author: Kern :

text:
    Glensder Textile Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102729.
    Promulgated January 27, 1942.

      David A. Goodkmd, O. P. A., and George H. Engelhard, Esq., for the petitioner.

      George B. Sherriff, Esq., and William G. Buymann, Esq., for the respondent.
   OPINION.

Kern :

Respondent, relying on Morrissey v. Commissioner, 296 U. S. 344, and the companion cases decided by the Supreme Court on the same day, contends that the petitioner possesses all the eight elements which were said in those cases to characterize an association in corporate form and hence taxable as a corporation; that it is, in short, a group of persons associated in a joint enterprise to carry on a business, possessing centralized control and continuity of existence; that it has transferable shares and limited liability; that it pays dividends or profits to its members in proportion to their respective interests; and, generally, that it has a substantial resemblance to corporate organization.

The revised regulations, already quoted, provide that a limited partnership organized under the Uniform Limited Partnership Act, such as petitioner, may or may not be an association, depending upon its essential characteristics. The line to be drawn is one of fact. Obviously, two or more persons associated together in a general partnership would fall under that well recognized category in the taxing statutes and, since the entity theory is not recognized by the act, its income would be taxed to the individual partners, but at the rates applicable to natural persons. As was said by the Supreme Court, per Brandeis, J., in Burk-Waggoner Oil Association v. Hopkins, 296 U. S. 110, the “term partnership as used in these sections obviously refers only to ordinary partnerships.” The Court then went on to point out that joint stock associations, notwithstanding classification as partnerships under the law of several states, could not be considered as such under the Federal revenue acts because they have a fixed capital stock divided into shares which are represented by transferable certificates and have also other indicia of corporate existence and corporate business effectiveness.

The limited partnership appears to hold a middle ground between the joint stock association and the general partnership, and, as the regulations aptly suggest, the powers of the particular limited partnership under the local statute must first be examined before a line can be drawn. The limited partnership in the sense of several general partners associated with several limited partners, the ordinary rules of partnership applying to the general partners, but the limited partners having no liability beyond their money actually embarked in the enterprise, was not known to the common law, see 8 Holds-worth, Hist. Eng. Law 196; but is derived from French law and was introduced by statute in New York as early as 1822, in the days of Chancellor Kent. See 3 Kent Com. 35; Ames v. Downing, 1 Bradf. 321 (N. Y. 1850); 3 Bouvier, Law Dict. (Rawle’s 3d Rev., sub verb. “Partnership”.) The limited partners in such a partnership are also silent partners who have no hand in the management of the business. Other types of limited partnerships exist by statute, it is true, as in Pennsylvania, see Bouvier, loe. dt., in which no member incurs any liability beyond the amount of his contribution. This latter form obviously approaches the confines of a corporation, whereas the former form inclines to that of a partnership, for although the Supreme Court has pointed out in Burk-Wag goner v. Hopkins, supra, that the individual liability of a partner for the debts of the partnership or association can not be taken as the sole touchstone of classification, it is nevertheless a very important means of discrimination.

Even within the form of limited partnership most generally known, in which general and limited partners are associated together, we may still suppose situations where the resemblance to corporate form would be so substantial as to justify classification of the limited partnerships as corporations. If, for instance, the general partners were not men with substantial assets risked in the business, but were mere dummies without real means acting as the"agents of the limited partners, whose investments made possible the business, there would be something approaching the corporate form of stockholders and directors. But, as a practical matter, to suppose such a situation we must also suppose that the limited partners were, in reality, not merely silent partners without control of affairs but were empowered to direct the business actively through the general partners. We suggest this possibility merely to show that designating a partnership as of a particular kind involves no more than applying a particular name, and that the really vital thing, the rights and duties of the partners as between themselves and the public, may vary as much as the legislatures of the several states may think fit to allow.

We must, therefore, first look to the statute to see what the law permits and next to the articles of partnership and certificate filed with the county clerk to see what has actually been done within the law.

The petitioner was organized as a limited partnership in 1936 under the Uniform Limited Partnership Act of New York, Laws 1919, ch. 408, art. 8; McKinney’s Consol. Laws of N. Y., Ann., bk. 38 (1923), and filed a certificate setting out the information required by section 91 of tbat act. A limited partnership as defined by the act is one formed by one or more general partners and one or more limited partners, and “the limited partners as such shall not be bound by the obligation of the partnership.” Sec. 90. A limited partner is not liable as a general partner unless he takes part in the control of the business, sec. 96; and if he contributes capital erroneously, believing himself a limited partner, he does not become a general partner provided he at once withdraws, sec. 100. A general partner, on the other hand, has all the rights and powers and is subject to all the liabilities of a partner in an ordinary general partnership, except that he may not do certain things without the consent of all the limited partners. Among these powers withheld on condition is that to admit a person as a general partner, or a person as a limited partner unless that right is given in the certificate; or to continue the business with partnership property on the death, retirement or insanity of a general partner, unless that right is given in the certificate. Sec. 98. A limited partner has the full rights of a general partner to inspect the partnership books and to partnership information, and to a share of the profits. Sec. 99. One person may be both a general partner and a limited partner, his latter status giving him in respect of his contributions the rights of a limited partner against the other members. Sec. 101. A limited partner may withdraw his contributions under certain conditions, sec. 105; and . his interest is assignable, sec. 108; but his assignee does not become a “substituted limited partner,” and as such have access to the partnership boobs except with the consent of all the members, unless the assignor’s power to make him such is set out in the certificate. Sec. 108. Retirement, death, or insanity of a general partner dissolves the partnership, unless it is continued with the consent of all the members or under a right stated in the certificate, sec. 109, but it is not stated that the death of a limited partner has such an effect. Sec. 110. The certificate is canceled on general dissolution of the partnership, and must be amended on admission of either a limited or general partner. Sec. 113.

When we„turn to the certificate to ascertain the powers reserved under it as allowed by the statute, we find that:

* * # * * * *
IX. Upon the written consent of all the general partners, and upon terms agreed upon by them in writing, additional limited partners may be admitted at any time.
X. On the death, retirement or insanity of any one or more of the general partners, the remaining partner or partners shall have the right to continue the business.
XI. A limited partner shall have the right to substitute an assignee of the whole or part of his interest as contributor in his place, on the terms and conditions governing his, the assignor’s, interest in the partnership. Such assignee shall have the rights and obligations of a substituted limited partner under the Partnership Law.

After this survey of statutory limitations on limited partnerships, we are in a position to examine the claims of corporate resemblance made by the respondent. What the four general partners did was to redistribute the net worth of the old ordinary partnership, $300,000, between themselves as general partners and their wives and children as limited partners, Klein’s contribution as a general partner being $50,000 as against $25,000 for the three other general partners, for the reason, apparently, that he had no children to make limited partners. The same amount of money, in short, was employed in the new partnership as in the old, and it was divided as before insofar as family ownership was concerned, but limited partners were introduced, with consequent changes in legal relations and status.

There was centralized control by the general partners, but this fact did not make them analogous to directors of a corporation. They were acting in their own interest as hitherto, which constituted five-twelfths of the partnership, and not merely in a representative capacity for a body of persons having a limited investment and a limited liability. Nor were the limited partners here able to remove the general partners and control them as agents, as stockholders may control directors. The general partners under powers reserved by the certificates might increase the limited partners, to obtain new money, but the latter, unlike new stockholders in a corporation, acquire no share in control.

A contingent continuity of existence had been provided for by the reservation in the certificate of the power of the surviving general partners to continue the business on the death, retirement, or incapacity of a general partner. We do not think this analogous to the chartered life of a corporation which continues regardless of the death or resignation of its directors or stockholders. A limited partnership is dissolved by death, as an ordinary partnership, unless the right to continue is retained, but continuity is not assured by this power, for it is one vested in the several general partners, apparently, and not in the partnership as an entity. Continuance will be certain only if the remaining general partners agree to it, as would be the case, in substance, in a general partnership. In an ordinary partnership, on the death of a partner a new partnership is formed; here the old partnership continues but receives new life, in effect, from the decision of the members. Moreover, on a general partner’s death his interest must be paid over to his personal representative, and the capital of the partnership is to that extent liquidated.

The death of a limited partner apparently has no such effect of dissolving the partnership. A limited partner’s interest is transferable but it is obvious from other provisions that the assignee does not thereby become a substituted limited partner, unless that power is reserved. It was reserved here; and some analogy, therefore, does arise between the interest of a limited partner and that of a corporate stockholder in the matter of transferability of interest. It does not appear, however, that such transfers were contemplated, for no mechanics were provided for the ready transfer of interests through certificates representing shares in the partnership. The limited partner had the power to substitute an assignee, but he also might merely assign without substitution. The anomalous class of assignees which would result in the latter case would bear no resemblance to a corporate stockholder’s status. The general partner’s interest was, of course, not any more transferable than that of a general partner in an ordinary partnership. We do not think that the transferability of the interest of a limited partner, however analogous in itself to the corporate stockholder’s right, can be taken as determinative here.

