author: MoMahon:

text:
    Prairie Oil and Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57117.
    Promulgated October 17, 1933.

      H. B. McCaidley, Esq., and S. Milton Simpson, Esq., for the petitioner.

      Bruce A. Low, Esq., and T. G. Riston, Esq., for the respondent.
   OPINION.

MoMahon:

This is a proceeding for the redetermination of an asserted deficiency in income taxes for the calendar year 1928 in the amount of $126,333.18.

It is alleged that the respondent erred in failing to allow as a deduction from the gross income of the petitioner for the calendar year 1928 the sum of $81,122.61, representing an allowance for depletion actually sustained upon oil-producing properties owned and operated by the petitioner.

On March 8, 1926, the petitioner entered into a contract with representatives of the Olean Petroleum Co. and its stockholders which is referred to hereinafter in a stipulation as Exhibit A, and, except for the signatures of the parties, is as follows:

Articles of Agreement, made and entered into this the Eighth day of March, 1926, by and between George A. Larkin and James P. Quigley, of Olean, New York, representing the Olean Petroleum Company, a corporation organized under the laws of the State of Delaware, and also representing the stockholders of said Olean Petroleum Company, hereinafter referred to as “ Sellers ”, parties of the first part; and the Prairie Oil and Gas Company, a Kansas corporation, hereinafter referred to as the “ Buyer ”, party of the second part.
Witnesseth That, for and in consideration of One Dollar ($1.00) and other good and valuable consideration to them in hand paid, receipt of which is hereby acknowledged, sellers to hereby agree to sell, assign and deliver to buyer One Hundred per cent (100%) of the issued and outstanding shares of the capital stock of said Olean Petroleum Company for the price of Three Million Three Hundred and Fifty Thousand Dollars ($3,350,000.00) payable in cash when the titles as hereinafter referred to are approved. Sellers may have twenty-five (25) days within which to deliver said shares of stock. If for any reason sellers shall be unable to deliver the said 100% of the shares of said capital stock, said sellers agree and undertake, for and on behalf of said Olean Petroleum Company, to sell and deliver to buyer all the tangible physical properties of said Olean Petroleum Company wherever located; it being understood that said properties consist, in the main, of oil and gas leaseholds, premises and properties located in the States of Oklahoma and New Mexico, for the said price of $3,350,000.00, payable as above. The physical properties aboye referred to consist of all the physical assets of every kind and character of the Olean Petroleum Company, consisting of real and personal property, real estate, leases, equipment, supplies, pipe, casing, tools, automobiles, furniture and fixtures, oil and all property of whatever kind and character pertaining to the operation of the leases now producing and in process of development, and all physical properties shown on the books to belong to the Olean Petroleum Company, not including cash in banks or bills and accounts receivable; the said cash in banks and accounts and bills receivable to remain the property of sellers. All of the said properties to be free and clear of all taxes, liens, incumbrances of all kinds and to be delivered with good merchantable title to the buyer.
Delivery of said physical properties shall be made as of Seven o’clock a.m., March 3, 1926; it being understood that buyer shall be entitled to all oil and gas produced on any oil or gas property in any tanks or pipe lines as of said Seven A.M., of March 3, 1926. Said buyer shall be entitled to said properties as of the said hour and date and will be liable for all operating expenses in connection therewith from and after the said hour and said date, and shall be entitled to direct the operations of the same through its agent.
It is understood that the sellers will pay all drilling cost on well or wells to the depth at which the well or wells were drilled as of Seven A.M., March 3, 1926.
It is further understood that pipe and casing in the possession of and not delivered by railroad company as of Seven A.M., March 3, 1926, shall be paid for by the buyer.
In the event of sellers delivering to buyer the said shares of capital stock, it is understood that the said delivery of the stock shall transfer full and complete control of the Olean Petroleum Company to the buyers as of Seven A.M., March 3, 1926, and that all of the foregoing provisions with reference to the passing of title to the properties and possession of the same, shall apply in the same degree and to the same extent and with like effect.
Immediately upon the execution of this contract, sellers will proceed to procure abstracts of title covering all leases and real property of every kind and nature owned by said Olean Petroleum Company and -within Fifteen (15) days, shall deliver the same to the buyer, who shall have a reasonable time within which to examine the same. If any defects are discovered in said titles, the sellers shall have a reasonable opportunity to cure the same.
It is understood further that in the event of the sellers delivering to the buyer the said 100% of the capital stock of the Olean Petroleum Company, instead of a direct sale of its physical properties, that the present stockholders of the Olean Petroleum Company will and do hereby guarantee to deliver the said stock free and clear of every kind and character of lien, incumbrance or liability whatsoever. The purpose being, in the sale of this stock by the present stockholders and the puchase thereof by the buyer, to secure the properties of the Olean Petroleum Company for the price above specified, without any kind or character of lien, incumbrance or liability whatsoever, that may in any wise attach to the properties, by and through the sale and delivery to buyers, of the capital stock of the Olean Petroleum Company.
It is understood that the Olean Petroleum Company has no outstanding debts or liabilities or taxes of any kind or character and the buyer and seller are dealing with each other in the making of this contract on that assumption, and the present stockholders of the Olean Petroleum Company agree to save the buyer harmless on account of any kind or character of liability that may arise that would make the cost of the stock or properties exceed the amount of $3,350,000.00.
Buyer agrees to purchase said stock or physical properties, as the case may be, according to the price, terms and conditions set forth above.

The parties stipulated as follows:

I. The petitioner, at all times herein referred to, was a Kansas corporation with its principal place of business and correct post-office address at Independence, Kansas.
II. On the 8th day of March, 1926, the petitioner entered into a written contract with George A. Larkin and James P. Quigley of Olean, New York, they representing the Olean Petroleum Company, a Delaware corporation, and also the stockholders of the said Olean Petroleum Company, whereby and by the terms of which it was provided that, for and in consideration of $3,350,000.00, the stockholders of the said Olean Petroleum Company agreed to sell and deliver to the petitioner, and the petitioner agreed to purchase, 100 per cent of the capital stock of the Olean Petroleum Company free and clear of incumbrance, within 25 days immediately following the 8th day of March, aforesaid; or, in the alternative, said contract further provided that if said stockholders were unable to deliver to the petitioner 100 per cent of said stock within the said period of 25 days, then, and in that event, to sell and deliver to the petitioner certain physical properties consisting of oil and gas producing properties, with equipment located thereon, as more particularly described in said contract, free and clear of all incumbrance for the same price, $3,350,000.00. A true and correct copy of said written contract is hereto attached, and marked Exhibit A.
III. The petitioner took possession of the physical properties described in said contract immediately after the said contract (Exhibit A) was signed, and has since that time continued to operate said properties. On or about the 1st day of April 1926, or within 25 days as provided in the written contract, 100 per cent of the capital stock of the said Olean Petroleum Company was delivered by said Larkin and Quigley to the petitioner company, and the consideration named ($3,350,000.00) was paid by the petitioner company to said Larkin and Quigley for the stockholders of the Olean Petroleum Company as follows: $3,000,000.00 cash; balance by check and discharge of indebtedness of the. Olean Petroleum Company coming due after properties were taken over as aforesaid.
IV. At the time the contract aforesaid was signed, the Olean Petroleum Company was possessed of other assets in the total amount of $1,077,625.25, consisting of cash, accounts and bills receivable, which said assets were all distributed to the stockholders of record prior to the delivery of the stock on April 1,1926, as aforesaid. All liabilities of the said Olean Petroleum Company, other than those assumed by petitioner as set out in paragraph III above, were assumed by these stockholders prior to the delivery of the stock, and by them discharged.
V. Having acquired all of the capital stock of the Olean Petroleum Company, as above set forth, the petitioner company on, to wit, the 2nd day of April, 1926, distributed in complete liquidation all the assets then owned by the Olean Petroleum Company in full payment for the capital stock of the said Olean Petroleum Company, which stock was subsequently cancelled.
VI. On or about the 10th day of February, 1927, the Olean Petroleum Company filed with the Collector of Internal Revenue in and for the District of Kansas at Wichita, a corporate income tax return, executed by its ofiicers who were also officers of the petitioner, in which it did not report any profit for the period beginning January 1, 1926 and ending March 8, 1926, as a result of this sale, and the Commissioner has not determined any profit against said company as a result of this sale.
VII. On or about the 15th day of March, 1929, the petitioner filed with the Collector of Internal Revenue, in and for the District of Kansas, at Wichita, its income and profits tax return for the calendar year 1928, in which its net income subject to tax for said year was reported. In arriving at the amount of said income, petitioner took, among others, a deduction representing an allowance for depreciation and depletion actually sustained on properties which it owned and operated during said year. In computing the deduction for depreciation and depletion sustained on properties acquired from the Olean Petroleum Company, as hereinbefore set forth, petitioner used as a basis of computation, the actual cost of said properties, or $3,350,000.00. The respondent, however, after an examination of the return and records of the petitioner company, used as a basis for the computation of the deduction for depreciation and depletion actually sustained on said properties, the cost of said properties in the hands of the Olean Petroleum Company, and as the result thereof reduced the amount of the allowable deduction for depletion sustained on said properties, thereby increasing the petitioner’s taxable income for said year 1928, which gives rise to that part of the proposed deficiency in question.

