzee, 135 Mass. 468; Bancroft v. Russell, 157 Mass. 47; 31 N. E. 710; and Haskins v. Kendall, 158 Mass. 224; 33 N. E. 495, on the ground that in those cases the policies were applied for by and procured by the husbands rather than the wives.

In so far as Millard v. Brayton, supra, may be considered helpful in the determination of our present question, it establishes, contrary to respondent’s contention, that petitioner’s husband and not petitioner was the applicant for the policy under consideration and that the policy was a contract between the insurance company and petitioner’s husband.

As stated above, we do not think that under any of the provisions of the insurance contract the petitioner had a right to receive the value of the policy at the date of maturity and therefore we are of the opinion that petitioner did not constructively receive the proceeds of the policy in 1938. Since it further appears that petitioner did not actually receive any payments of interest, dividends, or otherwise, under the policy in the taxable year 1938, she is not taxable in that year on any income therefrom.

The policy issued by the State Mutual Life Assurance Co. was somewhat different. That policy was applied for by the petitioner and petitioner paid all the premiums. She and she alone had the right to select the method of settlement. Under the method so elected the company retained the principal amount of the proceeds under an agreement to pay the petitioner during her lifetime interest of 3 percent per annum, plus dividends, and upon her death to pay the principal amount over to her estate. The settlement agreement (option C above) further provides that: “The amount so left with the Company may be withdrawn at any time when an instalment of interest is payable, unless otherwise directed by the insured during his lifetime.” There is no evidence that the insured ever directed, even if he had a right to do so, that the proceeds of the policy should not be withdrawn by the petitioner. Thus, it appears that even though petitioner may not have had the right to withdraw the entire amount of the proceeds of the policy on the maturity date, having made her election of the option C settlement five days previously, she did have that right during the taxable year 1938 when the interest payment or payments became due. She received seven monthly interest payments in 1938.

In I. T. 2380 (1921) C. B. VI-2, p. 32, it was held that the proceeds of a matured endowment policy which, under an option settlement agreement, were retained by the company, but which the insured had a right to withdraw at maturity or at any “annuity-paying date”, were taxable to the insured at maturity as constructively received by him. The ruling reads in part as follows:

The entire amount of $1,000, called for by tbe policy, was available to tbe insured at tbe maturity date, and, in fact, at any annuity-paying date thereafter. Although under tbe settlement made it was left with tbe company, the insured as beneficiary receives a return thereon of 4.8 per cent, and, as before stated, tbe principal sum may be withdrawn at any annuity-paying date. Tbe settlement made, therefore, amounts to the constructive receipt of the proceeds of the policy at the maturity date and the reinvestment of the same in accord-anee with the terms of the settlement. The so-called dividend of $22.67 paid to the insured at the maturity date represented merely an adjustment or refund on the last premium paid and, so treated, the net premiums paid are shown to have amounted to $861.94. As this amount of the proceeds is exempt from the income tax under the above-quoted provisions of the statute, the portion of the proceeds which constitutes taxable gain is $138.06, this being the amount by which $1,000 exceeds the net premiums paid. This amount, therefore, represents taxable income for the year 1925, subject to both the normal tax and surtax. * * *

Although the petitioner here was not the insured, she had complete ownership of the policy and the right to select the plan of settlement. The insured had no material rights in the policy.

In I. T. 2635, C. B. XI-2, p. 63, it was held that a beneficiary who had a right to receive interest but not to withdraw the entire proceeds of the policy was taxable only on the interest received. In I. T. 3202, supra, it was held that where the proceeds of a matured life insurance policy are left with the company under an agreement to pay “a fixed sum equal or less than the interest and earnings on such proceeds” the contract should not be treated as an annuity contract under section 22 (b) (2) of the Revenue Act of 1936. In G. C. M. 21666, supra, an “annuity” was defined as:

* * * a stated sum payable periodically at stated times during life, or a specified number of years, under an obligation to make tbe payments in consideration of a gross sum paid for sucb obligation, wbicb gross sum is exhausted in the making of the periodic payments. * * *

The payment of the interest and dividends under the policy here in question does not exhaust the principal amount of the policy and those payments were not annuities.