Nor can we believe the limited liability of the limited partner to be a final criterion. Limited liability is, of course, an essential element of doing business in the corporate form, but the persons here actually in control of all business activity of the partnership were the general partners only, and the moment that a limited partner should enter into business activity he would lose his status as a limited partner and become a general partner. We find nothing in the statute that limits the liability of general partners of a limited partnership, but, on the contrary, it is provided that their liability shall be the same as that of partners in an ordinary partnership except in certain matters not here relevant.

We think that the provision in the partnership articles (art. second) to which respondent refers can have no bearing, therefore, on their liability to general creditors, and that it does not go beyond the rights of the partners inter sese. Nor do we regard the provision as to “salaries” of the general partners nor that as to a guaranteed payment of 4 percent on contributions to all members as having any relevance in the present relation. Moreover, it would seem to be immaterial that under New York law a limited partnership may take real estate in the partnership name. For article 2, section 10, paragraph 2, of the General Partnership Law provides that the law of general partnerships shall apply to limited partnerships, except where inconsistent therewith; and article 5, section 51, paragraph 1 provides as follows: “A partner is co-owner with his partners of specific partnership property, holding as a tenant in partnership.” This would indicate that the partnership does not hold as an entity. The mere fact that the partnership is given power by implication in section 21 to hold real property in its name is not determinative. Section 21 of the General Partnership Law provides that, where land is so held, any general partner may convey legal title to it by a conveyance executed in the firm name, ibid, par. 1; or equitable title of the whole partnership interest by a conveyance executed in his own name, ibid, par. 2. The partnership agency thus provided for does not, however, constitute the partnership an entity, since the same general principles apply to real as to other property, and any general partner in respect of it acts, as in all other things, as if he owned it both jointly and severally. The general effect of these provisions is that, while the legal title to real property may be held in the name of the partnership, as it might be held in the name of an individual partner, the equitable title is in the several partners as tenants in partnership. (Sec. 51.)

A limited partnership may not sue in its own name. In actions brought by such a partnership, the general partners are the proper parties plaintiff. (See sec. 115.)

We must conclude, therefore, after an examination of the organization and legal powers and liabilities of the members of the limited partnership before us, that it does not bear such a resemblance to an association or operate effectively as such so as to justify our inclusion of it in that category for tax purposes. Although a limited partnership, it was still a partnership, and should be treated as such under the statute. The statute provides a category for individuals doing business in partnership and deriving income thus; and we may not disregard it where the likeness to an association is no plainer than it is here.

Decision will be entered for the petitioner.


source: Caselaw Access Project

author: Tyson:

license: Public Domain

text:
    Meyer Katz and Helen Katz, Petitioners, v. Commissioner of Internal Revenue, Respondent. Meyer Katz, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104007, 105511.
    Promulgated January 27, 1942.

      Max Swiren, Esq., for the petitioners.

      Gerald W, Brooks, Esq., for the respondent.
   OPINION.

Tyson:

The pleadings raise two issues involving the questions of whether the income of the three trusts for the benefit of petitioner’s children is taxable to petitioner (1) under the broad provisions of section 22 (a) of the Kevenue Acts of 1936 and 1938, because, in substance, he retained ownership of the trust property, or, (2) under the specific provisions of section 166 of those acts because he reserved a power of revocation of the trusts.

Under Helvering v. Clifford, 309 U. S. 331, the applicability of section 22 (a), supra, depends upon whether, after creating the trusts the petitioner, grantor, retained such incidents and attributes of ownership that he continued to possess the economic enjoyment of the property or the fruits of such property placed in trust. In that case the trust was for a short term and upon its termination the corpus was, under the specific terms of the trust, to revert to the grantor, who was the trustee and had broad powers over the control and management of the trust property in that short interim. The rationale of that case has been discussed and applied or not applied in numerous subsequent cases, a great many of which have been reviewed in the recent case of Commissioner v. Betts, 123 Fed. (2d) 534. It will serve no useful purpose in this opinion to again review those cases.

In the instant case, except for possible revocation by petitioner jointly with persons having substantial adverse interests hereinafter discussed, the trusts were to continue for an indefinite period, but at least until after the death of the grantor, petitioner; during the tenure of the trusts he had no dominion and control over the corpus and income therefrom except in the exercise of his duties as trustee and he could not receive individually any of the benefits of either the corpus or the income; and upon termination of the trusts after the grantor’s death both the corpus and any accumulated income was to be distributed to or held in trust for the benefit of specifically designated primary beneficiaries or specifically designated contingent beneficiaries, the latter including the surviving issue of the primary beneficiaries or the surviving sisters and brothers and mother of the primary beneficiaries, and, lastly, the petitioner’s (grantor’s) heirs at law upon the remote contingency that the grantor’s wife and all of his children, without leaving issue, predecease him. Here the corpus and income of the trusts were definitively and permanently disposed of by the terms of the trust instruments with no reversion to the grantor, petitioner, and with no power in him to make testamentary disposition thereof. We hold that the income of the trusts in question during 1937 and 1938 is not taxable to petitioner under section 22 (a), supra. Commissioner v. Betts, supra; Commissioner v. Branch, 114 Fed. (2d) 985; Jones v. Norris, 122 Fed. (2d) 6; Carleton H. Palmer, 40 B. T. A. 1002; affirmed per curiam, 115 Fed. (2d) 368; Frederick Ayer, 45 B. T. A. 146, and authorities relied upon in those cases.

The petitioner, grantor, as to each trust, did not retain in himself alone a power of revocation, but only jointly with his wife Helen, until the child named as beneficiary reached the age of 21, and thereafter or, upon the wife’s death prior thereto, jointly with the beneficiary. In our opinion, the primary beneficiary’s vested interest in the trust estate constituted a “substantial adverse interest” within the meaning of section 166, supra. The petitioner’s wife Helen was a living, definitely ascertained person who had the fixed right, in the event the primary beneficiary predeceased her without leaving issue, to have a substantial share of the trust income that might be currently distributed and of the entire trust estate, including accumulated income, distributed to her. Also, in our opinion, such contingent interest of the wife was a “substantial adverse interest” to the grantor, petitioner, within the meaning of section 166, supra. Jane B. Shiverick, 37 B. T. A. 454; Paul W. Litchfield, 39 B. T. A. 1017; Laura E. Huffman, 39 B. T. A. 880; Corning v. Commissioner, 104 Fed. (2d) 329; Commissioner v. Prouty, 115 Fed. (2d) 331. We hold that the income of the trusts involved herein is not taxable to petitioner under section 166, supra.

The case of Cox v. Commissioner, 110 Fed. (2d) 934, cited by respondent, in which the court concluded that the grantors of the trusts there involved were taxable on the income therefrom under both section 22 (a) and section 166 of the Revenue Act of 1934, is distinguishable on its facts from those in the instant proceedings. While in that case the court, in applying those sections and in connection with the grantors’ reserved rights to revoke the trusts in conjunction with any other beneficiary, appears to have considered that, in connection with all the other facts therein, the interests of beneficiaries, who were members of the grantors’ family, were not such substantial adverse interests as would bring the grantors within the protective provisions of section 166, yet the other factors of broad powers of control of the trust estates reposed in the grantors by the trust instruments would of themselves seem to have been sufficient to justify the holding in that case — among such other factors, the vital one being that grantor might, under the express terms of the trust instruments, at any time solely in his own discretion have paid the whole of the’corpus to himself for his support, comfort, or maintenance. There the right of the grantor to exercise such discretion was, for all practical purposes, equivalent to a power to revoke the trust and revest the corpus in himself without the consent of anyone else and thus the facts in that case brought it squarely within the operation of section 166, or, alternately, under section 22 (a) as was held by the court, independently of any consideration of the substantial adverse interest there involved.

The case of Altmaier v. Commissioner, 116 Fed. (2d) 162, also cited by respondent, in which the court concluded that the grantor of the trust involved was taxable on the income therefrom under the provisions of section 167 of the Revenue Act of 1932, is also distinguishable on its facts from those in the instant proceedings. In that case the court said:

* * * Here the trust instrument specifically directs that (1) the net income of the estate shall be accumulated,, invested and added to the principal while the settlor lives or until his wife dies, should she predecease him, (2) in which latter event, he shall receive the entire net income for the rest of his life, or in the alternative (S) may sweep clean the entire original and accumulated trust estate by the exercise of his reserved power to terminate and take all.

That reserved power of which the court spoke was in the grantor alone. The court held that “Under the arrangements of the trust agreement, the income of the trust ‘may be * * * accumulated for future distribution to the grantor.’ ” and was therefore taxable to him on the grounds that if under any circumstances or contingencies any part of the accumulated income might inure to the benefit of the grantor such income was taxable to him. In that case further facts were that during the life time of the grantor and bis wife the power to alter, amend, revoke, and terminate the trust was vested in them jointly. While the court said that in the circumstances the wife was not, in its judgment, a person having “a substantial adverse interest” within the meaning of the statute and proceeded to discuss the concept of family solidarity, yet the court’s decision rested on the possibility of the grantor acquiring the accumulated income as bringing that case squarely within section 16?.