The parties stipulated further as follows:

It is hereby stipulated and agreed by the parties, by and through their counsel of record, that in the event the Board decides the above-captioned appeal adversely to the respondent, that the income of the petitioner for the year 1928, as shown in the sixty-day letter, may be reduced by the sum of $81,122.61.

We are here called upon to determine the proper basis to be used by the petitioner in computing a deduction for the calendar year 1928 for depreciation and depletion sustained on properties acquired by the petitioner from the Olean Petroleum Co. We are governed by the Revenue Act of 1928, pertinent provisions of which are set forth in the margin. The respondent held that the transaction whereby such properties were acquired by the petitioner constituted a reorganization within the meaning of the statute, and that the proper basis to be used is the cost of such properties in the hands of the Olean Petroleum Co. Petitioner contends that the proper basis is $3,350,000, the actual cost of such properties to the petitioner.

In a case involving the income tax liability of this same taxpayer for the year 1926, Prairie Oil & Gas Co. v. Motter, 66 Fed. (2d) 309, reversing the decision of the United States District Court for the District of Kansas in Prairie Oil & Gas Co. v. Motter, 1 Fed. Supp. 464, the circuit court held that the same transaction involved in the instant proceeding constituted a sale of the assets of the Olean Petroleum Co. to the petitioner, and not a reorganization within the meaning of the Revenue Act of 1926. The circuit court there held that the proper basis for depletion deductions under the Revenue Act of 1926 was $3,350,000, the cost of the property to the taxpayer. That court was there concerned with sections 204 (a) (7), 204 (c), and 203 (h) (1) of the Revenue Act of 1926, whereas we are here concerned with the provisions of the Revenue Act of 1928. However, the corresponding provisions of the two acts are similar.

We agree with the holding of the circuit court in Prairie Oil & Gas Co. v. Motter, supra, wherein the court cites with approval and quotes from Warner Co., 26 B.T.A. 1225. For the discussions and other supporting authorities, see those cases. Upon the authority of those cases we hold that the proper basis to be used in the determination of the depreciation and depletion deduction for the calendar year 1928 is $3,350,000, the cost of the properties to the petitioner.

In accordance with the stipulation entered into between the parties, the income of the petitioner for the calendar year 1928 as shown in the notice of deficiency will be reduced by the sum of $81,122.61.

Decision will be entered imder Rule 50.

       Sec. 112. (i) Definition of reorganization. — As used in this section and sections 118 and 115—
      (1) The term “ reorganization ” means (A) a merger or consolidation (including the acquisition by one corporation oí at least a majority of the voting stock and at least a majority of the total number of shares of ail other classes of stock of another corporation, or substantially all the properties of another corporation), or (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 stockholder or both are in control oí the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
      *******
      Sec. 113. (a) Property acquired after February ⅜ 1913. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
      *******
      (7) Transfers to corporation where control of propertx remains in same persons. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount oí gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. * * *
      *******
      Sec. 114. (a) Basis for depreciation. — The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in section 113 for the purpose of determining the gain or loss upon the sale or other disposition of such property.
      (b) Basis for Depletion.—
      (1) General rule. — The basis upon which depletion is to be allowed in respect of any property shall be the same as is provided in section 113 for the purpose of determining the gain or loss upon the sale or other disposition of such property, except * * * [exceptions not here material].


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Bed Rock Petroleum Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54275.
    Promulgated October 17, 1933.

      George M. Wolcott, Esq., for the petitioner.

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

Smith:

This proceeding involves a deficiency in petitioner’s income tax for the calendar year 1928 in the amount of $1,525.20. The only question at issue is whether the petitioner sustained a deductible loss upon the sale of a pro rata part of its holdings of the preferred stock of another corporation. The material facts have been stipulated substantially as follows:

The petitioner is a Delaware corporation, engaged in the production of natural gas and oil. During the period 1924 to 1927, the petitioner acquired for cash or its equivalent 1,767 shares of preferred stock of the Tri-State Refining Co., a domestic corporation. The president of the petitioner and also of the Tri-State Refining Co., was one and the same individual, Gr. C. Davison, who was the majority stockholder of the outstanding stock of both corporations. As of December 31, 1927, there were issued and outstanding two classes of stock of the Tri-State Refining Co.; viz., second preferred and common. The second preferred stock had a par value of $100 per share. It entitled the owner to dividends at the rate of 8 percent per annum and no more before any dividends were payable to holders of the common stock. In the event of liquidation the holder of the preferred stock was entitled to receive par value of the stock plus accrued dividends thereon before any distribution was made to the holders of the common stock. Also, as of December 31, 1927, the balance sheet of the Tri-State Refining Co. showed an operating deficit of $50,737.53. The Tri-State Refining Co. in 1928 contemplated a new issue of perferred stock and, as a means of eliminating the operating deficit and making the proposed new issue of stock more attractive, it was agreed among the holders of the second preferred stock that they would turn in to the corporation, pro rata, a certain percentage of the stock then owned by them for a nominal amount of $1 per share to be paid by the corporation. The proposed agreement was executed on or about February 1, 1928. This transaction was recorded in the company’s books by a debit to capital stock account and a credit to surplus account, the result of which was the elimination of the operating deficit and the creation of a credit in the surplus account. The stockholdings of the corporation before and after this transaction were as follows:

Pursuant to the aforesaid agreement, the petitioner during 1928 surrendered it pro rata part, 222 shares of the second preferred stock, receiving from the corporation the amount of $222 in exchange therefor. The 222 shares had been acquired at a cost of $19,855.68. The proposed new issue of stock never took place. In the following year, 1929, the corporation had a further operating loss and in 1930 liquidation proceedings were begun. In its return for 1928 the petitioner claimed the deduction of $21,918 representing an alleged loss on the sale of its preferred stock, measured by the difference between the par value of the stock, $22,200, and $222, the amount received from the corporation in exchange therefor. The petitioner now admits that the amount claimed as a loss in its return is erroneous and that the deductible loss, if any, on account of the surrender of the stock is $3,251.08, representing the difference between the cost of the surrendered preferred stock, $19,855.68, and $16,604.60, the increased book value of the remaining common stock owned by the petitioner after the surrender of the preferred stock. The petitioner sold practically all of its remaining shares of the second preferred stock of the corporation on or before December 31, 1930, and the loss resulting therefrom was claimed as a deduction in its return for that year and was allowed by the respondent.

In the first place, it is quite apparent that, as the respondent has determined, there was not an outright sale by the petitioner and others to the Tri-State Refining Co. of a portion of their holdings of the company’s preferred stock. The preferred stock had a par value of $100 per share and was surrendered to the corporation for a nominal consideration of $1 per share. The transaction was, in effect, a surrender of the stock rather than a sale and the real consideration therefor was, as stated in the stipulation, the elimination of the operating deficit of the corporation for the purpose of making the proposed new issue of stock more attractive.

The Court of Appeals of the District of Columbia held, in Kistler v. Burnet, 58 Fed. (2d) 687; affirming 21 B.T.A. 433, that a stockholder of a corporation was not entitled to a deduction of a loss on account of the surrender of a pro rata part of his preferred stock to the corporation for the purpose of reducing the corporation’s deficit. The court in that case said:

The Bureau of Internal Revenue has consistently held that the surrender by stockholders ratably of a portion of their stock to the corporation for the purpose of supporting its credit constitutes capital contributions which are to be considered as additional cost to the stockholders of the stock retained; and that in such cases gains or losses of the stockholder are to be ascertained upon the final disposition of such stock.
$ ⅝ -1* * * # ⅜
The present ease is similar in principle to cases wherein a stockholder, in order to benefit the financial condition of a corporation, without other consideration, either voluntarily or by assessment, pays additional cash into the corporation in proportion to his holdings. It has been uniformly held that such payments are capital contributions, that no deductible loss is thereby sustained by the stockholder, and that gain or loss therefrom is to be determined and accounted for when the stockholder’s shares are finally sold or otherwise disposed Cf. First Nat. Bank in Wichita v. Commissioner (C.C.A.) 46 F. (2d) 283; Burns v. Commissioner (C.C.A.) 31 F. (2d) 399; Mastin v. Commissioner (C.C.A.) 28 F. (2d) 748, 753.
* * * * * * *
Accordingly, for income tax purposes, no deductible loss is recognized because of the surrender of part of appellant’s stock, nor is any gain recognized because of the 1,000 shares of additional common stock issued to appellant as part of the transaction. Such gains or losses, however, are not to be overlooked, but are to be considered when appellant’s retained shares shall be sold or otherwise disposed of, or become worthless in whole or in part.

