author: Hill : Blace, Leech:

text:
    The Ardbern Company, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90881.
    Promulgated April 23, 1940.

      J. Sterling Halstead, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.

       SBC. 275. PERIOD OP LIMITATION UPON ASSESSMENT AND COLLECTION.
      * * * * * * . *
      (c) Corporation and Shareholder. — If a corporation makes no return of the tax imposed by this title, but each of the shareholders includes in his .return his distributive share of the net income of the corporation, then the tax of the corporation shall be assessed within four years after the last date on which any such .shareholder’s return was filed.

   OPINION.

Hill :

Respondent originally asserted for the year 1929 the fraud penalty provided in section 293 (b) of the Revenue Apt of 1928, but on brief he concedes that the evidence fails to show that any part of the deficiency .for that year" is due to fraud with intent to evade tax and admits that he was in error in proposing such fraud penalty. On this issue, therefore, we find for petitioner.

Of the issues presented for decision, we shall.first consider issue (2), since it raises a question of limitations, >yhich, if sustained, would be a bar to.recovery of any of the deficiencies in controversy. Petitioner asserts that assessment and collection of the deficiencies are barred by the provisions of section 275. (c) of the Revenue Acts of 1928 and 1932, quoted in the margin.. Petitioner points to -the fact that Feustman, its sole stockholder, reported in his individual income tax returns dividends from petitioner for 1929 of $4,000, for 1930 of $13,500, and for 1931 of $6,000, and argues that this brings the case at least in substance within the purpose and language of section 275 (c). But the above amounts which Feustman •so; reported were only the amounts, actually distributed to him in -the years named and were not the full amounts of petitioner’s distributable income for those years. The facts found herein show that even on the basis of Feustman’s returns and of petitioner’s contention as to amounts of its distributable income Feustman failed .to report $1,274.29, $2,603.09, and $1,303.76 of such distributable income, respectively, for the years 1929, 1930, and 1931. This fact indicates that Feustman was not reporting under section 275 (c). Accordingly, we hold that such section does not apply.

Petitioner’s plea of limitation must in any event fail for lack of proof of the dates on which the shareholder’s returns were filed for the respective years. Feustman made no attempt to fix such dates in his testimony, nor are the dates of either execution or filing shown on the copies of the returns introduced in evidence. In the absence of such proof, we can not say that the notice of deficiency for any of the taxable years was not mailed within four years after the date on which the shareholder’s return was filed. Where there is no proof of the date of filing of the return; this Board will not hold that a deficiency is barred. M. A. Nicholson, 22 B. T. A. 744; Mary G. Iba, 20 B. T. A. 222; Fremont Canning Co., 17 B. T. A. 484.

Issue (1) raises the question of petitioner’s right to the benefit of deductions in computing its taxable income, under the circumstances set out in our findings of fact above. Respondent determined the deficiencies on the basis of gross income, and contends that petitioner is not entitled to the allowance of any deductions because the facts do not bring it within the limitations prescribed in section 233 of the Revenue Acts of 1928 and 1932. Petitioner argues that the returns prepared on form 1120 and lodged with conferee Marsh of the Bureau of Internal Revenue in Washington on November 12, 1937, or the returns filed with the collector at Baltimore, Maryland, on October 28, 1938, constituted substantial compliance with the statute so as to entitle it to the benefit of the deductions now claimed. If the returns filed meet the requirements of the statute, the parties are in agreement as to the amounts of the deductions allowable, and respondent admits that in such event the deductions allowable for each of the taxable years exceed gross income, with the exception of the year 1929. Even if petitioner’s contentions be conceded, it still appears that it had taxable net income for 1929 in an amount not less than $10,740.48.

The alleged returns prepared for petitioner on form 1120 and verified in Cuba by Feustman on June 7, 1937, were during the same month attempted to be filed with conferee Muller in New York, but Muller refused to accept them. Petitioner argues that such refusal was wrongful. However, these same forms were later, in November 1937, tendered to and received by Marsh, an employee of the Burean in Washington, conditioned upon a settlement of the case.

In support of its contention that returns may properly be filed by a taxpayer with the Commissioner, or subordinate employee of the Bureau of Internal Bevenue, other than a collector, petitioner cites and quotes at length from an unreported opinion of this Board entered April 13, 1939, in American Investment & General Trust Co., Ltd., Docket No. 85714. It is obvious from petitioner’s quotation from such opinion that the cited case is distinguishable on the facts. There it was contended that no returns had been filed, but it affirmatively appeared that returns had been filed, since the deficiencies were determined upon the basis of information contained in returns accepted ly the Bureau. The deficiencies in the present proceeding had been finally determined by respondent on the basis of a revenue agentfs report, the deficiency notice mailed to petitioner, and the petition filed with the Board prior to the date on which petitioner’s first set of returns were tendered to and conditionally received by conferee Marsh in Washington. The cited decision does not support petitioner’s present contention.

Section 52 (a) of the applicable revenue acts provides that every corporation subject to the income tax shall make a return, and section 53 (b) (2.) provides that returns of corporations shall be made to the collector of the district in which is located the principal place of business or principal office or agency of the corporation, or, if it has no principal place of business or principal office or agency in the United States, then to the collector at Baltimore, Maryland. Also, section 233, supra, it will be noted, requires a foreign corporation to file its return with the collector in order to receive the benefit of deductions. There is no statutory authority for the making or filing of a return with the Commissioner of Internal Bevenue, nor is it his duty or the duty of any conferee or employee of the Bureau, other than the collector designated in the statute, to accept returns. This question was considered by us in W. H. Hill Co., 23 B. T. A. 605; affd., 64 Fed. (2d) 506; certiorari denied, 290 U. S. 691, where we said at page 607:

•Petitioner contends that a return for this fiscal year was executed by the officers of the petitioner and delivered to the revenue agent at his request; that he promised to file the return, and that the execution and lodgment of the return with the revenue agent meets the requirements of the statute. There is no merit in this contention. * * * It is no part of the duties of an internal revenue agent or of an internal revenue agent in charge to file returns for taxpayers. That is the duty which law places on the shoulders of the taxpayers.

Petitioner did not, by the lodgment of returns with conferee Marsh, discharge the duty which the statute laid upon it. Also, the action of petitioner in filing returns with the collector at Baltimore on October 28, 1938, was ineffective to bring it within the limitations of the statute so as to entitle it to the benefit of deductions. These returns were filed , (a) after respondent had determined the deficiencies and prepared returns for petitioner under section 3176 of the Eevised Statutes, as amended, and (b) after the petition and answer had been filed and the case was at issue-before the Board, and only approximately two and one-half months prior to the hearing. Returns filed under such circumstances do not meet the requirements' of section 233. Taylor Securities, Inc., 40 B. T. A. 696. On the point under discussion, the facts of the instant proceeding are not distinguishable in. any material respect from those of the Taylor case. On authority of that decision and for the reasons therein stated, which need not be repeated here, respondent’s action in computing the present deficiencies without the allowance of deductions is approved.

The third issue is whether or not profit derived by petitioner from the sale in 1929 of 586 shares of Bank of America stock is subject to the United States income tax. Respondent determined, as stated in the deficiency notice, that petitioner sold 586 shares of Bank of America stock on May 27, 1929, and realized therefrom a profit of $63,093.06; also that petitioner sold 83 shares of stock of the same bank on "September 19, 1929; at a profit of $13,712.43. The profit from both transactions, in the aggregate amount of $76,805.49, respondent included in gross income in determining the deficiency for 1929. Petitioner assigns no error in respect of respondent’s action in taxing the profit on the sale of the 83 shares, nor does petitioner raise, any question concerning the asimount of the gain derived from the sale of the 586 shares, but alleges that the latter sale was made in Montreal, Canada. Hence, petitioner argues that the profit sought to be taxed to it- by respondent was derived by a foreign corporation from the .sale of property in a foreign country and is not subject to-United States income tax.' The sole question, then, is whether or not this sale was consummated in Canada, as petitioner avers, or whether it was in fact made in New York, as respondent contends.

