author: Van Fossan:

text:
    County Fire Insurance Company of Philadelphia, Petitioner, v. Commissioner of Internal Revenue, Respondent. Great American Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. American Alliance Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Union Insurance Society of Canton, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 100636, 100637, 100638, 100740.
    Promulgated October 24, 1941.

      Pressly R. Baldridge, Esq., and William P. Nottingham, Esq., for the petitioners.

      B. M. Brodsky, Esq., for the respondent.
   OPINION.

Van Fossan:

The question for decision is whether petitioners are entitled to deduct from gross income for 1935 the amounts paid into court during that year after final settlement of the rate litigation, or whether the petitioners should have accrued the liability and taken the deduction at some time prior thereto.

Petitioners contend that the excess amounts collected from the unlocated policyholders which were paid into court during 1935 were deductible in that year either as return premiums under section 204 (b) (5) of the Eevenue Act of 1934, or as losses incurred under section 204 (b) (6). It is the further contention of petitioners that if the amounts be considered as return premiums they are deductible only when paid, and if they be considered as losses they did not accrue prior to 1935, since the liability was in dispute and was not finally determined until that year.

The method of accounting to be followed by an insurance company, other than life or mutual, in determining its gross income is precisely set out in section 204 of the Eevenue Act of 1934, the applicable portions of which are as follows:

(b) Definition or Income, Etc. — In the case of an Insurance company subject to tbe tax imposed by this section—
(1) Gross income. — “Gross income” means the sum of (A) the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners * * *;
(2) Net income. — “Net income” means the gross income as defined in paragraph (1) of this subsection less the deductions allowed by subsection (c) of this section;
(3) Investment income. — “Investment income” means the gross amount of income earned during the taxable year from interest, dividends, and rents, computed as follows:
To all interest, dividends and rents received during the taxable year, add interest, dividends and rents due and accrued at the end of the taxable year, and deduct all interest, dividends and rents due and accrued at the end of the preceding taxable year;
(4) Underwriting income, — “Underwriting income” means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred;
(5) Premiums earned. — “Premiums earned on insurance contracts during the taxable year” means an amount computed as follows:
From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year;
(6) Losses incurred. — “Losses incurred” means losses incurred during the taxable year on insurance contracts, computed as follows:
To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year, and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year. To the result so obtained add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year;
****** jp

Deductions being a matter of legislative grace, the problem which confronts this Board is one of determining where the deductions claimed by petitioners fit into the accounting system prescribed by the statute.

Subsection (6) above furnishes a complete answer to the alternative contention that the items in question are deductible as “losses.” It is obvious that the “losses” covered thereby are insurance losses as commonly conceived, computed as indicated. The provision is not a “catch-all” covering corporate losses in the sense that the word “loss” is used in section 23 and elsewhere in the revenue act. It would require a distortion of meaning to comprehend the deductions claimed by petitioners in the category of losses.

Thus it is that if petitioners are to prevail they must establish that the payments into the court are to be catalogued as “return premiums.” No other provision of the statute that might be applied is suggested.

In Monarch Life Insurance Co., 38 B. T. A. 801, we had occasion to consider the meaning of the term “return premiums” as used in section 204 of the 1932 Act. We there held that the term did not include dividends declared by the petitioner, an insurance company, other than life or mutual, on participating life insurance policies, and paid or credited for the benefit of policyholders under the various options granted in the policies. Although the problems are by no means identical, we believe certain observations made in the Monarch, case are helpful here. We there noted that the term “return premiums” appears in the section defining and designed to arrive at “premiums earned.” After observing that the item is permitted as a deduction from gross premiums received, we stated, “it may therefore be assumed to be limited to premiums considered ‘unearned’.”

The payments into the court were amounts due to unlocated policyholders as a result of the reduction of 10 percent in rates. The amounts had been collected as premiums. The order fixed the amount that could be charged for insurance and, therefore, the amount that could legally be earned. The excess collected was, therefore, unearned.

It is stipulated that these amounts had been included in income of the petitioners. It follows that the subsequent change in character from earned income to unearned income should be reflected in the petitioners’ tax accounting.

Respondent does not contend that petitioners are not entitled to a deduction in principle, but maintains they should have accrued the item and taken deduction in some year prior to 1935. Although the rate reduction order became final in 1930 and petitioner proceeded to comply therewith by making refunds to all policyholders on demand, it is stipulated that petitioners did not know at that time whether demand would ever be made for the excess premiums by the unlocated policyholders. The same condition apparently obtained until 1935. There was no certainty the companies would ever have to pay the amounts in question. Except for the order requiring payment of such amounts into court, petitioners would never have been in position to claim the present deductions. The validity and enforcement of any such order was in litigation until the final order of the court, December 7,1935. At that date the liability of the companies to pay into court became fixed. Likewise became fixed the amounts due to unlocated policyholders. Our question arises not primarily from the rate reduction order, but from the order requiring payment into court of the amounts due the unlocated policyholders. It was when this order became final and payment into court occurred that the petitioners were in position to accrue the amounts due and claim the deductions here in question. Lucas v. American Code Co., 280 U. S. 445. Since the amounts were paid in the same year the liability became fixed, it is unnecessary to discuss the question of whether “return premiums” may be deducted in any year other than that in which paid.

In our opinion respondent erred in disallowing the deductions claimed.

Reviewed by the Board.

Decisions will be entered for petitioners in Docket Nos. 100636, 100637, 100633. Decision will be entered wider Rule 50 in Docket No. 100740.

Kern concurs only in the result.


source: Caselaw Access Project

license: Public Domain

text:
    Sandura Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104015.
    Promulgated October 28, 1941.

      Fred L. Iiosenbloom, Esq., for the petitioner.

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

Van Fossan:

The sole question before the Board is whether petitioner is entitled in each of the years 1936 and 1937 to a credit under section 26 (c) (2) of the Kevenue Act of 1936.

The several conditions of the statute must be concurrently met. The amount must be paid within the taxable year in discharge of a debt as required by a contract antedating May 1, 1936, expressly dealing with the disposition of current earnings and profits) or it must be irrevocably set aside within the taxable year for the discharge of a debt pursuant to a contract of similar tenor. In our opinion the facts before us fail to bring petitioner within either of the above situations.

On bi-ief petitioner concedes that the provisions of the promissory notes do not meet the statutory requirement that there be a “provision [which] expressly deals with the disposition of earnings and profits of the taxable year.” It contends that that lack is satisfied by the exchange of letters between the parties. Inasmuch as the exchange of letters took place after May 1, 1936, the letters can not themselves constitute a contract for purposes of section 26 (c) (2). They could only be used as parol evidence to show that the parties intended the notes to be paid out of earnings for the current year. But the introduction of parol evidence to show the intent of the parties that the payments should be out of current earnings does not meet the statutory requirement that the contract expressly deal with the disposition of earnings and profits for the taxable year. Helvering v. Moloney Electric Co., 120 Fed. (2d) 617. The contract here in question thus fails to meet the statutory test. The finding of such a contract is a requisite to either of the two situations entitling a taxpayer to credit.

Petitioner also argues that the introduction of parol evidence is proper in this case because the contract is ambiguous. The ambiguity is said to arise from the sentence in the notes which reads as follows:

* * * The Corporation agrees that, so long as any notes of this issue are outstanding, it will in each year set aside an amount equivalent to 50% of the net earnings of the Corporation for that year after deduction of current maturities of these notes and the dividends for that year on outstanding Preferred Stock, and that it will apply such amount, in multiples of $5,000. plus interest, to the payment by way of anticipation of later maturities of these notes and interest thereon, any portion of such amount not so applied to be held and added to such sum as may become available in the succeeding years for such payments by way of anticipation.

No claim for credit is made upon the basis of the sentence quoted above. It is stipulated that no amounts were irrevocably set aside during 1936 or 1937 by way of anticipation of later maturities which is what the quoted sentence deals with. That sentence is not concerned with the payment, or setting aside funds for the payment, of current maturities, which is the basis of petitioner’s claim for credit in the case at bar.

Petitioner contends, however, that the fact that it is specified that payments by way of anticipation of later maturities are to be out of current earnings while it is not specified from what source payments of current maturities are to be made, constitutes an ambiguity which may be resolved by showing the intent of the parties. We do not agree that the difference in treatment makes the note ambiguous so as to require explanation. The claim of ambiguity must fail.

It is claimed also that the payment of $40,000 on January 29, 1937, entitles petitioner to the credit in question for 1936, it being contended the amount was irrevocably set aside in that year. We have found that the contract in question does not meet the statute. There is, moreover, no stipulation of fact nor evidence that the $40,000 was irrevocably set aside in 1936 for the payment of notes maturing in 1937. We do not know the source 'of the payments.

The same observations apply as to the payment of $40,000 in 1938. There is no statutory contract nor is it stipulated that there was an irrevocable setting aside in the taxable year 1937. We know only that the sum of $40,000 was paid in 1938. We do not know its source or antecedent history. The statute is not satisfied.

Reviewed by the Board.

Decision will be entered for the respondent.

Leech concurs only in the result.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      * $ # * $
      (c) Contracts Restricting Payment of Dividends.—
      * * 1 * * *
      (2) Disposition op profits op .taxable year. — An amount equal to .the portion of the earnings 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 earnings 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: Mellott :

text:
    Ira H. Lohman and Ida May Lohman, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98604.
    Promulgated October 28, 1941.