See also Charles M. Haft, 20 B.T.A. 431; Edith Scoville, 18 B.T.A. 261. Cf. Commissioner v. Wright, 47 Fed. (2d) 871; reversing 18 B.T.A. 471, where the corporate stock was surrendered to an outside party rather than to the issuing corporation, resulting, as the court held, in a deductible loss. Cf. also City Builders Finance Co., 21 B.T.A. 800.

There is no merit in the petitioner’s argument that it did not own the preferred and common stock of the Tri-State Refining Co. in the same proportion and that the remaining stock which it held after the surrender of the preferred did not receive all or an equal proportion of the benefit to the corporation. The proportion in which the various classes of stock was owned by the petitioner is not material. The surrender of the stock for cancellation being a capital transaction, Kistler v. Burnet, supra, no adjustment for any gain or loss on account thereof can be made until the petitioner has disposed of the remaining stock.

Judgment will ~be entered for the respondent.


author: McMahon :

text:
    Amelie M. Staff, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles Staff, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 55601, 55602.
    Promulgated October 17, 1933.

      J. H. Amide, C.P.A., for the petitioner.

      Milford H. Payne, Esg., for the respondent.
   OPINION.

McMahon :

These proceedings, consolidated for hearing and decision, are for the redetermination of asserted deficiencies in income tax for the year 1928 as follows: Docket No. 55601, $1,015.07; Docket No. 55602, $315.05.

The sole question in controversy is whether the petitioners may elect to report gain derived from the sale of capital assets by reporting the gain on a portion of the capital assets sold as a capital gain and computing a tax thereon at the rate of 12½ percent under section 101 of the Revenue Act of 1928, and at the same time reporting the gain on the remaining capital assets sold as ordinary income and computing the tax thereon in accordance with sections 11 and 12 of the Revenue Act of 1928.

The proceedings were submitted upon separate stipulations of fact and we adopt the stipulations as our findings of fact, setting forth here only those facts necessary to an understanding of the question presented.

During the year 1928 petitioner Amelie M. Staff sold 1,000 shares of stock of the Larrowe Milling Oo. which she had acquired in the year 1917, and realized a gain therefrom of $18,440.

During the year 1928 she made a further sale of 3,850 shares of capital stock of the Larrowe Milling Oo. which was acquired by her in the year 1917, realizing a gain of $70,912.75.

Amelie M. Staff in her tax return reported the gain of $18,440 as taxable income and computed the tax thereon in accordance with the provisions of sections 11 and 12 of the Revenue Act of 1928.

In her return she also reported as a capital gain the gain of $70,912.75 and computed the tax thereon at 12½ percent.

The Commissioner has determined that the profits realized upon the above transactions may not be segregated into ordinary net income and capital net gain for the purpose of computing the tax thereon, and he has computed the tax on the total profit realized from such transactions under the provisions of section 101 of the Revenue Act of 1928.

Prior to the year 1928 petitioner Charles Staff sold certain parcels of real estate on the installment plan. The several parcels of real estate thus sold had been held by him for more than two years prior to the date of sale and the sales were consummated subsequent to December 31, 1921. During the year 1928 he received certain payments from these sales upon which there resulted taxable gain in the amount of $5,740.05.

During the year 1928 he sold 355.31 shares of stock of the Larrowe Milling Co. which he had acquired in the year 1917. He thereby realized taxable gain in the amount of $7,880.16.

During the year 1928 he made a further sale of 961.158 shares of capital stock of the Larrowe Milling C'o. which was acquired by him ⅜ in the year 1917, realizing a gain of $21,264.70.

In his tax return he reported $14,248.80, being the amount he then considered correct, as taxable income realized on the sales of several parcels of real estate and 355.31 shares of stock of the Larrowe Milling Co., and computed the tax thereon in accordance with the provisions of sections 11 and 12 of the Revenue Act of 1928.

In his return he also reported $21,264.70 as a capital gain, being the taxable income on the sale of the 961.158 shares of stock of the. Larrowe Milling Co., and computed a tax thereon at 12½ percent.

The Commissioner has determined that the profits realized from the sales made by Charles Staff may not be segregated into ordinary net income and capital net gain for the purpose of computing the tax thereon, and accordingly computed the tax on the total profit realized therefrom under the provisions of sections 11 and 12 of the Revenue Act of 1928, which resulted more favorably to him than if the total profit were computed under section 101 of the act.

The petitioners contend that under section 101 of the Revenue Act of 1928 they may elect, in reporting gain realized from the sale of capital assets, to treat part of such gain as ordinary net income and the remainder as capital net gain.

In Lu Frisk Thomas, 25 B.T.A. 810, the same contention was made relative to capital net gain realized in 1928 which the taxpayer had reported in part as capital net gain and in part as ordinary net gain. The Commissioner in that case eliminated from ordinary income that part of the capital net gain reported by the taxpayer as ordinary income and increased the capital net gain by such part. The Board approved the action of the Commissioner, stating:

* * ⅜ rjijjg gtatute specifically provides that “ capital net gain ” means the excess of the total amount of capital gain over the sum of the capital deductions and capital losses plus the amount, if any, by which the ordinary deductions exceed the gross income computed without including capital gains. The words “ total amount ” in the statute contemplate the whole or entire amount of capital gain and not a portion thereof. Anything less than the whole amount does not come within the purview of the statute. The petitioner, therefore, is not entitled to treat the profits from the sale of part of the group of stocks as “ capital net gain ” and the profit from the remainder as “ ordinary net income.”

The petitioners argue on brief that there is nothing in the language of the act to disclose that Congress intended the words “ capital assets ” to mean “ all property ” held by the taxpayer for two years; that section 101 (c) (8) of the Revenue Act of 1928 does not say “ all property ” held by the taxpayer, and that when the definition of “ capital assets ” is considered in connection with the phrase “ at the election of the taxpayer,” it is reasonable to assume that Congress intended the taxpayer to elect which, if any, of his assets he desired to be considered as capital assets in order to obtain the greatest possible benefit from the relief offered him by this section.

The pertinent provisions of section 101 of the Revenue Act of 1928 are set forth in the margin. Section 101 (c) (8) is not ambiguous. It merely defines “ capital assets ” and any “ property within such definition must be considered “ capital assets ” for the purposes of the section, whether such property be all or only a part of the property disposed of by the taxpayer so as to result in either capital net gain or capital net loss.

Preceding the exercising of the election granted the taxpayer by section 101 (a), there must arise “a capital net gain.” This term is defined in section 101 (c) (5) as “ the excess of the total amoimt of capital gain over the sum of (A) the capital deductions and capital losses, plus (B) the amount, if any, by which the ordinary deductions exceed the gross income computed without including capital gains.” (Italics ours.)

The election granted the taxpayer may be exercised only after a capital net gain has been derived, and pertains to the tax to be levied, collected and paid. De Lancey Nicoll, 16 B.T.A. 868; affd., 41 Fed. (2d) 1008.

Furthermore, if a taxpayer elects to have the tax computed under section 101, he is bound by all the provisions thereof. De Lancey Nicoll, supra. The tax computed under section 101 (a) is the sum of the tax computed upon the basis of the “ ordinary net income ” under sections 11 and 12 of the Act “ plus 12½ per centum of the capital net gain.” Subsection (c) (7) of section 101 defines “ ordinary net income ” and excludes therefrom “ all items of capital gain, capital loss and capital deductions.” Hence, the tax on ordinary net income is not properly computed under this section when any capital gain is included in ordinary net income.

The action of the respondent is therefore approved.

The parties stipulated also that if the action of the Commissioner is held by the Board to be proper, the deficiencies as determined by the respondent are correct in amount.

Decision will he entered for the respondent.

       SEC. 101. CAPITAL NET GAINS AND LOSSES.
      (a) Tax in case of capital net gain. — In the case of any taxpayer, other than a corporation, who for any taxable year derives a capital net gain (as hereinafter defined in this section), there shall, at the election of the taxpayer, be levied, collected and paid, in lieu of all other taxes imposed by this title, a tax determined as follows: A partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner as if this section had not been enacted and the total tax shall be this amount plus 12⅜ per centum of the capital net gain.
      * * # * * * *
      (e) Definitions. — For the purposes of this title—
      (1) “ Capital gain ” means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921.
      $s ***** *
      (5) “ Capital net gain ” means the excess of the total amount of capital gain over the sum of (A) the capital deductions and capital losses, plus (B) the amount, if any, by which the oidinary deductions exceed the gross income computed without including capital gains.
      * * * * * * *
      (7) “ Ordinary net income ” means the net income, computed in accordance with the provisions of this title, after excluding all items of capital gain, capital loss, and capital deductions.
      (8) “Capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business) * * *.


author: Teammell:

text:
    J. A. Dart, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. J. A. Dart, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56704, 56705.
    Promulgated October 20, 1933.