The record does hot -disclose a very clear picture of the transaction in controversy. We have difficulty in ascertaining precisely what transpired in that connection. Feustman, president of petitioner corporation, testified in part as follows:

Q. Who was it, then, who approached the Ardhern Company, or you as president of that company, in connection with the sale of any part of the Bank of America stock, of the 4,251 shares?
A. I can not answer because I do not remember which one of the officers of Blair & Company came to me; but one of them did, I presume, and told me of a plan to sell certain amounts of stock by various stockholders in order to provide, at a special price, stock for some of the percentage men in the old firm of Blair & Company. * * *
Q. Then give me the details of how Ardbern Company sold a part of its stock of the Bank of America. * * *
A. At sometime after the merger, one of the senior officers of Blair & Company came to me and asked me whether my company would not sell a certain number Of shares of stock at a price far below the market in order to provide'some stock for certain other people to purchase, and I s'aid yes, I would do it. ■
Q. Was that person a member of this committee that was formed?
A. I do not know. I presume so, but I can not say yes. * * *
Q. And after you gave your consent to it, what happened?
A. I presume that after I' gave my consent the stock was sold. ‘ * * *
Q. ■ What part did you, ■ as a representative of Ardbern Company, have to do with the sale of this stock? • . :
A. Nothing. * * * • .
Q. Did you authorize Mr. Crooks to take the certificates up to Montreal and sell them there?
A. T personálly did not, no.
Q. What.other officer or employee of Ardbern Company authorized Mr. Crooks to take the certificates up to Montreal?
A. I presume the one who authorized him to was the person to whom I had agreed to sell the stock.

Feustman, further, testified that while he had no personal knowledge.of the-matter, he understood that the .586 shares sold by his company, the certificates of which were in the possession of the Bancamerica-Blair Corporation, were sent by a messenger, one Crooks, an employee of that corporation, to Montreal, Canada, where they were sold to the Bank of Montreal, which paid petitioner corporation by check or draft deposited to its credit in the Canadian Bank of Commerce; he did not know who purchased the stock owned by the Ardbern Co.; it was not handled as an individual transaction, but as a part of a composite sale that involved “a lot of money and other shares of stock.”. Prior to this transaction, the certificates representing the shares of .stock owned by petitioner had been handed to-Feustman for. endorsement:

Crooks .testified that on May 25, 1929, he received from the securities clerk of the Bancamerica-Blair Corporation certificates representing more than. 15,000 shares of Bank of America stock (including the 586 shares owned by petitioner), and was instructed by. a member of the stockholders’ committee or by the treasurer , of Blair & Co. to. take the certificates to Montreal, Canada, for the purpose of making a sale of stock at that place. Prior to his departure Crooks had no discussion.with Feustman regarding the matter, and made no report to him on his return. What Crooks did in Montreal, as related in his testimony,-we have summarized in our findings of fact above. It is; not shown that Crooks had any authority to make a sale but was merely the messenger who carried the stock certificates to Montreal. Prior to Crooks’ departure, the sum of $2,120,950 was deposited with the New York agency of the Bank of Montreal, and a corresponding credit was wired to the Canadian Bank of Commerce, which distributed the money, upon Crooks’ arrival with the stock certificates, in accordance with instructions contained in a letter from the treasurer of the Bancamerica-Blair Corporation. In accordance with those instructions, $1,568,360 was wired back to New York for use of the Bancamerica-Blair Corporation two days later, on Monday, May 27.

While the details of the transaction are not clear, as before pointed out, it does reasonably appear, we think, that nothing was done in Canada which could be construed as constituting a sale of the stock involved in this case. Petitioner’s stock certificates were endorsed in blank by Feustman, as president, and delivered in New York to the committee or other person representing the purchaser or purchasers. Neither Feustman nor any other officer of petitioner authorized or directed any one to take the stock certificates to Montreal, Canada, for sale.

No negotiations between the parties were carried on in Canada; no contract of purchase or sale was entered into there; neither purchaser nor seller was present in person or represented by an agent in Montreal, unless Crooks or the Bank of Montreal could be so designated, and certainly the record does not indicate that either had any authority to represent any one in connection with the making of the sale of stock in controversy. Crooks merely took the stock- certificates to Montreal and turned them over to the bank. The bank performed purely clerical functions in accordance with the detailed instructions contained in the letter from the treasurer of the Bancamerica-Blair Corporation.

Whatever was done to constitute a purchase on the one hand and a sale on the other obviously was done in New York. Prior to the departure of Crooks for Montreal, all negotiations had been concluded and the contract of purchase and sale assented to by all interested parties; the stock certificates were in “street names” in the possession of the Bancamerica-Blair Corporation; they were endorsed in blank, so that physical delivery would constitute transfer of title, and the money consideration to be paid for the stock was likewise then in the possession of the same corporation, having been taken out of credits to the account of the percentage men. Many of the percentage men, who were the purchasers, lived in and near New York City. So far as they were involved, therefore, the money which they had paid and the stock certificates which they were to receive therefor were merely sent up to Canada, the money returned immediately for delivery to the sellers and the certificates returned for delivery to the purchasers. In fact, of the $2,120,950 wired to Montreal on May 25, more than a million and a half dollars was returned for use of the Bancamerica-Blair Corporation on May 27, apparently, for payment over to certain of the sellers. This, in our opinion, did not constitute a sale in Canada. As to petitioner, it does not appear specifically what disposition was made of the certificates of stock owned by it, but the amount of the selling price was placed to its credit in the Canadian Bank of Commerce on May 27 and withdrawn by check four days later, on May 31.

After an agreement of purchase and sale has been entered into and to complete the transaction there remains only an exchange to be made of the property for the consideration, the sale can not be said to be made at another place merely because such exchange is consummated there. The sale is made at the place “where the final act of the seller, causing title to pass, was done.” East Coast Oil Co., S. A., 31 B. T. A. 558; affd., 85 Fed. (2d) 322; certiorari denied, 299 U. S. 608. Any other conclusion would be to regard form rather than substance, to “elevate artifice above reality.”

“It is' well established that title to property passes at the place of sale where the final act of the seller making effective the sale takes place.” Hazleton Corporation, 36 B. T. A. 908, 923, and authorities cited. When Feustman, as president of petitioner corporation, endorsed the stock certificates in blank and delivered them to the agent of the purchasers in New York, it not being shown that it was intended that title thereto should pass at some other time or place, nothing further remained to be done by the seller, petitioner herein, to make the sale effective in accordance with Feustman’s agreement. Petitioner was thereupon entitled to receive the consideration agreed upon. There is nothing in the record to indicate that Feustman bad agreed that the sale should be consummated in Canada, or that the transaction there was at his request or for the benefit of his company. Obviously, of course, he must have designated the Canadian Bank of Commerce as a depositary of the money to be paid for the stock, but he testified that neither he nor any other officer of petitioner corporation authorized Crooks to take the certificates to Montreal and sell them, but that such proceeding, he presumed, was authorized by the person to whom he had agreed to sell the stock. Feustman testified that after he endorsed and delivered the certificates in New York he had nothing further to do with the transaction.

Petitioner cites and relies principally upon the East Coast Oil Co. and Hazleton Corporation decisions, supra. The factual situations in those cases distinguish them from the present proceedings. In the Hazleton case, while the taxpayer corporation negotiated the sale of its stock to the bankers in San Francisco, it was clearly understood that the sale was to take place in Canada and not in ■ the' United States. The agreement to sell was specifically predicated upon that condition. The stock certificates were then in Canada, on deposit with the Bank of Montreal. The bankers appointed'the Boyal Trust Co. of Montreal their agent for the purchase- of the stock. On the facts presented, we-reached the conclusion that the sale was-consummated in Canada for the reason that it was the' intention of all parties concerned that the seller should part with its title in the stock by delivery of the shares to the Royal Trust Co. in Montreal. No such facts appear in the instant case.