The important consideration here, in relation to the constructive receipt theory, is that petitioner had the right during the taxable year, if not actually at the date of the maturity of the policy, to withdraw the full amount of the proceeds of the policy, merely upon her request to the company and without any additional payment to the company. It was entirely of her own volition that she permitted the funds to remain in the custody of the insurance company. For practical purposes the result was precisely the same as if she had received actual payment of the proceeds of the policy and had then returned the funds to the company to be held at her pleasure at a guaranteed interest rate of 3 percent, plus whatever additional interest or dividends the company might choose to pay. We know of no reason why under such circumstances the doctrine of constructive receipt should not be held applicable to the proceeds of the policy.

We think that petitioner is taxable in 1938 upon the difference between the maturity value of the policy and the premiums paid thereon, in addition to the interest and dividends that were paid to her during the taxable year.

The final question is whether the amount of $1,167.29 paid to the Cleveland Trust Co. for services as trustee under revocable trusts established by the petitioner is a legal deduction from petitioner’s gross income. It is not a legal deduction unless it constitutes an ordinary and necessary expense of carrying on a' trade or business. This issue must be decided in favor of the respondent. See Higgins v. Commissioner, 312 U. S. 212; City Bank Farmers Trust Co. v. Helvering, 313 U. S. 121; United States v. Pyne, 313 U. S. 127; Elliott v. Commissioner, 117 Fed. (2d) 1012.

Eeviewed by the Board.

Decision will be entered under Rule 50.

Mellott dissents on the first point.


author: Leech :

text:
    John H. Wood Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105564.
    Promulgated April 7, 1942.

      George A. Swayze, Esq., for the petitioner.

      Bernard D. Daniels, Esq., for the respondent.
   OPINION.

Leech :

The petitioner was the owner of a debt in the uncontested amount of $43,587.91. That the mortgagor had died insolvent did not change this fact. Such condition merely affected the extent to which the debt was recoverable. Eecovery was thus limited to such amount as could be realized from the mortgaged property securing the debt.

It is apparent that for some time prior to the taxable year the security had a value substantially less than the amount of the debt. Thus, during that period, a basis existed for a partial charge-off had petitioner desired to avail itself of that privilege. It was not, however, required to take such action but could first realize upon the security and then charge off the balance of its cost of the receivable as then ascertained to be wholly worthless. Ross v. Commissioner, 72 Fed. (2d) 122; Alfred K. Knippert et al., Executors, 32 B. T. A. 892.

This it has done. The value of the collateral was realized and applied on the debt. This was done by the owner of the legal title to the mortgaged property making a transfer thereof by quitclaim deed to petitioner. In its essence for present purposes this is not different from the case in which foreclosure was effected and the proceeds from the sale of the property paid to petitioner; or where the owner of legal title paid in cash to petitioner the fair market value of the mortgaged property for a release of the mortgage. Petitioner merely realized from the security all that was recoverable on the debt, leaving an unpaid balance which was wholly worthless. Petitioner’s loss was not sustained upon a sale or exchange because it has neither sold nor exchanged property. It merely received payment in part of the indebtedness due it. Hale v. Helvering, 85 Fed. (2d) 819; Bingham v. Commissioner, 105 Fed. (2d) 971; Commissioner v. Spreckels, 120 Fed. (2d) 517; Commissioner v. National Bank of Commerce of San Antonio, 112 Fed. (2d) 946.

We hold that, under section 23 (k) of the Revenue Act of 1936, petitioner is entitled to deduction of that portion of its indebtedness unsatisfied after the transfer to it of the mortgaged property by the receiver. We have found that the receipt of this property constituted a recovery of $21,000.

Decision will be entered under Rule 50.


author: Black: Mellott,

text:
    The Warren Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104373, 104477.
    Promulgated April 8, 1942.