      John F. Rhodes, Esq., for the petitioners.

      R. P. Rertzog, Esq., for the respondent.
   OPINION.

Mellott :

The parties agree that petitioner was not an officer of the State of Missouri, and that the insurance department of the state is an instrumentality thereof, engaged in the exercise of an essential governmental function. Petitioner contends that the amount which he received was compensation for personal services rendered as an employee of the state and therefore exempt from Federal income tax.

In Graves v. New York ex rel O'Keefe (1939), 306 U. S. 466, the Supreme Court held that salaries of employees or officials of Federal instrumentalities are not immune under the Federal Constitution •from taxation by the states. The principle enunciated in the Graves case, supra, and State Tax Commission v. Van Cott (1939), 306 U. S. 511, that a state may impose an income tax on Federal employees is applicable to taxation by the Federal Government upon the income of state employees. See Helvering v. Gerhardt, 304 U. S. 405; J. E. Huckabay, 40 B. T. A. 9; John T. Rowland, 40 B. T. A. 11; affd., 115 Fed. (2d) 504.

In order to relieve state officers and employees from any hardship which might result from the retroactive application of a Federal income tax on their salaries, which, prior to the Graves decision, had been considered to be immune from such tax, Congress enacted the “Public Salary Tax Act of 1939.” This act provides for the abatement, credit, or refund of income tax upon “compensation for personal service as an officer or employee of a state, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing” for all years prior to 1938, with certain exceptions not here material; but “the term ‘officer or employee’ has a meaning no broader than that formerly given to the same words in exemptive provisions of income tax statutes and regulations,” Coates v. United States, 111 Fed. (2d) 609, affirming 28 Fed. Supp. 320, and “the immunity was to be no broader and no narrower” than it was prior to the Graves case. Meigs v. United States, 115 Fed. (2d) 13.

Upon brief the parties cite and discuss at length a large number of cases decided by the courts and this Board determining whether certain individuals were, or were not, employees of a state. The leading case on the question is Metcalf & Eddy v. Mitchell, 269 U. S. 514. In that case the taxpayers received compensation for personal services rendered as consulting engineers for various municipalities in connection with water supply and sewage assessments. In determining that they were independent contractors, rather than employees of the state, the Supreme Court said:
* * * In each instance the performance of their contract involved the use of judgment and discretion on their part and they were required to use their best professional skill to bring about the desired result.. This permitted to them liberty of action which excludes the idea of that control or right of control by the employer which characterizes the relation of employer and employee and differentiates the employee or servant from the independent ecu tractor.

In David A. Reed, 13 B. T. A. 513, this Board held that the petitioner, who was engaged as a special attorney by the Attorney General of Pennsylvania to handle certain litigation, was not an employee of the Commonwealth of Pennsylvania and that the compensation received by Trim for such services constituted taxable income, stating: “By tbe weight of authority, it appears that the crucial test lies in-the right of control, or lack of it, which the employer may exercise respecting the manner in which the service is to be performed and the means to be employed in its accomplishment, as well as the result to be attained.” In support of the conclusion reached the Board quoted from Singer Manufacturing Co. v. Rahn, 132 U. S. 518, in which the Supreme Court said: “The relation of master and servant exists whenever the employer retains the right to direct the manner in which the business shall be done, as well as the result to be accomplished, or, in other words, ‘not only what shall be done, but how it shall be done,’ ”

The Circuit Court of Appeals for the Third Circuit (34 Fed. (2d) 263) reversed, on the ground that the taxpayer “was in constant communication with the Attorney General”, and the latter had stated that “no important questions of policy were decided without his previous consultation with and authority from me.” The Supreme Court (281 U. S. 669), on the authority of Metcalf & Eddy v. Mitchell, supra, reversed the Circuit Court and affirmed the decision of this Board, holding that Reed was not an employee of the state.

It would serve no useful purpose to discuss or attempt to distinguish all of the cases cited by the respective parties upon brief. The conclusions reached may not always have been consistent. (Compare, for example, Burnet v. Livesey, 48 Fed. (2d) 159, strongly relied upon by petitioner, and Haight v. Commissioner, 52 Fed. (2d) 779, relied upon by respondent.) We have referred specifically to the Reed case because of the many points of similarity between the facts in it and the facts in the instant proceeding. In each, eminent attorneys had been employed as “special counsel” for the purpose of protecting the interests of the state. The designation or employment was made by a state officer in conformity with the state law. The attorneys were in frequent communication with the state officers and “no important questions of policy were decided” without first consulting them. The responsibility for the litigation in each instance rested primarily upon the state officers who made the designation or appointment. In the Reed case the taxpayer was paid out of moneys appropriated by the state. In the instant proceeding the method of payment' will be discussed later; but the payment was not made out of funds appropriated by the state. The Reed case, therefore, is respectable authority for denying the claimed exemption from tax in the instant proceeding unless there is a substantial difference in the facts. Petitioner contends that there is.

Petitioner argues that if the evidence of the “power to employ and discharge, to add to and subtract from the lawyers, without the consent of any of them”, and “the manifold evidences of control and power of control” shown by this record, had been present in the Reed case the Supreme Court undoubtedly would have sustained the Circuit Court’s holding that the compensation was exempt from tax. That, of course, is speculation. It may be pointed out, however, that for aught which appears in the findings of fact in the Reed case the State of Pennsylvania apparently had as much power to employ, discharge, add to, and subtract from its special counsel as the State of Missouri or its officers had in the instant proceeding. The latter part of petitioner’s argument has more merit; so the evidence upon which petitioner relies to show control and power of control will now be considered.

Petitioner and the other attorneys testified that Thompson kept in touch with their activities and at times directed what he wished to have done, who should conduct certain examinations, or where they should be held. This was corroborated by Thompson. On one occasion, as shown in the findings, he directed that testimony be taken to show the experience of certain companies rather than stipulating that as a fact, and on another he ordered that his theory of rate making be preserved in the pleadings, Thompson stated, however, that he did not “presume” to tell learned counsel how they should conduct the hearings or defend the litigation. This was left to their discretion. O’Malley testified to substantially the same effect, stating that he relied entirely upon the ability and professional skill of the attorneys to represent the state properly in the rate litigation. Practically all of petitioner’s services were performed during the administration of Thompson, O’Malley having advised him, almost immediately after becoming superintendent, that he was not thereafter to represent the state in the litigation. This is the substance of the evidence relating to control of petitioner. There is evidence, however, indicating that the governor and the superintendent of insurance did exercise additional control over the litigation. They, or at least O’Malley, conferred with representatives of the insurance companies and, independent of the attorneys, agreed upon the terms of a settlement, including the amount to be paid to the attorneys for their services. Petitioner, because of his previous connection with the litigation and his rights under his contract, was required to sign the stipulation of settlement. When this was done the $10,000,000 impounded in the Federal court was released and the check for $428,600 was delivered to Barker as trustee. But the funds which had been impounded in the Circuit Court of Cole County could not be released to the companies until and unless the Supreme Court of Missouri should either reverse the holding of that court to the effect that the funds'.must be returned to the policyholders, or approve the settlement, releasing to the companies 80 percent of the impounded fund. In connection with the proceeding in the Supreme Court of Missouri it appears that the governor and the superintendent did give some of the attorneys additional instructions. O’Malley ordered Barker, Weatherby, and Jacobs to present the matter to the Supreme Court solely upon the stipulation. The Governor ordered O’Malley to direct that it be presented to the court upon the merits and such directions were given. Apparently the settlement was before the Supreme Court, however; for the court, after passing upon the merits, declined to apiprove it.

It may be that more control was actually exercised by the Missouri officers in the instant proceeding than was exercised by the Pennsylvania officers in the Reed case; but the responsibility for the proper presentation of the state’s case in each instance rested upon the officers, and such control as was exercised seems to have been entirely compatible with the relation normally existing between public officials charged with the responsibility of protecting the rights of the state and attorneys, who, for a fee, undertake the actual, necessary legal work.

Petitioner urges that he was engaged for general services and not to accomplish any specific purpose. Thompson testified that the attorneys, “were employed to handle that fire insurance case”; that he “hired them for that job”; that nothing was said to petitioner at the time of his appointment about performing any other work; and that he had a regular monthly salaried employee who handled the ordinary legal work of the department. The contract of July 3, 1930, specifically stated that the attorney general and the superintendent had, according to law, designated petitioner and Bower-sock “to represent them as special counsel” in the fire insurance rate litigation cases and specifically referred to the cases pending in the Federal court and in the Circuit Court of Cole County. Weatherby testified that the 16% percent cases were “the only litigation Lohman was in” and petitioner testified that the length of his employment depended primarily on how long the rate litigation lasted. It is true that petitioner testified he was consulted by Thompson and Weatherby at times upon matters not involved in the fire insurance rate litigation. It appears from his testimony, however, that such instances were few; and the evidence does not indicate that they required any appreciable amount of his time or labor. The conclusion is inescapable that petitioner was employed for the specific purpose of assisting in protecting the interest of the state and the policyholders in the fire insurance rate litigation; that his employment was for a limited rather than for a general purpose; and that the compensation was paid tp'Tiim solely for the services rendered in connection with the rate litigation.