In East Coast Oil Co., S. A., supra, the taxpayer was ^ Corporation organized under the laws of Mexico, dealing in crude petroleum and having agents in the United States for negotiation of sales.: The profits sought to be taxed arose from sales of oil to parties in the United States through agents of the company, under contracts for future delivery, payments to be made to such agents in the United States after delivery. Some of the' contracts- provided for delivery f.o.b. and others for delivery c.i.f. Under either - form of contract, title to the oil passed from seller to buyer on delivery of the oil to the ocean carriers at the company’s docks in- Mexico. ■ In affirming our decision that the profits derived from such sales were not subject to the United States income tax, the Circuit Court of Appeals said:

In this case the important question is when and where were the profits earned. The company is a Mexican corporation, necessarily domiciled in that country. The property sold was produced in Mexico. The contract provided for firm sales. No profit resulted from the mere execution of the contracts. The oil was delivered to the buyer in Mexico. The title passed .to the .buyer in Mexico. When title passed the profit was earned in Mexico. Collection of the price in the United States was merely incidental and did not earn the profit.

In the instant case, since petitioner, acting through its president Feustman, endorsed its stock certificates in blank and delivered them to the agent of the purchasers in New York and it is shown that petitioner did not authorize any one to take the certificates to Canada for sale or delivery to the purchasers, we hold that the sale was made in New York, and that the profit derived therefrom is subject to the United States income tax. Collection of the price in Canada “was merely incidental and did not earn the profit.” On this issue, respondent’s determination is approved.

Issue (4) involves the question of whether or not petitioner received taxable gain from distributions- made to it in 1982 by the. Suffolk Corporation of Delaware or by the Suffolk Co., Ltd., a Newfoundland corporation. In computing the deficiency for 1932, respondent included in petitioner’s gross income “distribution from Suffolk .Corporation $49,340.84.” Petitioner alleges that respondent erred “in determining that tbe taxpayer received a taxable distribution from the Suffolk Corporation during the year 1932 amounting to $49,340.84, or a taxable distribution;in.any amount.”

:-Petitioner contends that, since the Suffolk Corporation transferred substantially-all of its assets to the Suffolk Co., Ltd., in exchange for all the latter’s stock, this was a reorganization within the meaning of clause (B) of section 112 (i) (1.) of the Revenue Act of 1928, and, since the Suffolk Corporation immediately distributed to its shareholders, in pursuance of the plan of reorganization, all of the Suffolk Co.’s stock without the surrender by its shareholders of their stock in the'Suffolk Corporation, no gain to, the distributees is recognizable under the provision of section 112 (g) of the 1928 Act.

Respondent takes the position that the transaction did not constitute a reorganization under the doctrine of Gregory v. Helvering, 293 U. S. 465, but further contends, in the alternative, that, even if it should be held to be a reorganization, petitioner would still remain subject to tax on ¡gain from distributions made to it during 1932 by the Suffolk Co., Ltd.,'in an amount equal to that determined by respondent, The latter.'contention is based on the provisions of section 119 of the Revenue Act of 1932, to which further reference will be made.

■While the deficiency notice alleges that petitioner received taxable gain in the amount included therein in income from Suffolk Corporation of Delaware, respondent says that the pleadings are broad enough to include a distribution of that amount from any source, and on this point petitioner does not object to the sufficiency of the pleadings. It should also be noted that petitioner on brief raises no question as to the amount of the distribution taxable to it, if it should be held to have received a tcCmable distribution, during 1932.

In connection with the consolidation of the Blair companies with the Bank of America in 1929, the Suffolk Corporation of Delaware was organized for the ostensible purpose, of liquidating such of the Blair assets as were not taken over by the Bank or its subsidiary. Undoubtedly ■ one of the purposes of the organizers of the Suffolk Corporation wa's.to have it effect such liquidation, but the conclusion is inescapable from a consideration of the whole record that that was not the sole actuating motive.

Shortly after the formation of the Suffolk Corporation in 1929, it proceeded to make cash “loans” to its stockholders at the rate of $20 per share, taking interest-bearing promissory notes of the stockholders therefor. Petitioner owned 3,250 shares of Suffolk Corporation stock and received a “loan” in the amount of $65,000. Since the Suffolk Corporation’s capital stock consisted of 205,853 shares, it must have distributed more than four million dollars among its stockholders in the form of so-called loans. The source from which the corporation obtained this money, like many other pertinent and material facts, the record does not directly disclose; however, since these “loans” were made to the stockholders shortly after the formation of the Suffolk Corporation, the assumption would seem to be justified that it had received the funds, along with other assets, either from Blair & Co., the partnership, or from Blair & Co., Inc., or both. Obviously, the new corporation had not had sufficient time to realize such a large sum of money from the liquidation of assets.

At any rate, late in 1931 or early in 1932 the directors of the Suffolk Corporation decided to declare a dividend payable in the notes of the stockholders then held by it, but it developed that, because of the insolvency of some of the stockholders and the pledging of their stock as collateral security for loans, this could not be done under the laws of any state of the United States. Upon consultation with an attorney in New York, it was ascertained that a corporation organized in Newfoundland could declare a dividend payable in stockholders’ notes, or offset the notes against dividend payments in the circumstances involved. Accordingly, in February 1932, the Suffolk Corporation of Delaware caused the Suffolk Co., Ltd., to be organized under the laws of Newfoundland, and the former corporation transferred substantially all of its assets to the latter company in exchange for all its capital stock. Thereafter, on February 20, 1932, the Suffolk Co., Ltd., declared a dividend of $2,100 per share, which was paid in notes and cash, and in July of the same year declared another dividend of $175 per share, which was paid in cash.

As a result of these transactions, the large accumulation of cash which the old Blair concerns apparently transferred to the Suffolk Corporation, along with other assets to be liquidated, was finally distributed to the old Blair stockholders in their capacity as Suffolk stockholders, and, at least so far as the present petitioner is concerned, if its contentions be sustained, it has received its proportionate part of such cash without the payment of any tax thereon.

The facts established by the evidence immediately suggest a number of questions, definite answers to which it is difficult to find in the record. Why did not the Blair firm distribute the accumulated cash to its stockholders at or prior to the consolidation? .If it had done so, the stockholders would have had to pay a tax on their dividends, but, by transferring the funds to Suffolk of Delaware and causing that corporation immediately to distribute the money among the stockholders as “loans”, no tax liability was incurred. Whatever may have been the motive for the so-called Suffolk reorganization, we think the evidence does not indicate that it was for the purpose of reorganizing the corporate business. It is well settled that if a transaction is such as to constitute a reorganization in reality, it is to be treated as nonetheless effective because of a motive to decrease or avoid taxes. But if every element required by the quoted statute is to be found in what was done, the transaction does not constitute a statutory reorganization unless it is a reorganization of the corporate business; “a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either” is not a reorganization within the meaning of the taxing statute, whether the motive relates to taxation or anything else other than a business or corporate purpose. Gregory v. Helvering, supra.

Petitioner suggests in its brief that the purpose of the alleged reorganization was to put the Suffolk Corporation on a basis which would be fair to all of its stockholders; that, because some of the stockholders had become insolvent and pledged their stock, the, impossibility of collecting upon their notes would result in a relative loss to stockholders who were : able to pay. But another result achieved by the transfer of the Suffolk Corporation’s assets to the Newfoundland company was to diminish or perhaps absolutely destroy the value of the collateral pledged by the insolvent stockholders to secure loans made by their creditors in good faith. Neither such a result nor the purpose suggested by petitioner, we think, had any reasonable relation-to the business of either corporation, and therefore did not constitute a reorganization within the meaning of the tax act. Cf. Robert M. Morgan, 41B. T. A. 379.

We need not, however, rest our decision of this issue solely on the conclusion that the transaction was not a reorganization. Section 119 (a) (2) (B) of the Bevenue Act of 1932 provides that an amount received as dividends from a foreign corporation shall be treated as income from sources within the United States unless less than - 50 per centum of the gross income of such foreign corporation was derived from sources within the United States. It is not shown in the instant case what percentage of the gross income of the Suffolk Co., Ltd., was derived from United States sources, and hence -the dividends received by petitioner from that corporation in 1932, to the extent determined by respondent, must be treated as income subject to United States income tax.

