author: Littleton

text:
    Appeal of HANNAH M. SPOFFORD, Administratrix of the Estate of LUCY M. MILLS, Deceased.
    Docket No. 1028.
    Submitted August 1, 1925.
    Decided March 10, 1926.
    1. Certain transfers of real and personal property helé not to have been made in contemplation of death.
    2. The Commissioner’s determination that a transfer of certain bonds was intended to take effect in possession or enjoyment at or after death approved.
    3. The provisions of section 402 (d) of the Revenue Act of 1918 are not retroactive.

      Walter K. Lincoln and George V. McIntyre, Esqs., for the taxpayer.

      John F. Greaney, Esq., for the Commissioner.
    Before LittletoN, Smith, and Trdssell.
    This appeal is from the determination of a deficiency in respect of estate tax in the amount of $54,687.18, arising from the inclusion in the decedent’s gross estate, under the provisions of section 402 (c) and (d) of the Revenue Act of 1918, of the value of certain real estate and personal property of which she made transfers, and of certain real estate in which she, at her death, held an interest as a joint tenant.
    FINDINGS OF FACT.
    Lucy M. Mills died intestate, at the age of 78, on September 18, 1919, a resident of Chicago, Ill., leaving as her only heir-at-law a sister, Hannah M. Spofford, who was appointed administratrix of her estate.

      Lucy M. Mills was a woman of wealth on or prior to April 7, 1916, and owned, in addition to other property, an undivided one-half interest in certain real estate situated in Chicago, as a tenant in common with her sister, Hannah M. Spofford, who owned the other undivided one-half interest therein, the same being their family inheritance. Each was also owner of a residence in Chicago. Hannah M. Spofford was a widow, having one child living, Florence M. Spofford, a spinster of about 40 years of age, and two grandchildren, children, of her deceased son. Lucy M. Mills was also a widow and about 78 years of age, without issue living.
    In the early part of 1916 a number of family conferences were had between the decedent, her sister, Hannah M. Spofford, and her niece, Florence M. Spofford, with the view of arranging for the disposition of the real estate which was held by Lucy M. Mills and Hannah M. Spofford as tenants in common. As a result it was agreed that Hannah M. Spofford would place her residence and undivided one-half interest in the real estate held by her and Lucy M. Mills as tenants in common in joint tenancy with Florence M. Spofford; that Lucy M. Mills would place in joint tenancy with Florence M. Spofford her residence and undivided one-half interest in the real estate mentioned; and that Hannah M. Spofford and Liicy M. Mills would execute wills giving to each other their respective properties; also that Florence M. Spofford would not marry during the life of Lucy M. Mills.
    In order to carry out the agreement, Lucy M. Mills and Hannah M. Spofford requested Charles E. Morrison, a relative, to take title to the real estate referred to and to give back to them and Florence M. Spofford joint tenancy deeds in accordance with their agreement. Thereupon, in company with Morrison, they consulted an attorney in regard to the transfer of the real estate and the preparation of the wills, and acordingly retained him to prepare the deeds and wills for execution.
    Several weeks were spent by the attorney in the preparation of the deeds and wills, and a number of conferences were held with them relative thereto. About the time they were ready to be executed Lucy M. Mills became ill with heart trouble and the signing of the papers had to be postponed. On April 7, 1916, however, she had* recovered to such an extent that, on that day, at her request, the attorney and Morrison went to her house, taking with them the deed and will for her to execute. On that date she executed the deed conveying to Morrison her residence and her undivided interest in the real estate held by her as tenant in common with Hannah M. Spofford. At the same time, or shortly thereafter, she also signed the will (which was witnessed), in which, after making certain bequests, she devised all the remainder of her estate to Hannah M. Spoiford and Florence M. Spoiford, share and share alike, the entire remainder, however, to go to Florence M. Spoiford in the event that Hannah M. Spofford should not survive Lucy M. Mills. On April 7, 1916, Hannah M. Spofford also conveyed to Morrison her residence and her undivided half interest in the real estate held by her and Lucy M. Mills as tenants in common. On April 21,1916, she executed a will in which, after making certain- bequests, she gave to her daughter, Florence M. Spofford, and Lucy M. Mills all the remainder of her estate, the entire remainder to go, however, to Florence M. Spoiford in the event Lucy M. Mills should not survive the testatrix.
    On April 8, 1916, Morrison conveyed to Lucy M. Mills and Florence M. Spofford, as joint tenants, the real estate that had been conveyed to him by Lucy M. Mills, and, on the same day, he conveyed to Hannah M. Spofford and Florence M. Spofford the real estate that had been conveyed to him by Hannah M. Spofford. The property transferred by Morrison to Lucy M. Mills and Florence M. Spofford, with the exception of the residence occupied by Lucy M. Mills, consisted of income-producing real estate.
    In connection with the transaction relating to the disposition of property herein detailed, Florence M. Spofford made a will in which she devised her estate to her mother and Lucy M. Mills, and Lucy M. Mills transferred, inter vivos, to Florence M. Spofford bonds of the value of $180,000. The bonds were returned as a part of decedent’s estate under the inheritance tax laws of the State of Illinois.
    Lucy M. Mills was apparently in good health at the time the various transfers of property were considered and agreed to. She was capable of managing and did manage her own affairs, had numerous conferences with her attorney relative thereto, and gave him directions as to what should be included in the various documents which he prepared. A short time prior to April 7, 1916, she was seized with a heart attack and was ill for several weeks. She recovered, however, and was able thereafter to leave Chicago to visit various cities, as well as to look after herself and her property. About one year before her death she met with an accident resulting in two of her ribs being broken. She quickly recovered, however, from the effects of this accident and lived until September 18, 1919.
    Whether the decedent destroyed the will which she signed about April 7, 1916, is not known, but no will was found after her death and the estate was administered under the intestate laws.
    The Commissioner included as a part of the gross estate of the decedent the value, at her death, of the real estate transferred by her to Morrison on April 7, 1916, and transferred by him on April 8, 1916, to the decedent and Florence M. Spofford as joint tenants; also the value at the time of her death of the bonds transferred by her to Florence M. Spofford about April 8, 1916.
   OPINION.

Littleton

: The issue presented by this appeal is whether the Commissioner erred in including in the gross estate of Lucy M. Mills the value at the time of her death of the bonds transferred by her to Florence M. Spofford on or about April 8, 1916, and of the real estate, a joint interest in which she transferred to Florence M. Spofford and which she and Florence M. Spofford held as joint tenants at the time of her death.

The Commissioner contends that the transfers of both the bonds and the real estate were made in contemplation of death, and that 'the transfer of the bonds was not made absolutely and without reservation of income, but was intended to take effect in possession or enjoyment at or after the death of Lucy M. Mills. He further contends that, if the transfer of real estate was not made in contemplation of death, the value thereof at the time of her death should, nevertheless, be included in the gross estate of the decedent under section 402 (d) of the Eevenue Act of 1918.

The tax involved herein arises under section 402 of the Eevenue Act of 1918, which provides—

That the value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
*******
(c) To the extent of any interest therein of which the decedent has at any time made a transfer, or with respect to which he has at any time created a trust, in contemplation of or intended to take effect in possession or enjoyment at or after his death (whether such transfer or trust is made or created before or after the passage of this Act), except in ease of a bona fide sale for a fair consideration in money or money’s worth. Any transfer of a material part of his property in the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such a consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this title;
(d) To the extent of the interest therein held jointly or as tenants in the entirety by the decedent and any other person, or deposited in banks or other institutions in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have belonged to the decedent.

The transfers which give rise to the issue here involved were not made within two years of the death of Lucy M. Mills, and there is no legal presumption that they were made in contemplation of death. Whether they were so made is therefore purely a question of fact to be determined from the evidence.

“ Contemplation of death,” as used in the statute, is an apprehension of death within the reasonably near future, arising from some existing bodily condition, and not the general expectation of death entertained by everyone. Contemplation of death must be the motive prompting the transfer of property in order to subject the transfer of property to the tax. Appeal of Philip T. Starck, 3 B. T. A. 514.

The Board is of the opinion from the evidence produced in this appeal that the real estate transferred by the decedent to her neice, through Morrison, on April 7 and 8, 1916, and the transfer of the $130,000 of bonds on the latter date, were not made in contemplation of death within.the meaning of the law. These transfers were made pursuant to an arrangement that had been entered into by Lucy M. Mills, her sister, and her niece several weeks prior thereto-Lucy M. Mills was at that time in good health and capable of managing her own affairs, which she did manage, and there is no evidence to show that she then believed, or had reason to believe, that she had any bodily infirmity that might cause her death within the reasonably near future. On the other hand, the evidence shows that she had reason to believe she might live for many years. It is true that between the time the transfers were agreed to and the time they were executed she suffered a heart attack, and that she was recovering from that attack when the*.transfers were made. Her illness, however, had nothing to do with the transfers, except to delay their execution. They were not made on account of her illness, and they would have been made even if the illness had not occurred, and at an earlier date. The illness of Lucy M. Mills was not of long duration, for she recovered therefrom and lived foi more than three years thereafter, leaving her home in Chicago and going to various places, as well as managing her business affairs. We are convinced that the transfers were not occasioned by the apprehension of death. The same conclusion applies to the transfer of bonds made by Lucy M. Mills to Florence M. Spofford on or about April 8, 1916.