But, it is contended, the question whether petitioner and the other attorneys were employees of the state has been set at rest by the decisions of the Supreme Court of Missouri in Aetna Insurance Co. v. O'Malley, 343 Mo. 1232; 124 S. W. (2d) 1164; State ex rel Garwood Realty Co. v. Dinwiddie, 343 Mo. 592; 122 S. W. (2d) 912; and State ex rel Lucas v. Blair, 144 S. W. (2d) 106. Aetna Insurance Co. v. O'Malley, supra, involved the allowance of attorney fees to Barker, Jacobs, and Weatherby in the so-called “Restitution Cases.” The superintendent of insurance, in November 1922, had made an order for a reduction of 10 percent in insurance rates. This reduction was resisted by the companies in court for a period of years, during which premiums were collected at the old rate. In August 1929 the Supreme Court of Missouri upheld the order of the superintendent and the insurance companies began refunding to the policyholders the excess premiums collected during the pendency of the litigation. When, in 1930, it became apparent to the superintendent that only a portion of the excess premiums had been refunded, he employed the three attorneys to recover the balance of the excess premiums collected by the companies and agreed that, if successful, they should be paid from the fund for their services such an amount as the court deemed adequate, but if they were unsuccessful they were to receive no pay. After recovery of the fund, the trial court made an allowance to the attorneys. The Supreme Court of Missouri held that although the superintendent, with the approval of the governor, had statutory power to employ attorneys, he did not have the power to contract that their compensation should be paid out of the fund to be collected. In its opinion, the court stated that “the only way such attorneys can be paid is like any other expense of the insurance department, that is, by an appropriation of the legislature”, and that they “must look to the legislature for the .payment of- their fees.” Similar holdings were made in State ex rel Garwood Realty Co. v. Dinwiddie and State ex rel Lucas v. Blair, supra, with reference to the funds impounded in the Cole County court during the pendency of the 16% percent rate litigation. . The' court was not required to determine whether the attorneys were employees of Missouri and did not do so. Such cases as Bacon & Sons v. Martin, 305 U. S. 380, enunciating the principle that the construction of a state statute by a state court is binding upon a Federal court, are therefore inapplicable.

The-question whether petitioner was an employee of the State of Missouri' is essentially a question of law. Most of the basic facts are not seriously in dispute. Reference has been made to some of the circumstances relied upon especially by petitioner to show that he was an employee. In our opinion the evidence does not justify such finding or conclusion; but even if petitioner were an employee of the State of Missouri, his claim for exemption could not be sustained. He has not shown that any part of the compensation which he received in 1936 was paid to him by the State of Missouri. Obviously it was paid by the insurance companies, either out of the portion of the impounded funds recovered or from other funds in their possession. The Constitution of Missouri requires that all moneys received by the state from any source shall go into the treasury and that none shall be paid out except in pursuance of an appropriation by law. Sec. 43, Art. IV; sec. 19, Art. X. Since even the general assembly has no power to divert any moneys received by the state “except in pursuance of regular appropriations made by law” it can not be found as a fact, upon the record before us, that the state received the money for the attorneys’ fees from the insurance companies and paid to petitioner his portion of the total.

Upon brief petitioner argues that the source of the fee is immaterial. He relies particularly upon Commissioner v. Stilwell, 101 Fed. (2d) 588 (certiorari dismissed on motion of petitioner, 307 U. S. 648), in which it was held by the Circuit Court of Appeals for the Seventh Circuit that the compensation, received by a master in chancery in Illinois in the nature of fees assessed against the losing party as part of the costs of litigation, was exempt from the Federal income tax. Judge Evans filed a vigorous dissenting opinion, espousing the view that Hevering v. Therrell, 303 U. S. 218, and Helvering v. Gerhardt, supra, required the denial of the claimed immunity from tax “when the interference with the state governmental functions, through the imposition of the Federal income tax, is so uncertain as to be conjectural, theoretical or speculative,”

In Helvering v. Gerhardt, supra, the Supreme Court stated that judicial pronouncements “establish, two guiding principles of limitation for holding the tax immunity of state instrumentalities to its proper function. The one, dependent upon the nature of the function being performed by the state or in its behalf, excludes from the immunity activities thought not to be essential to the preservation of state governments even though the tax be collected from the state treasury. * • * * The other principle, exemplified by those cases where the tax laid upon individuals affects the state only as the burden is passed on to it by the taxpayer, forbids recognition of the immunity when the burden on the state is so speculative and uncertain that if allowed it would restrict the Federal taxing power without affording any corresponding tangible protection to the state government; even though the function be thought important enough to demand immunity from a tax upon the state itself, it is not necessarily protected from a tax which well may be substantially or entirely absorbed by private persons.” The Court pointed out that “During the present term we have held that the compensation of a state employee paid from the state treasury for his service in liquidating an insolvent corporation, where the state was reimbursed from the corporate assets, was subject to income tax. Helvering v. Therrell, McLoughlin v. Commissioner, 303 U. S. 218.”

In Saxe v. Shea, 98 Fed. (2d) 83 (certiorari dismissed on motion of petitioner, 305 U. S. 665), the Circuit Court of Appeals for the Second Circuit applied the second principle mentioned in the Gerhardt case and held that an individual appointed by New York courts as referee or special guardian to act in the specific cases was not exempt from Federal income taxation on compensation paid him by parties to guardianship proceedings or from funds under the courts’ control, and not from the state treasury, since imposition of the tax could not increase to the state the cost of administering justice. The court said : “In the light of the Gerhardt opinion we believe that the source of appellants’ compensation is alone enough to defeat his claim of constitutional immunity from Federal income taxes * * This language was quoted with approval by the Circuit Court of Appeals for the Third Circuit in Commissioner v. Church, 103 Fed. (2d) 254, which said: “The important consideration is the source of the compensation. When it comes from the litigants and not the state, the taxation thereof can not possibly impose a substantial burden upon the state.” The Circuit Court of Appeals for the Eighth Circuit seems to have adopted the same view in Pickett v. United States, 100 Fed. (2d) 909, though it did not discuss the question at any length. It, however, quoted from the opinion in the Gerhardt case to the effect that “When immunity is claimed from a tax laid on private persons, it must clearly appear that the burden upon the state function is actual and substantial, not conjectural”, and denied the immunity claimed. This Board has similarly applied the Supreme Court opinions in the Therrell and Gerhardt cases in Mercer McCall Tharpe, 37 B. T. A. 1128; Frank Aranow, 38 B. T. A. 1089, and James F. Curtis, 39 B. T. A. 366; affd., 110 Fed. (2d) 1014.

We are of the opinion and hold that petitioner has failed to show that the compensation in issue was received by him as an employee of the State of Missouri; that he has failed to show it was paid to him by the state or resulted in any actual or substantial burden upon it; and that he has failed to prove that the Commissioner committed any error in determining the deficiency in tax.

Reviewed by the Board.

Decision will be entered for the respondent.

       Art. IV—
      Sec. 43. Appropriations, order of, must be by lam — revenue to go into treasury.— All revenue collected and moneys received by the State from any source whatsoever shall go into the treasury, and the General Assembly shall have no power to divert the same, or to permit money to be drawn from the treasury, except in pursuance of regular appropriations made by law. * * *

        Art. X—
      Sec. 19. Money to he paid as appropriated — limit—how continued — receipts and expenditures. — No moneys shall ever be paid out of the treasury of this State, or any of the funds under its management, except in pursuance of an appropriation by law; nor unless such payment be made, or a warrant shall have issued therefor, within two years after the passage of such appropriation act; and every such law, making a new appropriation, or continuing or reviving an appropriation, shall distinctly specify the sum appropriated, and the object to which it is to be applied; and it shall not be sufficient to refer to any other law to fix such sum or object. A regular statement and account of the receipts and expenditures of all public money shall be published from time to time.


author: Black :

text:
    Seaboard Loan and Savings Association, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104939.
    Promulgated October 28, 1941.

      Norman B. Frost, Esq., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Black :

The issues presented for decision are whether the respondent erred in determining that the petitioner was a personal holding company in the taxable year and in assessing a penalty of 25 percent for failure to file a personal holding company return on Form 1120H.

Although the taxable year of petitioner which is before us ended March 31, 1938, the Revenue Act of 1936 is the applicable ■act. This is so because section 1 of the Revenue Act of 1938 provides that “The provisions of this title shall apply only to taxable years beginning after December 31, 1937.” The taxable year before us began April 1,1937.

The applicable provisions of the 1936 Act and regulations thereunder are printed in the margin.

The petitioner concedes that more than 50 percent of the value of its outstanding stock is owned by not more than five of its stockholders, but denies that 80 percent of its gross income for the taxable year was personal holding company income within the meaning of the statute. Counsel for the petitioner argues that the collection from “fees” and “fines” are not interest; that Congress did not intend to include operating small loan companies within the scope and operation of the act; and that petitioner should not be subject to a penalty for failure to file a return. The respondent contends that “fees” and “fines” received by petitioner from its debtors were amounts received for the use of money loaned and, therefore, come within the term “interest” as defined in the statute and applicable regulations.