In the Gox and Altmaier cases the facts other than and independent of those with reference to the adverse interests there considered, clearly showed that the income of the trusts involved was taxable to the grantors under section 166 in the Cox case and under section 16? in the Altmaier case. The expressions in those cases to the effect that under the circumstances therein a member of an intimate family group had no substantial interest in the trusts adverse to the grantor within the meaning of sections 166 and 16? does not, in our opinion, establish a general principle to that effect which would be controlling here and warrant a holding in the instant case that petitioner’s wife had no “substantial adverse interest” merely because she was the grantor’s wife.

While no issue has been raised by the pleadings as to the taxability of petitioner under section 16? of the Revenue Acts of 1936 and 1938, we deem it proper to consider that question. See Carleton H. Palmer, supra. Though certain capital gains, if realized, were not distributable to the beneficiaries of the trusts, but were to be added to corpus, such gains, as a part of corpus, could never be distributed to the petitioner, grantor, except through his exercise of the power of revocation jointly with persons having substantial adverse interests as above stated. As to the net income of the trust which could be currently distributed to or accumulated for the benefit of the primary beneficiaries and/or the contingent beneficiaries, such income could never be distributed to the grantor, petitioner, even in the event of a revocation of the trust. It is clear that section 167, supra, has no application to the instant case.

The respondent erred in including in petitioner’s income any portion of the income of the three trusts in question for the years 193? and 1938.

Decision will be entered, under Bule 50.

       SEC. 22. GROSS INCOME.
      (a) Genebal Definition. — “Gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever lcind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

       SEC. 166. REVOCABLE TRUSTS.
      Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
      then the income of such part of the trust shall be included in computing the net Income of the grantor.

      . SEC. 167. INCOME EOE BENEFIT OF GRANTOK.
      (a) Where any part oí the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      ifc * # Jfc lit s}: *
      then such part of the income of the trust shall be included in computing the net income of the grantor.


author: Leech:

text:
    Evelyn M. L. Neill, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105307.
    Promulgated January 27, 1942.

      James P. Junkin, Esq., for the petitioner.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

Leech:

Respondent determined a deficiency in income tax in the amount of $481.83 for the calendar year 1938. The issues presented are (1) whether the income of petitioner, a nonresident alien individual, is to be computed under section 211 (a) (1) or section 211 (b) of the Revenue Act of 1938, and, if under section 211 (a) (1), (2), whether petitioner is taxable upon net income computed by deduction of mortgage interest paid and is entitled to a personal exemption of $1,000.

We find the facts as stipulated. Briefly, these are that petitioner is a nonresident alien. Her return for the calendar year 1938 was filed with the collector of internal revenue for the first district of Pennsylvania. Her income from sources within the United States consists of rentals paid by a tenant occupying property owned by her in Philadelphia, Pennsylvania. She inherited this property upon the death of her husband on October 26, 1937. It is held under a long term lease by a tenant who, under the terms of that lease, erected a building thereon and is obligated under the lease to pay taxes and insurance and maintain the property.

The property referred to is encumbered by a mortgage in the sum of $50,000 executed by petitioner and her husband in 1931, the ground lease on the property having been assigned at that time to the mortgagee as collateral security for the mortgage. For many years petitioner has employed a firm of attorneys with offices in Philadelphia, to whom the tenant pays the rentals due petitioner under her direction. These attorneys then pay for her the interest due upon the mortgage and such incidental expenses for which petitioner may be obligated.

During the calendar year 1938, rental in the sum of $5,000.04 was paid by the tenant to petitioner’s attorneys for her account. Of this amount the attorneys paid out $3,360.90, interest due upon the mortgage, $15 in insurance premiums, and miscellaneous expenses of $8.28, or a total of $3,384.18. The petitioner reported upon her return the net rent received after deducting these items, or $1,615.86. Against this income she took credit for $1,000 as a personal exemption as a nonresident alien engaged in a trade or business within the United States. In determining the deficiency, the respondent has computed a tax due under section 211 (a) (1) of the Revenue Act of 1938 at the rate of 10 percent on her gross income of $5,000.04, disallowing the deductions of $3,384.18 and the personal exemption of $1,000.

The issues are determined by whether petitioner is a nonresident alien carrying on business or having a place of business in the United States and therefore taxable on net income under section 211 (b). If she is not, it is clear that her tax is to be computed on gross income under section 211 (a) (1).

Although admitting that she does not operate the building owned by her in Philadelphia, such operation being by the tenant, petitioner contends that such ownership constitutes the carrying on of business. We do not agfee. The ownership of this property by petitioner is no more a business activity carried on within the United States than her ownership of stocks or bonds of American companies held for her by an American agent. Cf. Higgins v. Commissioner, 312 U. S. 212. We think the rule is settled that the mere ownership of property from which income is drawn does not constitute the carrying on of business within the purview of the cited section. McCoach v. Minehill & Schuylkill Haven Railroad, Co., 228 U. S. 295; Stafford Owners, Inc. v. United States, 39 Fed. (2d) 743.

Petitioner contends, however, that, if it should be held that she is not engaged in business within the United States within section 211 (b), sufra, then the facts established show that she maintains an office there for the transaction of business, which is the office of her attorneys in Philadelphia. Upon this question petitioner is concluded by our decisions in Aktiebolaget Separator, 45 B. T. A. 243, and Recherches Industrielles, S. A., 45 B.T.A. 253.

Petitioner also argues that since the mortgage was in default in 1938 the mortgagor, who held the lease as security for its payment, was entitled to collect the rents and retain, at least, the interest — that petitioner thus never had a right to receive in the taxable year anything more than the net rents after deduction of the contested interest. Any question on this point is eliminated because no such default has been established.

We hold that petitioner is taxable under section 211 (a) (1), supra, that her tax must be computed upon the gross rentals received by her through her attorneys in Philadelphia, and that she is not entitled to the deduction of mortgage interest or expenses, nor to the personal exemption allowed to a nonresident alien engaged in business here.

Decision will he entered, for the respondent.

       SEC. 211. TAX ON NONRESIDENT ALIEN INDIVIDUALS.
      (a) No united States Business on Office.—
      (1) General rule. — There shall be levied, collected, and paid for each taxable year, in lien of the tax imposed by sections 11 and 12, upon the amount received, by every nonresident alien individual not engaged in trade or business within the united States and not having an office or place of business therein, from sources within the United States as interest (except interest on deposits with persons carrying on the banking business), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income, a tax of 10 per centum of such amount, except that such rate shall be reduced, in the case of a resident of a contiguous country, to such rate (not less than 5 per centum) as may be provided by treaty with such country. For inclusion in computation of tax of amount specified in shareholder’s consent, see section 28.
      (b) United 'States Business or Office. — A nonresident alien individual engaged in trade or business in the United States or having an ofliee or place of business therein shall be taxable without regard to the provisions of subsection (a). As used in this section, section 110, section 143, section 144, and section 231, the phrase “engaged in trade or business within the United States” includes the performance of personal services within the United States at any time within the taxable year, but does not include the performance of personal services for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the united States, by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of ninety days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. Such phrase does not include the effecting of transactions in the United States in stocks, securities, or commodities through a resident broker, commission agent, or custodian.


author: HaRROn:

text:
    A. E. Staley Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99347.
    Promulgated January 27, 1942.

      O. C: Le Forgee, Esq., for the petitioner.

      Frank F. KoreTl, Esq., for the respondent.
   OPINION.

HaRROn:

The sole question is whether in the taxable year in the computation of the surtax imposed by section 14 of the Revenue Act of 1936 petitioner is entitled to a credit in the amount of $371,223.80 under section 26 (c) (2), the provisions of which are set forth in the margin. On its income tax return for the taxable year in the computation of the surtax imposed by section 14, petitioner took a credit for contracts restricting dividend payments in the amount of $371,223.80. The credit was disallowed by respondent on the ground that it was not a proper credit within section 26 (c).

In its brief petitioner claims that it is entitled to the credit in question under section 26 (c) (2) and bases its claim on the provisions of section 17 of the trust indenture. Section 26 (c) (2) grants a credit in the nature of a special tax exemption and is to be strictly construed. See Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. Therefore, the provisions of section 17 of the trust indenture must be carefully scrutinized to determine whether the requirements of the statute are met. The first paragraph of section 17 provided in substance that on June 1, 1937, and on June 1 of each year thereafter for a specified period, petitioner was to make a sinking fund payment the amount of which was to be measured by whichever of the following two amounts was the greater: (1) 3 percent of the aggregate principal amount of its bonds, or (2) 25 percent of the net earnings of the preceding year. The second paragraph of section 17 gave petitioner the right to make any sinking fund payment either in whole or in part in cash or in its bonds issued and bought in by it. It could make the sinking fund payment all in cash, all in bonds, or part in cash and part in bonds. The third paragraph of section 17 allowed petitioner to anticipate a sinking fund payment in its bonds, only, but forbade it to anticipate a sinking fund payment in cash. In December of the taxable year petitioner estimated that net earnings for that year would amount to about $1,600,000, and that 25 percent thereof, or $400,000, would exceed 3 percent of its bonds, or $120,000, and petitioner made a sinking fund payment of $400,000 in cash on December 26, 1936. Net earnings for the taxable year actually amounted to $1,484,895.18 and 25 percent thereof amounted to $371,223.80, which is the amount of the credit in question. In June of 1937 the trustee made a repayment to petitioner of $28,776.20, the difference between $400,000 and $371,223.80.