It is clear from the evidence that the transfer of the real- estate referred to was not made to take effect at or after the death of Lucy M. Mills. The conveyance was absolute and vested Florence M. Spofford with an interest as a joint tenant in the real estate conveyed, entitling her to joint possession thereof and to one-half of the rents and income therefrom. Her possession and enjoyment of the estate conveyed to her was not in any way dependent on the death of Lucy M. Mills.

With respect to the transfer of bonds, however, a different situation exists. The record shows that, at about the same time the transfer of land was made, Lucy M. Mills also transferred to her niece bonds of the value of $130,000. Whether they were transferred absolutely and in praesenii, so as to divest Lucy M. Mills of all interest in and control over them, the record does not show. Subsequent to the hearing counsel for the administratrix filed a motion to correct the transcript of the testimony, upon thé ground that testimony that the bonds were transferred absolutely and without reservation of income had been given but not recorded by the reporter. This motion was set down for argument and upon consideration was denied, upon the ground that such testimony had not been given. The Commissioner included the value of the bonds in the gross estate of the decedent, upon the ground that they were not given to Florence M. Spofford absolutely and without reservation of income, but were intended to take effect in possession or enjoyment at or after the death of Lucy M. Mills. The burden is upon the taxpayer to show that the Commissioner erred in his determination. The only evidence presented is to the effect that on or about April 8, 1916, the bonds in question were transferred to Florence M. Spofford and that the value of these bonds was returned by the administratrix of the estate of Lucy M. Mills as subject to the Illinois inheritance ta-x. The Board is not justified upon the evidence in holding that the transfer of the bonds was not made to take effect at or after the death of Lucy M. Mills, or that it was a bona fide sale for a fair consideration in money or money’s worth, and, therefore, the determination of the Commissioner with respect to the bonds must be approved.

The taxpayer urges, however, that even if the transfers involved in this appeal were made in contemplation of death, or to take effect in possession or enjoyment at or after the death of Lucy M. Mills, the value at the time of her death of the property so transferred should not be included as a part of her gross estate, for the reason that the retroactive provision of section 402 (c) of the Bevenue Act of 1918 is in violation of the United States Constitution. This question has been passed upon several times by the inferior courts of the United States, and, while the decisions are in conflict, the weight of authority supports the conclusion that the provision of the statute is not subject to any constitutional infirmity. Safe Deposit c& Trust Go. v. Tait, 295 Fed. 429; Cleveland Trust Co. v. Routzahn, 7 Fed. (2d) 483. See Frew v. Bowers, 9 Fed. (2d) 644; and Reed v. Howbert, 8 Fed. (2d) 641, holding constitutional the retroactive provisions of section 402 (c) of the Bevenue Act of 1921. See also Shwab v. Doyle, 269 Fed. 321. In Coolidge v. Nichols, 4 Fed. (2d) 112, the District Court for Massachusetts held the retroactive provisions of section 402 (c) of the Bevenue Act of' 1918 unconstitutional. That case, however, involved a transfer made prior to the passage of the Bevenue Act of 1918 and not in contemplation of death, by which the transferor completely divested herself of any interest in the property transferred.

We are of the opinion that the contention on this point is not well taken.

The last question for determination is what part, if any, of the value of the real estate held by Lucy M. Mills at the time of her death as joint tenant with Florence M. Spofford should be included in the gross estate of the decedent. The situation presented here is practically identical with that in Kissam v. McElligott, 280 Fed. 212, and in Walker v. Grogan, 283 Fed. 530, except that those cases arose under section 202 (c) of the Revenue Act of 1016. Each involved property held by husband and wife as joint tenants, the joint tenancy having been created prior to the enactment of the Revenue Act of 1916 out of property owned by the husband in severalty. The courts held that section 202 (c) of the Revenue Act of 1916, the wording of which is identical with section 402 (d) of the Revenue Act of 1918, was not retroactive, and that only one-half of the value of the property held jointly by the decedent and his wife should be included in the gross estate of the decedent subject to the estate tax. In Kissam v. McElligott, supra, the court said:

At the time the statute was passed Cornelia Kissam’s interest belonged to her. In other words, the time of the transfer of the interest which Cornelia Kissam got from Jonas Kissam, in his lifetime, had passed. From the structure of the act, to say that the measure of the tax is the extent of the interest of both joint tenants, is, in effect, to say that a tax will be laid on the interest of Cornelia in respect of which Jonas had in his lifetime no longer neither title nor control.

Kissam v. McElligott was reversed by the Circuit Court of Appeals. 275 Fed. 545. The Supreme Court of the United States, however, in Knox v. McElligott, 258 U. S. 546, reversed the judgment of the Circuit Court of Appeals, held that the Act under which the tax was assessed was not retroactive in its operation, and quoted with approval the language above set forth from the opinion of the District Court. In the Revenue Act of 1918, Congress has inserted apt language, showing conclusively that section 402 (c) was intended to apply retroactively to transactions falling within the scope thereof. No language, however, was inserted in the Revenue Act of 1918 to indicate that section 402 (d) was intended to apply retroactively. “A statute sho'uld not be given a retrospective operation unless its words make that imperative.” Shwab v. Doyle, 258 U. S. 529. Wherefore, we conclude that section 402 (d) of the Revenue Act of 1918 is not retroactive. In view of the decisions in Walker v. Grogan, supra, and Kissam v. McElligott, supra, we are of the opinion that only one-half of the value, at the time of the death of L'ucy M. Mills, of the real estate held by her and Florence M. Spofford as joint tenants should be included in the gross estate of Lucy M. Mills for the purposes of the tax.

Order of redetermination will he entered on 10 days’ notice, under Rule 50.

Smith dissents.


source: Caselaw Access Project

author: Tbussell

license: Public Domain

text:
    Appeal of PLYMOUTH COAL MINING CO.
    Docket No. 4003.
    Submitted November 7, 1925.
    Decided March 10, 1926.
    Evidence respecting the value of a leasehold of coal lands paid in for stock of a corporation in 1905 examined and held to be sufficient to support a value equal to the par value of the stock issued therefor, both for the purposes of invested capital and deduction for exhaustion.

      Virgil 7. Moore and Andrew T. Smith, Esqs., for the taxpayer.

      E. O. Lake, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Trussell.
    This appeal is taken from the determination of deficiencies aggregating $11,237.73, asserted in a deficiency letter determining the taxpayer’s liability for the years 1917 to 1920, inclusive, and finding deficiencies for the years 1918, $4,418.86; 1919, $3,257.63; 1920, $3,561.24; and an overassessment for the year 1917 in the amount of $1^847.34.
    FINDINGS OE FACT.
    The taxpayer is a corporation organized under the laws of Pennsylvania on February 8, 1905, by Boy A. Hatfield and his partner, a man named Hillis, who were at the time interested in coal-mining properties in Pennsylvania, for the purpose of mining and selling coal and manufacturing and selling coke. Its plant and leasehold are located in Portage Township, Cambria County, Pa. John C. Martin was the owner of about 5,000 acres of coal and timber lands in Cambria County. In 1903 he leased to William A. Price the “ C ” seam of coal on 660 acres of the above-mentioned tract of land. Price operated a coal mine thereon from the time the lease was acquired by him until December, 1904. Price had large business interests in New York, where'he operated a fleet of barges. In the course of the operation of this business he became financially involved, and in December, 1904, he made efforts to secure money. While he was making efforts to secure money he met Hatfield, whom he knew to be interested in coal properties in Pennsylvania near his own. He offered to dispose of his interest in the mining property here under consideration if he could obtain an immediate cash payment, and, as a result of these conversations, he finally agreed that he was willing to take $26,000 for all of his interest in the property:
    Hatfield consulted with his counsel, who knew of Price’s financial difficulties, and advised that it would not be safe to take an assignment of lease from Price under the circumstances. It was thereupon arranged between Hatfield, Price, and Martin that Price should surrender and agree to the cancellation of his lease, for which he was to receive $26,000 from Hatfield, and that Martin should give to Hatfield a new lease on the same coal properties. This plan was carried out and completed on or about December 23,1904, when Hatfield and Hillis paid Price $26,000, and the new lease from Martin to Hatfield was made, and Hatfield at the same time purchased from Martin various properties, consisting of mules, harness, mine cars, etc., for which he paid Martin $6,017.60.
    On January 12, 1905, an involuntary petition in bankruptcy was filed against Price by certain of his creditors in the District Court for the Eastern District of New York, and he was thereafter duly adjudged a bankrupt by said court.
    Hatfield and Hillis organized the taxpayer with an authorized capital of $100,000. They subscribed for $10,000 of the stock in cash at par, $6,017.60 of which was paid to Hatfield for the mine property above described, and $55,000 of the stock was issued to themselves in consideration of the transfer of the leasehold to the taxpayer corporation. This transaction was made on February 24, 1905, according to the following resolution, as shown by the minutes of the taxpayer:
    Resolved that Directors of the Company be instructed to purchase from Roy A. Hatfield all of his right, title and interest in and to the coal lease between John C. Martin, of the first part, and the said Roy A. Hatfield, of the second part, dated the 23rd day of December, 1904, 'covering certain property in the Township of Portage, in the County of Cambria, in the State of Pennsylvania, and all of his right, title and interest in and to the Bill of Sale made by the said John C. Martin to the said -Roy A. Hatfield, bearing date the said 23rd day of December, 1904, selling to the said Roy A. Hatfield the goods and chattels therein described, and to obtain from the said Roy A. Hatfield a release from all claims and demands that he may have against the company by reason of the mining operations of the company hereafter carried on [on] the premises described in the said lease, and to issue in payment therefor 550 shares of the full paid capital stock of the Company, and to pay in cash to the said Roy A. Hatfield the sum of $6,017.60.
    The “ C ” seam of coal which was covered by the leasehold on 660 acres was at the time of acquisition known to be continuous over the acreage and contained approximately 2,500,000 tons of recoverable coal. The mine which had been opened into the seam was what is known as a drift mine. This drift was upgrade into the coal, so that the mine drained itself, and the loaded cars of coal could be carried from the working places to the mouth of the mine by force of gravity. The lease gave the lessee the privilege of cutting all timber necessary for the mine, not only on the tract under lease but also on all of the 5,000 acres of the John C. Martin land at that point. Under this privilege taxpayer secured .all timber needed for the mine from 1905 until about 1923.
    At the time of acquisition by the taxpayer the mine had reached its full development, a system of double entries having been driven 1,800 or 2,000 feet from the mouth of the mine, with cross entries and other developments providing ample working places to produce the mine’s tonnage. A railroad siding had been built capable of accommodating 28 steel railroad cars. All buildings and machinery necessary to operate the property were in place and the mine was a going concern. The development which had been done on the property prior to acquisition by taxpayer had cost between $40,000 and $50,000.
    In computing the taxpayer’s invested capital for the taxable years 1918, 1919, and 1920, the Commissioner valued the plant and leasehold at $26,000, the .amount paid to Price -for the surrender of his lease. The taxpayer claimed that the plant and leasehold had a value of $55,000. This difference in value is the basis of the deficiencies determined by the Commissioner.
    The Board finds that the actual cash value of the taxpayer’s coai-land lease at the time paid in for stock was $55,000.
   OPINION.