The petitioner strenuously objects to such holding on-.the ground that, since the deficiency notice said nothing with' respect -to any distribution from the Suffolk Co., Ltd., it was respondent’s burden to prove that the distributions in controversy come within the provisions of section 119, and, there being no proof on this point, respondent can not prevail. In support- of this contention, petitioner cites Tex-Penn Oil Co. v. Commissioner, 83 Fed. (2d) 518; affd., 300 U. S. 481, which is based upon Helvering v. Taylor, 293 U. S. 507. Both of those decisions rest upon an affirmative showing that the tax determination of respondent was arbitrary and excessive. No such showing is-made in the case at bar. The burden here is upon petitioner to 'show in the first instance that respondent’s determination is erroneous. See authorities cited in the Taylor case, supra. Nor may we disapprove the deficiency determined by respondent in the absence of any evidence that the deficiency is erroneous in amount, even if' it is shown to be based upon an erroneous principle. Houston Lighting & Power Co., 34 B. T. A. 745, 750; J. R. Raible Co., 18 B. T. A. 1140, 1142; American Bond & Mortgage Co., 15 B. T. A. 264. If petitioner in' fact received taxable income as determined by respondent, it is not our duty to aid it to escape the tax thereon merely because respondent, from the information before him at the time of his determination, erroneously concluded that the amount was received from the Suffolk Corporation instead of the Suffolk Co., Ltd. John I. Chipley, 25 B. T. A. 1103, 1106.

On the fourth issue, respondent’s action is approved. ■ "

The remaining issue is whether or not respondent' - has properly held petitioner liable for delinquency penalties because of its failure to make and file income tax returns for the taxable years within the time prescribed by law. Section 291 of the Revenue Acts of 1928 and 1932 provides that, in case of á failure to make and file a required return within the time prescribed by law, 25 per centum of the tax shall be added to the tax, except that when a return is- filed after such time and it is shown that the failure to file it-Was due to' reasonable cause and not to willful neglect, no such addition :shall be made tó the tax.

The duty imposed upon every taxpayer to make and file á timely return in accordance with the provisions of the revenue acts is not a matter of unimportance, and can be disregarded by a taxpayer only at his peril. Every taxpayer is in the first instance his own assessor, and it is his responsibility not only to file a return, 'but to make á full revelation and fair return of all taxable income, and to deal frankly and honestly with the Government. Charles E. Mitchell, 32 B. T. A. 1093, 1128. Petitioner in this case did neither.

All of petitioner’s capital stock was owned by Feustman, its president ; it was, during the taxable years, his personal holding corporation. Yet, so far as disclosed by the record, Feustman evidenced no interest in the matter of its tax liability. His attitude was that of complete and utter indifference. It is not shown that he even consulted the attorney whom he employed to organize the corporation, who acted as its vice president. Som,e four years after the return for the last taxable year was due, and after a letter had been received from the Commissioner proposing to assess tax deficiencies, the first steps were taken looking to the filing of the required income tax returns. Even then,.petitioner did not make a fair revelation,-.nor indeed any revelation, of the facts surrounding the transactions herein held to have produced taxable income, but decided all questions of tax liability in favor of his corporation. It was more than a year and four months after the first set of returns were prepared and verified by Feustman in Cuba before petitioner took the trouble to ascertain where and with whom the returns should be filed.

The only excuse offered by Feustman in his testimony for the failure to file returns within the time required by law was that he thought the corporation had sustained losses and there was no tax due. He thought that the Bank of America stock sold in 1929 was sold at a loss because the market value was approximately $250 per share when it was sold for about $150 per share; yet respondent determined that the cost basis of the stock was only $34.79 per share, and such determination was not questioned by petitioner. ' .

We think petitioner has not shown that its failure to file returns within the time prescribed by law was due to reasonable cause. The delinquency penalties determined by respondent are, theréfore, approved.

Reviewed by the Board.

Decision, in respect of all deficiencies in tax and penalties, except the fraud penalty for 19%9, will he entered for respondent.

Blace,

dissenting: I dissent from the majority opinion wherein it holds that petitioner has not filed income tax returns for the taxable years in question so as to entitle it to have allowed whatever legal deductions it has proved by the evidence in this case. The returns which petitioner has filed, though late, should in my opinion be considered as removing the ban prescribed by section 233 to the taking of otherwise legal deductions. Petitioner should be taxed with a delinquency penalty of 25 percent of whatever deficiencies there may be, if any, computed by the allowance of whatever legal deductions may have been proven. Cf. Anglo-American Direct Tea Trading Co., Ltd., 38 B. T. A. 711.

AkuNdell and HarroN agree with this dissent.

Leech:

I concur in the above dissent and, in addition, disagree with the conclusion which the majority reaches on the point appearing as number 4 in the headnote.

       SEC. 233. ALLOWANCE OF DEDUCTIONS AND CREDITS.
      A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this title only by filing or causing to be filed with the collector a true and accurate return of its total Income received from all sources in the United States, in the manner prescribed in this title; including therein all the information which the Commissioner may deem necessary for the calculation of such deductions and credits.

       SEC. 112. RECOGNITION OE GAIN OR LOSS.
      *******
      (i) Definition of Reorganization. — As osea in this section and sections 113 and 115 — .
      (1) The tetm “reorganization” means * * , * (B) a transfer' by a corporation of all or a part of its assets to. another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred * * * "

       (g) Distribution of Stock on Reorganization. — If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or’ in another corporation a party to the reorganization, without.the surronder'by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.


source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    F. Eldred Boland, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95157.
    Promulgated April 24, 1940.

      J. W. Radii, Esq., for the petitioner.

      Harry R. Sorrow, Esq., for the respondent.
   OPINION.

Van Fossan:

The sole question for consideration is whether, or not the agreement of February 28, 1929, converted petitioner’s earnings for personal services from community property- to his own separate property. Petitioner contends that-the' wife reserved a, right in the community property and that the community was not’ destroyed by the agreement. He maintains that the wife retained her community interest in a portion of his earnings and, hence, that interest is not taxable to petitioner. Kespondent, on the other hand, argues that the agreement substituted a new right in petitioner’s wife in lieu of her community rights and, therefore, petitioner should be taxed upon his entire earnings during the taxable years.

In the absence of agreement to the contrary, petitioner’s earnings during the taxable years would have been community property. California Civil Code, sec. 161a, 162-164. Nor is the fact that petitioner and his wife were separated material. Brown v. Brown, 170 Cal. 1; 147 Pac. 1168. Community income earned and received after 1927 must be returned one-half by the husband and one-lialf by the wife. United States v. Malcolm,, 282 U. S. 792. Under California law, a husband and wife may enter into a contract with each other respecting property. California Civil Code, sec. 158. Such a contract may apply to community property. Cheney v. City & County of San Francisco, 7 Cal. (2d) 565; 61 Pac. (2d) 754. Thus, under local law, petitioner’s wife might enter into a contract changing her rights in the community.

For purposes of income tax, effect will be given to contracts abrogating community rights. Helvering v. Hickman, 70 Fed. (2d) 985. Having determined that petitioner and his wife might, by contract, convert petitioner’s earnings from community property to his own separate property, we now inquire as to the effect of the agreement of February 28, 1929.

The petitioner and respondent base their respective arguments mainly on divergent interpretations of paragraph 6 of the agreement, which is set forth in our findings of fact. Petitioner contends that the wife reserved a portion of her community rights by virtue of this paragraph. Upon examination of the agreement as a whole, we conclude that respondent correctly determined that the parties intended to, and did in fact, terminate the community status. The wife excepted from her release only her right to receive 25 percent of petitioner’s earnings and the community property consisting of the shares of stock, real estate, and insurance policies which petitioner agreed should become the separate property of the wife. Here there is no reservation of a community interest by the wife. She released all her rights except a stipulated portion of petitioner’s salary and her ownership of specifically described property turned over to her by this very agreement. She accepted, in lieu of her community interests, an assignment of 25 percent of petitioner’s earnings, not to fall below a specified minimum. In the year 1934 the practical effect of the agreement was to give the wife all but $507.20 of petitioner’s earnings. This was far in excess of any community interest which petitioner’s wife might have under the California law. In our opinion the agreement converted petitioner’s earnings during the taxable years from community property to his own separate property.

Assignment of earnings does not preclude taxation of those earnings to the assignor. Lucas v. Earl, 281 U. S. 111. Accordingly, we hold that all of petitioner’s earnings are includible in his gross income for the taxable years.

Decision will be entered umder Rule 50.


author: Opper :

text:
    Harry J. Riebe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95152.
    Promulgated April 24, 1940.