In support of its contention that section 17 meets the requirements of the statute, petitioner relies especially on the Board’s decision in Strong Manufacturing Co., 41 B. T. A. 1273, which, subsequent to the filing of briefs in this case, has been affirmed by the Circuit Court of Appeals for the Sixth Circuit in Commissioner v. Strong Manufacturing Co., 124 Fed. (2d) 360. See also, Commissioner v. Warren Tool Corporation, 124 Fed. (2d) 397; Commissioner v. Ohio Leather Co., 124 Fed. (2d) 397; and Commissioner v. Michigan Silica Co., 124 Fed. (2d) 397, all of which were decided by the Circuit Court of Appeals for the Sixth Circuit on December 9, 1941, on the authority of its opinion in the Strong Manufacturing Co. case. The contractual provision on which the allowance of the credit was based in that case was in some respects similar to the first paragraph of section 17; the taxpayer was required to make a sinking fund payment of a fixed percentage of the net earnings of each year for a specified period of years, but was not required by the terms of the contractual provision to make such payment until Sy2 months after the end of the respective year. The contractual provision in that case did not contain, inter alia, paragraphs similar to the second and third paragraphs of section 17, here, which allow the making of sinking fund payments in bonds and prohibit the making of an anticipatory sinking fund payment in cash.

The opinion of the Sixth Circuit in the Strong Manufacturing Co. case is apparently in conflict with the opinion of the Fourth Circuit in Antietam Hotel Corporation v. Commissioner, 123 Fed. (2d) 274, and with the opinion of the Eighth Circuit in Helvering v. Moloney Electrical Co., 120 Fed. (2d) 617, on the question as to whether under section 26 (c) (2) the contractual provision must m terms require that a part of the earnings and profits of the taxable year be irrevocably set aside or paid within the taxable year. The Fourth Circuit, in the Antietam Hotel Corporation case, and the Eighth Circuit, in the Moloney Electrical Co. case, held that the contractual provision must in terms so require, while the Sixth Circuit, in the Strong Manufacturing Co. case, came to the contrary conclusion. If the conclusion reached by the Fourth and Eighth Circuits is correct, then the credit is not allowable in this case because section 17 did not in terms require that 25 percent of the earnings of the taxable year be paid or irrevocably set aside within the taxable year.

Even if the conclusion reached by the Sixth Circuit in the Strong Manufacturing Co. case were correct, the credit would not be allowable in this case for several reasons. In the first place, section 17 contained a paragraph not contained in the contractual provision in the Strong Manufacturing Co. case, to the effect that petitioner had the right to make any sinking fund payment in whole or in part in its bonds issued and bought in by it. Because of the presence of a very similar paragraph, a credit under section 26 (c) (2) was disallowed in Fox River Paper Co., 44 B. T. A. 986 (on appeal to the Seventh Circuit). In that case, under a trust mortgage securing its bonds, the taxpayer on March 1 of each year during a specified period was to make a sinking fund payment equal to 25 percent of its net earnings for the preceding fiscal year ending on December 21. In December of 1936 the taxpayer estimated that its net earnings for that year would be about $100,000 and made a sinking fund payment of $25,000. Under the trust mortgage petitioner had th'e right to make any sinking fund payment in its bonds issued and bought in by it. The Board held that, since it had this right, it was not required under the trust mortgage to pay or irrevocably set aside, either during or as of the taxable year 1936', any portion of its 1936 net earnings and profits. It is true that in the Fox River Paper Go. case the taxpayer had in its treasury in December of 1936 bonds issued and bought in by it having a principal amount far in excess of $25,000, and far in excess of 25 percent of its net earnings for 1936, while in this case the record indicates that petitioner had in its treasury in December of 1936 bonds issued and bought in by it having a principal amount of $75,000, or less than $371,223.80, the amount of the credit in question. However, petitioner could have converted other assets into a sufficient amount of bonds to make the sinking fund payment of $371,223.80 and thus could have paid out all of its current earnings free of the restrictions of section 17. In the second place, section 17 contained a paragraph which forbade an anticipatory sinking fund payment in cash. Such a paragraph was not contained in the contractual provisions involved either in the Fox River Paper Co. case or the Strong Manufacturing Co. case. Despite petitioner’s contention to the contrary, the payment made by it in December of 1936 clearly was an anticipatory sinking fund payment in cash. The payment was not called for under section 17 until June 1 of the following year. The trustee labeled the payment as one “in anticipation” both in the letter which it sent acknowledging receipt of the payment and in the entries which it made on its books recording the receipt of the payment. Obviously, the payment of $371,223.80 in cash in December of 1936 not only was not required, but was expressly forbidden, by section 17 to be made in the taxable year. Respondent’s determination is sustained.

Decision will l>e entered for the respondent.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation tile following credits shall be allowed to the extent provided in the various sections imposing tax—
      ft ft £ ft ft ft ft
      (c) CONTRACTS RESTRICTING PAYMENT OP DIVIDENDS.-
      * * * * * t *

      (2) Disposition op profits op taxable year. — An amount equal to the portion of the warnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earning's and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.


author: Disney :

text:
    Claude R. Fooshe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106640.
    Promulgated January 27, 1942.

      John L. Wheeler, Esq., for the petitioner.

      Frank T. Horner, Esq., for the respondent.
   OPINION.

Disney :

It is the petitioner’s position that the services for which the sum of money here involved was received were rendered in California, under the agreement by which he took over the Los Angeles agency, and therefore the money is community income; while the respondent argues that the money was received under a contract having its inception in a noncommunity state, and therefore the money is petitioner’s separate property. There can be no doubt that the decline in petitioner’s income which would ensue from acceptance of the Los Angeles agency was the reason for the waiver by the company of the imposition of its 2 percent collection fee; nor is there doubt that in order to secure the benefit of such waiver the petitioner must continue as a manager in the employ of the company. But does it follow therefrom that the moneys here involved constitute additional compensation for the services performed while the community existed in California? We find the question close and interesting, but after much consideration we come to the conclusion that the petitioner has not shown the income to be earnings of petitioner while a member of a marital community in California. The answer depends largely upon whether what was done in California constituted earning the income, or merely fulfillment of a condition inhering in a contract having its inception in another, noncommunity, state. Obviously, the income had a connection, not only with the original contract of 1919. but with that of 1938, resulting from the correspondence early in that year and prior to the contract of April 25, 1938, all outside the State of California.

The 2% percent to which, before deduction of collection fee by the company, the petitioner was entitled, was based upon services rendered at St. Louis. The company waived the 2 percent collection fee prior to the services in Los Angeles, subject to a condition — rendition of managerial services (in Los Angeles as it transpired). We think that the inception of the earning was the old contract and services outside of California, and that there was, in California, only performance of the condition, and not earning of compensation without base in a non-community state. The waiver of the collection fee was, in our opinion, mere inducement, not an addition to compensation earned in California. If the earnings have their inception in a noncommunity state, there appears to be no requirement that nothing whatever can transpire in the community state without making the income that of the community. In Creamer v. Briscoe, 109 S. W. 911, the first community settled upon land and did everything required for homestead purposes, except to complete the time requirement as to possession. The wife died, the husband remarried and a second community completed the necessary occupancy and secured the patent. The property was held to have been acquired by the first community. The authority seems well settled to the effect that performance in a community state of a condition involved in a contract made in a noncommunity state leaves the property noncommunity. In Sara R. Preston, 35 B. T. A. 312, we quoted McKay on Community Property, § 517, as follows:

* * * when a right, legal or equitable, is acquired whether before or during marriage, all things of value into which the initial right develops by the performance of conditions, the running of time or the like, or into which it is converted by an assignment, or, if the initial right rests in obligation, all that which is obtained through the performance, discharge, satisfaction, enforcement or assignment of the obligation, are deemed in law to have been acquired as of the date of the acquisition of the initial right, and take the character, as separate or common, of that right.