Tbussell

: The negotiations between Price and Hatfield were had at a time when Price was experiencing financial embarrassments which culminated in his enforced bankruptcy a few weeks later. He was then striving to convert some of his interests into cash in order to avoid impending bankruptcy. For this purpose he was willing to and did offer to dispose of his interests in the mining property here in question for an amount of cash apparently not more than one-half of what he had expended in developing the mining property. Persons who acquire property under these circumstances and later organize a corporation for taking it over and managing it are, under the decisions of the Board in the Appeals of The Markenheim Co., 1 B. T. A. 1240; Pittsburgh Grinding Wheel Co., 2 B. T. A. 712, and Cross Mountain Coal Co., 2 B. T. A. 587, entitled to have the fair cash market value of the property they acquire under such circumstances ascertained and allowed for the purposes of invested capital and exhaustion deductions.

Both Hatfield and Hillis, who organized the taxpayer corporation, were men of large experience in the operation of coal properties in Pennsylvania. They knew the value of such properties, and especially the cost of the early development of a new mining operation, and the record clearly discloses that when they placed the valuation of $55,000 upon this lease they undertook to give to it a conservative estimated value.

The record also contains the testimony of two disinterested witnesses, both of whom had been mine operators, and one of whom had been for many years a valuation expert in the employ of the Bethlehem Steel Co. and the Pittsburgh Coal Co. They were both familiar with the taxpayer’s property and the improvements and development made thereon. Each of them testified that in his opinion the taxpayer’s lease on February 24, 1905, was worth at least $75,000; that in arriving at such valuation he took into consideration the advantages of the drift-mine situation, the valuable timber rights, the cost of the development which had previously been made, and the recoverable tonnage then in sight.

The value of a leasehold of coal lands is at all times a question of fact, which must be determined in the light of the evidence produced. The record of this appeal convinces us that the taxpayer’s claim of $55,000 is a conservative valuation, and we therefore find that the lease in question had, at the time paid in for stock, a value of not less than $55,000.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.


author: Marquette:

text:
    Appeal of GRANT TRUST AND SAVINGS CO., Trustee of Estate of ANDREW SCHICK, Deceased.
    Docket No. 3659.
    Submitted July 14, 1925.
    Decided March 10, 1926.
    The fair market value of certain shares of stock determined.

      Forrest D. Siefkin, Esq., for the taxpayer.

      Lee I. Park, Esq., for the Commissioner.
    Before Marquette and Morris.
    This is an appeal from the determination of a deficiency in income tax for the year 1919 in the amount of $25,632.86.
    The single question is whether the taxpayer realized a gain on the sale of stock as determined by the Commissioner, or a loss as contended by the taxpayer.
    FINDINGS OF FACT.
    The taxpayer is an Indiana corporation, with office at Marion, and is the duly appointed trustee of the estate of Andrew Schick, deceased. As such trustee it had full management and control of the entire personal property of said estate under the direction of the Circuit Court of Grant County, Indiana, during the life of the widow of said Andrew Schick, deceased. The widow is still living.
    Andrew Schick died on October 25,1914, possessed of 470 shares of ‘ stock of the Western Drop Forge Co., a corporation in which the stock was closely held and which was organized in 1909. No sales of the stock occurred in the open market prior to October 25, 1914. All of the stock in the company was sold in 1919, and the taxpayer then received $172,268.85 for the stock held by it as trustee, the number of shares having been increased to 881½ by reason of stock dividends.
    The Commissioner determined the fair market value of the stock on October 25, 1914, as $86,679.66, with a resulting profit on the sale of $85,864.29.
    The Western Drop Forge Co. was engaged in the manufacture of drop forgings, and had among its customers many of the automobile manufacturers. It had a capital stock on March 1, 1913, of $75,000 par value, all of which was held by five individuals. At the time of decedent’s death the capital stock was $160,000. On April 15, 1919, the date of sale, the capital stock was $300,000 par value, the increase during the six years being entirely by way of stock dividends.
    The average net tangible assets at June 30th in the years 1911 to 1918, inclusive, were as follows:
    1911_$153,328. 68 1915_$307, 531.43
    1912_ 196, 694. 31 1916_ 403, 516. 85
    1913_ 238,188. 75 1917_ 471,342.61
    1914_ 271,121. 39 1918_ 612, 918.00
    The average for the years 1911 to 1914, inclusive, is $214,833.28. The annual earnings of the company were:
    1911___$49,949.49 1915_$59, 561. 91
    1912_ 71, 365. 78 1916_ 158, 008.93
    1913_ 65, 707.10 1917_ 320, 491.40
    1914_ 28, 758.17 1918_ 266, 649. 63
    The average for the years 1911 to 1914, inclusive, is $53,945.14. Cash dividends were paid as follows:
    June 30, 1913_ $8, 000.00 Oct. 24, 1914-í._ $4,800.00
    July 19, 1913-1, 500. 00 June 30, 1915_ 1, 600. 00
    Aug. 19, 1913-1, 600. 00 June 30, 1916_ 2, 492.42
    Sept. 19, 1913 1, 600. 00 June 30, 1916, to Dec. 19,
    June 30, 1914_ 14,400. 00 1916_ 140, 000. 00
    The entire capital stock of par value of $300,000 had a book value in 1919, at the time of the sale, of $725,560.96. The total sales price received for all of the stock on the sale in 1919 was $592,000. No good will value was carried on the books.

      In 1916 the capital stock was $300,000 par value and tbe surplus $275,160.31. On April 15, 1919, the capital stock was $300,000 and the surplus $373,163.11. The stockholders received an offer of $750,- ■ 000 for their stock in connection with a contemplated merger of the company with several other companies. The sale was not consummated because one of the other companies refused to join in the merger. Between 1916 and 1919 the general manager of the Western Drop Forge Co. died and two other officers and stockholders withdrew from the company. During the war years the company, at the request of the Government and in order to facilitate war production, divulged to competitors certain of its secret processes. Competition greatly increased during the years 1916 to 1919, and, in the sale which finally occurred in 1919, no consideration was given for good will value.
    The only sale of the company’s stock prior to 1919 was one on August 19, 1913, to an employee whose services the company desired to retain. That sale was of treasury stock at par. At the date of the death of Andrew Schick, October 25, 1914, the outstanding capital stock of the company was $160,000 and the book surplus was $135,079.70. The book value of the 470 shares in question on October 25, 1914, was $86,679.66.
    The surplus of the company on June 30, 1918, was $479,887.46. The surplus on April 15, 1919, was $373,163.11. The last stock dividend was under date of December 20, 1916, and the reduction in surplus between June 30, 1918, and April 15, 1919, was made up of dividends, Federal tases, and a net operating loss of about $44,000 in the period June 30,1918, to April 15, 1919.
    The fair market value of the 470 shares on October 25, 1914, was $119,072.06.
   OPINION.

Marquette:

The only question presented herein is th# value of certain shares of stock of the Western Drop Forge Co. at the date of the death of the decedent stockholder, to-wit, October 25, 1914, for the purpose of determining the gain or loss on the subsequent sale thereof in the year 1919. The taxpayer contends that there was a good will value at the date of death, based on earnings prior thereto, attributable proportionally to the stock, which compels a higher valuation than results from the use of book value only. The Commissioner valued the stock at its book value. He declined to include in such valuation any good will value and determined a gain of $85,364.29 on the sale in 1919. The taxpayer claims it sustained a loss of $5,657.18.