      George D. Finnie, G. P. A., for the petitioner.

      DeWitt M. Evans, Esq., Paul A. Sebastian, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Opper :

Petitioner assails respondent’s' inclusion in bis income of two-thirds of the proceeds of a lottery ticket purchased by petitioner. Petitioner contends that he made a gift to his wife and children of that portion of the ticket and that he is not chargeable with its receipt. The gift, however, is not asserted as of the time of original purchase, but is claimed to have taken place between the initial drawing and the running of the horse race upon which the ultimate result depended.

The problem presented is perhaps elusive by reason of the divergent principles necessarily to be applied. Although gambling transactions may be illegal and contracts and rights resulting therefrom unenforceable, income produced thereby is nevertheless taxable. United States v. Sullivan, 274 U. S. 259. It is petitioner’s contention in effect that, since his contract with the sweepstakes operators was unenforceable, he should be charged only with that part of the income which he actually received; and, since the claimed arrangement whereby he was to permit members of his family to share in the proceeds was in fact executed, that he is entitled to treat as his income only that which actually came into his hands.

We think petitioner can not succeed. It is clear that when the ticket was purchased it became his property and that its avails would be taxable to him unless some intervening alteration of that ownership can be found to have taken place. It is petitioner’s claim that evidence of such an event is furnished by his statement to his wife and children that he was giving them a share in the ticket. Granting that that transaction occurred exactly as described by the petitioner’s witnesses, we think the evidence falls short of showing that such a change in ownership as would follow from a completed gift has thereby been established. There is no evidence of anything more than petitioner’s oral statement. The official receipt referred to as the ticket was in petitioner’s possession. He could have made physical delivery to the donees or at least to some one in their behalf and his own. It would have been possible for something in the nature of a symbolic or constructive delivery to have taken place as, for example, the execution of an instrument of gift. See Henry v. Graves, 16 Gratt. (57 VA) 244, cited by ■ petitioner. Nothing of the sort, however, was even attempted, so far as the record, shows. We can not say, therefore, that petitioner made as perfect a delivery “as the nature of the property and the circumstances and surroundings of the parties will reasonably permit.” Lunsford Richardson, 39 B. T. A. 927. Since such delivery is an essential of a valid gift, we think petitioner has failed to show that his original ownership was diluted prior to the time when the proceeds of the ticket were fully collectible. Lunsford Richardson, supra.

Petitioner contends that since the subject matter, a gambling contract, was incapable of lawful transfer, it is of no consequence that the gift was legally incomplete. We are of a contrary opinion. There is no reason to assume that for tax purposes the requirement of a completed transfer of some kind is to be dispensed with and the original owner is to be permitted to escape the tax consequences of his own transactions merely because there is some unenforceable element aside from the inconclusiveness of the transfer itself. If anything, we may regard the requirement as more forceful because by a completed physical transfer petitioner could have eliminated at once the doubly ineffectual character of the present contract as to both its lack of consideration and its illegal subject matter. To hold with petitioner that the legal requisites of a gift may be dispensed with here would place the owners of unlawful contracts in a favored position over those dealing with legitimate property. We see no necessity for such a result. Petitioner must be treated as the sole owner of the ticket and its proceeds, and not as jointly interested therein with his wife and children. See Christian H. Droge, 35 B. T. A. 829, 833.

It is contended that petitioner’s failure to receive the proceeds of the ticket, beyond the one-third share which he retained, makes application of the doctrine of constructive receipt impossible and leads to the conclusion that he is taxable only on what he actually obtained. The evidence shows that, in spite of petitioner’s notification to them, the sweepstakes authorities had a check for the full amount, payable to him, ready for delivery. It was his suggestion and not theirs that resulted in the delivery of a check to his order for the smaller amount. While it may be true, although no evidence of the Canadian law has been introduced, that petitioner could not have compelled the payment of the entire amount or of any part of it to himself if the debtor had resisted, yet that is not what happened and we think upon these facts petitioner voluntarily “turned his back” upon the proffered payment of the full amount of the winnings. See Cecil Q. Adams, 20 B. T. A. 243, 246; affd., 54 Fed. (2d) 228 (C. C. A., 1st Cir.); Saenger, Inc. v. Commissioner, 84 Fed. (2d) 23 (C. C. A., 5th Cir.). Unless the doctrine of constructive receipt is inapplicable to illegal transactions, and we see no reason why it should be, it is equally conclusive here.

The cases of Christian H. Droge, supra, and Samuel L. Huntington, 35 B. T. A. 835, are distinguishable from the present facts. In the Droge case the reasoning employed by the Board in permitting petitioner to deduct that portion of the winnings which he paid to his wife was that petitioner’s arrangement with his wife was itself a gambling transaction. It was the result of the pooling of their respective tickets. The Board held that petitioner was entitled to set off against his gambling gains the loss sustained in the gambling transaction with Ms wife. See Mitchell M. Frey, Jr., et al., Executors, 1 B. T. A. 338. There is, of course, no basis for any such determination here, since there was no arrangement of any kind with petitioner’s family which could be treated as the cause of an offsetting gambling loss.

In the Huntington case the petitioner husband had placed the ticket in his wife’s name, put it in her possession, and caused the authorities to deal with the ticket in such a way that when the winnings were distributed it was to his wife and not to petitioner that they were payable. Petitioner’s right to receive any portion of the winnings was the result of a contract by which his wife had agreed to make such a payment to him. It is apparent that he was not the owner of the ticket nor chargeable with any part of the winnings to which he was not entitled by reason of the contract with his wife. And the Board pointed out that the situation of the wife was not before it.

It is suggested that certain language of the Board with reference to double taxation is favorable to petitioner. We think it clear that in its context that statement has no application to the present case. Here, as we have seen, there was no effective transfer to the wife and children until the proceeds had actually been collected and, passing through the hands of petitioner, had reached his wife and children as gifts of money represented by the bank drafts. The income upon which petitioner is taxable had already been received by him, at least constructively. The receipts by the wife and children were by way of gift and not as a taxable result of the gambling venture. It follows that these proceeds were not taxable income to any one but petitioner and hence that no taxation of him will result in the double taxation to which reference was made in the cases cited. And at least as to the wife, though it may be immaterial to this discussion, the enactment of section 820, subdivision (b) (1), Revenue Act of 1938, may well place her in a position to correct the results of her mistaken self-assessment.

Decision will he entered for the respondent.


text:
    Kay Kimbell, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92955-92959, 94673-94674, 94689-94690.
    Promulgated April 25, 1940.

      Hamf O. Weeks, Esq., and B. B. Gannon, Esq., for the petitioners.

      H. G. Clark, Esq., James L. Bachstrom, Esq., and D. D. Smith, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Mrs. Kay (Velma) Kimbell; Wm. Fleming; Mrs. Wm. (Anna Hand) Fleming; Fleming-Kimbell Corporation; and Anna Maud Fleming.

   OPINION.

Black.:

Tlie issues will be considered in the order previously stated.

Issue 1. — The principal issue is whether petitioners Fleming and Kimbell and their respective wives during the years 1934 and 1985, constructively received any of the oil payments reserved by those petitioners in 1931 when they assigned to the Fleming-Kimbell Cor-, poration the six leases mentioned in our findings of-fact, or whether-the corporation properly reported the income in question. The’ respondent has treated the income as belonging both to the corporation and also to the individuals, but now concedes that, if his determinations as to the individuals be sustained, the income which he proposes to tax to the individuals must, to the extent that it is also included in the corporation’s income fo.r the fiscal year ended April 30, 1935, be excluded therefrom.