Petitioner’s gross income for the taxable year was $79,640.86. Of this amount $49,171.55 was admittedly interest from notes; $20,519.71 was from “fees” charged (2 percent of the face value of the loan for investigation); and $8,940.18 was from fines. It is, therefore, obvious that unless the amounts collected as “fees” are considered as interest, 80 percent of petitioner’s gross income for the taxable year was not personal holding company income within the statutory definition. The case, therefore, turns on whether amounts collected by petitioner from its debtors of 2 percent on each loan made for “investigation” are in fact “interest” within the meaning of the statute and regulations. ■ The question of whether fines are interest becomes immaterial to the decision of the case if we hold that the 2 percent collected on each loan for “investigation” is interest, because in that event con-cededly more than 80 percent of petitioner’s gross income in the taxable year would be from interest.

The questions raised here have heretofore been before the Board and the courts and have been decided adversely to the petitioner’s contentions. Seaboard Small Loan Corporation, 42 B. T. A. 715; Girard Investment Co. v. Commissioner, 122 Fed. (2d) 843, affirming memorandum opinion of the Board. Both Seaboard Small Loan Corporation and Girard Investment Co., supra, were decided on authority of Noteman v. Welch, 108 Fed. (2d) 206.

All of the questions raised here were raised in Noteman v. Welch, supra, and were decided adversely to the petitioner’s contentions.

The petitioner’s argument that the segregation on its books of amounts received for “fees”, “fines”, and “interest” differentiates this case from the Noteman case, supra, and the Girard case, supra, is not persuasive. In both those cases amounts collected from the borrower for services were treated as interest, i. e., amounts paid by the borrower for the use of money loaned. In those cases, as in the instant case, substantially all the services charged for were for the benefit of the lender and not for the benefit of the borrower, and the only consideration received for the amounts paid by the borrower was the money loaned. As to the fines paid, the court in Noteman v. Welch, supra, indicates there might be a difference, but, as we have already stated, it is unnecessary to decide that question in this proceeding.

Petitioner urges that Congress never intended to include small loan corporations such as petitioner within the provisions of the personal holding company provisions of the applicable' revenue act. This question was thoroughly considered by the courts of appeal in both the Noteman v. Welch and Girard Investment Co. v. Commissioner cases, and was decided adversely to petitioner’s contentions. In both cases the legislative history of section 351 was reviewed by the court. On the authority of these cases we decide this issue in favor of the Commissioner.

The second issue is whether petitioner is liable for the 25 percent penalty which the Commissioner has added to the tax in accordance with the provisions of section 291 of the Revenue Act of 1936.

The evidence shows that petitioner did not file a personal holding company return on Form 1120H for the taxable year ended March 31, 1938. Petitioner’s accountant, who prepared petitioner’s return on Form 1120, testified at the hearing and gave as his reason for not preparing a return for petitioner as a personal holding company on Form 1120H: “Simply that in my opinion the amount of the interest did not reach the necessary 80 percent.”

This being the state of the evidence, we think petitioner has failed to show that its failure to file a personal holding company return on Form 1120H was due to reasonable cause. Lone Pine Lawn Corporation, 41 B. T. A. 638; affd., Lone Pine Lawn Corporation v. Helverirng, 121 Fed. (2d) 935. On this issue we sustain respondent.

Decision will be entered for respondent.

       Title IA of the Revenue Act of 1936, as amended by the Revenue Act of 1937 provides, among other things, as follows :
      “SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
      “There shall be levied, collected, and paid, for each taxable year (in addition to the taxes imposed by Title I), upon the undistributed adjusted net income of every personal holding company a surtax equal to the sum of the following:
      “(1) 65 per centum of the amount thereof not in excess of $2,000 ; plus
      “(2) 75 per centum of the amount thereof in excess of $2,000.”
      “SEC. 352. DEEINITION OP PERSONAL HOLDING COMPANY.
      “(a) General Rule. — For the purposes of this title and of Title I the term ‘personal holding company’ means any corporation if—
      “(1) Gross income requirement. — At least 80 per centum of its gross income for the taxable year is persona] holding company income as defined in section 353 ; * * *
      “(2) Stock ownership requirement. — At any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.”

      “SEC. 353. PERSONAL HOLDING COMPANY INCOME.
      “For the purposes of this title the term ‘personal holding company income’ means the portion of the gross income which consists of:
      “(a) Dividends, interest, royalties (other than mineral, oil, or gas royalties), annuities.”

        “SEC. 35S. ADMINISTRATIVE PROVISIONS.
      “All provisions of law (including penalties) applicable in respect of the taxes imposed by Title I of this Act, shall insofar as not inconsistent with this title, be applicable in respect of the tax imposed by this title * *
      Regulations 94, as amended by T. D. 4791 (1938-1 C. B. 102), is as follows:
      “Akt. 353-1. Personal holding company income. — The term ‘personal holding company Income’ means the portion of the gross income which consists of the following:

        * * * * * * *
      .“(2) Interest.' —The term ‘interest’ means any amounts, includible in gross income, received for the use of money loaned.”
      Section 291, Title I, of the Revenue Act of 1936 is as follows :
      “SEC. 291. FAILURE TO FILE RETURN.
      “In case of any failure to make and file return reauired by this title, within the time prescribed by Daw or prescribed by the Commissioner in pursuance of law, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the tax: 6 per centum if the failure is for not more than thirty days with an additional 5 percentum for each additional thirty days or fraction thereof during which such failure continues, not exceeding 25 per centum in the aggregate. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which case the amount so added shall be collected in the same manner as the tax. The amount added to the tax under this section shall be in lieu of the 25 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended.”


author: Kern:

text:
    Estate of Henry W. Putnam, Deceased, Guaranty Trust Company of New York, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 102689, 102690.
    Promulgated October 28, 1941.

      J. H. Nichols, Esq., for the petitioner.

      L. A. Spalding, Esq., for the respondent.
   OPINION.

Kern:

The question which this proceeding poses is whether dividends declared prior to the death of decedent but which, by the terms of the declaration, are payable only to stockholders of record as of a date subsequent to decedent’s death are accruable to decedent and taxable as his income, or are taxable as the income of his estate.

Upon this question the law of the domicile of the corporation declaring the dividend is controlling and it is to such law that we must look in determining whether and at what time a corporate debt arises pursuant to such declaration. Helvering v. McGlue, 119 Fed. (2d) 167; Estate of Lewis Cass Ledyard, Jr., 44 B. T. A. 1056.

In those cases it was held that under the laws of New York and New Jersey, in which states the corporations involved were domiciled, a corporate debt arises upon the declaration of a dividend even though the dividend is payable to stockholders of record on some future date.

That rule, however, in effect in New York and New Jersey, does not represent the weight of authority. The rule in Connecticut and Massachusetts is to the effect that where dividends declared are, by the terms of the declaration, payable to stockholders of record at some future date, the corporate debt on account of such dividend does not arise until the future record date. Union & New Haven Trust Co. v. Watrous, 109 Conn. 268; 146 Atl. 727; Richter & Co. v. Light, 97 Conn. 364; 116 Atl. 600; Nutter v. Andrews, 246 Mass. 224; 142 N. E. 67. Dicta in decisions in other states are in accord. See Ford v. Ford Manufacturing Co., 222 Ill. App. 76; In re Opperman's Estate, 319 Pa. 455; 179 Atl. 729. This latter rule seems to be that recognized by the Federal courts. Sharp v. Commissioner, 91 Fed. (2d) 802; Buchanan v. National Savings & Trust Co., 23 Fed. (2d) 994. See Alexander & Alexander, Inc. v. United States, 22 Fed. Supp. 921, 923. However, compare Lamberth v. Commissioner, 120 Fed. (2d) 101, wherein the Circuit Court of Appeals for the Ninth Circuit erroneously and unnecessarily cites Helvering v. McGlue, supra, as authority for a general rule, whereas it is obvious that it merely stated the rule existing in New York. Compare also First National Bank & Trust Co. v. Glenn, 36 Fed. Supp. 552, wherein a contrary rule is stated on the .sole authority of New York decisions. This latter rule of substantive corporation law was recognized by us as the general rule to be applied in Estate of G. Percy McGlue, 41 B. T. A. 1186. This case was reversed, but on the ground that the law of New York, the state in which the corporation was domiciled, was not in accord with the rule which we there took and which we now, after careful consideration, continue to take as representing the weight of authority.

In the absence of a convincing showing that the law of the corporation’s domicile is to the contrary, we shall continue to apply the rule which we consider to represent the weight of authority, viz., that, where a corporation declares a dividend payable hr the future to stockholders of record on some future date, a corporate debt on account of such dividend does not arise until such future date and, in the event a stockholder dies before such future record date, the dividend is not accruable to him and is not taxable as his income.

In the instant proceeding the corporations declaring the dividends involved were domiciled in New Jersey, Delaware, Pennsylvania, and Maine. As to the dividends declared by the New jersey corporations, we hold, pursuant to Estate of Lewis Cass Ledyard, Jr., supra, that they were taxable as income of decedent. As to the dividends declared by the Delaware, Pennsylvania, and Maine corporations, we hold that they were not accruable to decedent and taxable as his income, but were taxable as the income of his estate.

[Reviewed by the Board.

Decision will be entered wnder Rule SO.

AhuNdell, Smith, TuRNEr, Mellott, and Offer dissent.


text:
    Barber Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100844.
    Promulgated October 28, 1941.