Section 520 of the same work is quoted by us in John M. King, 26 B. T. A. 1158 (affd., 69 Fed. (2d) 639), as follows:

An inchoate title or pecuniary right is property in the sense of the law of separate and common property, just as truly as the most unimpeachable or perfect title. It takes its rank as separate or common property, for the same reason, and in response to the same tests, as the perfect or complete title or right, and it retains its character as separate or common so long as it can be traced; its development from, an inchoate to the absolute or complete form does not shift it from one fund, to another; it may be relieved of conditions and burdens but this does not change its character; it may pass from a conditional to an unconditional form, without change or legal character; it m'ay be exchanged for other things or rights, and its character as separate or common passes to whatever was acquired by the exchange. If the property consists of an obligation, either contractual or delictual, it may be performed or enforced; and whatever is so acquired takes the same character as the obligation. [Italics supplied.]

We think that the petitioner herein had, prior to the inception of the community in California, an inchoate right which was property, albeit subject to condition, and that under the above authority the inception of the income was in the previous contract and services, and not the earnings in California. The rationale of the above quotations seems to have been consistently followed, though the circumstances differ. See William Semar, 27 B. T. A. 994; W. L. Honnold, 36 B. T. A. 1190; Albert J. Houston, 31 B. T. A. 188 (D. C. California), citing a number of cases. In our opinion, this proceeding involves, not additional compensation earned in California, but performance of a condition involved in the contract wherein the amounts involved have their inception. We therefore hold that the Commissioner did not err in including the entire amount in petitioner’s income.

Decision will be entered for the respondent.


author: Mellott :

text:
    J. J. Larkin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102593.
    Promulgated January 27, 1942.

      Hilary D. Mahin, Esq., and L. Karlton Hosteller, Esq., for tlie petitioner.

      W. H. Payne, Esq., for the respondent.
   OPINION.

Mellott :

The instant proceeding, involving a deficiency in income tax for the year 1936 in the amount of $1,536.46, the major portion of which is in controversy, was submitted upon the following stipulation :

1. The Petitioner is an individual residing in Tulsa, Oklahoma. The taxable year involved is the calendar year 1936, for which year Petitioner filed his income tax return with the Collector of Internal Revenue, Oklahoma District. Petitioner is on the cash receipts and disbursements basis, and for 1936 filed his income tax return on such basis. Petitioner was a director of the Exchange National Bank of Tulsa, Oklahoma, from January 11, 1916, until April 23, 1933. On April 24, 1933, Petitioner was elected one of the directors of the National Bank of Tulsa, Oklahoma, which bank succeeded the Exchange National Bank of Tulsa, Oklahoma, and has been a director of the National Bank of Tulsa since that time.
2. At the close of business May 13, 1930, Joseph R. and Frances D. McGraw of Tulsa, Oklahoma, owed the Continental Illinois Bank and Trust Company, hereinafter referred to as the Continental Bank, a sum in excess of $320,000.00 upon a promissory note and had prior thereto pledged and deposited with the Continental Bank in excess of 4,000 shares of stock of the Exchange National Bank of Tulsa, Oklahoma, as collateral security to said promissory note.
At the close of business May 13, 1930, the Exchange National Company, a corporation doing business in Tulsa, Oklahoma, owed the Continental Bank the sum of $1,690,000.00, being the principal sums of the following promissory notes: .
Note dated May 13, 1930, for_$725, 000. 00
Note dated May 13, 1930, for_$500,000. 00
Note dated March 31, 1930, for___$340, 000.00
Note dated April 4, 1930, for_$125, 000. 00
The note dated May 13, 1930, in the principal sum of $725,000.00 included in its principal sum discounted interest at 5%% per annum from the date of the note to its maturity. This discounted interest was $5,000.00. Included in the collateral security pledged to the Continental Bank with respect to all of the foregoing notes was 9,000 shares of stock of the Exchange National Bank of Tulsa, Oklahoma, the certificates for which were physically in the possession of the Exchange Trust Company, a trust receipt executed by the Exchange Trust Company with respect to these shares of stock being in the possession of the Continental Bank. The Exchange Trust Company was a wholly-owned affiliate of the Exchange National Bank of Tulsa, Oklahoma, and maintained its offices in Tulsa, Oklahoma. The Exchange National Company was a wholly-owned affiliate of the Exchange National Bank of Tulsa, Oklahoma, and maintained its offices in Tulsa, Oklahoma.
3. On May 14, 1930, the Petitioner, together with six other directors (H. F. Sinclair, E. W. Sinclair, J. A. Hull, J. H. Evans, J. H. Markham, Jr., and Harry H. Rogers) of the Exchange National Bank of Tulsa, Oklahoma, who are hereinafter referred to as associates, entered into a certain transaction for profit involving the acquisition of 12,000 shares of stock of the Exchange National Bank of Tulsa, Oklahoma, expecting at that time to thereafter resell, within about sixty days, the said block of 12,000 shares of stock. The stock of the Exchange National Bank of Tulsa, Oklahoma, acquired through this transaction consisted of 4,000 shares of said stock owned by Frances D. and Joseph R. McGraw, of Tulsa, Oklahoma, and then pledged and physically on deposit with the Continental Bank, as recited in Item 2 hereof, and 8,000 shares of the stock of the Exchange National Bank of Tulsa, Oklahoma, being a part of the 9,000 shares of said stock physically in possession of the Exchange Trust Company and represented by a trust receipt in the possession of the Continental Bank executed by the Exchange Trust Company and referred to in Item 2 hereof.
Petitioner and his associates agreed with Frances D. and Joseph R. McGraw and the Exchange National Company, the respective owners of the said 4,000 and 8,000 shares of stock, to acquire all their rights, titles, interests, and equities in said blocks of stock. Following this agreement Petitioner and his associates executed on May 14, 1930, a joint note in the principal sum of $1,040,000.00 payable to the Continental Bank. As collateral for this loan the Continental Bank retained 4,000 shares of stock of the Exchange National Bank of Tulsa, Oklahoma, previously owned by Frances D. and Joseph R. McGraw and then in its possession, and received 8,000 shares of stock of the Exchange National Bank of Tulsa, Oklahoma, delivered to it by the Exchange Trust Company, these 8,000 shares being a portion of the stock represented by the trust receipt issued by said Exchange Trust Company. Thereupon the amount of the loan to Petitioner and his associates totaling the principal sum of $1,040,000.00 was applied by the Continental Bank in reduction of indebtedness due it by Frances D. and Joseph R. McGraw by the principal amount of $320,000.00 and the balance of the said principal sum of $1,040,000.00 was applied in cancellation and in satisfaction of the $725,000.00 note of the Exchange National Company dated May 13, 1930, due the Continental Bank, the amount then due on said note being $720,000.00 (principal of note $725,000.00 less $5,000.00 unearned discount).
During the years 1930 and 1931 the stock of the Exchange National Bank of Tulsa, Oklahoma, had a substantial value.
No consideration, other than as herein outlined, passed to the Petitioner, his associates, Frances D. and Joseph R. McGraw, the Exchange National Company, or the Continental Bank.
4. Following the conclusion of the meeting between the Petitioner and his associates on May 14, 1930, at which time the note for $1,040,000.00 was signed, the Petitioner on said date informed E. L. Connelly, his business associate, of the general nature of the transaction and offered Connelly one-half of the interest he had therein and to share equally with Connelly the profits and losses resulting therefrom. This offer of the Petitioner was accepted by Connelly. At the time the Petitioner informed Connelly regarding the general nature of this transaction he did not advise Connelly that he had joined in the execution of a joint note for the principal sum of $1,040,000.00 payable to the Continental Bank. Before the end of the calendar year 1930 the Petitioner did advise Connelly that he had signed, on May 14, 1930, the said joint note for $1,040,-000.00, and then advised him of all details of the entire transaction. Mr. Connelly did not, at any time, sign this note.
5. On September 21, 1931, Petitioner and associates arranged with the Continental Bank that the original joint note for the principal sum of $1,040,000.00 be cancelled and separate notes be executed by them or that payments be made thereon, as their several interests appeared. At that time, that is, September 21, 1931, the Petitioner executed his promissory note for the principal sum of $148,000.00 payable to the Continental Bank, this sum representing Petitioner’s portion of the total liability to the Continental Bank, as between Petitioner and his associates, under the note of the principal sum of $1,040,000.00. Attached hereto and made a part hereof is a true and correct copy of this note for the principal sum of $148,000.00, marked Exhibit “A”. [The note is payable 120 days after date with interest at 5 percent per annum payable monthly, recites that to secure its payment the maker has pledged, transferred and delivered 3,801 shares of Exchange National Bank stock to the bank, and authorized the bank to sell the collateral upon maturity and nonpayment and apply the net proceeds to the payment of the obligation.] Prior to the time the Petitioner executed the note for the principal sum of $148,000.00, he and E. L. Connelly discussed the situation then confronting them and agreed to continue their oral agreement as described in Paragraph 4 hereof. E. L. Connelly did not, at any time, sign this note.
6. On September 21, 1931, Petitioner and his associates executed guaranty agreements whereby all severally guaranteed to the Continental Bank the payment of the various individual notes executed by the several associates on September 21, 1931. Mr. Connelly did not, at any time, execute any of the guaranty agreements but was fully advised of them prior to their execution by the Petitioner. Prior to the hearing of this proceeding no payments have been required of or made by the Petitioner or B. L. Connelly with respect to said guaranty agreements.
'7. On September 21, 1931, 1,659 shares of the 12,000 shares of stock of the Exchange National. Bank of Tulsa, Oklahoma, previously pledged as collateral to the $1,040,000.00 joint note were issued in the name of the Petitioner and were retained by the Continental Bank as collateral to Petitioner’s $148,000.00 note and his obligation under the guaranty agreements. These 1,659 shares represented the portion of the 12,000 shares to .which Petitioner was entitled under the agreement with his associates. On the same date Petitioner deposited with the Continental Bank 2,142 shares of stock of Exchange National Bank, individually owned by Petitioner, as additional collateral to the note and the guaranty agreements, making a total of 3,801 shares.
8. Petitioner renewed his $148,000.00 note from time to time as follows: January 19, 1932; May 19, 1932; August 17, 1932; September 16, 1932; October 17, 1932; January 16, 1933. The last renewal was for a period of 90 days and was in the sum of $148,000.00.
9. On April 24, 1934, the 3,801 shares deposited by Petitioner as collateral security for the $148,000.00 note and guaranty agreements, were sold by the Continental Bank for $1.67 and the proceeds thereof credited to Petitioner’s note.
10. During the calendar year 1936, Petitioner paid $10,998.33 upon the principal amount of the obligation evidenced by the $148,000.00 note. During the year 1936 Petitioner was reimbursed by Mr. Connelly for one-half of such payment, or the sum of $5,500.00. This payment of $10,998.33 and the credit in 1934 of $1.67 reduced the principal balance of the said note to $137,000.00.
11. All of the acts performed and agreements made by Petitioner after the end of 1930, in connection with the transaction entered into for the acquisition of the shares of stock of the Exchange National Bank, were with the knowledge of E. L. Connelly and with the understanding between them that Petitioner was acting for both, pursuant to their oral agreement to share equally in the transaction and in the profits and losses resulting therefrom, and also in conformity with their understanding that Connelly would reimburse Petitioner for one-half of any loss or losses which Petitioner might incur with respect thereto.
12. The stock of the Exchange National Bank of Tulsa, Oklahoma, became worthless prior to January 1, 1935. Petitioner did not claim any loss or deduction in 1983 because of the worthlessness of the Exchange National Bank stock or in 1934 because of the sale of this stock by the Continental Bank.
13. In his amended income tax return for the year 1936, Petitioner claimed as a bad debt deduction the said sum of $5,500.00, referred to in paragraph 10 hereof, and Respondent disallowed the deduction so claimed on the ground that the evidence indicated that the stock of the Exchange National Bank of Tulsa, Oklahoma, became worthless in the year 1933.