The facts regarding this issue are fully set- out in pur findings. The issue turns on the recognition to be given- the second oral agreement entered into late in 1933 whereby the time when Fleming and Kimbell were to share in the oil produced from the six leases assigned to the corporation in 1931 was extended from January 1,' 1934, to September 16, "1936. It is only by giving'recognition to the first oral agreement entered into at the tune the leases were assigned tó the corporation that the respondent has any semblance of reason, for his determination that the individuals constructively received the income in question. If the parties had a right to make the first oral'agreement, they had a right to make the second, and our only concern is whether these agreements actually exist£d„andjwere’ inv' ■f-H^ild^~aFTeairgeiinine, bona fide"agreements between the parties, "jj TEe'"a"greéments-afé^ñppbrted by uncontradicted testimony of rep's utable and credible witnesses. This testimony is borne out by.the | conduct of the parties and is verified by written instruments sub- | sequently executed which appear to be in all respects regular and trustworthy. Upon such a record, we know of no reason why from a tax standpoint full legal effect should not he -accorded the second' oral” agreement referred to above, which was entered into prior to ■ the date that any of the oil payments"ili' 'question were to' begin. Under that agreement Fleming and Kimbell were not -entitled to. receive-any of the production which was-to apply against their reserved interests until September 16, 1936. Until that time all of the production belonged to the Fleming-Kimbell Corporation,, and we think it was correctly reported as income by that corporation. It may be proper also to say at this point that the evidence shows that both Kimbell and Fleming sold or exchanged their $114,250 oil payments in years later than 1935. Fleming’s exchange of $59,000 of his oil payment in 1936 is the subject of issue 4, later to be dis'cussed herein. The $15,000 extra oil payment which each was to receive as consideration for the extension of the time of payment was received by each in years later than the taxable years we have before us, and each reported that amount in his income tax return for taxation. It follows that the respondent was in error in determining that petitioners Fleming and Kimbell and their respective wives were in constructive receipt of income during 1934 and 1935 ■ by virtue of the reservations of oil made at the time the six leases were assigned to the corporation in 1931. Cf. George P. Douglas, 1 B. T. A. 372. No change, therefore, will be made in the income reported by the corporation and approved by ■ the respondent for the'fiscal year in question. - -

In support of his determination, the respondent in his brief cites Herbert v. Commissioner, 81 Fed. (2d) 912; Hamilton National Bank of Chattanooga, Administrator, 29 B. T. A. 63; Corliss v. Bowers, 281 U. S. 376; John A. Brander, 3 B. T. A. 231; Helvering v. Gordon, 87 Fed. (2d) 663; Security First National Bank of Los Angeles et al., Executors, 28 B. T. A. 289, 316; Brooks v. Commissioner, 35 Fed. (2d) 178; American Trust Co., 21 B. T. A. 30; and Isadore Schuman, 20 B. T. A. 1167. These cases could be in point only if no recognition were given to the second oral' agreement. For reasons already given we think the question at issue is controlled by the second oral agreement, which we hold to be entirely valid, and on this issue we decide against the respondent.

Issue B. — The second issue is whether the respondent erroneously limited a loss sustained by petitioner Fleming and his wife in 1934 through the sale of a business property formerly occupied by them as their residence. In 1921 petitioners constructed a residence at a cost in excess of $50,000. On June 1, 1930, they converted it into rental property, at which time it had a fair market value of $35,000. Petitioners sold the property in 1934 for $10;000. ~ The depreciation .sustained between June 1, 1930, and the date of sale in 1934 was $2,450. ’ The respondent determined that the “los? recognized,” as that term-is used in section 117 (a) of the Revenue Act of 1934, was the amount of $22,550; that petitioners had held the property for more than ten years; and that under section 117 (a) only 30 per centum of the loss recognized could be taken into account in computing net income.

At the outset petitioners concede that under Heiner v. Tindle, 276 U. S. 582, the loss to be taken into, account could in no event exceed $22,550, which is the difference between the fair market value of the property when rented on June 1, 1930, less depreciation; and the selling price. They contend, however, that the respondent erred in using the amount of $22,550 as the “loss recognized upon the sale” as the word “recognized” is used in section 117 (a). Petitioners contend that the word “recognized” refers back to section 112 (a) which provides that “Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except [for certain provisions not herein applicable]”; that the entire amount of loss determined under section 111 is the difference between the original cost of $50,000, less depreciation (no proof of which is in the record), and the selling price; that the result thus obtained is the “loss recognized” to be used in applying the percentages provided in section 117 (a), which under this contention petitioners concede would be 30 percent; and that the result thus obtained would then be limited to the maximum amount of $22,550 computed under Heiner v. Tindle, supra.

We see no merit in this contention. It is our opinion that in the case of residential property which has been converted into business property and later sold at a loss, both the “loss recognized” under section 117 (a), and the loss “determined under section 111” must be ascertained by applying the principles enunciated in Heiner v. Tindle, supra, and that in the instant case the loss so “recognized” to be taken into account in computing net income at the percentages mentioned is the above amount of $22,550.

As an alternative, petitioners contend that the period of holding should commence from J une 1, 1930,’ so as to bring the percentage limitation within the 60 percent bracket instead of the 30 percent bracket. We think that under the plain provisions of section 117- (b) the property in question had been “held” by petitioners since 1921, which was more than ten years prior to the sale thereof in 1934. In making his determination in this respect the Commissioner has followed his I. T. 3041, reported in C. B. 1937-1, p. 148. We think this determination is correct.

The respondent’s determinations in Docket Nos. 92957 and 92958, in so far as they relate to the second issue, are sustained. Cf. Paul and Mertens. vol. 2. sec. 19.16.

Issue 3. — The respondent must he sustained as to this issue upon the authority of Helvering v. Wilshire Oil Co., 308 U. S. 90, and F. H. E. Oil Co. v. Helvering, 308 U. S. 104.

Issue If. — Richter Exchange. — The assignment of error as to this issue in Docket Nos. 94689 and 94690, as far as it relates to the Richter exchange, is the same, namely: “Respondent erroneously determined that Petitioner and wife [husband in Docket No. 94690] received taxable income in the year 1936 in the sum of $858.46, by reason of an exchange of an interest in an oil and gas lease for an oil payment.” The facts are set out in our findings and need not be repeated.

Petitioners contend that the exchange of their working interest (except for a reservation of one-fourth of seven-eighths of produc-' tion until oil of the value of $4,000 was received) in the Richter “A” lease, together with all the leasehold equipment and personal property located thereon, for two certain oil payments of $6,500 and $8,500 to be derived from oil when, as, and if produced from the Richter “B” and “C” leases, respectively, constituted a nontaxable exchange under section 112 (b) (1) of the Revenue Act of 1936. This contention must be decided against petitioners, upon the authority of Midfield Oil Co., 39. B. T. A. 1154. All that we said in that case is substantially applicable here. Petitioners, however, further contend that:

There is an additional reason why taxable gain cannot be recognized from the Richter transaction. Mr. Fleming received a contingent oil payment depending entirely upon production of oil and cannot be required to treat the receipt of such an interest in property as taxable gain under Rocky Mountain Development Company v. Commissioner, 38 B. T. A. 1303. Instead, he is entitled to apply all of his receipts from the oil payment to liquidate the cost of the property exchanged and is required to report only the excess when received as income.

The respondent objects to this further contention upon the ground that it is untimely, untenable, not raised by the pleadings and is presented for the first time in petitioners’ brief.

We think petitioners’ additional contention is within the assignment of error, and should be sustained. In Edwards Drilling Co., 35 B. T. A. 341; affd., 95 Fed. (2d) 719, we said: “The fact that the rights had a fair market value does not of itself require that the amount thereof be accrued as taxable income.” In the instant proceedings, the respondent not only attempts to tax petitioners on what he terms as the value of the two oil payments to be received from the Richter “B” and “C” leases, when, as, and if produced, but also attempts to tax petitioners on the value, of what they reserved in the Richter “A” lease, We think this constitutes error on the part of the respondent. Columbia Oil & Gas Co., 41 B. T. A. 38, 46. We decide this issue, in so far as it relates to the Richter exchange, for the petitioners. There will be no taxable income from this exchange to petitioners until they .have recovered from the contingent oil payments, the cost basis of the property which they gave in exchange for the contingent oil payments. Cf. Rocky Mountain Development Co., supra.