      Herman Goldman, Esq., and Milton J. Levitt, Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Van Fossan:

The questions raised for decision are two: Whether it is practicable to apportion a part of the cost to petitioner of the units of the Chase Bank and Amerex stock to the Amerex stock sold by petitioner during the taxable year; and similarly, whether it is practicable to apportion a part of the cost to petitioner of the units of Commercial Bank and Commercial Corporation stock to the Commercial Corporation stock which was liquidated during the taxable year. The problems with respect to the practicability of apportionment are identical in the case of both pairs of corporations. Petitioner cites article 22 (a)-8 of Regulations 94. The respondent suggests that if apportionment is practicable, article 1567 of Regulations 62 (1921) is the nearest approach to the rule. He contends, however, that the facts do not permit an apportionment.

It will be at once observed that article 22 (a)-8 of Regulations 94 does not purport on its face to deal with a situation such as we have before us. In fact, neither the Revenue Act of 1936 nor the regulations promulgated thereunder specifically cover the instant case. However, in H. A. Green, 33 B. T. A. 824, addressing itself to the question of apportionment in a case arising under the 1928 Act, the Board observed:

There is no provision in the statute (Revenue Act of 1928) directing either an apportionment of cost between two or more kinds of property received in a nontaxable exchange, nor is there any statutory authorization for deferring the reporting of a profit where an apportionment is impracticable. However, for a number of years the respondent’s regulations have provided for apportionment of cost under various circumstances and for the deferment of recognition of gain until full cost is recovered where apportionment is impracticable. See art. 39, Regulations 45; arts. 39, 1567, Regulations 62; art. 39, Regulations 65 and 69. Tlie validity of these regulations has been recognized. See Salvage v. Commissioner, 76 Fed. (2d) 112, and eases there cited. Article 1567 of Regulations 62, interpreting the Revenue Act of 1921, provided in part as follows:
* * * the proportion of the original cost, or other basis, to he allocated to each class of new securities is that proportion which the market value of the particular class bears to the market value of all securities received- on the date of the exchange. * * * [Italics supplied.]
Regulations issued under subsequent revenue acts do not contain the exact language that appears in the foregoing quotation. It has been held, however, that the quoted provision lays down a principle that is equally applicable in determining gain or loss under subsequent revenue acts. See I. T. 2335, C. B. VI-1, p. 18, so holding with respect to the Revenue Act of 1926, which we approved in Glenn H. Curtiss, 21 B. T. A. 629; affd., 57 Fed. (2d) 847, a case arising under the Revenue Act of 1924; Sallie Strickland Tricou, 25 B. T. A. 713, involving the Revenue Act of 1926. Cf. Edwin D. Axton, 32 B. T. A. 613, a case under the Revenue Act of 1928.

There is thus ample authority for an apportionment if the same be practicable. See Stanley Hagerman, 34 B. T. A. 1158; affd., 102 Fed. (2d) 281.

The parties have stipulated the book values as of the date of acquisition by petitioner of the stock of the Chase Bank and Chase Securities and similarly as to the Commercial Bank and the Commercial Corporation. They further stipulate, however, that the book figures do not reflect appreciation or depreciation in market value above or below cost of the underlying assets. Proof of market value as of the date of the acquisition of the stocks is essential to our inquiry. We believe this lack of proof to be a fatal bar to petitioner’s contention. We do not know when the underlying assets were acquired, but, considering the history of the times before and after 1930, of which we take judicial notice, we can not assume that the book values represent true market values. Hence, the book figures can not be accepted as showing the true value of the shares of the separate corporations. There is no opinion evidence of values nor any record of separate earnings of the securities companies. Accordingly, there is no factual basis upon which we can apportion petitioner’s cost. Edwin D. Axton, 32 B. T. A. 613. Cf. De Coppet v. Helvering, 108 Fed. (2d) 787; also Stanley Hagerman, supra, where the Board was furnished with opinions of market value, the separate earnings of the Security Co., and other forms of evidence not presented here.

The above result follows whether the basic date be considered to be the year 1930, as contended by petitioner, or 1934, as contended by respondent. The respondent is sustained.

Decision will be entered under Bule 50.

       Art. 22 (a) — 8. Sale of stock and' rights. — * * * If common stock is received as a bonus with the purchase of preferred stock or bonds, the total purchase price shall be fairly apportioned between such common stock and the securities purchased for the purpose of determining the portion of the cost attributable to each class of stock or securities, but if that should be impracticable in any case, no profit on any subsequent sale of any part of the stock or securities will be realized until out of the proceeds of sales shall have been recovered the total cost.

       Art. 1567. Gain or loss from, subsequent sale. — (a) Where property is exchanged for other property and no gain or loss is recognized under articles 1564 or 1566 the property received shall for the purpose of determining gain or loss from its subsequent sale be treated as taking the place of the property exchanged therefor. But see article 1568. For exchange of property acquired prior to March 1, 1913, see article 1561. If property is exchanged for two kinds of property and no gain or loss is recognized under articles 1564 or 1566 the cost of the original property should be apportioned, if possible, between the two kinds of property received in exchange for the purpose of determining gain or loss upon subsequent sale. If no fair apportionment is practicable, no profit on any subsequent sale of any part of the property received in exchange is realized until out of the proceeds of sale shall have been recovered the entire cost of the original property. * * *


author: Hill :

text:
    L. & C. Mayers Co. Inc., Formerly L. & C. Mayers Importing Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103595.
    Promulgated October 28, 1941.

      Andrew B. Trudgian, Esq., for the petitioner.

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

Hill :

In addition to the issues which we have stated in the preface to our findings of fact in this proceeding, petitioner urges the unconstitutionality of section 14 of the Eevenue Act of 1936 and requests that we determine that it overpaid undistributed profits surtax for the taxable years imposed under that section of the statute. Respondent determined no deficiencies in surtax on undistributed profits of petitioner in either of the taxable years. We have, therefore, no jurisdiction to consider the constitutionality of such tax in this proceeding, nor may we determine whether petitioner overpaid undistributed profits surtaxes. Union Telephone Co., 41 B. T. A. 152; Hobbs Western Co., 43 B. T. A. 5.

The first issue for our consideration is whether or not petitioner’s excess profits tax for the taxable years is to be computed on the basis of petitioner’s capital stock tax return for 1936 filed on or about July 31, 1936, or on the basis of petitioner’s amended capital stock tax return for 1936 filed on or about April 26, 1937. Petitioner contends that its excess profits tax should be computed on the basis of the capital stock value declared in its amended return filed April 26, 1937, and asserts that such return was a “first return” within the meaning of section 105 of the Revenue Act of 1935 as amended. Respondent argues that the amended return was not timely filed and hence can not be considered as a “first return.”

Petitioner relies on Haggar Co. v. Helvering, 308 U. S. 389, in support of its argument that the amended return is to be considered a “first return” for purposes of declaration of capital stock value. In that case the Supreme Court, in considering section 215 of the National Industrial Recovery Act, predecessor of section 105 of the Revenue Act of 1935, upheld the taxpayer’s contention that a “first return” may include an amended return, stating:

“First return” thus means a return for the first year in which the taxpayer exercises the privilege of fixing its capital stock value for tax purposes, and includes a timely amended return for that year.

Thus, if petitioner’s amended return were “timely” the declaration of value declared therein would be the proper basis of computation rather than the declaration of value contained in the original return. We note, however, that the Supreme Court did not hold that any amended return might be used to substitute a declaration for that contained in the original return filed. In Riley Investment Co. v. Commissioner, 311. U. S. 55, the Supreme Court held that an amended return filed after the period within which an original return might be filed was not a “first return” within the meaning of section 114 (b) (4) of the Revenue Act of 1934 (election of percentage depletion). Cf. Healy River Coal Corporation, 44 B. T. A. 613. We are of the opinion that if an amended return is to be considered a “first return” the amended return must be filed within the time permitted for filing under the controlling revenue act. Section 105 (d) of the Revenue Act of 1935 provides that a capital stock tax return must be filed within one month after the close of the taxable year. It is further provided that the Commissioner may extend the time for filing such return, but that no extension might exceed 60 days. The amended return here under consideration was not filed within the time provided by the statute. Healy Rimer Coal Corporation, supra. We hold that the correct basis for computing petitioner’s excess profits tax liability for the taxable years is the declared value of $500,000 contained in petitioner’s original return filed on or about July 31,1936.

The other issue relates to the constitutionality of section 106 of the Revenue Act of 1935 as amended. Petitioner has advanced no convincing argument on this point. Section 216 of the National Industrial Recovery Act, the predecessor of section 106 of the Revenue Act of 1935, has been held constitutional. Allied Agents, Inc. v. United States, 26 Fed. Supp. 98; certiorari denied, 308 U. S. 561. We are of the opinion that Allied Agents, Inc., supra, was correctly decided, and hereby hold that its scope extends to section 106 of the Revenue Act of 1935 as amended.

Decision will he entered for respondent.