      Edward B. Kane, Esq., and Joseph B. Brennan, Esq., for the petitioner.

      F. L. Van Haaften, Esq., and Charles P. Bagley, Esq., for the respondent.
   OPINION.

Black:

Two issues remain for our decision: (1) Whether the respondent erred in increasing petitioner’s income by the excess of the selling price over the net price on all sales made by petitioner’s agents during the taxable years and allowing petitioner as a deduction therefrom only the sales agents’ commissions actually paid during the year, thereby disallowing as a deduction during the respective current taxable year that part of the agents’ commissions which remained unpaid at the end of the year; and (2) whether petitioner is entitled to a credit under section 26 (c) (1) of the Revenue Act of 1936 by reason of a contract restricting the payment of dividends.

1. The facts relative to the first issue are fully set forth in our findings. Briefly, petitioner sold its product chiefly through agents to whom petitioner quoted a “net price” and permitted the agents to establish the “selling price” with the understanding that the excess of the selling price over the net price was to be paid to the agents as their commissions. In no case was petitioner entitled to keep for itself more than the net price. It was agreed by petitioner and its selling agents that the purchaser would pay petitioner the entire selling price; that the difference between the selling price and the net price would represent the agent’s total commission; that 25 percent of this commission would be credited to a regular reserve account and not paid to the agent until the entire selling price had been paid to petitioner; that 75 percent of this total commission, called the current commission, would be paid to the agent immediately, provided the down payment made by the purchaser equaled 75 percent of the total commission; that in case the down payment did not equal 75 percent of the total commission, the entire down payment was to be paid to the agent and the balance of the current commission would be credited to a special reserve account and paid to the agent on the basis of 50 percent of the monthly collections from the purchaser until the current commission was fully paid. Petitioner accrued and reported as income only the net price. It claimed no deductions for commissions. The respondent determined that petitioner should accrue and report as gross income the entire selling price and then deduct from the selling price only the commissions actually “paid” to the agents during the taxable year. Although petitioner kept its books and reported according to the accrual method of accounting as distinguished from the cash receipts and disbursements method, the respondent determined and contends that the portion of the agents’ commissions contained in the regular and special reserve accounts did not accrue as a liability for the reason that the payment of these amounts to the agents was contingent upon collection being made by petitioner from the purchasers. In support of this contention the respondent cites Reuben H. Donnelley Corporation, 22 B. T. A. 175, as a case on all fours with the present case; and Air-Way Electric Appliance Corporation v. Guitteau, 29 Fed. Supp. 379.

Petitioner contends that it should either be sustained in accruing as income only the net price and not deducting therefrom any agents’ commissions, or, if required to accrue as gross income the selling price, then it should be permitted to deduct the entire amounts of the agents’ selling commissions whether collected in the taxable year or not; and that, to the extent the respondent’s argument finds support in the Donnelley case and the Air-Way Electric Appliance Corporation case, those decisions are unsound and should not be followed by the Board in the instant case.

Since the briefs in the present proceedings were filed the Sixth Circuit has reversed the District Court in Air-Way Electric Appliance Corporation v. Guitteau, supra. See 123 Fed. (2d) 20. In that case the taxpayer was a manufacturer of vacuum cleaners. Its marketing system consisted of the appointment of distributors who in turn entered into arrangements with retail dealers who sold to the public generally on installment conditional sales contracts which were assigned by the dealer to the distributor and by the distributor to the taxpayer. The taxpayer charged the distributor for merchandise delivered to him. Upon assignment of the sales contracts to the taxpayer, the latter would credit the distributor with the face amount of the contract and debit accounts receivable for the same amount. At the same time the taxpayer would charge the distributor’s current account with 10 percent of the face of the contract and credit the distributor’s deferred account which was captioned “Reserve for Contingent Collection Expense” with a like amount. The deferred credits were payable to the distributor from month to month as the installments were paid by the purchaser of the vacuum cleaner. As the deferred credits were paid to a distributor, the amounts so paid were charged to the reserve for contingent collection expense account. During the taxable years involved, the credits to this reserve exceeded the debits by $112,183.38 in 1927 and $138,494.40 in 1928. The Commissioner included in the taxpayer’s gross income the face value of the conditional sales contracts but refused to allow as deductions the amounts of $112,183.38 and $138,494.40, respectively, on the ground that such amounts were not properly chargeable to expense during the tax years because prospective. The District Court sustained the Commissioner, citing as authority the Donnelley case. The Sixth Circuit in reversing the District Court, among other things, said:

The Collector relies upon the rule that reserves are not deductible if they are set up merely to cover contingent liabilities. [Citations] If the obligation to pay is, in a true sense, based upon a contingency in the sense that that term is used in the cited cases, the judgment should stand. But analysis discloses that it is not. True, the purchasers might never pay up their contracts and be uncollectible, but upon the installments being paid the obligation to' pay them over to the distributor is absolute and not contingent and the obligation accrued when the right to collect accrued during the tax years. In this respect that portion of the installment contracts represented by the 10% reserve stands on no different basis than that portion represented by the 90% net credit, for both are subject to the possibility that the purchaser might default, and to defer the liability to pay with respect to the one until the money is received, and to credit the other in advance of payment as accrued, is to divide the transaction and to place part of it upon an accrual basis and part of it on a cash basis, and this does not reflect true income. * * *

"We think the Sixth Circuit correctly decided in favor of the taxpayer in the Air-Way Electric Appliance Corporation case, and that the same reasoning used by the court in that case is applicable to the instant case and brings about a decision in petitioner’s favor.

It seems clear to us that when petitioner made sales of its equipment through its agents to customers and received their installment notes secured by the retention of title to the equipment, it should accrue the entire sales price as gross income. Cf. George Hyatt, 36 B. T. A. 121. There were no conditions as to payments which would make these notes in any sense contingent assets. True, some of them might never be paid, but that fact has nothing to do with their accrual as income unless they were of the class that their collection was so improbable as to make their accrual as income unnecessary under a well known line of Board and court decisions. But there is no evidence in the instant case that any of the notes and accounts were of that nature and there is no such contention.

It seems equally clear that petitioner should have the right to accrue against the above mentioned income items its liability to pay* the agents’ commissions thereon. The contract which petitioner had with its agents definitely provided that the company would pay the agent as his selling commission “the difference between the selling price and the Company’s net price.” True, it is that certain portions of this commission were not to be paid to the agent until collections were made from the customers but the liability to pay these commissions was just as certain as payment of the notes was certain, no more and no less. If payment of these notes receivable was sufficiently certain to justify their accrual as gross income, and we have held it was, we think the obligation of petitioner to pay agents’ commissions was sufficiently certain to justify their accrual as liabilities.

To treat petitioner’s income and deductions in the manner we have just suggested is simply to treat both sides of the ledger in the same way. Cf. American National Co. v. United States, 274 U. S. 99; Bonded Mortgage Co. v. Commissioner, 70 Fed. (2d) 341.

The fact that some of the commissions which petitioner definitely agreed to pay its agents were not payable until the notes which had been given for the equipment had been paid in full did not change the liability of petitioner into a contingent liability. Cf. Shoemaker-Nash, Inc., 41 B. T. A. 417. See also G. C. M. 9571, X-2 C. B. 153.

We think Reuben H. Donnelley Corporation, supra, upon which respondent so strongly relies, is distinguishable on its facts. In that case we found, among other things, that “The contracts for advertising or extra listings were obtained by soliciting agents or salesmen who were paid on a commmission basis against which they had drawing acccounts. This commission was not payable until the charge for the advertising was collected from the customer.” On those facts we held that no liability to pay agent’s commissions accrued until the taxpayer collected the accounts from its customers. In so holding we said: “In the instant case the petitioner did not charge on its books as an expense incurred, the unpaid commmissions to these salesmen nor did it credit to the accounts of such salesmen the commissions on contracts for which payment had not been made. On the contrary it was distinctly understood that no salesman was entitled to a credit to his commission account for any particular contract until payment had been made in settlement of that contract!" (Italics supplied.)