The stock of the corporation was closely held and there were no sales thereof in the open market prior to the decedent’s death. We have found that the average net assets of the corporation over the four-year period from 1911 to 1914 were $214,833.28, and the average earnings over the same period were $53,945.14. There was an addition to surplus between June 30, 1914, and the date of death of $14,129.23, which, added to the capital and surplus as of June 30, 1914, gave the stock a book value of $295,079.70 at the date of death, or $184.43 per share.

In the valuation of closely held stock the book value must serve as a basis, if the result, as stated by one court, is to be anything more than a “ dignified guess.” In In re Dupignac's Estate, 204 N. Y. S. 273, 279, the court stated the following basis for valuing closely held securities:

The method adopted hy the courts in arriving at the fair or clear market value of closely held securities is sound. It is to value the corporate assets in the manner that a buyer would value them; to ascertain the cash value of the property which the shares represent, assigning to each share its proportionate worth. The book value of stock is its intrinsic value. If there have been no sales, the assessor must necessarily fall back upon the book value as the nearest approximation to the fair market valúe. In the absence of sales, the book value must be taken as the basis of computation. Any other rule would be illogical, and create an impotent conclusion. The use of the words “ fair market,” or “ clear market ” value, when applied to closely held stock, is meaningless. Because there is no market to guide, such stock must he appraised at its value in money — its intrinsic worth. It can only be compared and measured in money value, according to the assets as shown by the balance sheet, less liabilities. The assets of the balance sheet is the inventory value. Authorities in .abundance support this method. [Citing cases.] The method adopted in these cases has been followed in Matter of Felton, 176 Cal. 663, 169 Pac. 392.

At page 281 the court said:

The courts in this country have not adopted any inflexible rule for ascertaining the value of good will. They have decided that the value of good will may be fairly arrived at by multiplying the average net profits for a number of years by a number of years purchase, such number being suitable and proper, having regard to the nature and character of the business as a question of fact, depending upon the facts in each case.

In New York the return on the tangible net assets is usually computed at 6 per cent, and the amount thereof is deducted from the average earnings to determine the average net earnings attributable to intangibles. No reason appears from the authorities in that State why this return should not be a variable, dependent upon the risk in the enterprise, the value of money, and other relevant facts. In our opinion the New York rule is basically sound, but we believe that the fair rate of return on tangible assets must be ascertained from the facts in each case before the average net earnings attributable to intangibles are capitalized to determine good will value, and the fixing of this rate of return is itself a question of fact. The same authorities hold that the number of years purchase to be used in determining good will value is a question of fact, depending upon all the facts of each case, and there is no set years of purchase by which to multiply the average profits. This necessarily follows if the rule is to be anything more than a mere formula.

The taxpayer herein claims a rate of 8 per cent on net tangibles and capitalizes the net earnings at 15 per cent. In view of the facts, we believe an 8 per cent rate on tangibles is fair, but to capitalize the net earnings at 15 per cent to determine good will value is, in the light of the facts, exorbitant. Considering the facts that the corporation had been in existence but four and one-half years, that its earnings had decreased largely in 1913 and 1914 from the previous year, and that the dividends paid to the basic date herein were small, we believe that a three-year purchase of the net earnings would fairly represent the value of good will. In arriving at this conclusion we have not overlooked the fact that the corporation had a secret process claimed to have been of value in its business.

Applying these rates, we find that 8 per cent on the average net tangible assets is $17,186.66, which, subtracted from the average net earnings of $53,945.14, gives $36,758.48 as the part of the net, earnings attributable to intangibles. Multiplying the average net earnings attributable to intangibles by 3, the number of years purchase, results in a good will value to the corporation of $110,275.44. The number of shares outstanding in 1914 was 1,600, making the proportional amount of good will attributable to each share $68.92. This latter figure multiplied by 470, the number of shares owned by the decedent, shows the proportional good will therein to have been $32,392.40, which, added to the book value of these shares of $86,679.66, gives a value to the shares in question of $119,072.06. The stock was sold in 1919 for $172,268.85, and a gain was realized on this sale in the amount of $53,196.79.

Order of redetermination will 5e entered on 15 days’ notice, •under Bule 50.


author: Trammell:

text:
    Appeal of GEORGE THEIS, Jr.
    Docket No. 3958.
    Submitted November 11, 1925.
    Decided March 12, 1926.
    1. Cost of certain bonds determined for purposes of computing gain or loss on the sale thereof.
    2. Taxpayer transferred certain bonds and gave his check in payment for certain preferred stock, which was to be held until he received cash for the bonds and was then to be presented for payment. Held, that the transaction in which he received cash for the bonds amounted to a sale thereof and not an exchange of ' bonds for preferred stock and cash.

      Nelson T. Harts on, Esq., for the taxpayer.

      E. G. Lake, Esq., for the Commissioner.

      Before Grattpner and Trammell.
    This is an appeal from the determination of a deficiency in income tax for 1917 in the amount of $48,587.10. The deficiency arose from the action of the Commissioner in attributing to the taxpayer a gain resulting from the sale of certain bonds of the Arkansas Valley Interurban Railway Co.
    FINDINGS OF FACT.
    1. The taxpayer is an individual residing at Wichita, Kans. During the times mentioned herein he was a stockholder and director of the Arkansas Valley Interurban Railway Co. and its president since July, 1913.
    2. During the period from 1913 to January 19, 1917, the taxpayer acquired bonds of the said Railway Company of a par value of $453,800. A substantial portion of the bonds acquired were purchased from the Interurban Construction Co., which had received the bonds from the said Railway Company in payment for construction work.
    The taxpayer was also a stockholder in the said Construction Company. He purchased said bonds from the Construction Company and other parties at various times, at prices ranging from 50 to 85 per cent of the par value. The said bonds acquired by the taxpayer from December 29, 1913, to January 19, 1917, are shown by the books of the taxpayer as follows:

    i Liquidation.

      The Interurban Construction .Co. was liquidated in 1916. Its assets, consisting of bonds of the said Railway Company, were distributed to the stockholders in proportion to their holdings. The taxpayer held stock of the Construction Company which cost him $69,477.00, for which, on January 13, 1916, he received bonds of the Railway Company of the par value of $144,000 in said liquidation. The book entry of said transaction is that shown above as of J anuary 13,1916.
    3. The outstanding bonds of the said Railway Company amounted to $1,303,000, maturing in the year 1919. In 1916 steps were taken to arrange for refinancing the Railway Company in order to pay off the said bonds. On October 25, 1916, it made an agreement with a certain financial house to take an entire issue of mortgage bonds of the par value of $900,000. As this amount was insufficient to retire the old bonds, it became necessary to issue $500,000 preferred stock which should net to the corporation $89.32 per share to take care of the balance of the old mortgage indebtedness. It was agreed between the Railway Company, the stockholders, and the financing firm that the said firm would purchase $100,000 of the preferred stock at $89.32 per share and that the stockholders of the Railway Company, which included this taxpayer, would subscribe to the remaining $400,000 at $89.32, but the financing firm was to have an option on the latter stock at the same price, which option they would exercise if the sale of the first allotment was successful. The taxpayer subscribed for $200,000 of the preferred stock and the balance was subscribed-by other stockholders. The said stock was placed in escrow, however, pending the outcome of the sale of the first $100,000 and the exercise of the option by the financing firm.
    The said firm installed their headquarters at Wichita, Kans., placed their best salesmen in the field, and conducted an intensive campaign to sell the preferred stock at $95 and $96 per share. They were able to sell only $30,000 of their $100,000 preferred stock. They thereupon abandoned the selling campaign, refused to exercise their option on the remaining $400,000, and sold the .balance of their stock on hand to the taxpayer at $80 per share. Upon the refusal of the financial firm to take the balance of the preferred stock, the stockholders, as a part of the refinancing scheme, did so. There was no actual market for the preferred stock, and neither the taxpayer nor any of the stockholders were able to sell their preferred stock on the market.
    4. The taxpayer, on January 22, 1917, gave his check for $178,640 for $200,000 par value of the said preferred stock, which was at the rate of $89.32 per share. This amount was fixed as the selling price, without reference to its value, because at that amount per share the amount of money which was required would be raised. At the time of the issuance of the check for the preferred stock there were insufficient funds in the bank to the credit of the taxpayer to meet it, but it was agreed between the parties that it should be held until the taxpayer received his money for the old bonds he owned. Upon the payment of the bonds, January 29, 1917, the check for the preferred stock was paid and the stock delivered. For the bonds he held the taxpayer received $458,800, in two payments, as follows: January 29, 1917, $325,000; February 6, 1917, $128,800.
    5. The Commissioner determined the profit from the transaction as follows:
    Received, from bonds_$453, 800. 00
    Paid for bonds- 319, 073. 83
    Profit_ 134,726.17
    The actual cost of the bonds was as set out in the statement taken from the taxpayer’s books, except those which were purchased on December 31, 1913, and on June 16, 1914. The books show that the $18,000 par value were purchased at 50 per cent and that $1,500 par value were purchased at 50 per cent. Sixty per cent was the actual value at that time. The difference of 10 per cent was allowed by the Construction Company to the taxpayer in the nature of a dividend. The company by resolution permitted its stockholders to acquire the bonds at less than market in lieu of declaring dividends.
   OPINION.