       SEC. 105. CAPITAL STOCK TAX.
      (a) For each year ending June 30, beginning -with tbe year ending June 30, 1936, there is hereby imposed upon every domestic corporation with respect to carrying on or doing business for any part of such year an excise tax of $1.40 for each $1,000 of the adjusted declared value of its capital stock.
      * * * * * * *
      (d) Every corporation liable for tax under this section shall make a return under oath within one month after the close of the year with respect to which such tax is imposed to the collector for the district in which is located its principal place of business or, if it has no principal place of business in the united States, then to the collector at Baltimore, Maryland. Such return shall contain such information and be made in such manner as the Commissioner with the approval of the Secretary may by regulations prescribe. The tax shall, without assessment by the Commissioner or notice from the collector, be due and payable to the collector before the expiration of the period for filing the return. If the tax is not paid when due, there shall be added as part of the tax interest at the rate of 6 per centum per annum from the time when the tax became due until paid. All provisions of law (including penalties) applicable in respect of the taxes imposed by section 600 of the Revenue Act of 1926 shall, insofar as not inconsistent with this section, be applicable in respect of the taxes imposed by this section. The Commissioner may extend the time for making the returns and paying the taxes imposed by this section, under such rules and regulations as he may prescribe with the approval of the Secretary, but no such extension shall be for more than sixty days.
      * * * * * * *
      (f) For the first year ending June 30 in respect of which a tax is imposed by this section upon any corporation, the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended), as of the close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section). For any subsequent year ending June 30, the adjusted declared value in the case of a domestic corporation shall be the original declared value plus (1) the cash and fair market value of property paid in for stock or shares, (2) paid in surplus and contributions to capital, (3) its net income, (4) the excess of its income wholly exempt from the taxes imposed by Title I of the Revenue Act of 1934, as amended, over the amount disallowed as a deduction by section 24 (a) (5) of such title, and (5) the amount of the dividend deduction allowable for income tax purposes, and minus (A) the value of property distributed in liquidation to shareholders, (B) distributions of earnings or profits, and (C) the excess of the deductions allowable for income tax purposes over its gross income; adjustment being made for each income-tax taxable year included in the period from the date as of which the original declared value was declared to the close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section. The amount of such adjustment for each such year shall be computed (on the basis of a separate return) according to the income tax law applicable to such year. For any subsequent year ending June 30, the adjusted declared value in the case of a foreign corporation shall be the original declared value adjusted (for the same income-tax taxable years as in the case of a domestic corporation), in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, to reflect increases or decreases in the capital employed in the transaction for its business in the united States.


author: Arnold:

text:
    Commonwealth Theatres Corporation, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101549.
    Promulgated October 31, 1941.

      A. F. Sohaetzle, Esq., and O. P. M. Allen, O. P. A., for petitioner.

      W. Frank Gibbs, Esq., and Angus Boy Sharmon, Jr., Esq., for the respondent.
   OPINION.

Arnold:

The Commissioner determined a deficiency of $2,191 in income tax for the calendar year 1936. The only issue involved is whether the petitioner is entitled to a credit under section 26 (c) (2) of the Revenue Act of 1936. The facts were presented by stipulation, which we adopt as our findings of fact.

The petitioner is a Nebraska corporation with offices in Des Moines, Iowa. Its business consisted exclusively of the operation of a theatre and office building in Omaha, Nebraska, known as the World Theatre Building, under a long term lease. It commenced business in October 1934, with an invested capital of $46,400 consisting of capital stock of $4,400 and paid-in surplus of $42,000, all of which was paid in cash by the stockholders.

On November 13,1934, the petitioner entered into an agreement with the World Realty Co., a Nebraska corporation, whereby it acquired a 99-year ground lease covering real estate situated at the northwest corner of Fifteenth and Douglas Streets, in Omaha, Nebraska, on which was located a modern theatre building, including commercial space consisting of four ground floor shops and a large basement in which recreation parlors were operated. The ground lease covered the period from September 11,1917, to April 29,2016. The purchase price for the unexpired term of the lease was $150,000, payable $50,000 in cash and the balance of $100,000 in 48 equal monthly installments beginning December 1,1934, and ending November 1, 1938. The payments made in 1936 aggregated $24,999.98. The 48 payments were evidenced-by 48 negotiable notes executed by the petitioner, payable to the order of World Realty Co. and bearing interest from December 1, 1934, at the rate of 5 percent per annum until maturity and 8 percent per annum thereafter. The notes were secured by a trust deed dated November 13, 1934, to the Omaha National Bank, trustee, transferring, conveying, and assigning to the trustee all right, title, and interest of petitioner in the property above referred to as evidenced by the lease dated September 11,1917, and all leases of the property or any part thereof then in existence or thereafter to be executed by the petitioner, “together with all rents, issues and profits thereof”, and the buildings and improvements on the premises or which may be erected thereon. The trust deed provided, inter alia, as follows:

1. In ease of a default hereunder as aforesaid, the “Trustee” shall have the right to immediately take possession of the mortgaged property and collect the rents, issues and profits therefrom and apply the same to the performance of the 99 year lease, to the payment of taxes on the mortgaged property, the repayment of any advances or other sums due from the “Mortgagor” hereunder, to the payment of any and all costs and expenses incurred in collection of said rents, issues and profits or in enforcement of the remedies herein provided, and to the payment of the notes secured hereby. To enable the “Trustee” to exercise this power, the “Mortgagor” will forthwith upon demand of the “Trustee” turn over to the “Trustee” all leases and records pertaining to the mortgaged property and all fixtures and appliances necessary to enable the “Trustee” to hold, operate and administer the property.

The petitioner, in connection with the trust deed, assigned on November 13, 1934, all subleases acquired from the World Realty Co. to the Omaha National Bank, trustee. On the same date it also assigned all the rents from the World Theatre Building to the trustee, which assignment contained the following provisions:

Foe and in Consummation of the sum of One Dollar to it in hand paid, receipt whereof is hereby acknowledged, and the further securing of the debt hereinafter referred to, Commonwealth Theatbes Coepoeation does hereby sell, assign, transfer and set over to Omaha National Bank, Teustee, the rents, issues and profits of the following described real estate, situated in the City of Omaha, Douglas County, State of Nebraska, to-wit:
* * * * * $ *
Peovided That, Whereas the Commonwealth Theatres Corporation has executed and delivered to World Realty Co., forty-eight notes of even date herewith in the aggregate principal amount of $100,000.00 bearing interest at the rate of 5% per annum before maturity and &% per annum thereafter and secured by a Trust Deed of even date herewith executed by Commonwealth Theatres Corporation to Omaha National Bank, Trustee, covering all the right, title and interest of the Commonwealth Theatres Corporation in and to the above described property, it is agreed that unless and until default is made by the Commonwealth Theatres Corporation in the payment of principal or interest of any of the said notes or in the performance or observance of any of the terms, provisions or conditions in the said Trust Deed or in this assignment contained, the Commonwealth Theatres Corporation shall have the right to collect and receive the rentals accruing from said property prior to any such default, as and when and only as and when such rental becomes due and payable under the terms of said leases on said premises.
In the event of any default by the Commonwealth Theatres Corporation in the payment of interest or principal of any of the above mentioned notes or in the performance of any of the terms, provisions or conditions of the above mentioned trust deed or of this Assignment, and if any such default shall continue for fifteen (15) days, the Omaha National Bank, Trustee, shall have and is hereby given the right to take and keep possession of the said premises and to collect all the rents, issues and profits thereof either by its officers or by any other person duly authorized by it as agent for that purpose until all of said above mentioned notes and Trust Deed shall have been fully paid and satisfied; and the Commonwealth Theatres Corporation hereby makes, constitutes and appoints the said Omaha National Bank, Trustee, its attorney-in-fact, giving unto said attorney power irrevocably, either in its own name or in the name of Commonwealth Theatres Corporation to take all necessary steps by proceedings in court or otherwise, to collect all rentals, to cause the said premises to be vacated, and when vacant to relet said premises and to do all such things either by its own officers or by other parties duly authorized and appointed by it as agent for said purposes, all the above at such times and in such manner and on such terms as to said attorney may seem best, with full power of substitution.
This Assignment is made in connection with the above-mentioned Trust Deed executed by Commonwealth Theatres Corporation to Omaha National Bank, Trustee, and the provisions of said Trust Deed with reference to the application of the rents, issues and profits of said property collected and received by the Omaha National Bank, Trustee and with reference to the conditions upon and subject to which the said Trustee accepts the trusts stipulated and provided for under the terms of said Trust Deed shall apply to and in connection with this assignment of leases to said Trustee.

During the years 1934 to 1936, inclusive, all of the provisions of the trust deed were complied with.

From the inception of petitioner in October 1934 to December 31, 1936, its cash receipts and disbursements were as follows:

Its earned surplus computed on the accrual basis was as follows:

Nov. 13 to Dec. 31,1934_$2,766.48
1935_ 10, 692.95
1936_'_ 14,203. 98
Total earned surplus Dec. 31, 1936- 27, 663.41

The only question involved is whether the petitioner is entitled to the credit allowed by section 26 (c) (2) of the Kevenue Act of 1936. This section provides for the allowance of a credit in determining undistributed net income for the purpose of computing undistributed profits surtas of:

* * * An amount equal to tlie portion of the earnings 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 earnings 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. * * *

Admittedly, in G. B. R. Oil Corporation, 40 B. T. A. 738; Michigan Silica Co., 41 B. T. A. 511; Joell Co., 41 B. T. A. 825; Strong Manufacturing Co., 41 B. T. A. 1273; Baltimore Steam Pachet Co., 44 B. T. A. 629; and Meridian & Thirteenth Realty Co., 44 B. T. A. 865, relied upon by petitioner, wherein taxpayers claimed the credit under section 26 (c) (2) and prevailed, there were written provisions in contracts requiring that earnings be applied on the debt, whereas in this proceeding there is no such express provision in the trust deed or the assignment. It is contended by the petitioner that the lack of such an express provision is no basis for .distinction because petitioner was legally in the same position as the taxpayers in the above cases. It is argued that, not having any assets other than the 99-year lease and no income other than rent from the subleases thereunder, it was required, in order to fulfill its contractual obligations and avoid default, to use its rent income for the payment of the 12 notes falling due in 1936, interest, ground rent, and local taxes.