The sole issue is whether petitioner sustained a deductible loss in the year 1936 in the amount of $5,499.17 when that amount was paid to the Continental Illinois National Bank, or whether .he sustained a capital loss in an earlier year. While the deduction was claimed by petitioner in his return as a “bad debt” under section 23 (k) of the Revenue Act of 1936, it is obvious that the “debt” was one owed by, rather than to, petitioner. Manifestly he would have no right to deduct such a debt from his gross income.

The facts have been set out in full largely because the parties, upon brief, draw conflicting conclusions from them. Respondent contends that petitioner paid the amount “on a loan obtained from a bank in 1930, the proceeds of which were used and applied in the purchase from certain stockholders of shares of corporate stock, which shares were lost through sale by the pledgee bank and which also became. worthless prior to the taxable year.” He therefore seeks to apply the rule enunciated by this Board in A. W. D. Weis, 13 B. T. A. 1284. Petitioner contends that he purchased the property on credit; that, although the transaction took the form of a purchase of stock from the former owners, its real substance was an assumption by him and his associates of the indebtedness of the former owners without any change in the underlying collateral security; that “the Continental Bank and not petitioner was the party that had the real investment in the stock of the Exchange Bank and that incurred the risk of loss from the transaction”; and that under the rule of Eckert v. Burnet, 283 U. S. 140, he was not entitled to any deduction for a loss prior to actual payment of his indebtedness in the taxable year.

Respondent’s interpretation of the stipulated facts is correct. Petitioner and his associates “agreed with * * * the respective owners * * * to acquire all their rights, titles, interests, and equities” in the stock. They executed a joint note payable to the Continental Bank and “thereupon the amount of the loan * * * was applied by the Continental Bank in reduction of indebtedness due it” by the McGraws and “in cancellation and in satisfaction of” the note of the Exchange National Bank. As collateral for the loan made to petitioner and his associates the Continental Bank retained the McGraw shares and received the shares of the Exchange National Bank. The substance of the transaction, as well as its form, was a loan by the bank to petitioner and his associates, the use of the proceeds in the purchase of stock, and the pledging of the stock as collateral to the loan. It is idle to contend that the bank “was the party that had the real investment in the stock.” .True, it had loaned a substantial sum and there was a possibility it might sustain a large loss; but it had no “investment” in the stock either before or after its transaction with petitioner and his associates, at least prior to the sale of the collateral in 1934. This conclusion is inescapable, especially when consideration is given to the events occurring on and after September 21, 1931, on which date 1,659 shares of the stock being acquired from the McGraws and the Exchange were issued in petitioner’s name and accepted by the bank, together with 2,142 similar shares “individually owned” by him, as collateral security for his note and on which date his associates “severally guaranteed” his obligation.

In addition to Eckert v. Burnet, supra, petitioner relies upon the following cases: Page v. Rhode Island Hospital Trust Co., 88 Fed. (2d) 192; Jenkins v. Bitgood, 101 Fed. (2d) 17; Tams v. United States, 33 Fed. Supp. 764; Max Gross, 36 B. T. A. 759; and an unpublished memorandum opinion of this Board. He also contends that recent decisions of the courts, especially Helvering v. Price, 309 U. S. 409, indicate “that the third party borrowing cases [A. W. D. Weis, supra, and other cases cited by respondent] are no longer entitled to the weight once accorded them.”

In Page v. Rhode Island Hospital Trust Co., supra, a taxpayer, later deceased, had purchased and sold through a broker substantial amounts of stock, the account being grossly undermargined. Notes had been given to the broker for the indebtedness and some stocks yet remained in the account when the taxpayer died. After his death the remaining stocks were sold, the proceeds were applied upon the notes, and the executor of the decedent’s estate paid the balance due. The court held that the giving of the notes in the earlier year had not constituted payment of the losses, quoted from Burnet v. Huff, 288 U. S. 156, to the effect that “the mere existence of liability is not enough to establish a deductible loss”, and applied the rule of Eckert v. Burnet, supra, allowing the deduction in the year paid. It distinguished cases applying the rule that “sales of stock are ordinarily sufficient to identify losses as occurring in a certain year”, pointing out that in the case of a grossly undermargined account the loss merely represents a debt due a broker from the customer and until there is a reimbursement to him there is no certainty the customer will ever pay or actually suffer a loss within the purview of the revenue act.

Both parties cite Jenkins v. Bitgood, supra, respondent pointing out that it inferentially approves the same rule as that applied by the Board in the Weis case and petitioner relying upon the fact that it applies the rationale of Eckert v. Burnet, supra. The issue involved the deduction of a loss claimed by a taxpayer who, in 1931, gave his note for $25,000 to a bank in which he owned stock, the amount being the cost to the bank of bonds then worth but $5,550. The court held that the substance of the transaction was a purchase of bonds at a price of $5,550, and a contribution of $19,450 to the capital of the bank; but since payment of the note was not made until a later year it denied the deduction of the loss which had been claimed in the year 1931. The court recognized the soundness of the principle of the Weis case, supra, citing also Jarvis v. Heiner, 39 Fed. (2d) 361; Crain v. Commissioner, 75 Fed. (2d) 962; and Humphrey v. Commissioner, 91 Fed. (2d) 155; but, adverting to the fact that the parties had not even gone through the form of a loan by the bank and a payment by the taxpayer, pointed out that “the giving of an unsecured note cannot be deemed an ‘expenditure’ that increased the taxpayer’s investment, when the taxpayer is on the cash basis”, and said: “It was rather the substitution of the taxpayer’s note for the obligation already existing under the director’s agreement, and falls within the principle of the Eckert case supra.” The court also held that the fact the note was secured by collateral did not justify treating it as equivalent to a cash payment — a view subsequently expressed by the Supreme Court in Helvering v. Price, supra. Cf. Quinn v. Commissioner, 111 Fed. (2d) 372.