      Frarilc J. Albus, Esq., for the petitioners.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Teammell:

The petitioners do not question the correctness of the action of the respondent in including in taxable income the amount of interest credited to their’short accounts, but contend that the amounts of the charges made against their accounts as the equivalent of dividends paid on stock which they had sold short should be allowed as ordinary and necessary expenses and for the purpose of determining the profit from the short sales should not be added to the cost of stock when purchased to complete such short sales. The respondent contends that a short sale of stock is not a completed transaction until shares of the same kind as those sold are purchased by the seller to cover the transaction and that the amounts charged against the petitioners’ accounts as the equivalent of dividends paid on the stock they had sold short were not ordinary and necessary business expenses, but constituted a part of the cost of the stock purchased to cover the transaction and therefore were not deductible until the short sales became completed transactions. He also makes reference to I.T. 1764, C.B. II-2, p. 22, and S.M. 4281, C.B. IV-2, p. 187, to show that his contention is in conformity with his prior rulings on the question.

In Provost v. United States, 269 U.S. 443, referred to in the findings of fact, the question involved was whether transfers of shares of corporate stock involved in loan ” and return ” transactions made in accordance with the rules and practice of the New York Stock Exchange were taxable transfers within the meaning of the stamp tax provisions of the Revenue Acts of 1917 and 1918. The court there considered the nature and procedure involved in a short sale and said:

The loan of stock is usually, though not necessarily, incidental to a “ short Sale.” As the phrase indicates, a short sale is a contract for the sale of shares which the seller does not own or the certificates for which are not within his control so as to be available for delivery at the time when, under the rules of the Exchange, delivery must be made. Under the rules of the New York Stock Exchange, applicable so far as the facts of this case are concerned, a broker who sells stock is required to make delivery of the certificates on the next business day. If he does not have them available, he must procure them for the purpose of making delivery. This he may do by purchasing or borrowing the required shares, delivery of the certificates to be made to the brokei to whom he has already contracted to sell.
If he borrows them, he deposits with the lending broker their full market price; and until the loan is returned, this deposit is maintained, by means of daily payments back and forth between the borrower and the lender, at the varying level of the market value of the shares loaned. The lender, who thus receives in money the full market value of the shares — much more than he would ordinarily realize by pledging them — usually pays interest on the money so received, at the current rate for demand loans. But the rate of interest is a matter of negotiation and agreement, and the deposit may, on occasion, carry no interest, or the borrower of the stock may pay a premium when the stock is greatly in demand.
During the continuance of the loan the borrowing broker is bound by the loan contract to give the lender all the benefits and the lender is bound to assume all the burdens incident to ownership of the stock which is the subject of the transaction, as though the lender had retained the stock. The borrower must accordingly credit the lender with the amount of any dividends paid upon the stock while the loan continues and the lender must assume or pay to the borrower the amount of any assessments upon the stock. The lender of the stock, concurrently with the receipt of the deposit, delivers to the borrower the certificates of the stock lent * * *. The stock thus borrowed then becomes available for delivery on the short sale.
The original short sale is thus completed and there remains only the obligation of the borrowing broker, terminable on demand, either by the borrower or the lender, to return the stock borrowed on repayment to him of his cash deposit, and the obligation of the lender to repay the deposit, with interest as agreed. The stock for this purpose, if not provided by the customer, must be obtained by borrowing stock of like kind and amount from other brokers, or by purchasing the stock in the open market and charging the customer for whose account the sale was originally made, with the purchase price. In that case the short sale transaction and the borrowing transaction as well are brought to their conclusion by the actual purchase of stock of which the customer was short at the time when the sale was made and the delivery of the stock, thus purchased, to the lender. ⅜ * ⅛
It will be observed that the completed short sale transaction usually involves four separate steps in each of which there is either a sale or a complete transfer of all the legal elements of ownership. These are (1) the sale of the stock by the person effecting the short sale, followed by the transfer and delivery of the certificates for the borrowed stock to the purchaser’s broker; (2) the transfer of the shares from the lender to the borrower, who uses them for delivery on the customer’s short sale; (3) the purchase by the borrowing broker of the stock required to repay the loan; and (4) the transfer and delivery by the borrower to the lender of the certificates for the purchased shares to replace the shares borrowed. Each transfer may be accompanied by a physical delivery of certificates of the stock transferred; but the intermediate deliveries in (2) and (3) are usually eliminated by use of the Stock Exchange Clearing House.
*******
But the borrower of stock holds nothing for account of the lender. The procedure adopted and the obligations incurred in effecting a loan of stock and its delivery upon a short sale neither contemplate nor admit of the retention by either the borrower or the lender of any of the incidents of ownership in the stock loaned. The seller hawing contracted to sell securities which, he does not own, is under the necessity of acquiring dominion over stoch of the hind and amount which he has sold, with unrestricted power of disposition of it in order that he may fulfill Ms contract. Whether his broker acquires the stock by purchase or by giving to the lender of it the market value of the stock plus his personal obligation to acquire and return to the lender, on demand, a like kind and amount of stock, the legal effect of the transfer is the same. Upon the physical delivery of the certificates of stock by the lender, with the full recognition of the right and authority of the borrower to appropriate them to his short sale contract, and their receipt by the purchaser, all the incidents of ownership in the stock pass to him.
When the transaction is thus completed, neither the lender nor the borrower retains any interest in the stock which is the subject matter of the transaction and which has passed to and become the property of the purchaser. Neither the borrower nor the lender has the status of a stockholder of the corporation whose stock was dealt in, nor any legal relationship to it. Unlike the pledgee of stock who must have specific stock available for the pledgor on payment of his loan, the borrower of stock has no interest in the stock nor the right to demand it from any other. For that reason he can be neither a pledgee, trustee nor bailee for the lender, and he is not one “with whom stock has been deposited as collateral security for money loaned.” For the incidents of ownership, the lender has substituted the personal obligation, wholly contractual, of the borrower to restore him, on demand, to the economic position in which he would have been, as owner of the stoch, had the loan transaction not been entered into.
When the borrower returns the borrowed stock, he acquires it by purchase or by borrowing again and in the process acquires and transfers to the lender all the incidents of legal ownership in securities which neither possessed before.
We therefore conclude that both the loan of stock and the return of borrowed stock involve “transfers of legal title to shares of stock” within the express terms of the statute; * * *
* * * * * * *
We therefore conclude that while there is no indication of a purpose to impose a discriminatory tax upon short sales or transactions necessarily involved in short sales, there was a general purpose to tax all transfers of legal ownership of shares of stock which includes those made necessary in order to complete a short sale, [Italics ours.]

From the foregoing it is clear that when a person makes a short sale he is under the necessity of acquiring dominion over stock of the kind and in the amount which he has sold, together with the unrestricted power of disposition of it, in order that he may fulfill his contract by transferring the legal title of such stock to the purchaser under the short 'sale. This necessity must be met irrespective of whether the broker is to furnish the stock from a lot which he owns, or is to purchase or borrow it from another. Regardless of the source from which the stock is to be obtained the short seller, by directing that the short sale be made, has assumed the financial responsibilities incident to effecting the sale. One of the responsibilities is to make payment to the broker through whom the short sale is made, either for the benefit of that broker or for another from whom the stock was borrowed, of an amount equal to the amount of any dividends paid on the stock during the time the loan continues, or, in other words, until the short sale is completed by a covering purchase by the short seller. In making the covering purchase the short seller does so for the purpose of acquiring dominion over the stock and the unrestricted power to transfer the legal title therein to the party who furnished the stock necessary for effecting the short sale. The petitioners do not contend, nor do we think it can be successfully contended, that the amount paid by the short seller for the stock acquired by his covering purchase is not an element entering into cost in. determining the profit or loss from the short sale. Cf. Osgood Land & Livestock Co., 22 B.T.A. 387. As indicated above, the amount paid by the short seller on account of dividends paid during the time the short sale is uncompleted is an obligation assumed incident to the acquisition and transmittal of the legal title to the stock delivered to the purchaser under the short sale. The amount being paid for this purpose we think is just as much a part of the cost basis to be used in determining the profit or loss from the short sale when completed as the expenditure made in the covering purchase. Amounts paid in connection with the acquisition of property do not come within the classification of ordinary and necessary business expenses, but are capital expenditures, properly to be considered as items of cost of the property acquired. See R. E. Thompson, 7 B.T.A. 391; Marjorie Post Hutton, 12 B.T.A. 265; affd., 39 Fed. (2d) 459; I. N. Burman, 23 B.T.A. 639.