The use of the rent income by petitioner to meet its obligations under the trust deed and assignment was not actuated or compelled by an express contractual requirement. What was said in Campbell Transportation Co., 43 B. T. A. 417, 422, is apposite here:

* * * Tbe mere fact of repayment or setting aside of funds does not satisfy tbe terms, and we think tbe intent, of tbe statute. Unless it was required by tbe contract to be paid or irrevocably set aside, tbe petitioner would be free to elect wbetber to so treat its earnings or to pay dividends. Sucb is not the situation contemplated by tbe statute, which concerns itself, as we said in tbe G. B. R. Oil Corporation ease, with contracts which “inevitably require in their performance a drawing on current earnings.” [Italics supplied.] * * *

Deductions are a matter of legislative grace and a taxpayer seeking a deduction must bring himself within the letter of the statutory provisions. New Colonial Ice Co. v. Helvering, 292 U. S. 435; Taft v. Commissioner, 304 U. S. 351.

The 99-year lease, subleases, and rents were assigned to the trustee by petitioner as security for the performance of its contract with the World Realty Co. The petitioner had the right to collect and receive the rentals and it was expressly so provided in the assignment. It was in no way restricted in the use of such rentals. The trustee had no right under the assignment of rentals to collect or receive the rentals unless and until default in the payment of the principal of notes, interest, and other payments required to be made by the trust deed and assignment occurred and continued for fifteen days. Until default occurred and continued for fifteen days the petitioner had the unrestricted right to the rents and was not required to surrender possession of its property or income. Such a contract does not “inevitably require” in its performance the use and application of petitioner’s rental, “thus removing current earnings as a source of dividend payments.” G. B. R. Oil Corporation, supra. Such a contract does not meet the requirements of section 26 (c) (2). Artesian Water Co., 43 B. T. A. 408. That the petitioner had no cash with which to pay dividends and its cash account was overdrawn is not material. It had earned profits of $14,203.98 in 1936. The petitioner was free in the taxable year to dispose of such earned profits as it saw fit.

We therefore hold that petitioner is not entitled to the credit provided for in section 26 (c) (2) of the Revenue Act of 1936. The Commissioner’s action in disallowing the credit is approved.

Decision will he entered for the respondent.


author: Murdock :

text:
    Annie A. Colby, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104367.
    Promulgated October 31, 1941.

      Allan H. W. Higgins, Esg., and Charles D. Post, Esq., for the petitioner.

      T. G. Histon, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $6,363.26 in income tax for 1935. The issue for decision is whether interest of $24,176.39 is taxable to the petitioner in 1935 when she made a gift of the right to receive that much accrued interest. The Board adopts as its findings of fact the facts as stipulated by the parties.

The petitioner is an individual who filed her return with the collector in Massachusetts. She used the cash receipts method of reporting her income. She had owned since 1932 a note and mortgage executed by Frances E. O’Brien. The amount of the unpaid principal of the indebtedness was $130,000 on December 30, 1935, and there was at that time interest thereon accrued and unpaid in the amount of $24,176.39, consisting of the following:

Interest due and payable prior to 1/1/35-$16,033.34
Interest due and payable on 3/29/35- 3, 250.00
Interest due and payable on 9/29/35- 3,250. 00
Interest accrued from 9/29 to 12/30/35- 1,643. 05

No interest had been paid on the indebtedness while it was owned by the petitioner. The petitioner, on December 30, 1935, assigned the note and mortgage, with all rights to interest, to a trust for the benefit of her children. The trustee collected the $24,176.39 of interest, $18,000 in 1936 and the balance of $6,176.39 in 1937. The petitioner reported the interest as a part of her 1935 gifts but did not report any part of it as income. The Commissioner included the $24,176.39 in her income for 1935.

No contention is made that any of this interest was taxable to the petitioner in 1935, independently of the gift, upon the theory that it was readily available to her, she deliberately avoided receiving it, and, therefore, she must be held to have constructively received it. The stipulated facts would not support any such contention.

The Commissioner attempts to justify his determination upon the ground that this case is controlled by Helvering v. Horst, 311 U. S. 112. He says the Supreme Court there in effect approved I. T. 3011, C. B. XV-2, p. 132, and laid down the principle that one who uses a cash receipts method of reporting income and makes a gift of his right to earned interest realizes the earned interest as income and becomes taxable upon that income by reason of and at the time of the gift, even though the interest is not paid by the debtor or received by the donee until a later year. The facts in the Horst case did not present that kind of a situation and did not require the decision of that question. The gift and the collection of the interest in the Horst case occurred in the same taxable year. The Supreme Court decided that, where both of those events occur in the same year, the interest is taxable in that year to the donor on a cash receipts basis.

The Court pointed out that the taxable event under section 22 (a), for one using a cash receipts method, is the realization of the income which he owns; realization is ordinarily the actual receipt of the income in cash or property, but it may occur in other ways; realization occurs when the last step is taken by which the owner of the right to receive income obtains the fruition of the economic gain which has already accrued to him, as where he “diverts the payment from himself to others as the means of procuring the satisfaction of his wants”; Horst procured payment of the interest to his donee and thus realized income which was taxable to him under section 22 (a). The Court, in the course of its opinion, said:

Underlying the reasoning in these cases is the thought that income is “realized” by the assignor because he, who owns or controls the source of the income, also controls the disposition of that which he could have received himself and diverts the payment from himself to others as the means of procuring the satisfaction of his wants. The taxpayer has equally enjoyed the fruits of his labor or investment and obtained the satisfaction of his desires whether he collects and uses the income to procure those satisfactions, or whether he disposes of his right to collect it as the means of procuring them. Cf. Burnet v. Wells, supra.

The last sentence above quoted, and also several other sentences in the opinion, if separated from their context and from the facts in the case, might lead to the conclusion that the Court placed all of the emphasis upon the gift and held that realization occurred at the time of the gift, regardless of when the interest was actually collected. But it must be remembered that in the Horst case the interest was collected by the donee in the same year that the gift was made, and in the first sentence of the quoted portion of the opinion payment is mentioned. Likewise, at several other places in the opinion, the Court has coupled the gift and payment of the interest to the donee in reaching its conclusion that Horst realized his income in the years 1934 and 1935. For example, the final sentence of the opinion is as follows:

* * * When, by the gift of tbe coupons, he has separated his right to interest payments from his investment and procured the payment of the interest to his donee, he has enjoyed the economic benefits of the income in the same manner and to the same extent as though the transfer were of earnings and in both cases the import of the statute is that the fruit is not to be attributed to a different tree from that on which it grew.

Since the Court has been careful to couple both the gift and payment, the opinion should not be read as if the gift alone were sufficient, realization. Furthermore, there was taxed to Horst not only interest which had accrued up to the date of the gift, but interest which accrued thereafter. The Court later, in the recent case of Harrison v. Schaffner, 312 U. S. 579, again drew attention to the importance of payment in these words:

* * * But we think it quite another matter to say that the beneficiary of a trust who makes a single gift of a sum of money payable out of income of the trust does not realize income when the gift is effectuated by payment * * *.

No case has been called to our attention where income is taxed to a donor prior to the time that it is actually received by or becomes available to the donee, while it has been held in many cases that income is taxable to the donor at the time that it is paid to the donee or for the benefit of the donor. Old Colony Trust Co. v. Commissioner, 279 U. S. 716; Corliss v. Bowers, 281 U. S. 376; Lucas v. Earl, 281 U. S. 111; Burnet v. Leininger, 285 U. S. 136; Burnet v. Wells, 289 U. S. 670; Douglas v. Willcuts, 296 U. S. 1; Helvering v. Clifford, 309 U. S. 331; Helvering v. Horst, supra; Helvering v. Eubank, 311 U. S. 122; Harrison v. Schaffner, supra. The present case, involving interest which had been earned prior to the time of the gift, may present a stronger case than those above cited to support the argument of the Commissioner that the interest is taxable to the donor at the time of the gift, regardless of the date of collection. But the above cases have long established a general rule to which, so far as we know, there is no exception which would apply here. The interest would not have been taxable to the donor in 1935 if she had made no assignment, but would only have been taxable income to her when it was collected. The practical difficulties of waiting until the interest is actually collected in this case are no greater than those which were present in some of the cases above cited. We held in Rebekah C. Schoonmaker, 39 B. T. A. 496, petition for review dismissed, that a gift in trust for a grandson, of certain bonds upon which there was accrued but unmatured interest at the time of the transfer, did not make the undue interest income of the donor at the time of the gift. We do not regard the Horst case as authority in the present case, and, since none of the income was collected in the taxable year, none of it may be taxed to the grantor as income of that year. This conclusion makes it unnecessary to discuss another difference between this case and the Horst case, this difference being that here the petitioner assigned everything she had, both debt and interest, whereas, there, the coupon was separated from the debt and only the coupon was assigned.

Reviewed by the Board.

Decision will be entered for the petitioner.