In Tams v. United States, supra, the taxpayer had given his oral promise to repurchase from a group of stockholders their stock in a coal company, agreeing to pay par ($100) at the rate of $5 per year, the stockholders also to have the right to repurchase the stock at any time within five years. The stock became worthless shortly after the taxpayer had undertaken the purchase. The court sustained his contention that the amounts paid by him under this agreement were deductible in the years paid, saying:

The instant ease is governed by Eckert v. Burnet, supra, Jenkins v. Bitgood, 101 F. (2d) 17 (39-1 USTC ¶9253), and the recent case of Helvering v. Price, (Mar. 25, 1940), 309 U. S. 409, which reaffirms both. See also Page v. Rhode Island Hospital Trust Company, 88 Fed. (2d) 192 (37-1 USTC ¶9138). The principle which these cases enunciate, is that a taxpayer on the cash basis who purchases property which later becomes worthless, payment for which is to be made in the future, can only deduct his loss when his debt is liquidated by cash or its equivalent, irrespective of when the property becomes worthless, this being true even though in an earlier year he gives his secured note to cover his indebtedness; or, in other words, the year when the deduction is allowable to a taxpayer on the cash basis is not necessarily the year in which the stock becomes worthless, nor the year when he recognizes the debt and gives his note or even his secured note, but it is the year, after, or within which, the property becomes worthless and within which he liquidates the debt by the payment of cash or its equivalent. The time of liquidation by cash or its equivalent is the criterion.

In Max Gross, supra, an associate of the taxpayer purchased bank stock, the taxpayer agreeing to share the losses. His portion of the loss was determined to be $11,925 and notes aggregating that amount were delivered to his associate. This Board held that, since the taxpayer was on a cash basis and did not part with any money or property during the taxable year, the claimed loss could not be allowed.

It will be noted that in none of the cited cases were the facts similar to those now before us. In Page v. Rhode Island Hospital Trust Co. there are more points of similarity than in any of the others; yet it is clearly distinguishable. The loss, as the court pointed out, “in the case of [a] ‘grossly under-margined’ account, merely represents a debt due a broker from the customer.” In other words the borrowing and the purchase were integral parts of the same transaction. If the Continental Bank had purchased the stock for petitioner and his associates and held it as security the facts would be more nearly analogous. But petitioner and his associates were acquiring the stock, not through dealing with the bank, but through dealing with “the respective owners” of it. The other cases are likewise distinguishable in that in all of them the transactions giving rise to the loss had involved only the payee and the maker of the note and in none of them had there been a borrowing from a third party.

A. W. D. Weis, supra, was one of the first cases decided by this Board involving the right of a taxpayer to deduct a loss paid with borrowed money. It was pointed out that there had been two separate and distinct transactions — a purchase of securities with an ultimate resultant loss through sale or worthlessness, and a borrowing of funds with a corresponding obligation to make repayment. The fact that the taxpayer repaid the loan in an earlier or a later year was deemed to be immaterial; for losses may be deducted only when “sustained during the taxable year” (sec. 23 (e), Revenue Act of 1936).

We are not convinced that the Weis case is unsound in principle or that it was overruled, as to a taxpayer upon the cash basis, by Eckert v. Burnet, supra, notwithstanding the statement to that effect — probably obiter dictum — in Burns Manufacturing Co. v. Commissioner, 59 Fed. (2d) 504; cf. Frank Kuhn, 34 B. T. A. 274, and Max Gross, supra. The Eckert case dealt with a taxpayer who, being secondarily liable upon an obligation, executed a note and thereby became primarily liable. It was held that he sustained no deductible loss until the note was paid. Petitioner; however, used his own credit and the stock which he was purchasing, borrowed the money from the bank, discharged his obligation to make payment to his vendors by securing satisfaction and cancellation of their indebtedness, and thereby became the owner of the stock. His loss upon this transaction occurred either when the stock became worthless or when it was sold in partial satisfaction of his indebtedness. He could not defer the taking of a deduction until such time as he chose to make payment of his obligation; for, as pointed out in the Weis case, “It is hardly reasonable to impute to Congress an intent to permit taxpayers to elect, for their own benefit, the years in which business losses should be deducted from income.”

The decided cases, as the Circuit Court of Appeals for the Second Circuit pointed out in Jenkins v. Bitgood, supra, hold that where there are two transactions — a borrowing of funds and a purchase of stock — a taxpayer is permitted to deduct the loss in the year when the stock becomes worthless or the transaction is closed by sale, even though the borrowed money has not then been repaid. Compare Jarvis v. Heiner, Crain v. Commissioner, and Humphrey v. Commissioner, supra, all cited by the court. See also T. Harvey Ferris, 38 B. T. A. 312; affirmed per curiam, 102 Fed. (2d) 985. All of these cases, except Jarvis v. Heiner, were decided since Eckert v. Burnet. It is also significant that the Ninth Circuit in Humphrey v. Commissioner, ignored its obiter dictum in the Burns case and stated:

Where a taxpayer is on the cash basis, the fact that he borrowed money with which to pay a loss does not postpone the right to deduct the loss until the payment of the loan, Crain v. Com’r. (C. C. A.) 75 Fed. (2d) 962, 963.

Helvering v. Price, supra, did not involve the question now before us. The taxpayer claimed he had satisfied his liability as a guarantor by giving his note, secured by collateral. The Court merely applied the doctrine of the Eckert case and held “the giving of the taxpayer’s own note was not the equivalent of cash to entitle the taxpayer to the deduction.”

The unpublished memorandum opinion of this Board, which petitioner contends is quite similar to the instant proceeding, has been examined but is distinguishable upon its facts. Three individuals were liable as guarantors in an amount aggregating $14,000. One of the guarantors paid his share of the obligation and also the share which should have been paid by the taxpayer and accepted the taxpayer’s note for that amount. The taxpayer being on the cash basis and having made no outlay of cash or its equivalent in the taxable year, it was held on the authority of Helvering v. Price, supra, that he had not sustained a deductible loss.

In Estate of Thomas Spruance, 43 B. T. A. 221 (on appeal, C. C. A., 5th Cir.), one of the minor issues involved the deduction of a claimed loss on 46 shares of bank stock. The decedent had agreed to purchase these shares for $4,600. Thirty of them had been endorsed by the seller and delivered to the purchaser, the remainder being pledged to secure an indebtedness of the seller. Decedent agreed to take up the indebtedness for which the 16 shares were pledged, receiving a credit on the price in this amount, but this was never done. None of the agreed consideration was ever paid except an amount of approximately $800 credited on the purchase price through a trade of automobiles. We held that no loss was allowable for the $3,800 due on the purchase price since.that amount had not been paid, citing Helvering v. Price, supra. That holding is not at variance with the Weis case nor with the conclusion reached in the instant proceeding. The situation would have been different as to the 16 shares if the taxpayer in that case had secured the cancellation and satisfaction of the obligation of his vendor, as petitioner and his associates did under the facts presently before us, even though this had been accomplished by the delivery of his note to the money lender.

Other cases cited by petitioner are not particularly relevant or helpful. E. R. Hawke, 35 B. T. A. 784 (reversed upon another issue, 109 Fed. (2d) 946; certiorari denied, 311 U. S. 657), and Miniger v. Denman (U. S. Dist. Ct., N. Dist. Ohio, July 2, 1930), both involved claimed losses upon stock, tlie purchase price of which had not been paid, though notes had been given. Jacob F. Schoellkopf, Jr., 35 B. T. A. 855; affd., 100 Fed. (2d) 415, held, following the Eckert case, that a taxpayer who had assumed an indebtedness of a corporation then in liquidation had sustained no loss until the note which he executed was paid.

We are of the opinion and hold that the Commissioner correctly disallowed the claimed deduction.

Reviewed by the Board.

Decision will be entered for the respondent-


author: Mellott:

text:
    E. L. Connelly, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102592.
    Promulgated January 27, 1942.

      Hilary D. Mahin, Esq., and L. Karlton Mosteller, Esq., for the petitioner.

      W. H. Payne, Esq., for the respondent.
   OPINION.

Mellott:

This proceeding is a companion case to J. J. Larkin, Docket No. 102593, decided this date. (J. J. Larkin, 46 B. T. A. 213.) It involves a deficiency in income tax in the amount of $1,630.89 for the calendar year 1936, the major portion of which is in controversy. It was submitted upon a separate stipulation of facts and we find the facts to be as stipulated. They are all contained in the stipulation set out at length in the Larkin case and need not be repeated here.

The question is: Did petitioner sustain a deductible loss in the amount of $5,499.17 in 1936 when this amount was paid by him to Larkin, or did he, as a joint adventurer with Larkin, sustain a capital loss in an earlier year? The deduction of this amount was claimed by him in his amended return as a “bad debt” under section 23 (k) of the Revenue Act of 1936; but it is obvious that the “debt” was one owed by, rather than to petitioner, so the deduction could not be allowed under that section. Both parties, however, discuss upon brief the question as stated by us, so we will do likewise.

Briefly summarizing the facts, Larkin and some associates — not including petitioner — in 1930, executed a joint note to a bank for the purpose of acquiring certain stock from the owners of it. The stock was then pledged with the same bank as security for the indebtedness of the owners. “Thereupon the amount of the loan * * * was applied by the * * * Bank in reduction of the indebtedness due it [by one group of owners] and in cancellation and in satisfaction of the” note of the other owners, the stock being retained as collateral to the note of Larkin and his associates. Subsequently the original note of Larkin and his co-signers was canceled and separate notes were executed by each, secured by an aliquot part of the stock then held by the bank, each of the parties also severally guaranteeing the notes of the others, and, in Larkin’s case, he also putting up additional collateral.