Trammell:

We are to determine the basis upon which to compute the gain, if any, realized from the transaction as set forth in the findings of fact. There is a question of fact as to the cost of the bonds to the taxpayer, and a further question as to whether the transaction wherein the taxpayer acquired the preferred stock was a purchase or in part an exchange.

We will consider the last question first. The taxpayer contends that, in fact, he received as part payment for the bonds preferred stock of the par value of $200,000, to which he was forced to subscribe as a part of the refinancing scheme, and that the market value of this stock was substantially less than par. In our opinion the acquisition of the preferred stock was an independent and separate transaction. The taxpayer, in substance as well as in form, actually received in cash $453,000 for his bonds. His disbursement of a portion of this money for the preferred stock is another transaction, however close together in point of time the two transactions might have been. While it was a part of the refinancing scheme that the stockholders would subscribe for and take the preferred stock, this was not a requirement imposed upon or accepted by the bondholders of the old bond issue. There appears no evidence that they agreed to accept preferred stock in exchange for bonds. The stockholders agreed to take the preferred stock. As a bondholder the taxpayer was under no obligation to take any preferred stock in exchange for his bonds. If it was necessary for the taxpayer to get funds from the sale of bonds with which to carry out his obligation to take preferred stock, that fact does not constitute the transaction an exchange of bonds for stock. With this view of the transaction, it is not necessary to consider the market value of the preferred stock at that time.

This leaves solely for consideration the question of the cost to the taxpayer of the bonds. In his original petition he alleges the cost to be $319,073.83, which is the cost used by the Commissioner in computing gain. This cost is based on an average rate of 70 per cent plus. In his amended petition the cost is alleged to be $405,-432.69. In his brief the taxpayer states that, if the bonds purchased from the Construction Company were computed at $80, the cost Avould be $396,026.50, and if figured at $85, the cost would be $398,401.50.

It was stipulated that the books of record of the taxpayer showed that the bonds purchased by the taxpayer from December 19, 1913, to and including January 1, 1917, cost the amounts set out in the findings of fact, and that the total actual cost was $334,077.84. It was claimed by the taxpayer that the Construction Company, in lieu of declaring dividends and distributing its earnings in that way, decided to sell its bonds to its stockholders at a price below market, and that the difference between the market price and the price at which they were sold represented the distribution of profits. From the evidence we are of the opinion that, with respect to certain of the bonds, this contention of the taxpayer is sustained. The $18,000 par value of bonds acquired by the taxpayer on December 31, 1913, at 50 per cent were actually worth at least 60 per cent of par. This being true, the cost of the bonds appearing in the statement taken from the books, set out in the findings of fact, should be increased. The cost of the $18,000 par value purchase of bonds on December 31, 1913, should be stated at $10,500 instead of $9,000, and the $1,500 par value bonds purchased on January 16, 1914, which appear on the books to have cost the taxpayer $750, actually cost him $900. The cost of the bonds, therefore, should be increased by the amount of $1,950, on account of the fact that they were acquired partly by way of a distribution of profits and partly by an actual purchase.

It also appears that the bonds acquired on January 13, 1916, at a book cost of $69,477, were received on that date in liquidation. The Interurban Construction Co. was liquidated in 1916. It had assets consisting of bonds of the Railway Company which were distributed in proportion to the stock holdings. The $69,477 appearing as the book cost of these bonds was in fact the cost' of the stock which the taxpayer held in the company which was liquidated. In the liquidation the taxpayer received taxable gain to the extent of the difference between the purchase price of his stock and the fair market value of the bonds received in liquidation. The value of the bonds received in liquidation we find from the evidence to have been 85 per cent. This value is found from the fact that the bonds were selling at 85 per cent at and near the date of the liquidation. The receipt of the bonds in liquidation was a separate and closed transaction, and creates a new basis for the determination of gain or loss on the sale of the bonds. This would make the cost of the $144,000 par value of bonds $122,000 instead of $69,477, an increase of $52,923. This amount and $1,950 should be added to the amount of $334,077.64, appearing on the books of the taxpayer, to determine the tax liability resulting from the sale of the bonds.

Order of redetermination will be entered on 15 days' notice, under Bule 50.

On reference to the Board, Lansdon did not participate.


author: Littleton:

text:
    Appeal of STRONG, HEWAT & CO., INC.
    Docket No. 5069.
    Submitted December 1, 1925.
    Decided March 30, 1926.
    1. In the reorganization of a business, a partnership paid in to a corporation on March 1, 1918, all of its tangible and intangible assets for all of the capital stock of the corporation and for notes in the amount of $70,000. Held, that section 331 of the Revenue Act of 1918 prevents the corporation from valuing the assets so acquired at a greater amount, in computing invested capital, than that at which the partnership could have valued them, in computing invested capital, if they had not been so transferred.
    2. Value of property acquired on March 1, 1918, for stock, determined for the purpose of deductions for exhaustion, wear and tear.

      Laurence A. Tamer and J. O. Peacoch, Esqs., for the taxpayer.

      Ellis W. Manning, Esg., for the Commissioner.
    Before Littleton, Smith, and Teussell.
    This is an appeal from the determination of deficiencies in income and profits tax for the fiscal years ending August 31, 1920 and 1921, in the amounts of $21,932.36 and $1,895.45, respectively, arising from the reduction of invested capital claimed by the taxpayer, in respect of tangible property and good will acquired from a predecessor partnership for stock and notes, by reason of the provisions of section 331 of the Revenue Act of 1918, and the reduction of the amount claimed for exhaustion, wear and tear of the property so acquired;

      BINDINGS OF FACT.
    The taxpayer is a New York corporation engaged in the manufacture of woolen cloth, with principal office at New York City and mills at North Adams, Mass. It was organized on March 1, 1918, at which date it succeeded to the business theretofore carried on by a partnership of the same name, taking over its entire assets, both tangible and intangible, and issuing in exchange therefor its entire capital stock, consisting of $500,000 par value of preferred and 10,000 shares of no par value common stock, and promissory notes in the amount of $10,000 to the members of the partnership in proportion to their interest therein, and assuming the liabilities of the partnership.
    The assets taken over consisted of lands, factory and tenement buildings, machinery and equipment, and good will. The predecessor partnership made a practice of charging to expense the cost of acquiring and constructing machinery, equipment, and buildings, and did not carry its plant upon its books as an asset. In opening its books on March 1, 1918, the taxpayer entered the plant thereon at $216,834, this being the figure required to balance the capital stock account of $550,000, after crediting against capital stock account and liabilities the amount of inventory, accounts receivable, and other assets, exclusive of the plant. The capital stock account of $550,000 consisted of the par value of the preferred stock and $5 a share for the no par value common stock.
    In computing the invested capital in respect of the property acquired for stock and notes, the Commissioner included the same at cost to the partnership, less depreciation, and arrived at a value of approximately $200,000.
    For the purpose of computing the deduction for exhaustion, wear and tear, the Commissioner determinéd that depreciable assets had a value of approximately $200,000.
    On October 24, 1925, the taxpayer had an inventory appraisal made of its depreciable assets for the purpose of determining their value as of March 1, 1918. This appraisal was made upon the basis "o-f the cost of reproduction, less depreciation, and showed a value of the entire property on March 1, 1918, of $340,148.11, apportioned as follows:
    Brick buildings- $66, 598.15
    Frame buildings_ 7,257. 72
    Machinery and equipment_ 266, 292. 90
    Total-$340,148.77
    The earnings of the predecessor partnership for the fiscal years ending August 31, 1916 and 1917, and the six-month period ending March 1, 1918, were $108,361.45, $148,783, and $197,650, respectively.

      The earnings of the taxpayer for the six-month period ending August 31, 1918, and the fiscal years ending August 31, 1919 and 1920, were $267,000, $151,000, and $295,000, respectively. The actual value on March 1, 1918, of the tangible assets acquired by the taxpayer from the predecessor partnership was $357,000, divided as follows:
    Land and water rights- $25, 700. 00
    Brick buildings_ 64, 603. 50
    Frame buildings_ 6, 957. 30
    Machinery and equipment_ 259, 739. 20
   OPINION.

Littleton:

As to the question of the application of section 331 of the Revenue Act of 1918 to the computation of this taxpayer’s invested capital, in respect of the assets acquired from the predecessor partnership for stock and notes, we are of the opinion that the determination of the Commissioner that this section prevents the inclusion of the assets thus acquired in invested capital at a greater amount than the cost thereof to the predecessor, less depreciation, was correct. Appeal of Baker, Hamilton & Pacific Co., 2 B. T. A. 1. No evidence was submitted showing that the value determined by the Commissioner upon this basis was incorrect. His action, therefore, in this regard is approved.

For the purpose of the deduction for exhaustion, wear and tear of the depreciable assets acquired by the taxpayer, we have determined the values thereof as of March 1, 1918, from the evidence submitted. At the hearing testimony was given by a broker engaged for about eight years in the purchase and sale of textile mills. This witness was thoroughly acquainted with the condition of the woolen industry in 1918 and with the market value of mills of the character of that acquired by the taxpayer. He testified that in March, 1918, the woolen industry was in a prosperous condition; that mills were operating to their full capacity and allotting goods; that the demand for mills of this character exceeded the supply; and that the mill acquired by the taxpayer was well located, with a good supply of water for manufacturing processes and for auxiliary power, and compared favorably with other mills of that character. He further testified that the market price for mills of this character in March, 1918, depended principally upon their production capacity, and that this plant had 14 sets of cards and was overloomed. Using the prevailing price at that time of $25,000 a set and $500 a loom for 14 extra looms, he valued the assets acquired by the taxpayer at $357,000. The market value of woolen mills advanced subsequent to 1918.