For reasons which we have already pointed out herein, we think the contract which petitioner had with its sales agents was one under which, by its very terms, commissions accrued to the sales agents immediately when sales were made, although only a part of the commissions was then payable and the balance was to be paid later when collections were made. These facts, we think, make the instant case distinguishable from the Reuben H. Donnelley Corporation case.

We also think that Swain & Myers, Inc., 42 B. T. A. 306, is distinguishable on its facts. In that case the sales tax levied by the State of Illinois was not on gross sales, but upon “gross receipts from sales,” as we pointed out. In other words if a merchant sold his goods on a credit, no tax accrued against him until collections were made. This latter event had to occur before there was any accrual of the tax. Under those circumstances we held that the taxpayer in that case was not entitled to accrue as a liability in the taxable year $1,497.61 taxes as due tbe State of Illinois, based on sales which the taxpayer had completed but upon which no collections had been made in the taxable year. We see no conflict in our holding in the Swain & Myers, Inc., case with our holding in the instant case.

2. In determining petitioner’s “undistributed net income” as that term is defined in section 14 (a) (2) of the Revenue Act of 1936, is petitioner entitled for the fiscal years ending September 30, 1937, and September 30, 1938, respectively, to a credit under section 26 (c) (1) of the same act, relating to contracts restricting dividends ? The material provisions of this section are in the margin.

Petitioner contends that it could not during the fiscal years involved distribute any amount as dividends without violating section 13 of article V of the trust indenture executed by petitioner on March 1, 1928. The material provisions of section 13 are as follows:

The Company covenants and agrees that it will not pay any dividends on its outstanding capital stock * * * unless its current assets will equal at least twice the amount of its current liabilities, after the payment of any dividends * * *.

Section 14 of article V of the trust indenture defines the terms “current assets” and “current liabilities,” the definition of the latter term being as follows: “Accounts payable; trade acceptances; bills current and notes current, and any other liabilities other than these bonds.” (Italics supplied.)

Petitioner contends that the amounts embodied in the stipulation as representing the amounts at the close of each month during the fiscal years involved remaining outstanding and unpaid by the maker of the deferred payment paper sold by petitioner and the New York corporation to C. I. T. and by the Beaumont company to C. I.. T. Corporation, respectively, represent “contingent liabilities” of petitioner and as such must be considered as “any other liabilities” in applying the definition of “current liabilities” as used in the trust indenture.

The respondent contends that the phrase “and any other liabilities other than these bonds” contained in the definition of “current liabilities” as defined in the trust indenture “must be read in porn materi.a with the section from which it is clear that the current assets and current liabilities therein referred to are fixed, known, or asc-er-tamable current assets and liabilities — not contingent current assets and liabilities.” The respondent further contends that “under the ejusdem generis rule, it is obvious that this phrase is intended to refer to any other cwrrent liabilities other than these bonds which are fixed current liabilities.” The respondent further- contends that in any event the amounts remaining outstanding and unpaid on paper sold by the Beaumont company should be excluded as a current liability for the reason that as to such paper petitioner was merely an accommodation endorser in violation of its charter and the corporation laws of the State of Georgia. The remaining contentions of the respondent relate to certain other minor objections to the list of current assets and current liabilities introduced in evidence as petitioner’s Exhibit 15 referred to in our findings.

At the outset it should be noted that petitioner has overstated the amount of its alleged contingent liability at the close of each month during the fiscal years involved by the 10 percent holdback, which is the amount that would be paid to petitioner (including the New York corporation) or the Beaumont company upon payment in full of the discounted paper by the maker thereof. Petitioner was not liable to C. I. T. for the 10 percent holdback, contingently or otherwise. Petitioner (including the New York corporation) and the Beaumont company, respectively, merely agreed that, if there should be default, “we agree on request without any tender of paper being required to repurchase from you the paper or the entire series of paper on which such default has occurred at the remaining amount of your investment therein.”