. Gomo Exchange. — Very little need be said regarding this transaction. It should be noted, however, that petitioners in this trails-action received in exchange for- contingent oil payments an outright-working interest in the Como lease. There was nothing contingent about this working interest which they received. In that respect it is unlike the contingent oil payments which petitioners received: in the Richter exchange discussed above. Petitioners likewise contend that this exchange is nontaxable under: section 112 (b) (1) of the Revenue Act of 1936. They concede that Midfield Oil Co., supra, is-adverse to such a contention but argue that 'the decision in that case is not warranted by the legislative history of the act. We will abide by our former decision. We hold, therefore, that the Como exchange was a taxable exchange, and, since petitioners have- offered no evidence to show that the respondent erred in - commuting the taxable profit of $22,532.29 as set. out in- our findings, 'we- affirm the respondent’s determination on this point. .’■■■■

The deficiencies should be redetermined in accordance with this ieport.

Decisions will he entered under Rule 50.

       SE.C- 117. CAPITAL GAINS AND LOSSES.
      (a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income;
      100 per centum if the capital asset has been held for not more than 1. year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years ; •
      60 per centum if the capital asset has been held for more than 2 years "but not for . .more than" 5 years ;
      40 per centum if the capital asset has been held for more than 5 years but not for for more than 10 years;
      30 per centum if the capital asset has been held for more than 10 years.
      (b) Definition of Capital Assets. — Eor the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business) * * *.


author: Leech :

text:
    Page Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 90515, 95674, 96186.
    Promulgated April 26, 1940.

      dames P. Quigley, Esq., and O. J. McCarthy, Esq., for the petitioner.

      E. O. Hanson, Esq., and Thomas R. Lewis, Jr., Esq., for the respondent.
   OPINION.

Leech :

Petitioner introduced no evidence and made no contentions on brief as to the so-called “management fee” of $16,800 nor as to the $147 paid on account of a capital stock tax. Having recourse to the usual presumption of correctness, respondent’s actions in these two respects are sustained.

Of the issues remaining for decision, the first is whether petitioner is entitled to a deduction of the interest on the four subordinate notes, which, is claimed to be deductible in each of the taxable years to the extent of $120,000. A necessary preliminary inquiry here is whether petitioner accounted on the accrual basis, for, since the interest was never paid, the only theory upon which petitioner may have this deduction is that it used the accrual method of accounting. Respondent did not question petitioner’s accounting methods in his deficiency notice or in his answer. He raises this issue for the first time on brief.

This record, we think, supported by the testimony of the bookkeeper who kept petitioner’s books, indicates the petitioner was properly on the accrual basis during the taxable years and was entitled to compute its income for those years on that system of accounting. Accordingly, we have found that as a fact. The minor deviations apparent here are not sufficient to affect that fact or its propriety, so long as income is accurately reflected. Niles Bement Pond Co. v. United States, 67 Ct. Cls. 693; 281 U. S. 357; M. D. Rowe, 7 B. T. A. 903. And there is nothing in this record that indicates otherwise than that this system reflected the income of the taxpayer reasonably accurately. Cf. Helvering v. Jane Holding Corporation, 109 Fed. (2d) 933. Since this same system of accounting and returns thereon had been used ever since petitioner’s organization, petitioner did not require the approval of the Commissioner to make a change, since no change, in fact, was made.

The evidence as to petitioner’s accounting basis discloses that proceeds from sales of oil, repairs, and general expenses of operation were accounted for only as realized or paid. But these oil sales were made to a pipe line company and were paid practically when accruable, i. e., when delivered to the pipe lines of the purchaser. So it was with labor.costs, which made up the greater part of the repair and general expense items. The book of original entry, petitioner’s journal, shows the computation of profit and loss, the closing entries for each year in which are reflected the deferred items here in question, and the balance sheets attached to the returns show that such returns were all made upon this accrual basis. The interest on notes and mortgages, taxes, insurance, salaries, and drilling costs were all accrued. Since the petitioner was using the “flooding” method for oil production, the oil and water wells drilled were permitted to stand for 12 to 18 months before production began. The costs of the drilling of these wells were billed to petitioner and then accrued as expenses, as each well was completed. It may be that some ambiguity exists as to whether these costs were then properly accruable, since they were to be paid, at least primarily, from oil produced from such oil wells. However, it is noted that these wells were all in a field which had produced oil over a long period of time and, as a practical matter, production was not in doubt. But even if not properly accruable until oil was actually produced from the wells, the significant fact remains that the costs for each well were thus accrued. It is the fact of accrual, alone, which is now denied by the respondent. The right to so accrue does not seem important because the right to deduct such accrued items is not questioned. After examination of the books of the petitioner for each year since its organization, respondent has permitted the deduction of these items as and when so accrued, as well as other accrued items, including interest on the development notes. He has not attacked, and does not here attack, the propriety of any of those deductions, although the items they represent had not been paid.

In his deficiency notice respondent disallows the claimed deduction for interest on the four subordinate notes only because “the essential element of cost of the property to you has not been established, nor has any detail with respect to the notes been submitted which justifies the interest accrual as an allowable deduction from income.” We take it that respondent was contending that the acquisition of the Ralph property by petitioner was direct from the Associated Producers Co., with Diament and Page merely as agents of petitioner in procuring title, and, accordingly, no consideration could be recognized except that of the $750,000 passing to the Associated Producers Co.

If this was the basis of the disallowance, the evidence not only contains nothing in support of respondent’s assumption, but, we think, convincingly disproves it. It is established that petitioner did not acquire all that Diament received from the Associated Producers Co. The former reserved a one-eighth carried interest in conveying to Page, while the conveyance by the latter to petitioner included the 100-acre lease acquired by him from Diament for a consideration of $50,000. In addition to this, it is shown that, subsequent to the acquisition of these properties from Diament, Page attempted unsuccessfully to dispose of them to othey interests and only upon the failure of these efforts were they conveyed to petitioner.

However, respondent contests the propriety of the deductions of interest upon two other grounds: First, that they were not bona fide obligations, intended to be paid, but merely the medium of obtaining a deduction for interest, and, second, that if bona fide obligations they are not of the character which permitted of the deduction of interest accrued in the taxable years before us.

In support of the first contention, respondent calls attention to the fact that the Ralph property was sold by the Associated Producers Co. for $750,000 and insists that this establishes its value as not in excess of that amount. It is urged that this fact negatives the bona tides of a transaction in which it is claimed the property was acquired by petitioner for a consideration in excess of $2,000,000. It is further argued by respondent that the proof is incomplete as to the total consideration paid by petitioner, in that the offer made by Page and accepted by petitioner was to convey the Ralph and Diament properties for $2,000,000 in subordinate notes, another note for $161,650, cash in the sum of $16,000, and the assumption of mortgages of $600,000 and $37,500, and that the only proof as to payment is the issuance of the $2,000,000 in subordinate notes and the assumption of the $600,000 mortgage on the Ralph property.

As to the first argument, it is quite true that the consideration paid the Associated Producers Co. for the Ralph property was $750,000, but a reasonable value for the property very largely in excess of that price is, we think, clearly established. Witnesses, qualified by substantial experience in oil properties and their market values in that section, testified to a value in excess of $3,000,000 for the property. The Diament lease on 100 acres, included in the sale to petitioner, had been bought for $50,000, or $500 per acre. This latter property lay within the Ralph property and at the same rate would indicate a value, for the latter, in excess of $5,000,000. In addition to this, there were on the Ralph property, in excess of $250,000 in equipment and approximately 200 producing wells. There is, in our opinion, ample evidence to sustain our finding of a value of $3,000,000 for the latter property. In view of the record, the acquisition of this property by Page and his associates for $750,000 is easily understood. It had been operated by the Associated Producers Co. under a method which had not proved successful. Page recognized its possibilities if the flooding method of production was used. The correctness of the estimate of value is well supported by the record of oil production under petitioner’s operation.

As to the lack of complete proof of the payment of the full consideration appearing in the offer and acceptance, it is noted that the only item of that consideration, the actual payment of which was questioned, was the $2,000,000 in subordinate notes. But there is direct proof of their issuance. The record is silent as to the payment of the other items of the consideration. In that situation we can not find that these other items were not paid. The witnesses with knowledge of the facts were examined and cross-examined, and were merely interrogated as to the issuance of the subordinate notes. Under these conditions, we think, the absence of evidence of payment of the consideration other than the issuance of the deferred notes is of little significance.