Should we be in error in taking the foregoing view of the matter, and if the short sales are to be considered purely as sales and in no wise involving the acquisition of property and the amounts here in controversy are to be considered solely as expenditures incurred by the petitioners in effecting such sales, the position of the petitioners is not improved. Expenditures incurred in effecting the sale of se-cnrities by one not a dealer are not deductible as ordinary and necessary expenses, but operate to reduce the profit upon disposition of the securities. Florence G. Baldwin, 23 B.T.A. 512. While the purchases and sales of securities by the petitioners during the taxable years involved constituted a business carried on by them and if they had sustained losses on such transactions in excess of their income from other sources such amounts undoubtedly would have constituted net losses which could have been carried forward to subsequent years, Ignaz Schwinn, 9 B.T.A. 1304; William A. Hodgson, 24 B.T.A. 256, we do not think such transactions would entitle them to classification as dealers in securities. In holding that a taxpayer was a dealer in securities the court, in Harriman Natl Bank v. Commissioner, 43 Fed. (2d) 950, said:

Tlie foregoing summary of the testimony suffices, in our opinion to make a prima facie showing that the hank was a dealer in securities within the meaning of the Treasury Regulations. It shows that it was “ a merchant of securities,” that is, “ one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived ”; that it was “regularly engaged in the purchase of securities and their resale to customers,” having a separate department for such purchases and sales and an established place of business.

There is nothing in the record of the instant proceedings to indicate that the petitioners were, as merchants, buying securities and selling them to customers or were acting as brokers. On the contrary the evidence indicates that they bought, sold or held securities on their own account for investment or speculation. A taxpayer whose business is buying, selling and dealing in securities solely for its own account and who makes no purchases or sales of securities for the account of customers is not a dealer in securities. Adirondack Securities Corp., 23 B.T.A. 61. In that case we said:

The evidence in this proceeding discloses that the petitioner did not operate as a broker and there is no evidence that it regularly sold securities to customers. The proof clearly shows, however, that the petitioner bought and sold securities solely for its own account. Article 1615 of Regulations 69 defines a dealer in securities whose income may be determined by the use of inventories as an individual, partnership, or corporation regularly engaged in the purchase of securities for their resale to customers. Obviously, the petitioner does not come within this definition, but, on the contrary, it appears that the petitioner bought, sold or held securities for investment or speculation. Therefore, it is not entitled, under section 205 of the Revenue Act' of 1929 and article 1615 of Regulations 69, to deduct from income an inventory loss.

In tbe light of tlie foregoing we do not think it can be said that the petitioners were dealers in securities during the taxable years involved. Consequently, if the amounts here in controversy be considered solely as expenditures incurred in effecting the sale of securities, they are not deductible as ordinary and necessary expenses, but operate to reduce the profit from the disposition of the securities. Florence G. Baldwin, supra.

In view of the foregoing we are of the opinion that the action of the respondent here complained of is correct and should be sustained. See Gladys G. Terbell et al., Executors, 29 B.T.A. 44.

The petitioners urge that to include in taxable income, as the respondent has done, the amounts received by them as interest in connection with their short sales and not allow them to deduct the amounts here sought with respect to dividends involved in such sales would be inconsistent and would distort their income. This contention we think overlooks the fact that while the interest arose in connection with short sale transactions it resulted directly and primarily from the use of funds of the petitioners and that in accordance with the provisions of the statutes it is to be included in taxable income for the year in which received or made available to them.

Reviewed by the Board.

Judgment will be entered wider Rule 50.


author: Matthews :

text:
    J. S. J. Lyell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43540.
    Promulgated October 20, 1933.

      W. Leo Austin, Esq., L. E. Oalúll, Esq., and George H. Abbott, O.P.A., for the petitioner.

      W. R. Lansford, Esq., and E. G. Sievers, Esq., for the respondent.
   OPINION.

Matthews :

1. The relevant sections of the 1924 Revenue Act are set out in the margin. The first question is whether respondent allowed an adequate amount of depletion in 1924 in respect of the one-eighth royalty interest owned by petitioner in a 60-acre tract of oil and gas lands in Union County, Arkansas; and this depends, all other facts and factors having been stipulated by the parties, on the discovery value of the petitioner’s interest in the tract when oil was found there on June 25, 1923. Petitioner claims a discovery value of $80,000, but respondent has allowed only $32,500.

The evidence showed that petitioner’s 60-acre tract lay directly between two producing wells, one about two miles to the southeast and the other three miles to the northwest. There was also a gas well two miles to the north. On the basic, or discovery, date in 1923, the only known oil sand in the field was the first, or Smackover, sand.

The petitioner testified that on the eve of discovery, between June 15 and 20, 1923, he had received an offer of $6,000 for a one sixty-fourth interest in 40 of the 60 acres over which his royalty extended. Petitioner declined this offer because he thought the interest was worth $10,000. Evidence was also put in to show that there had been a sale, between June 10 and 20, 1923, of a one sixty-fourth royalty interest in another tract of 40 acres, belonging to one Laney, about two miles a little west of north of petitioner’s tract, for $16,000. There was a producing well on the farm adjoining the Laney tract about one half mile west of Laney’s property. Both the offer and the sale were for all the minerals which might be in the land and not merely for the oil in the first sand.

Upon such slender evidence petitioner seeks to sustain his claim to a discovery value of $80,000. It will be observed that both the offer to buy a portion of the petitioner’s royalty interest and the sale of the Laney royalty interest were made a few days before petitioner’s discovery date, although the regulations require that fair market value be determined “at the date of discovery or within thirty days thereafter.” Treasury Regulations 65, art. 221. Moreover, it was clearly demonstrated here that the only productive sand discovered on petitioner’s tract was the first, or Smackover, sand, and the discovery value to be ascertained, of course, is the value of that sand. Ibid, art. 222. The offer received by petitioner, even if accorded the full evidential value which a mere offer, as opposed to a sale, seldom obtains, was for a royalty interest in all the minerals in the tract. Likewise, the sale by Laney was of all the minerals, not merely those in a particular sand. An offer to buy, or a purchase of an interest in, oil that has been discovered in a particular sand and all oil which may be later discovered in other sands in the area is obviously not data which can be of use in determining the discovery value of a single oil sand.

The evidence submitted fails to show that the discovery value of petitioner’s royalty interest in the 60-acre tract was any greater than the amount of $32,500 allowed by the respondent.

2. The second issue involves the depletion allowable on the 20-acre tract of oil and gas land owned by the petitioner in fee, but this issue is disposed of by the stipulation, supra, wherein the parties agreed upon all the facts and factors necessary to calculate such depletion. Depletion will be allowed accordingly.

3. The third issue and the affirmative issue raised by respondent, being closely^related, may be considered together: (a) Whether the bonus received by petitioner for granting an oil and gas lease constituted income or a return of capital; and (b) whether the bonus was subject to depletion. The petitioner had an 80-acre tract, the south 20 acres of which he retained in fee throughout the taxable year and developed himself. The north 60 acres he leased, retaining a one-eighth royalty interest on the whole. Of the 60 acres so leased, there was a south 20-acre tract upon which petitioner received as a bonus, out of the proceeds of the sale of seven sixteenths of the oil and gas produced from the working interest, $35,000, which was made up of payments aggregating $14,348.42 in 1923 and $20,651.58 in 1924. It is this bonus which is in question here. Depletion of the bonus, as calculated under T.D. 3938, had already been allowed by respondent. Whether the bonus was depletable, a question raised by the respondent by an affirmative plea in his answer to safeguard the Government’s interest, he now waives in his brief, since it is disposed of by the Supreme Court’s decision in Murphy Oil Co. v. Burnet, 287 U.S. 299, allowing depletion. This leaves the question of whether the bonus was capital and how depletion is to be calculated. The relevant provision of the statute is set out in the margin, ante.

The question has been settled by the Supreme Court’s decision in Burnet v. Harmel, 287 U.S. 103, and the Murphy Oil Co. case, supra. A mining or oil lease bonus, the court said, represents income and is to be taxed as such, but because of the peculiar nature of the business, it also represents in part a return of capital in the same way as a lease royalty, and to the extent of such capital investment is subject to depletion. In the Murphy case, the court reviewed and approved, the method employed by the Commissioner. (See Treasury Regulations 45, art. 215, and the corresponding provision, Regulations 65, and T.D. 3938, V-2 C.B. 117, Nov. 13, 1926, amending the regulations.) This method differs from former practice only in the situation where the Commissioner properly finds that the sum of the bonus and expected royalties exceeds the lessor’s capital investment in the oil in the ground. In such case, the allowable depletion is to be apportioned ratably between bonus and estimated royalties. If bonus and expected royalties do not exceed petitioner’s capital investment, the whole bonus received in advance of royalties will be treated, as hitherto, as a return of capital and depletion allowed accordingly.