The taxpayer made an inventory of the buildings, machinery, and equipment on hand at March 1, 1918, and valued the same on the basis of cost of reproduction, less depreciation, at $840,148.77. We can not accept this method of valuation in the absence of proof that the value thus determined was the actual value at March 1, 1918. The evidence submitted, however, shows that the inventory is correct, and it further establishes to the satisfaction of the Board that the actual value of the entire property, including the land and water rights, on March 1, 1918, w,as $357,000. The Commissioner valued the land and water rights at $25,700, and this the taxpayer accepts. The record does not disclose the value which the Commissioner placed upon the buildings, machinery, and equipment. By allocating $25,700 of the total" value of $357,000 to land and water rights, and apportioning the remaining $331,300 to brick and frame buildings, and machinery and equipment, we arrive at the values for the various properties as set forth in the findings of fact, which should be used in computing the deduction for exhaustion, wear and tear.

Order of redetermination will be entered on 10 days’ notice, under Rule 50.


text:
    Appeal of THE NATIONAL BANK OF BALTIMORE.
    Docket No. 3844.
    Submitted July 9, 1925.
    Decided March 30, 1926.

      H. O. Pojfenberger, Esq., for the taxpayer.

      R. P. Smith, Esq., for the Commissioner.
    Before SteeNhagen and Love.
    The Commissioner determined a deficiency of $949.61 income and profits tax for 1919 by including in gross income an amount of $6,195 received by the petitioner as the last payment on account of the principal of a loan existing in 1911, and an amount of $11,413.18 received in that year as accumulated interest on the original loan.
    FINDINGS OF FACT.
    On September 1, 1911, the petitioner had loaned to a partnership the sum of $105,000 on demand negotiable notes secured by negotiable bills of lading and warehouse receipts. Some of the bills of lading and warehouse receipts were forgeries. Some payments were made, or in some other way the account was reduced to a balance outstanding on November'3, 1911, of $71,317.78. On November 3, 1911, a national bank examiner was examining the petitioner’s books, and he suggested that the petitioner immediately charge off $70,000 of the account, which the board of directors thereupon authorized on November 4,1911. Of this $70,000 charged off, payments amounting to $13,805 were received up to June 30, 1913. Later one of the partners wanted to borrow $10'000 from the petitioner, which the petitioner would only lend with a satisfactory assurance of repayment of the $70,000. One of the partners wrote the petitioner a letter in which he said he reacknowledged the debt and intended to pay it. He gave notes for the amount, signed by him and his brother, and payments were made of $20,000 in 1917, $30,000 in 1918, and $6,195 in 1919. In 1919 interest on the account was received of $11,413.18.

      The deficiency should be computed by excluding $6,195 from petitioner's income for 1919. Judgment accordingly will be settled on 15 days’ notice, under Rule 50.


text:
    Appeal of Estate of P. E. O’HAIR.
    Docket No. 4184.
    Submitted September 23, 1925.
    Decided March 30, 1926.

      Andrew T. Smith, Esq., Virgil 7. Moore, Esq., and H. L. Mc-Laren, O. P. A., for the taxpayer.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    Before MaRquette, Mokkis, Love, and Green.
    The Commissioner has asserted a deficiency in income taxes for the year 1920 in the sum of $7,827.53, all of which is involved in this appeal. The petitioner contends that certain income included by the Commissioner in the gross income of P. E. O’Hair, deceased, was in fact income of P. E. O’Hair & Co., a partnership in which the deceased had no interest.
   FINDINGS OP FACT.

P. E. O’Hair, a resident of San Francisco, Calif., died intestate on October 9, 1923. He was survived by his wife, Cora A. O’Hair, and their five children, Donald, Neil, Ethel, Patrice, and Cora J.

For some time prior to the earthquake and fire which destroyed a portion of the City of San Francisco in 1906, the deceased had been conducting a small plumbing supply business. In this he was assisted by his sons, Donald and Neil, who were of the ages of 21 and 18, respectively. The deceased had been in poor health for some time, and just prior to the fire, upon the advice of his physician, he determined to abandon his business and go to Chico, Calif., hoping there to recover his health and strength. The business was turned over to the two sons, who were associated with him, and was to have been conducted by them.

The store and its contents were entirely destroyed by the fire, with the result that O’Hair had liabilities in excess of his assets. Shortly after that O’Hair and his wife and daughters proceeded to Chico, the two sons remaining in San Francisco.

About a month after the fire Donald O’Hair, having at that time some $600 of his own money, established, with his brother, a small plumbing supply business under the name of O’Hair <& Proctor. Proctor, a journeyman plumber, had no actual interest in the business other than commissions, and his name was carried only for the purpose of representing to the public and the unions that there was in the firm a qualified plumber. Several months later the deceased returned to San Francisco, and, without contributing any capital to the business, took an active part in its conduct. About 1908 the name was changed to P. E. O’Hair & Co. The father and the mother and each of the five children devoted practically their entire time to the business, and it was at that time generally understood between them, that each had an interest in the business. The family all lived together for the purpose of reducing living expenses, and each drew from the business only so much as was necessary for his or her living expenses, and as a result of the joint efforts and economies of all the members of the family the business grew and prospered. In 1915 the deceased sought to obtain from the business funds sufficient to enable him to engage in another enterprise. The sons pointed out to him that he had contributed no capital to the business and that they did not wish to contribute any money to the new venture. The father conceded the fairness of their position, and it was at this time that the parties agreed upon the interest of the respective partners. Under this arrangement the business of P. E. O’Hair & Co., a partnership, was to be owned 50 per cent by Cora A. O’Hair and 10 per cent by each of the five children. Thereafter the partnership was operated under this arrangement until May 1, 1919.

The statutes of California require the filing of a certificate of ownership by businesses operating under a fictitious name, and there was filed for the business of P. E. O’Hair & Co. a certificate setting forth that P. E. O’Hair was the owner thereof. This appears to have been done because of the prominence of the deceased, his reputation for fair dealing, the fact that he was the head of the family, and that his name appeared in the firm name. In 1919 Donald O’Hair consulted an attorney and was advised by him that it was inadvisable to continue the operation of the business in this rather loose and confusing manner. Pursuant to this advice the father executed several assignments, assigning to the wife and children any interest lie might have in the business. In November, 1919, a partnership agreement was prepared setting forth the interests of the mother and the five children. This agreement was executed by all of the partners except two of the daughters. During the year 1920 the business conducted under the name of P. E. O’Hair & Co. was owned by the mother and the five children as copartners. P. E. O’Hair, deceased, had no interest in the business or in the income therefrom.

Order- of determination will be entered accordingly.


author: Giieen:

text:
    Appeal of UTAH ORPHEUM CO.
    Docket No. 3693.
    Submitted October 2, 1925.
    Decided March 30, 1926.
    1. Deduction for exhaustion of leasehold denied for want of proof of value on March 1, 1913.
    2. Where taxpayer is on a cash receipts and disbursements basis, it may not deduct interest until actually paid.

      Jacob Mortens, Jr., Esq., for the taxpayer.

      M. N. Fisher, Esq., for the Commissioner.
    Before Maequette, MoRRis, Love, and GreeN.
    This appeal is from a deficiency in income and profits taxes for the year 1919 in the sum of $8,666.04. The petition alleges that the Commissioner erred in disallowing three deductions claimed by the taxpayer: First, $5,000 depreciation on equipment; second, $5,000 annual allowance for the exhaustion of the leasehold; third, interest in the sum of $9,260.59.
    FINDINGS OF FACT.
    The taxpayer is a California corporation, organized in 1912 and dissolved by decree of the Superior Court of the State of California in 1922. It was organized for the purpose of leasing and operating a theatre in Salt Lake City, Utah. Sometime in 1912 it leased from the Orpheum Theatre & Realty Co. (the builder and owner of the theatre building), for an annual rental of $15,000, the portion thereof constructed for theatre purposes, and proceeded immediately thereafter to furnish and operate a theatre therein. These operations were carried on at a loss up to the year 1919. Sometime after the date of the lease it was found that the theatre was too large, and it was remodeled with considerable reduction in its seating capacity.
    The taxpayer, during the several years prior to the taxable year, became indebted to the Orpheum Theatre & Realty Co. This indebtedness became the subject of a dispute between the majority and the minority stockholders of the Realty Company, and, in an effort to arrange the matter to the satisfaction of all, a promissory note was demanded from and given by the Utah Orpheum Co. The note was for the principal sum of $68,808.03, and included therein was interest on the indebtedness to December 30, 1919, in the sum of $10,548.60. The taxpayer reported its income on a cash receipts and disbursements basis.
   OPINION.

Giieen:

The taxpayer abandoned its allegation of error relating to the depreciation on equipment. It contends that the lease which it secured prior to March 1, 1913, had a value on March 1, 1913, of $100,000. It appears from the evidence, however, that the theatre was larger than necessary, that its size was subsequently reduced, and that for many years after March 1, 1913, the theatre was operated at a loss. One of the witnesses for the taxpayer testified that in his judgment a reasonable rental for the theatre would have been $30,000 a year, but he did not fix the year for which he thought such rental would be reasonable. There is no evidence which would warrant us in believing that this leasehold had any value whatever on March 1, 1913, and upon this point we must affirm the Commissioner.