Are these remaining amounts, exclusive of the 10 percent holdback, “current liabilities” as that term is used in the trust indenture? Before answering this question we think that the respondent is in error in contending that in any event the remaining investment of the C. I. T. Corporation in paper sold by the Beaumont company should be excluded as an alleged contingent liability of petitioner. We hold that the contract dated June 8, 1935, between petitioner and C. I. T. (set out in our findings) was not a violation of petitioner’s charter or the corporation laws of the State of Georgia. We will now consider the preceding question.- •

In approaching the question it might be well to bear in mind that accounting authorities generally classify liabilities that appear in the balance sheet proper as. either fixed or current; that although arbitrary if is customary to regard liabilities as fixed if more than one year intervenes before they fall due; that bonded indebtedness is generally regarded as a fixed liability as distinguished from current ; and that contingent liabilities “are those which become definite liabilities in. the future only in. case of occurrences, which may or may not transpire, as, contingent liability on notes receivable discounted, and on securities of other companies guaranteed as to principal or interest, or both.” Accountants’ Handbook, by E. A. Saliers, pp. 337, 338. From an accounting standpoint, it has been said, there are four methods of showing contingent liabilities on the balance sheet. These are set out in the margin. Of course, the parties to the trust indenture could define “current liabilities” in any manner that they chose. They could even have agreed that no dividends whatever would be declared or paid while any of the bonds were outstanding. But it was their intention to permit dividends whenever the “current assets” exceeded twice the “current liabilities” and they defined the latter term as meaning: “Accounts payable; trade acceptances; bills current and notes current, and any other liabilities other than these bonds.”

If we were to construe the broad term “liabilities” as used in the above definition alone and apart from the remainder of the definition, it is our opinion that the so-called remaining amounts of “Investment” would have to be considered as coming within the broad term. First National Bank of Redlands v. Consolidated Lumber Co., 16 Cal. App. 267; 116 Pac. 680. Cf. Cochran and Sayre v. United States, 157 U. S. 286, 295, 296. But we think the term must be restricted in accordance with the rule of ejusdem gen&ris. 25 R. C. L. 997 states this rule in part as follows:

* * * In accordance with the rule of ejusdem generis, such terms as “other,” “other thing,” “others,” or “any other,” when preceded by a specific enumeration, are commonly given a restricted meaning, and limited to articles of the same nature as those previously described.

Under this rule the general words “any other liabilities” must be assimilated to the particular words “Accounts payable; trade acceptances ; bills current and notes current” and restricted to liabilities of the same kind. Cf. Helvering v. Stockholms Enskilda Bank, 293 U. S. 84. We have not overlooked the fact that the general words “any other liabilities” are qualified by the exception “other than these bonds.” By reason of this exception it might be argued upon behalf of petitioner that the parties to the trust indenture attached to the general words a larger meaning than they would have if limited to things ejusdem generis as those specifically enumerated. But when it is remembered that the parties to the trust indenture were defining a term which had already come to have a generally understood meaning, it is believed that the phrase “other than these bonds” had been introduced only for greater caution. Otherwise, the particular words “Accounts payable; trade acceptances; bills current and notes current” would all be superfluous and it would have been sufficient to have defined “current liabilities” simply as “all liabilities other than these bonds.”

After a careful consideration of all the facts and argument of the parties, we are of the opinion that the contingent liabilities in question are not “current liabilities” as that term is used in the trust indenture, and we have made our finding accordingly.