In 1934 the collateral to Larkin’s note was sold for a nominal amount and it had become worthless prior to 1935. In 1936 Larkin paid upon his obligation the sum of $10,998.33 and petitioner paid Larkin one-half of this amount, or $5,499.17, the amount presently in issue.

Petitioner’s payment to Larkin was made pursuant to an agreement which he made with Larkin after the original note was signed by him and the other co-signers. Petitioner never signed any of the notes. After the original note was signed and on the same date Larkin “informed petitioner, his business associate, of the general nature of the transaction and offered petitioner one-half of the interest he had therein and to share equally with petitioner the profits and losses resulting therefrom. This offer of J. J. Larkin was accepted by petitioner.” Subsequently Larkin advised petitioner of all the details of the entire transaction and:

All of the acts performed and agreements made by J. J. Larkin after the end of 1930, in connection with the transaction entered into for the acquisition of the shares of stock of the Exchange National Bank, were with the knowledge of Petitioner and with the understanding between them that J. J. Larkin was acting for both, pursuant to their oral agreement to share equally in the transaction and in the profits and losses resulting therefrom, and also in conformity with their understanding that Petitioner would reimburse J. J. Larkin for one-half of any loss or losses which J. J. Larkin might incur with respect thereto.

Respondent insists that the arrangement between petitioner and Larkin constituted a..joint venture; that the borrowing of the money and the investment in the stock were equally for the benefit of both; that if Larkin and petitioner were not joint adventurers, Larkin was petitioner’s agent; that the acts performed and the agreements made by Larkin were with the knowledge of petitioner and with the understanding between them that Larkin was acting for both, pursuant to their oral agreement to share equally in the profits and losses; and that the loss, which petitioner and Larkin sustained, occurred in 1934 when the stock was sold by the bank or at least in some year prior to 1936.

Petitioner contends that he entered into a contract with Larkin to acquire, upon credit, an interest in the stock; that he was not a joint adventurer with Larkin in the purchase of the stock because his agreement was made after Larkin and his associates had obligated themselves to acquire the stock and after they had borrowed the money to do so; that respondent has drawn erroneous and unjustified inferences from the stipulated facts, particularly in assuming that the agreement between Larkin and petitioner was made at or before the time the money was borrowed from the bank to acquire the stocks; and that the facts are analogous to those before the Board in Max Gross, 36 B. T. A. 759.

We agree with petitioner. The stipulated facts are quite similar to those of the Gross case and the same conclusion should be reached here. Petitioner and Larkin were not joint adventurers. They did not invest their funds or contribute their money or property in carrying out a single venture for their common benefit. Cf. Chase S. Osborn, 22 B. T. A. 935, 945; Motter v. Smyth, 77 Fed. (2d) 77. Larkin invested his funds, albeit they had been borrowed, acquired the stock, and thereafter offered petitioner one-half of the interest he had therein and to share equally with petitioner the profits and losses resulting therefrom. This offer was accepted by petitioner. Nor does the fact that the “acts performed and the agreements made” by Larkin subsequently “were with the knowledge of petitioner and with the understanding” that he “was acting for both” have the effect of making them joint adventurers. Inferentially respondent admits that this is true; for he asks us to conclude from the stipulated facts, that the money was obtained by Larkin and applied in the purchase of the stock after the agreement to share the profits and losses was made. He relies upon the fact that the agreement between petitioner and Larkin was made on the very day that the note for the purchase money was executed. We can not spell out of the stipulated facts an acquisition of the stock by Larkin and petitioner after the money was obtained nór can we conclude that the stock was acquired with funds belonging to or furnished by Larkin and petitioner as joint adventurers. The stock was acquired by Larkin and thereafter petitioner agreed to reimburse him “for one-half of any loss or losses which [he, Larkin] might incur with respect thereof.”

Respondent’s argument to the effect that petitioner “is in the same situation as Larkin” has been considered but is believed to be untenable. Larkin, as is being held in the opinion contemporaneously promulgated, borrowed money, purchased stock, and sustained a loss either when the stock became worthless or when it was sold by the lender under the note. Petitioner, however, had no investment in the stock, but was merely under an obligation to reimburse Larkin for one-half of the loss which he should sustain. Under the rule of Eckert v. Burnet, 283 U. S. 140; Jenkins v. Bitgood, 101 Fed. (2d) 17; Helvering v. Price, 309 U. S. 409, Quinn v. Commissioner, 111 Fed. (2d) 372; and Max Gross, supra, his loss, he being on the cash basis, occurred when he performed his obligation and made payment.

The Commissioner erred in disallowing the _ claimed deduction. Other adjustments made by him are not contested.

Reviewed by the Board.

Decision will he entered under Bule 50.

Arundell dissents.


author: Sterniiagen:

text:
    Estate of T. Handasyd Cabot, William Ferguson, and T. H. Cabot, Jr., Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105295.
    Promulgated January 27, 1942.

      Jay B. Angevine, Esq., for the petitioner.

      Davis Haskin, Esq., for the respondent.
   OPINION.

Sterniiagen:

The Commissioner disallowed the deduction of $25,269.06 because it was not “a claim against the estate incurred or contracted bona fide for an adequate and full consideration in money or money’s worth, within the meaning of section 303 (a) (1) of the Revenue Act of 1926 as amended.” The disallowance is sustained. This amount was not the subject of a claim against the estate, notwithstanding the payment by the estate. The excess debit was in the wife’s account, and was the result of her overdraft. She had independent means and was primarily liable on the account. She was not insolvent. The claim was primarily against her, and the decedent was only a “guarantor” in accordance with the terms of the 1932 letter. By that letter, he “guaranteed” the firm against loss and waived demand upon him and notice of default, giving the firm the right to take from his account to save it from loss in hers. There is no foundation for regarding this as a direct or simple obligation of his irrespective of whether the deficit represented a loss. The arrangement was that she should bear some of the expenses, and he “guaranteed” the firm against loss; not that he was to be the obligor in the first instance of any current deficit. So far as this record shows, he, during life, and his estate, after death, could rightfully resist the firm’s demand for payment of a shortage in the account until by insolvency of the wife or otherwise the firm had a loss. Nonresistance and voluntary payment are not the recognition of a legal claim, and do not per se prove the existence of a claim. United States v. Mitchell, 74 Fed. (2d) 571; Commissioner v. Porter, 92 Fed. (2d) 426; Carney v. Benz, 90 Fed. (2d) 747; Estate of Charles H. Lay, 40 B. T. A. 522.

Since there was no claim against the estate, it is unnecessary to determine whether the consideration was adequate and full in money or money’s worth. It is also unnecessary to determine whether the estate was subrogated to the firm’s right against the wife. Cf. Bartholomew v. Stobbs, 280 Mass. 559; 182 N. E. 846; MacAleese’s Case, 308 Mass. 513; 33 N. E. (2d) 280. Even though’ there were no such right of subrogation after the payment in question, this would not support the deduction.

Other items are abandoned or settled.

Decision toill be entered under Bule SO.


author: SteRnhagen :

text:
    Apartment Operators Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106666.
    Promulgated January 29, 1942.

      Edward E. Merges, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

SteRnhagen :

The petitioner claims exemption under Revenue Act of 1938, section 101 (7), as a business league not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual. . The claim, we think, was properly denied by the Commissioner. The petitioner’s purchase of supplies at a discount and its resale to the members at less than they would otherwise pay is a business operation and its advantage is the sort of profit inuring to the benefit of the members which is preclusive of the statutory exemption. The fact that the corporation was organized under the state laws relating to nonprofit corporations and the officers had no intention to conduct its operations at a profit is less important than its actual operations. Under article XY of the bylaws supplies1 may be sold to members at a price which includes a service charge or handling fee, the profits from which may be set aside in a surplus fund; and by article XVI the surplus fund may be distributed among the members. Petitioner wag a cooperative buying organization, withholding a margin, however small. Such cooperatives are not among the exempt organizations of the statute, as are farmers’ cooperatives, which buy supplies and turn them over to members at actual cost plus necessary expenses. Sec. 101 (12).

The determination is sustained. Uniform Printing & Supply Co. v. Commissioner, 33 Fed. (2d) 445; Northwestern Jobbers' Credit Bureau v. Commissioner, 37 Fed. (2d) 880; Produce Exchange Stock Clearing Association, Inc. v. Helvering, 71 Fed. (2d) 142; Retailers Credit Association of Alameda County v. Commissioner, 90 Fed. (2d) 47; Northwestern Municipal Association, Inc. v. United States, 99 Fed. (2d) 460; Park West-Riverside Associates, Inc. v. Helvering, 110 Fed. (2d) 1022; Durham Merchant's Association v. United States, 34 Fed. Supp. 71.

Decision will be entered for the respondent.