Here the Commissioner determined depletion in accordance with the method described in T.D. 3938. This method having been upheld by the court and the amount so determined not having been questioned by petitioner, the depletion allowed by respondent in his notice of deficiency is approved.

4. We now pass to the last issue, touching certain incidental expenditures made by petitioner in connection with hi^ operations on his oil land held in fee, including lease equipment and drilling, of $39,971.81. All these expenditures were capitalized by the petitioner for the respective years. The question is whether they should be returnable, as petitioner contends, through depreciation, or as respondent urges, following article 225, Treasury Regulations 65, through depletion.

This question has now been put at rest by the Supreme Court’s decision in United States v. Dakota-Montana Oil Co., 288 U.S. 459. Cf. Burnet v. Jergins Trust, 288 U.S. 508, and Petroleum Exploration Co. v. Burnet, 288 U.S. 467. The legislative history of depletion and depreciation allowed on oil production was reviewed by the Supreme Court in the Dahota-Montana case, and the following conclusion reached:

Thus the Acts of 1918, 1921 and 1924 were consistently construed by the regulations to permit a depletion, but not a depreciation allowance for the costs of development work and drilling, which were treated for this purpose either as a part of the cost or an addition to the discovery value of the oil in the ground. The administrative construction must be deemed to have received legislative approval by the reenactment of the statutory provision, without material change. No. 80, Murphy Oil Co v. Burnet, decided December 5, 1932; Brewster v. Gage, 280 U.S. 327, 337.

These expenditures for nonphysical improvements will accordingly be returned through depletion.

Judgment will be entered under Bule 50.

       Sec. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in. respect of any property shall be the same as is provided in subdivision (a) or (b) for t'he purpose of determining the gain or loss upon the sale or other disposition of such property, except that in the case of mines, oil and gas wells, discovered by the taxpayer after February i'8, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter; but such depletion allowance based on discovery value shall not exceed 50 per centum of the net income (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value.
      Sec. 214. (a) In computing net income there shall be allowed as deductions:
      *******
      (9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee.


author: Smith :

text:
    National Casket Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50320.
    Promulgated October 20, 1933.

      James L. DoJur, Esq., for the petitioner.

      PMUp M. Olarh, Esq., and Prew Savoy, Esq., for the respondent.
   OPINION.

Smith :

The first question presented is the amount of the deductible loss sustained by the petitioner upon the liquidation of Hornthal & Co. as of April 30, 1928. The petitioner claims that the loss sustained was $105,355.07. The respondent admits that this would be the amount of the deductible loss were it not for the fact that Horn-thal & Co. sustained operating losses for the fiscal years ended June 30, 1926, 1927 and 1928, in the aggregate amount of $100,359.37, which operated to reduce the taxable net income of the affiliated group for the years in which sustained. The respondent contends therefore that the deductible loss of $105,355.07 should be reduced by the losses of Hornthal & Co. during the period of affiliation, and that the actual loss sustained from the liquidation of Hornthal & Co. was only $4,995.70. The petitioner contends that its actual loss upon the liquidation of Hornthal & Co. was not lessened by the fact that Hornthal & Co. had operating losses during the three fiscal years ended June 30, 1926, 1927 and 1928. It further contends that if the loss sustained is to be reduced in any amount it should not be reduced in an amount exceeding the operating loss of Hornthal t% Co. for the fiscal year ended June 30, 1928, namely, $11,278.42; further, that in any event the loss of $105,355.07 should not be reduced by a greater amount than the net operating loss of Hornthal & Co. from the date of acquisition of the capital stock of that company, namely, July 1, 1924, to the date of liquidation in 1928, and that the net operating loss on such computation was only $57,267.40.

The question here presented has been before the Board and the courts a number of times. United Publishers Corp. v. Anderson, 42 Fed. (2d) 781; Burnet v. Riggs Natl. Bank, 57 Fed. (2d) 980; Burnet v. Aluminum Goods Mfg. Co., 287 U.S. 544; McLaughlin v. Pacific Lumber Co., 66 Fed. (2d) 895; Hernandez v. Ilfeld Co., 66 Fed. (2d) 236. The facts in Hernandez v. Ilfeld Co., supra, are substantially the same as those involved in this proceeding. The court there held that the loss on liquidation must be reduced by the net loss of the subsidiary during the period of affiliation; for otherwise the business unit would be obtaining a double deduction of a net operating loss. We reached the same conclusion in Summerfield Co., 29 B.T.A. 77. We are of the opinion, therefore, that the liquidating loss sustained by the petitioner upon the liquidation of Hornthal & Co. in the fiscal year ended June 30, 1928, claimed to be in the amount of $105,355.07, must be reduced by the operating losses of $57,267.40 of the subsidiary during the period of affiliation.

The second question presented by this proceeding is the right of the petitioner to deduct from gross income as ordinary and necessary expenses an amount of $4,861.96 which the respondent has disallowed in the computation of a deficiency. At the hearing it was stipulated by the parties that of this total $2,586.96 constituted ordinary and necessary expenses deductible from gross income and that $2,275 was properly disallowed by the respondent.

The third point in issue is the right of the petitioner to deduct from gross income accruals of the Massachusetts excise tax within the taxable year ended June 30, 1928, of $6,088.94, $7,143.06 and $124.10. The first named amount represents the excise tax based upon the petitioner’s income for the fiscal year ended June 80, 1927. Both parties are agreed that the amounts of $7,143.06 and $124.10 are excise taxes which accrued on June 80,1928, and are deductible from gross income. The only question is whether the item of $6,088.94 is also a legal deduction.

Under the Massachusetts Excise Tax Law, which was in force in 1927, the excise tax accrued for the fiscal year ended June 30, 1927, on April 1, 1928, although not payable until the following October. H. H. Brown Co., 8 B.T.A. 112. By an amendment effective January I, 1928 (ch. 258, Laws of Massachusetts, 1927), the above statute was amended to provide that the excise tax payable accrued as of the end of the calendar or fiscal year of the corporation. It was by virtue of the amendment that the parties stipulated that the excise taxes due upon the petitioner’s business for the fiscal year ended June 30, 1928, accrued on June 30, 1928. The respondent raises the question, however, as to the date of accrual of the excise tax paid by the petitioner for the fiscal year ended June 30, 1927.

In General Counsel Memorandum 8553, Cumulative Bulletin IX-2, p. 109, it was held that under the Massachusetts Corporation Excise Tax Law, as amended April 15, 1927, effective January 1, 1928, in the case of a corporation which filed a return for the calendar year 1928 and kept its books of account on the accrual basis, there might be deducted in computing net income of that year the amount of excise taxes which had accrued upon the business of the year 1927 and which under the old law accrued April 1, 1928, and also those which accrued as of December 31,1928. The respondent was of the opinion that the only result of the amendment, so far as it affected the excise tax liability of a corporation for the calendar year 1927, which accrued on April 1, 1928, was to set back the date of accrual to January 1, 1928, the effective date of the act. Whether this be a correct conclusion is not material to the proceeding at bar. Clearly, under the old law, this petitioner’s tax liability for the amount of $6,088.94 accrued on April 1, 1928. The respondent makes no contention that the petitioner was exempt from payment of the $6,088.94 in question and the evidence shows that this amount was paid in October 1928. It is immaterial to decide whether the correct date of accrual was January 1 or April 1, 1928. In either event the petitioner, keeping its books of account upon the accrual basis, was entitled to deduct the amount. This issue is determined in favor of the petitioner.

Judgment will be entered under Rule 50.


text:
    Keck Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 37821.
    Promulgated October 24, 1933.

      Thomas B. Dempsey, Esq., and A. Galder Machay, Esq., for the petitioner.

      B. W. Wilson, Esq., for the respondent.
   OPINION.

Smith :

Although the petitioner claimed no deduction from gross income for the year 1923 in respect of an alleged loss on the exchange of 321,275 shares of capital stock of the Miley-Keck Oil Co. for shares of stock of the Pacific Oil Co., it alleges in its petition that the respondent erred in refusing to allow the deduction of a loss of $250,594.50 upon such exchange. The basis of this claim is that the fair market value of 321,275 shares of stock of the Miley-Keck Oil Co. at the time acquired by it in exchange for shares of its own capital stock was $1,535,694.50 and that inasmuch as the fair market value of the stock of the Pacific Oil Co. at the time it was received by it in 1923 in exchange for the stock of the Miley-Keck Oil Co. is deemed to have been only $1,285,100, the difference represents a deductible loss.