Among the current assets listed in petitioner’s Exhibit 15 were “Notes Receivable — Net (Less Deferred Crs.).” The deferred credits thus deducted consisted of finance charges not yet earned on notes which matured in future tax years and also the 10 percent held back by C. I. T. on notes purchased by C. I. T., and amounted to $47,521.27 ($21,297.24 of which represented the 10 percent holdback) for each month during the 12-month period ending August 31, 1937, and $65,461.80 ($64,196.06 of which represented the 10 percent holdback) for each month during the 12-month period ending August 31, 1938. The respondent contends that these amounts should be added to petitioner’s current assets. Petitioner admits that these charges have been included in the face of the notes receivable. The trust indenture defines current assets in part as meaning “(d) Bills receivable after proper deduction for doubtful bills.” Since the amounts representing the 10 percent holdback concerned notes which petitioner had sold to O. I. T., we do not think those amounts should be considered as a part of petitioner’s “current assets” as that term is defined in the trust indenture. The balance of the said amounts of $47,521.27 and $65,461.80, respectively, represented charges on notes which apparently were still held by petitioner. We hold that these charges in the amounts of $26,224.03 and $1,265.74, respectively, being a part of the bills receivable, come within the definition and should be included in petitioner’s current assets.

In our findings we.have found the total current assets and the total current liabilities at the close of every month for the fiscal years ending September 30, 1937, and September 30, 1938. At the close of each month for the first eleven months of the fiscal year ending September 30, 1937, and at the close of each month for the first eleven months of the fiscal year ending September 30, 1938, petitioner could have paid dividends in excess of its adjusted net income for the respective fiscal year without violating a provision of a written contract executed by petitioner prior to May 1,1936.

Article 26-2 of Eegulations 94 provides in part as follows:

(b) Prohibition on payment of dividends. — The credit provided in section 26 (c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend—
*******
(2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable year) without violating such provision—
then the amount is one which, under section 26 (c) (1), can be distributed within the taxable year as a dividend without violating such provisions.

We hold that the above regulations are reasonable and correctly interpret the statute. Cf. Honokaa Sugar Co., 43 B. T. A. 151, 157; Henry Mill & Timber Co., 43 B. T. A. 1073, 1077. The statute (see footnote 1) allows a credit of an amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed “within the taxable year” as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936. Since petitioner could have distributed amounts in excess of its adjusted net income for each fiscal year at the close of any month during the first eleven months of each fiscal year without violating a provision of the trust indenture, we hold that it is not entitled to any credit under section 26 (c) (1) of the Eevenue Act of 1936. The respondent’s determination as to this issue is sustained.

Reviewed by the Board.

Decisions will he entered wider Rule 50.

Mellott,

concurring: While I concur in the holding of the majority, I do not believe that the distinction of the Reuben H. Donnelley Corporation case is sound. In so far as it is contrary to the conclusion reached upon the first point, I think it should be overruled.

Leech and Disney agree with the above.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—

        ■* ' # * *. .* *
      (c) CONTRACTS RESTRICTING PAYMENT OB’ DIVIDENDS.-
      (1) Prohibition on Payment of Dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating , a provision of a written contract executed by the corporation" prior to May 1; 1936, which provision expressly d"eals“witli the payment of dividends. * * »

       Contingent Liabilities. — From an accounting standpoint there are four different ways of showing contingent liabilities on the balance sheet. Method one, which is the best where practical, is to show the contingent liability as a contra item to the corresponding contingent asset. For instance, when notes receivable are discounted, a corresponding amount of cash (less discount) is received. Instead of omitting mention of the notes receivable, they should be retained upon the balance sheet as a contra item to notes receivable discounted upon the liability side, both amounts affecting the balance. A second method is to show gross amount of the notes receivable and deduct from them the amounts which have been discounted, showing the net amount on the assets side of the balance sheet. A third method is to omit mention of the notes receivable which have been discounted but to indicate the notes receivable discounted as a contingent liability on the liability side, and write the amount short to indicate that they have not been included in the total. A fourth method, probably the simplest and most useful of all, is to asterisk the notes receivable and call attention in a footnote that a certain proportion of notes receivable (stating the exact amount) have been discounted. Auditing Theory and Practice, Montgomery, Vol. 1, p. 371.