Hill dissents.


author: Disney : Arnold,

text:
    Dr. Pepper Bottling Company of Memphis, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101626.
    Promulgated October 31, 1941.

      Sylvanus W. Polls, Esq., for the petitioner.

      Frank M. Thompson, Esq., for the respondent.
   OPINION.

Disney :

The Commissioner determined a deficiency in petitioner’s income tax liability for 1937 in the amount of $6,428.62. The only question involved is whether the petitioner is entitled to a credit of $29,924.38 under section 26 (c) (1) and (2) of the Revenue Act of 1936, relating to contracts restricting dividends.

The facts were stipulated and are found as stipulated. We set forth herein only such facts as are pertinent.

The petitioner is a Tennessee corporation, with its principal office and place of business at Memphis, Tennessee, and the return was filed with the collector for the district of Tennessee.

On June 27, 1933, the petitioner entered into a written agreement with the National Bank of Commerce at Houston, Texas, acting as trustee for a group of creditors. The agreement was in the form of a deed of trust to the bank as trustee acknowledging and securing the payment of debts in the aggregate amount of $37,086.30, evidenced by a series of 59 notes. The agreement contained, inter alia, the following provisions:

Tbe Corporation covenants and agrees as follows:
Section 1. That it will perform all obligations which, either expressly or by reasonable implication, are imposed on’ it by this Indenture, and will permit no default hereunder to occur.
****** *
Section 3. In tbe event tbe corporation’s cash on band shall exceed tbe sum of $7,500 at any time while this indenture is in force and effect tbe Corporation shall, * * * set aside and apply two-tbirds of tbe excess over and above $7,500.00, and may, in its sole discretion, set aside and apply any further part or all of such excess for whichever of tbe following purposes tbe Corporation shall deem preferable, to-wit:
(a) The purchase for the purpose of cancelling the same of any note or notes or of one or more installments of any note or notes issued hereunder, at the lowest price obtainable by tenders from the holders of same, provided such price is below the face value of principal and interest then accrued thereon.
(b) A payment on the principal of each note secured hereby plus the interest accrued to date of payment upon the part of said principal so paid, such principal payments to be made on each of said notes ratably in proportion to the unpaid principal of each of said notes.
Section 4. It will not declare and/or pay any dividends to its stockholders until all said notes are fully paid and discharged.

On June 30,193T, the petitioner sold for $51,000 in cash its franchise for distribution of Seven-Up in this territory to an independent corporation in which petitioner had no interest. The franchise was originally acquired by petitioner without cost and the entire proceeds from its sale represented earnings and profits.

The unpaid balance of the notes secured by the above mentioned deed of trust at the time of the sale of the franchise amounted to $29,924.38. The petitioner immediately upon the sale of the franchise deposited in the National Bank of Commerce at Houston a part of the proceeds from the sale sufficient to satisfy the unpaid balance on the notes. On July 31,1937, the notes were paid in full out of the funds so deposited with the bank.

The net income of the petitioner for 1937, before deducting excess profits taxes, was $50,409.67. The money applied to the payment of the notes secured by the trust deed was a part of such net income, earnings, and profits of petitioner for 1937.

Under the terms of the deed of trust, the holders of the notes had a right to require the application of $29,924.38 of the proceeds from the sale of the franchise to the payment of their notes. The deed of trust remained in full force and effect until such payment was made.

The Commissioner recognized the above mentioned deed of trust as one entitling the petitioner to a credit under section 26 (c) of the Revenue Act of 1936 in determining its tax liability for 1936.

The adjusted net income of petitioner for 1937 was $40,597.11. The balance sheet of petitioner as of January 1,1937, discloses an operating deficit of $98,812.27 and its balance sheet as of December 31, 1937, discloses an operating deficit of $63,182.72.

The petitioner, in computing undistributed profits surtax in his return, claimed credit for $29,924.38 on account of contracts restricting dividend payments. The credit claimed was disallowed, the deficiency notice making reference to section 26 (c) (2) of the Revenue Act of 1936, the result being computation of a deficiency in income tax in the above stated amount of $6,428.62. In the petition and upon brief the petitioner contends for the allowance of the credit under both subsection (c) (1) and subsection (c) (2) of section 26, Revenue Act of 1936.

We first consider the application of subsection (c) (2) for the reason that we think it can be very briefly disposed of. In our opinion, though the contract was written and executed prior to May 1, 1936, section 26 (c) (2) does not apply for the simple reason that the contractual provision relied upon does not expressly deal with the disposition of earnings and profits of the taxable year, nor expressly require them to be paid or set aside within the taxable year in discharge of debt. The provision merely provides that, in the event the corporation’s cash on hand shall exceed $7,500, two-thirds of the excess shall be applied upon the debt. It' is obvious that “cash on hand” is not the equivalent of “earnings and profits of the taxable year”, for cash on hand might have a source entirely unrelated to earnings or profits, e. g., capital contributed, and earnings and profits might not be cash on hand. The company might have far more earnings and profits than cash on hand, yet the contractual provision requires the application only of “cash on hand”, to the designated extent, upon the debt. We hold that section 26 (c) (2) does not entitle the petitioner to the credit sought. Helvering v. Maloney Electric Co., 120 Fed. (2d) 617.

Nor do we think that section 26 (c) (1) covers the situation placed before us or entitles petitioner to the credit desired. Though the contract, as above seen, was written, was executed prior to May 1, 1936, and expressly deals with the payment of dividends, nevertheless we think that no contractual provision prevented distribution of the amount involved as a dividend “within the taxable year.” The contract nowhere provides that dividends shall not be distributed within the taxable year here involved or any other year, but merely provides against such payment of dividends until, the indebtedness involved is paid and discharged. This might have been done upon the first day of the year, leaving the corporation free to pay dividends the entire year, save the one day; or, as above seen, the debt might have been paid from a capital contribution or other source not constituting earnings or profits. It is clear that the intent of the statute is to allow the credit, ivhere an express contract is violated by distribution of adjusted net income as dividends, in a manner corresponding to a-credit where the dividend is actually paid. The contract here did not forbid distribution of income as dividends during the year, nor provide that the debt be paid from income. The petitioner could have distributed within the taxable year all of its adjusted net income, undiminished by the $29,924.38 paid on its debts, without violating any provision of any written contract, for the contract could have been satisfied with funds other than income, and thus not be violated by distribution of income. Thus it appears that it is not the contract, but the manner in which the petitioner transacted the matter of its discharge by the use of income, that prevents the distribution of dividends to the extent of the $29,924.38 here involved only because it was in fact paid from the petitioner’s only income. In Roquemore Gravel & Slag Co., 44 B. T. A. 841, we held that section 26 (c) (1) did not confer credit where a contract provided against payment of dividends after a loan was obtained, the loan was obtained on August 28 of the taxable year, and it was not shown that the net profits of $33,833.06 for the taxable year had not been earned prior to August 28. We conclude and hold that the Commissioner did not err in denying the credit claimed.

Reviewed by the Board.

Decision will be entered for the respondent.

Arnold,

dissenting: It seems to me that the majority have decided the issue on the basis of matters purely speculative. I see no reason under the facts peculiar to this case to venture into the realm of speculation. This taxpayer derived a profit of $51,000 cash from the sale. By the terms of its contract a specified portion thereof was required to be paid to its creditors. The petitioner recognized that it was contractually bound to pay its creditors out of such moneys and forthwith complied with the terms of its contract.

Petitioner started the year with an operating deficit; it closed the year with net income less than the gain realized on the sale. It is beside the point to say that payment might have been made from other sources and the gain from the sale distributed as dividends. The parties have stipulated that the debts were paid from “net income, earnings and profits” of the taxable year. To the extent that this cash was used to satisfy its debts, petitioner was deprived of earnings and profits otherwise available for distribution as dividends. To say that the debts could have been paid the first of the year or at any other time prior to sale of the franchise does not square with the facts. Petitioner would have had no taxable income for the year but for the sale.

The situation in Roquemore Gravel & Slag Co., 44 B. T. A. 641, now on appeal to the Fifth Circuit, is different. There, the petitioner failed to show that it had no earnings prior to August 28, 1936, the effective date of the contract. The opinion states, p. 644:

* * * Had it been shown that on August 28,1030, petitioner had no earnings from which dividends could have been declared, it would be clear that any 1936 dividends would have to have been declared out of earnings of the petitioner acquired after the date of the loan. A distribution of these earnings was strictly forbidden by the contract here in evidence. * * *

It seems to me that this petitioner has shown that before July 31, 1936, it was contractually prohibited from distributing dividends, and that after July 31,1936, it had only $6,172.73 of undistributed profits subject to surtax. The $29,924.38 used by petitioner on July 31,1937, to discharge the indebtedness was not available for payment of dividends at any time during the taxable year. Prior to that date it could not be distributed as dividends because of contract restrictions; thereafter, it was not in petitioner’s control for any purpose.

Petitioner’s adjusted net income of $40,597.11 less the $29,924.38 leaves $10,672.73 which could be distributed. Petitioner distributed $4,500 of this amount, which respondent allowed as a dividends paid credit, leaving $6,172.73 as the only amount subject to tax. In my opinion the credit should be allowed.

Leech, ToeneR, and Tyson agree with this dissent.

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

        ****** *

      (c) Contracts Restricting Payment of Divídenos—
      (1) Prohibition on payment of dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
      (2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings 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 earnings 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.