When the petitioner acquired the 321,275 shares of stock of the Miley-Keck Oil Co. on November 17, 1922, they were placed upon its books as an asset at $1,285,100. The petitioner now contends that that entry was in error. Although admitting that the values of the other assets placed upon its books of account in 1922 represented their fair market value, it contends that the fair market value of the Miley-Keck Oil Co. stock was $1,535,694.50. In support of this contention the petitioner has adduced the testimony of John K. Roberts, an internal revenue agent, who in 1927 valued the leasehold interests of the Miley-Keck Oil Co. as of November 17, 1922, for the purpose of determining proper allowances for depletion. He estimated that the petitioner should recover 7,651,296 barrels of oil from its leasehold interests and that the value of the oil in the ground on November 17, 1922, was $5,141,670.91. Inasmuch as the liabilities of the Miley-Keck Oil Co. was $357,368.85 in excess of all assets, exclusive of the leasehold interests, the petitioner assumes that the net value of the assets of that company on November 17, 1922, was $5,141,670.91 less $357,368.35, or $4,784,302.56. Since the company had 1,000,000 shares of stock outstanding, the petitioner assumes that the fair market value of all of its shares on November 17,1922, was $4,784,302.56, or at the rate of $4.78 per share, and that the fair market value of the 321,275 shares acquired by the petitioner was $1,535,694.50. The petitioner also adduced the testimony of William M. Keck, who stated that in his opinion the value of the stock at the date of the organization of the petitioner was in excess of $5 per share.

We think that the evidence presented by the petitioner does not overcome the presumption of the correctness of the taxpayer’s books of account and of the determination of the respondent in accordance therewith. We have no reason to assume that in 1922 the value of the 321,275 shares of stock of the Miley-Keck Oil Co. was determined on any basis different from that of the other assets acquired by the petitioner at the same date and the petitioner admits that the other assets were placed upon its books of account at their fair market value. The valuation by the revenue agent in 1927 was for the purpose of determining a correct allowance for depletion. It may or may not have borne a direct relationship to the fair market value of the shares of stock of the Miley-Keck Oil Co. Even if it did bear such relationship to the total number of shares outstanding, it is bjr no means proved that the fair market value of 321,275 shares was at the same rate as the total number of shares outstanding, namely, 1,000,000. We think that the estimate of the officers of the corporation in 1922 is entitled to more weight than the estimate of William M. Keck in 1932, the date of the hearing of this proceeding, that the shares of stock in 1922 had a fair market value of $5 per share. It is furthermore to be noted that there is no evidence that the fair market value of the 321,275 shares of stock in question suffered any diminution from the date of acquisition by the petitioner to the date of exchange in 1923 for shares of stock of the Pacific Oil Co., and both parties agree that in 1923 the fair market value of the shares of stock of the Pacific Oil Co. received in exchange was $1,285,100. Furthermore, the petitioner’s books of account do not reflect that it sustained any loss in respect of the exchange transaction. We, therefore, think that there is no basis for the claim of a deductible loss on the part of the petitioner in respect of the exchange. The contentions of the petitioner upon this point are not sustained.

The deficiency notice dated February 27, 1928, forming the basis for the petition, states:

* * * the information on file discloses that inasmuch as the stock of the Keek Investment Company is closely held, and whereas balance sheets submitted with your return for the year 1923 disclose the fact that you received during the year, taxable income and nontaxable dividends in the aggregate amount of $226,188.76, and distributed to your stockholders within the year dividends aggregating only $50,000.00, this office holds that your corporation was availed of for the purpose of evading the imposition of surtaxes upon its stockholders and that the tax imposed by Section 220 of the Revenue Act of 1921 attaches to the year 1923. * * *

Section 220 of the Revenue Act of 1921 provides:

That if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 25 per centum of the amount thereof, which shall be in addition to the tax imposed by section 230 of this title and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax: Provided, That if all the stockholders or members of such corporation agree thereto, the Commissioner may, in lieu of all income, war-profits and excess-profits taxes imposed upon the corporation for the taxable year, tax the stockholders or members of such corporation upon their distributive shares in the net income of the corporation for the .taxable year in the same manner as provided in subdivision (a) of section 218 in the case of members of a partnership. The fact that any corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax; but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the tax in such ease unless the Commissioner certifies that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner, or any collector, every corporation shall forward to him a correct statement of such gains and profits and the names and addresses of the individuals or shareholders who would be entitled to the same if divided or distributed, and of the amounts that would be payable to each.

The evidence indicates that the petitioner was purely a holding or investment company in 1923. All but one of its shares of stock were held equally by William M. Keck and Alice B. Keck, his wife. Interest and dividends which were received by it in 1923, and income from other sources, were used for paying certain expenses and the balance was principally availed of for further investment, with the exception of $50,000 which was paid out as dividends to stockholders. The petitioner contends that it was necessary for it to finance the Superior Oil Co., which had little bank credit, and that if it had not financed that company its investment in it would have been lost by forfeiture of leases. We are not, however, impressed by this argument. The business of the Superior Oil Co. was not the business of this company. After a careful consideration of all of the evidence we conclude that the petitioner was organized primarily as a holding company for the purpose of holding certain of the investments of William M. Keck and Alice B. Keck. It was so operated in 1923. If the Keck Investment Co. had not been formed there is no question but that the two principal stockholders would have been liable to surtax not only upon the net incomé shown by the petitioner upon its income tax return for 1923, but also to income tax upon $146,966.44 of dividends from domestic corporations. Through the instrumentality of the petitioner surtax was avoided by the two principal stockholders upon all but $50,000 paid by the petitioner as dividends. The action of the respondent in holding the petitioner liable to the 25 percent tax imposed by section 220 of the Revenue Act of 1921 is sustained. Cf. United Business Corp. of America v. Commissioner, 62 Fed. (2d) 754; affirming United Business Corp. of America, 19 B.T.A. 809; Williams Investment Co. v. United States, 3 Fed. Supp. 225.

The third contention of the petitioner is that the respondent erroneously and illegally computed the tax asserted to be due under the provisions of section 220 of the Revenue Act of 1921 in that he computed a tax of 25 percent on an amount equal to the net income of petitioner plus dividends received by petitioner from domestic corporations less the amount of dividends paid by petitioner during the year, instead of a tax of 25 percent upon petitioner’s net income for the year 1923, as provided by section 220. Upon brief the respondent concedes error in his computation and states that the petitioner’s return for 1923 discloses net income of $79,222.32 and that the correct deficiency thereon would be 25 percent of that amount, to wit, $19,805.58.

Reviewed by the Board.

Judgment will be entered for the respondent in the amou/nt of $19,805.58.

Teammell, Black, GoodRioh and Adams dissent on the application of section 220 of the Revenue Act of 1921.


author: •Tbammell :

text:
    Skaneateles Paper Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 21561.
    Promulgated October 24, 1933.

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

      J. H. Yeatmcm, Esq., and J. A. Lyons, Esq., for the respondent.
   OPINION.

•Tbammell :

The petitioner suggests in its brief that we are without jurisdiction in this case because of certain facts appearing in the record, to which reference will be made seriatim hereinbelow. No such question was raised in the pleadings, but since the jurisdiction of this Boardi is prescribed and limited by the statute, we deem it our duty, in all cases where the essential jurisdictional facts do not clearly appear from the record, to consider and determine first of all whether we do or do not have jurisdiction of the proceeding.

The first question of jurisdiction suggested by the petitioner arises from the following facts: (1) The deficiency notice of September 29, 1926, from which this appeal was taken, was addressed to “ Skan-eateles Paper Company, Skaneateles, New York,” (2) which corporation had been consolidated with two other corporations on or about January 31, 1922, to form the Oswego Falls Corporation, and on that date the component corporations had been dissolved by operation of law, and (3) the petition filed with the Board was signed “ Skaneateles Paper Company, By Its Sole Beneficiary Oswego Falls Corporation, of Fulton, New York, By S. C. Stiver, Secretary.”

In Bowman Hotel Corp., 24 B.T.A. 1193, precisely the same jurisdictional question, arising from a parallel state of facts, was considered by us and decided in the affirmative. On authority of that decision we hold that, in so far as the point here considered is concerned, we have jurisdiction to redetermine the deficiency involved in the instant case. See also Oswego Falls Corp., 26 B.T.A. 60, and cf. Burnet v. San Joaquin Fruit & Investment Co., 52 Fed. (2d) 123, followed by us in San Joaquin Fruit & Investment Co., 28 B.T.A. 395.