It is argued that the evidence in connection with the payment of the purchase price for the smaller property bought by Page from Diament conflicts. Page testified that he paid the entire consideration of $50,000, borrowing this amount from Shay. But when he offered the property to petitioner, he notified petitioner that it was subject to a mortgage for $37,500. He also entered this sum on his books as a note payable. His proposal to the petitioner called, attention to the existence of this mortgage, though it did not ask that petitioner assume it. Petitioner did not assume this mortgage.

In view of the lapse of at least ten months between the date of Page’s proposal to petitioner and the execution of the deed including this property, it is wholly possible that Page paid this mortgage before the execution of that deed. That being so, his testimony that he paid the entire $50,000 consideration to Diament for the smaller property stands unimpeached. Though of relative unimportance, that payment has, therefore, been found as a fact.

This leaves for consideration the respondent’s contention that the subordinate notes, if bona fide obligations of petitioner, were not of a character to support a deduction for interest accrued. He contends that notes which are payable as to principal and interest only out of profits do not represent a liability for either unless and until there' are such profits realized and that prior to such time interest may not be accrued as a deduction from income. We agree fully with the principle, but here the factual premise, essential to its application, is lacking. We find nothing in the record to sustain respondent’s assertion that the notes and interest were payable only from earnings. There is no such limitation of liability in the notes themselves or in the offer and acceptance mider which they were issued, nor is there any evidence that an agreement or understanding to that effect existed. They were demand notes bearing interest from date, expressly made subordinate in payment to certain loans for development purposes. The only understanding disclosed is that no demand would be made for payment until 1934. There is no evidence indicating in any way that during the three years here involved the holders could not have demanded payment of both principal and accrued interest, irrespective of whether there were profits accrued, and compelled satisfaction out of the corporate assets, after provision to satisfy the outstanding obligations for development. Cf. Commissioner v. Schmoll Fils Associated, Inc., 110 Fed. (2d) 611.

So we do not agree with respondent’s added contention that the notes were, in effect, stock certificates with cumulative dividends payable from profits. They evidence a definite intent to create a debtor-creditor relationship rather than a corporation-stockholder relationship and they have been consistently treated by the parties as valid and subsisting obligations of petitioner. Palmer, Stacy-Merrill, Inc., 39 B. T. A. 636; Tennessee Co., 40 B. T. A. 154.

Under ordinary circumstances, that notes in this large amount have not been paid either as to principal or interest would probably cast some reflection upon the bona tides of their issuance. However, the record contradicts any such reflection. At the time of the acquisition of the Ralph property and the issuance of these notes, oil from that field was selling at $4.30 per barrel. A drop in the market was not anticipated. However, after that time the price of oil from the Bradford field fell to $2 per barrel. If the higher price had been maintained, the oil actually produced during the period intervening between the time when these notes were issued and the date of the hearing herein would have brought gross receipts of more than $6,000,000. Such income was reasonably to have been anticipated when the notes were issued and, if actually received, not only interest on the notes could have been met, but a substantial reduction of their principal could have been effected.

On the whole record, we conclude that petitioner has established its right to a deduction of the interest accrued on the subordinate notes for each of the taxable years. See Helvering v. Jane Holding Corporation, supra.

The next issue is whether petitioner is entitled to depreciate the cost of drilling so-called “water wells,” or whether it must recover these costs through its allowance for depletion. The evidence shows that the water wells are drilled, cased, and shot in exactly the same manner as oil wells. Their effect, when four of them are placed in the corners of a square in the center of which an oil well has been drilled, and thereafter filled with water under pressure, is to concentrate oil in the center well by means of the pressure exerted by the water through the oil sand. Petitioner urges that they constitute depreciable improvements within section 23 (m) of the Revenue Act of 1934. It is argued that respondent’s regulations covering the point (Regulations 86, art. 23 (m) — 1) refer only to gas and oil wells as depletable, which thus excludes “water wells” from that category.

This is a case of first impression, so far as we know. There seem to be no decisions as to whether costs of drilling these aids to production are to be treated in a manner different from the costs of drilling oil wells. Nevertheless, we believe that the principles enunciated in United States v. Dakota-Montana Oil Co., 288 U. S. 459, cover the facts here and require a conclusion that the cost of drilling water wells is to be treated the same as the cost of drilling oil wells, in that such cost is recoverable only through the allowance for depletion. In the Dakota-Montana Oil Co. case, the taxpayer contended that an oil well was an improvement and that, logically, there was no distinction for accounting purposes between the cost of the hole and the admittedly depreciable cost of buildings and machinery. The Government argued that a well was not a tangible physical property that would wear out with use and that its regulations accorded with the practice in the oil industry. The Court, holding for the Government, ruled that the question had been settled by a long and consistent administrative practice, regulatory provision for which was within the powers delegated to the Commissioner by the statute. This practice was to treat, as depreciable, tangible physical property, such as machinery, tools, equipment and pipe lines; and capital investment in the oil, including costs of development other than costs of physical property, drilling costs being considered as a development cost, were regarded as recoverable only through depletion allowances.

It is our opinion that the so-called “water wells” involved in this proceeding are sufficiently similar to oil wells to require the same tax treatment. A water well does not wear out with use as does physical machinery or a pipe line; it is drilled, cased and shot in the same manner as an oil well; and its sole value and function is to complement the oil well by causing the oil to concentrate in the area into which the oil well has been drilled. As such, we think, it is no more than a part of the oil well itself.

Having regard to the settled administrative practice of making a division between tangible physical property on the one hand and the well itself on the other, we hold that petitioner is not entitled to depreciation on the drilling costs of its water wells. See also Petroleum Exploration v. Burnet, 288 U. S. 467; Burnet v. Jergins Trust, 288 U. S. 508; Simms Petroleum Co., 28 B. T. A. 1107; J. S. J. Lyell, 29 B. T. A. 133; and Commissioner v. Hickman, 68 Fed. (2d) 997.

In addition to petitioner’s assertion of a right to deduct depreciation upon its cost of water wells, it has charged error in the determination of respondent in his failure to compute enough depreciation upon assets with respect to which there is no dispute as to their depreciable character or their cost. Petitioner contends that the rates used by respondent upon various assets are too low and asks that, in each case, a higher rate be used. In connection with this allegation of error, petitioner sets out the amount of depreciation upon each asset resulting from a use of the higher rate he asks to be used, but, in some' instances, it happens that the amount of depreciation as computed by him by the use of the higher rate is less in amount than the depreciation computed by respondent by the use of a lower rate. It is quite evident that the computation by petitioner was in error. That error appears to arise through application of the percentage rate to the depreciated balance of cost of the asset instead of to the original cost. In his answer, respondent, although not admitting the correctness of the rates for depreciation which the petitioner here asks, has made formal admission that the amounts computed by petitioner in those instances in which they are less than the amounts allowed in the determining of the deficiency are correct. Subsequently, at the hearing, petitioner abandoned the issue as to depreciation upon these assets other than water wells and respondent now takes the position that he is entitled to judgment upon the pleadings with respect to the particular items in question.

With this we can not agree. Since there appears to be no dispute as to the cost of each asset, the only real issue is the proper rate of depreciation to be used. The amount of the depreciation allowable is thus merely a mathematical calculation. We sustain respondent in his allowance of depreciation computed with the rates used by him. However, in recomputing the deficiency, depreciation should be allowed at those rates upon the actual cost of the various assets as established.

The last issue is whether petitioner is entitled to a credit under section 26 (c) (1) of the Revenue Act of 1936 by reason of a contract restricting the payment of dividends. The contract into which petitioner entered with three of its largest creditors provides that petitioner shall not declare any dividends until the indebtedness is discharged and that, if it pays any dividends before that condition is met, the notes representing the indebtedness shall become due and payable. At the close of 1936, the year to which the credit, if otherwise allowable, applies, petitioner owed these creditors $756,801.95 on development notes. Respondent argues that petitioner could have paid dividends without violating the contract, for the ^reason that the only consequence of so doing would have been to have made the notes immediately payable.

We do not so read the agreement. Had petitioner declared and paid a dividend, it would have violated the express agreement not to do so. This agreement had been exacted of it by its creditors as a condition for continuing the loans and making further ones. We think petitioner is entitled to this credit.

Decision will 6e entered under Rule 60.