As to the interest which the taxpayer claims the right to deduct, there is nothing in the evidence to indicate that the note was accepted by the Orpheum Theatre & Realty Co. in payment, and the indications are that the note was the conventional promise to pay in the future. The interest was not paid by the taxpayer during the year in question,- and, since it is on a cash receipts and disbursements basis, it may not deduct interest unless such interest was actually paid in the taxable year. There was no error on the part of the Commissioner.

Order of determination will be entered accordingly.


author: Moréis:

text:
    Appeal of Estate of DAVID R. DALY.
    Docket No. 1373.
    Submitted November 30, 1925.
    Decided March 30, 1926.
    Certain payments made to the decedent held, to be gifts.

      Parke A. Gallelier and Henry T. Stetson, Esqs., for the taxpayer.

      A. Oalder Haekay, Esq., for the Commissioner.
    Before Marquette, Morris, Green, and Love.
    This is an appeal from the determination of deficiencies in income taxes for the years 1917 and 1918 of $21,808.73 and $6,157.77, respectively, arising from the inclusion in the decedent’s gross income for those years of $60,000 and $12,000, received by him from J. H. Gautier & Co.
    FINDINGS OF FACT.
    J. H. Gautier & Co. is a New Jersey corporation, having 1,600 shares of common capital stock of a par value of $100 each, 200 shares of which were owned by David K. Daly during the years 1917 and 1918.
    During the first part of the year 1917 Daly was vice president and general manager of the corporation, and from April, 1917, through 1918, he was president and received a salary of $20,000 annually. During the years 1917 and 1918 he was one of three members of its board of directors. The board of directors of said corporation held a meeting on June 12, 1917, at which Daly and D. G. Gautier were present. The following resolution was passed:
    On motion of Mr. Gautier, seconded by Mr. Daly, the following gifts were ordered paid as of June 20th — David R. Daly, §40,000 * * ⅜.
    At a meeting held December 31, 1917, the board of directors, the same two directors being present, passed the following resolution:
    On motion of Mr. Daly the following distribution of gifts be made — to David R. Daly, $20,000 * * *.
    On July 17, 1918, the board of directors again held a meeting, at which time there were present Daly, Gautier, and Walter C. Wither-bee. At this meeting the following resolution was passed:
    On motion of Mr. Daly the following gifts were distributed. — -David R. Daly $12,000 * * *.
    Under the above resolutions 12 other employees received payments in various amounts. The payments thus authorized were made by the company to the persons designated in the resolutions.
    The decedent received from the company, by virtue of the resolutions of its board of directors hereinbefore described, the sum of $60,000 during the year 1917 and $12,000 during the year 1918. He was the only one of the 13 persons in the employ of the company designated in those resolutions who owned stock of the corporation, his holding being 12½ per cent of the outstanding capital stock. These payments were charged upon the company’s books to “ surplus ” and “ profits ” accounts and the company did not deduct them in making up its income-tax returns for 1917 and 1918. During the years 1915 and 1916 J. H. Gautier & Co. made small annual payments to certain of its employees and some officers, which payments were in addition to their fixed salary and were considered as deductions from gross income in its tax returns.

      From April, 1917, until bis death in February, 1919, Daly was seriously ill and unable to attend to the business of the company, except to attend the meetings of the board of directors. During the greater portion of this period he was under the care of physicians and trained nurses. His home was in Jersey City, N. J. The last six months of the year 1917 he was either in a hospital in New York City or in a sanitarium at Newfoundland, N. J. In May, 1918, he went to New Milford, N. J., where he remained until he died.
    The decedent did not include in his income-tax return for the year 1917 the $60,000, nor for the year 1918 the $12,000, which he received from J. H. Gautier & Co. under the above resolutions, but treated them as gifts. The Commissioner included them in the decedent’s income for the years in question as additional compensation.
   OPINION.

Moréis:

The question involved in this appeal is whether the amounts of $60,000 and $12,000, received by David R. Daly in the years 1917 and 1918, respectively, should be included in his gross income for those years under the provisions of section 2 (a) of the Revenue Act of 1916, as amended by section 1200 of the Revenue Act of 1917 and section 213 (a) of the Revenue Act of 1918. A gift has been judicially defined as “ a valid transfer of his property from one to another without consideration or compensation therefor.” Gray v. Barton, 55 N. Y. 68. The essential elements of a gift are an intention to give, a transfer of title or delivery, and an acceptance by the donee. Reviewing the evidence in this appeal, we find an actual delivery of the property and the acceptance by the donee. The intention may be ascertained from the resolutions of the board of directors and the subsequent treatment of the payments by the corporation. The three resolutions specifically designate the payments as “ gifts,” and the amounts thereof were posted in the corporate books to either the “profits ” account or the “ surplus ” account, and were not treated as an operating expense of the business. This consistency of treatment was carried into the Federal tax returns of Gautier & Co. for the years 1917 and 1918, wherein the amounts were not claimed as a deduction from gross income. Such evidence is particularly strong in view of the fact that by such treatment the corporation deprived itself of a substantial deduction in the computation of its net income for tax purposes, without indirectly benefiting its majority stockholders, as the decedent was the only one of the 13 receiving such payments who was a stockholder. Viewing the evidence in the light of what we deem to be the essential characteristics of a gift, we are led to the conclusion that the payments to the decedent were gifts and should not therefore be included in his gross income for the years in question.

The Commissioner contends that this appeal comes squarely within the Appeal of John H. Parrott, 1 B. T. A. 1, and Appeal of E. B. Tousek, 1 B. T. A. 1164, but in our opinion it is clearly distinguishable. Reverting again to one of the essential elements of a gift, namely, the intention to give, we find that factor entirely lacking in the Touseh appeal and only a faint indication of it in the Parrott appeal through the use of the words “ gratuitous appropriation ” in the resolution authorizing the payment. In both appeals, however, the intention to make a gift was negatived by the treatment of the payments by the corporations as compensation for services and therefore as deductible items from their corporate incomes.

Order of determination toill he entered accordingly.


author: Lansdon:

text:
    Appeal of HAMILTON MANUFACTURING CO.
    Docket No. 2507.
    Submitted June 1, 1925.
    Decided March 30, 1926.
    1. The taxpayer reissued shares of treasury stock to employees, charged the book value of such shares to personal stock accounts of the recipients, credited against such accounts amounts measured by dividend declarations, and charged the same with interest on debit balances. Held, that the treasury stock so reissued •was outstanding, that the dividend credits may not be deducted from income as additional compensation paid to employees, and that interest charged on debit balances was income to the taxpayer.
    2. On the evidence, held, that depreciation reserves relating to tangible assets set up by taxpayer prior to March 1, 1913, reflect the actual physical deterioration of such property and should not be disturbed for invested capital purposes.
    3. Unadjusted claims for refunds-of Federal taxes disallowed as elements of invested capital.
    4. Claims for additional deductions on account of bad debts disallowed.

      E. A. Wilde, G. P. A., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before SteRNhagen, Lansdon, Green, and Love.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1919 in the amount of $5,806.07. In its original and amended petitions the taxpayer alleges 16 errors in the computation of its tax liability for the year involved. At the hearing six of the alleged errors were disposed of by stipulation and a seventh was waived by the taxpayer. The issues remaining for determination by the Board involve the following points: (1) Adjustment of invested capital in connection with reissue of treasury stock; (2) additional compensation of employees; (3) addition to income of interest on debit balances of stock purchase accounts of employees; (4) depreciation of plant and equipment prior to March 1, 1913, for invested capital purposes, and correct rates of depreciation for period subsequent thereto for income adjustments; (5) inclusion in invested capital of amounts of refund claimed for Federal taxes not yet allowed; and (6) disallowance of a part of deduction claimed on account of bad debts.
    FINDINGS OF FACT.
    The taxpayer is a Wisconsin corporation with its principal place of business at Two Rivers. During the taxable year, and for many years prior thereto, it was engaged in the manufacture and sale of wood and steel printers’ equipment and of dental cabinets and furniture. It keeps its books of account and makes its income and profits-tax returns on the accrual basis.
    The net result of the stipulations filed by the parties to this appeal as a part of the record is to decrease the taxpayer’s net income and invested capital as stated in the deficiency letter in the respective amounts of $1,875.03 and $343.27.
    Some time prior to January 1, 1919, the taxpayer took into its treasury by purchase from its stockholders certain shares of its outstanding capital stock. Thereafter it reissued some of such shares to various of its employees without cash consideration and charged the book values of the same to personal stock accounts of the persons who received it. Such issues were evidenced by 'the ordinary common-stock certificates of the taxpayer modified by numerous conditions.
    On the face of each certificate this condition was printed diagonally across the usual contract form for such stock:
    Notice to whom, it may concern: This certificate and 'the shares of stock, -which it represents are held by the person named hereon as owner, subject, to the conditions and stipulations endorsed on the back thereof.
    On the back of each certificate the following conditions and stipulations were set forth:
    1. The Hamilton Manufacturing Company,, hereinafter called the company,. guarantees to-, hereinafter called the holder, that the within stock shall and will earn 10 per cent on $-, (purchase price) per annum for two-years after date of this certificate; but this guaranty shall not require the company to pay out all such earnings as dividends within said two years.
    2. The company guarantees to the holder that at the expiration of said two years it will, if the holder so demands, purchase said stock or procure a purchaser thereof at the present purchase price plus interest, less all sums and interest that may then be owing to the company from the holder, and to secure the payment of all such sums the company is hereby given a lien on said stock.
    3. The holder agrees to pay interest to the company on any unpaid portion of said purchase price; to devote all cash dividends that may be declared hereafter to the payment to the company of such unpaid portion of purchase price and interest, so far as necessary to complete full payment of such purchase price; and not to sell, pledge or assign said stock or this certificate within ten years from date of issue of certificate, except to the company.
    4. The holder hereby grants to the company an option during the period of ten years from the date of issue of this certificate, to purchase said stock from the holder at any time the holder’s employment by the company shall terminate, either by reason of death, resignation or other cause; but this option shall not be enforced by the company if the holder’s employment is merely suspended by reason of temporary incapacity. If the company purchase under this -option it shall pay the holder, or his legal representatives, the book value of said stock as appears by the last preceding annual statement with interest thereon to the date of such re-purchase, less all sums and interest that may then be owing to the company from the holder.
    5. So long as the holder stands to his agreements herein set forth, he may have the privilege of paying the entire portion of the purchase price now unpaid, with interest, out of the cash dividends that may be declared on said stock; but in case'of any breach of the conditions hereof by the holder, the •entire remaining portion of said purchase price shall become due and payable forthwith.
    6. The word “interest” as used herein means interest at the rate of 5% per annum.
    7. At the date of the issue of this certificate the holder owes the company for unpaid purchase price $-.
    8. If at the expiration of ten years from said date of issue the holder is still in the employ of the company and has complied with the terms of this agreement and has paid the full purchase price above named, he shall be entitled to surrender this certificate and receive in lieu thereof a like certificate freed from the conditions endorsed hereon. If at the expiration of said ten years the holder shall be entitled to such unconditional certificate except that he has not fully paid such purchase price, then he shall be so entitled whenever he •completes such payment; and any unpaid balance existing at the end of said ten years shall become immediately due and payable to the company.
    9. Any cash dividends received by the holder after he has completed payment of said purchase price shall be the absolute property of the holder, notwithstanding the conditions and options herein contained.
    10. The holder agrees to all the above conditions.
    Prior to the taxable year, in conformity with the terms set forth aboye, the taxpayer reissued its treasury stock to certain of its employees in the total number of 227 shares. At January 1, 1919, the •debit balances in the accounts evidencing such reissues amounted to $130,846.44. During the year 1919, as dividends were declared, such accounts were credited in the gross amount of $8,528 and •charged with interest on debit balances in the amount of $6,280.79. The holders of the conditioned stock certificates were entitled to vote and did vote in meetings of the stockholders of the taxpayer.
    From the beginning of its operations, about 1895, until December 31, 1912, the taxpayer acquired buildings, machinery, and equipment at a total cost of $535,272.41, and during the same period wrote off depreciation on the same in the total amount of $89,272.86. The book value of its depreciable capital assets at December 31, 1912. and at March 1, 1918, was $446,086.45. Upon audit of the taxpayer’s income and profits-tax return for the year 1919 the Commissioner increased accumulated depreciation for the period prior to March 1, 1918, to the amount of $188,134, and reduced the value of the taxpayer’s depreciable assets as of that date to $347,324.43, which he made the basis for computing depreciation on the straight-line basis at varying rates down to and including the taxable year. Prior to January 1, 1913, the taxpayer wrote off depreciation from the book values of its depreciable assets in amounts that, in the judgment of its officers, represented the actual facts in respect of the deterioration of its property.
    Prior to January 1, 1919, the taxpayer filed claims for refund of Federal taxes paid on account of the years 1912, 1913, 1917, and 1918, in the respective amounts of $842.53, $116.58, $1,161.67, and $20,359.16, or a total amount of $22,515.94. In its income and profits-tax return for the taxable year it included the gross amount of such claims for refund, all of which were at that time and still are undetermined, in the computation of its statutory invested capital for profits-tax purposes.
    In, its income and profits-tax return for the year 1919 the taxpayer deducted from gross income the amount of $4,408.03, alleged to represent debts ascertained to be worthless and charged off during the taxable year. Upon audit of such return the Commissioner allowed only $2,100 of the amount so deducted.
   OPINION.

Lansdon:

The result of the stipulation and of the waiver of one of its contentions by the taxpayer is that the issues remaining for the consideration of the Board may be summarized as follows: (1) The effect of the reissue of certain shares of treasury stock to employees, to be paid for out of dividends, and the collateral transactions connected therewith, on the invested capital and taxable income of the taxpayer; (2) the effect on invested capital of the action of the Commissioner in writing off additional depreciation on the taxpayer’s assets for the period prior to March 1, 1913; (3) the disallowance of unadjusted claims for refund of Federal taxes paid in prior years as elements of invested capital; and (4) whether there should be an additional deduction for bad debts ascertained to be worthless and charged off during the year in question. These issues will be discussed in the order of their statement.

The taxpayer contends in the matter of the reissued treasury stock, (1) that the transactions in question were of such a character that the status of such stock as treasury stock was not affected; (2) that the amounts credited to the personal accounts of the employees receiving the conditioned certificates should be regarded as additional compensation paid to such employees, and therefore deductible from income for the taxable year as ordinary and necessary expenses incurred in trade or business; (3) that invested capital should not be decreased by the amount of dividends credited to the personal accounts of such shareholders; and (4) that interest on debit balances of such accounts charged against the accounts should not be included in taxable income.

The taxpayer contends that the issues of the conditioned stock certificates evidencing transfer of treasury stock to its employees, by reason of the contingent character of the certificates, should not be regarded as capital transactions, and that the conditions imposed were of such a nature that the nominal reissue was a mere segregation of certain shares of its treasury stock without any actual change of ownership. If this claim is conceded, it follows that the amounts credited to the personal stock accounts of employees, although measured by dividends paid to all other stockholders of record, were not distributions of surplus but payments from earnings as additional compensation for services, as alleged in the petition.

The evidence and argument of the taxpayer in support of its first contention are not convincing. .We are of the opinion that the stock issued to employees, even though affected by certain conditions agreed to by the recipients, lost its character as treasury stock when reissued. The holders of the so-called contingent stock certificates were entitled to and did receive dividends as credits on their personal stock accounts, and at all times had the right to vote their stock in the meetings of the taxpayer’s shareholders. From the date of the certificates so issued such stock was outstanding. The amounts credited to the personal accounts representing these stock transactions were dividends, and their payment automatically reduced earned surplus ratably for that part of the taxable year subsequent to their credit to the personal accounts of the employees. This, however, had no effect on the total amount of statutory invested capital, since the amounts so credited, constructively at least, were paid in for shares. Having decided that the amounts of dividends credited to the personal stock accounts of the employees were, in fact, contributions of capital, it follows that the taxpayer may not deduct such credits from its income as ordinary and necessary expenses. The interest on the debit balances of such accounts was income to the taxpayer and should be included in its gross income for the year in question in the amount of $6,280.79.

It appears from our findings of fact that prior to March 1, 1913, the taxpayer acquired depreciable assets at a cost of $535,272.41, and wrote off depreciation in the amount of $89,272.86. The Commissioner held that such write-off was inadequate, and, by applying the straight-line method to various classes of assets, increased the taxpayer’s depreciation reserve as of March 1, 1913, to the amount of $188,134, thereby reducing its invested capital in the amount of $98,861.14.

The evidence adduced at the hearing is convincing that the reserves for depreciation set up by the taxpayer prior to March 1, 1913, reasonably reflect the actual facts of the physical deterioration of the tangible assets involved and should not now be disturbed. Appeal of Rub-No-More Co., 1 B. T. A. 228, and Appeal of Russell Milling Co., 1 B. T. A. 194.

It appears that since January 1,1914, and including the year 1919, the taxpayer has depreciated its capital assets on the straight-line method at rates as to which there is no controversy. For this period the only issue involved in the computation of depreciation, and the resulting effects on invested capital and taxable income, is whether the basis of such computation shall be the taxpayer’s book value of its assets as of March 1, 1913, or the reduced value resulting from the Commissioner’s deduction of alleged additional depreciation accumulated before that date. We have already decided this issue above. The taxpayer is, therefore, entitled to any increase in its invested capital and to adjustments of its gross income for the taxable year which may result from the application of reasonable rates of depreciation to the book value of its assets in the amount of $446,086.45 at March 1, 1913,-with due consideration for additions and abandonments.

The Board finds no merit in the taxpayer’s contention that the amount of claims for refunds of Federal taxes pending unadjusted before the Commissioner should be included in its invested capital for the taxable year. It may be that eventually such refunds will be paid, and if so it may then become necessary to readjust invested capital and tax liability for the years affected by such payments. Determinations of tax liability by the Commissioner are prima facie evidence that the amounts so determined are due, and until reversed by him or by competent tribunals must be accepted as final ascertain-ments as to the matters involved. To adopt the rule suggested by the taxpayer would establish an endless-chain system of readjustments of tax liability equally unsatisfactory to the Government and to taxpayers.

The taxpayer offered no evidence in support of its contention for a greater deduction on account of bad debts ascertained to be worthless and charged off during the taxable year sufficient to justify us in reversing or modifying the determination of the Commissioner on this point.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.