The next question suggested by the petitioner touching our jurisdiction of this proceeding is predicated upon the fact that two deficiency notices were mailed to the taxpayer covering the same taxable year. Under date of December 5, 1925, the respondent mailed a deficiency notice to the taxpayer substantially in the same form as the second deficiency notice dated September 29, 1926, from which the present appeal was filed, and each deficiency notice purported to advise the taxpayer of the respondent’s final determination of its tax liability. No appeal was taken from the first deficiency notice, and by letter dated January 12,1926, the respondent advised the taxpayer as follows:

Reference is made to your letter dated 11-28-25 requesting- that your profits tax for the year 1917 be computed under Sec. 210 of the Revenue Act of 1917.
The provisions of the 60-day letter * * * dated December 5, 1925, may he disregarded.

Under the Revenue Act of 1924, after having sent the taxpayer a deficiency notice, the Commissioner nevertheless had the right, without revoking the first notice, to send a second deficiency notice covering the same taxable year. J. W. Bowman, 8 B.T.A. 526. Cf. Dallas Brass & Copper Co., 3 B.T.A. 856; Gilbert B. Goff, 18 B.T.A. 283; Corn Products Refining Co., 22 B.T.A. 605. This right was taken away by section 274 (f) of the Revenue Act of 1926 if the taxpayer appealed to the Board from the first deficiency notice, and after the enactment of the latter act the Commissioner in such case was prohibited from determining any additional deficiency, except that he was authorized to assert a claim for increased deficiency at or prior to the hearing or rehearing before the Board.

In the instant case, the taxpayer did not appeal to the Board from the first deficiency notice, and the respondent, therefore, was not prohibited from sending the second notice under the 1926 act. Lewis E. Smoot, 25 B.T.A. 1038. See also Miami Metals Co., 10 B.T.A. 421, and City Baking Co., 10 B.T.A. 593.

As stated in City Baking Co., supra, the second deficiency notice constituted respondent’s final determination of the petitioner’s tax liability, and, having been mailed subsequent to the enactment and in pursuance of the provisions of the Revenue Act of 1926, and an appeal having been filed with the Board within 60 days thereafter, we have jurisdiction to redetermine the deficiency.

The petitioner also questions our jurisdiction in respect to the jeopardy assessment of $25,302.18. The amount was assessed by the respondent on March 14, 1924, and 12 days later the taxpayer filed its claim in abatement. By notice of December 5, 1925, the respondent notified the taxpayer of his determination of a deficiency in the amount of $545.20, which was in addition to the jeopardy assessment of $25,302.18, and in the notice respondent further advised the taxpayer that its claim for abatement of the jeopardy assessment would be rejected in full. Thereafter, in order to give consideration to the taxpayer’s request for special assessment of its profits tax, the respondent on January 12,1926, advised the taxpayer that the provisions of the notice of December 5, 1925, might be disregarded.

The withdrawal of the deficiency notice applied to the rejection of the claim for abatement of the jeopardy assessment as well as to the determination of the additional deficiency of $545.20. On April 24, 1926, respondent mailed to the taxpayer a 30-day letter advising of the tentative determination of an additional deficiency of $545.20, and in that letter it was further stated that “ In accordance with the foregoing conclusions, your claim for the abatement of $25,302.18 will be rejected in full.”

The final deficiency notice of September 29, 1926, which is the basis for this appeal, makes specific reference to the letter of April 24, 1926, for further explanation of the deficiency. Thus, the deficiency letter of September 29, 1926, constituted respondent’s notice to the taxpayer of the final rejection of its claim in abatement, and in this situation section 283 (e) of the Revenue Act of 1926 confers upon us jurisdiction to redetermine the entire deficiency, including the jeopardy assessment.

However, even if the deficiency notice of September 29, 1926, had made no reference to the final rejection of the claim for abatement of the jeopardy assessment, since our jurisdiction has been invoked to redetermine the additional deficiency of $545.20, we may consider all facts determinative of the petitioner’s tax liability for the year 1917, including the redetermination of the jeopardy assessment and any question of limitation properly before us. Friend M. Aiken, 10 B.T.A. 553; Peerless Woolen Mills, 13 B.T.A. 1119; Peerless Woolen Mills v. Rose, 28 Fed. (2d) 661; Melville W. Thompson, 18 B.T.A. 1192; Northern Anthracite Coal Co., 21 B.T.A. 1116.

The petitioner pleads the statute of limitations in bar of the collection of the jeopardy assessment of $25,302.18, and in bar of both assessment and collection of the additional deficiency of $545.20. This issue is to be determined in the light of the following facts: The taxpayer filed its income and profits tax returns for the year 1917 on March 29, 1918, and the five-year period for assessment and collection, provided in section 250 (d) of the Revenue Act of 1921, expired not later than March 29, 1923. On February 14, 1921, the taxpayer executed a so-called “ unlimited waiver ” which, under the Commissioner’s Mimeograph 3085 of April 11, 1923, expired April 1, 1924. On March 14, 1924, respondent made the jeopardy assessment of $25,302.18, which was within the statutory period for assessment as extended by the waiver. On March 26, 1924, a claim in abatement was filed. On December 9, 1924, the next waiver was filed, which purported to extend the time for both assessment and collection to April 1, 1925, and again on January 26 and November 25, 1925, waivers were executed purporting to extend the period for assessment to December 31, 1926. The deficiency notice appealed from was mailed September 29, 1926.

From the foregoing it is clear that while the amount of $25,302.18 was assessed timely, collection thereof became barred on and after April 1, 1924, and that both assessment and collection of any additional amount became barred on the same date. This situation without change existed on June 2, 1924, the effective date of the Revenue Act of 1924, and continued to exist at least until the execution of the waiver of December 9, 1924. Did the execution of the waiver of December 9, 1924, and the subsequent waivers referred to, serve to revive the right of the respondent to collect the jeopardy assessment and to assess and collect the additional deficiency? This question must be answered in the affirmative only (1) if the waivers were validly executed, and (2) if they were competent to lift the bar of limitation which had theretofore fallen. The petitioner argues that the waivers are invalid and without legal effect for the reason that they were executed for and in behalf of the Skaneateles Paper Co. by the consolidated corporation, petitioner herein, as successor of the original taxpayer, and since the latter corporation was dissolved in 1922, the petitioner was without authority as such successor to execute a waiver for or in its behalf. This contention of the petitioner must be denied on authority of our decision in Oswego Falls Oorp., supra, where we held that similar waivers were validly executed by this same petitioner; that the consolidated corporation, having been made by statute directly liable for all obligations of its components, was acting for itself as principal and not for another as agent, when it executed the waivers. See 26 B.T.A. at page 66.

The petitioner also urges that collection of the jeopardy assessment of March 14, 1924, in the amount of $25,302.18 was in any event barred on and after April 1, 1924, when the so-called unlimited waivers were held to expire, and that even if the waivers subsequently executed were valid to extend the time within which additional taxes might thereafter be assessed and collected, such waivers were not competent to extend the period for collection of a tax theretofore assessed, citing Russell v. United States, 278 U.S. 181.

The Bussell case did not involve a waiver executed after the applicable period of limitation had run and which purported to revive and extend such period; hence, that decision is not pertinent here, and petitioner’s contention on this point, we think, must be rejected. Tire waiver of December 9, 1924, recited that the taxpayer and the Commissioner “ hereby consent to extend the period prescribed by law for a determination, assessment, and collection of the amount of income, excess-profits or war-profits taxes due under any return made by or on behalf of said taxpayer for the year 1917.” It follows that, since the jeopardy assessment of $25,302.18 concededly represented income and profits taxes due for the year 1917, if said waiver was valid to extend the period for determination and assessment, it was equally valid to extend the period for collection of any such tax due for 1917, whether theretofore or thereafter assessed. While the subsequent waivers of January 26 and November 25, 1925, refer only to assessment,” the term so used must be construed as comprehending the entire procedure necessary to a determination and collection of the tax. Stange v. United States, 282 U.S. 270.

Petitioner’s final argument on the issue of limitations is that since either assessment or collection of the 1917 taxes in question was barred during the period from April 1 to December 9, 1924, the waiver executed on the latter date did not operate to lift the bar, for the reason that on June 2 of that year the Revenue Act of 1924 was enacted, and while section 278 (c) thereof provided for extension of the assessment period by consents in writing between the Commissioner and the taxpayer, this provision was subject to the limitation contained in paragraph (e) of section 278 to the effect that “This section shall not (1) authorize the assessment of a tax or the collection thereof by distraint or by a proceeding in court if at the time of the enactment of this Act such assessment, distraint or proceeding was barred by the period of limitation then in existence, or (2) affect any assessment made, or distraint or proceeding in court begun, before the enactment of this Act.”

This point was decided adversely to the petitioner’s contention in McDonnell v. United States, 288 U.S. 420, where it was held that paragraph (e) of section 278 did not constitute a limitation on paragraph (c) thereof, and that a waiver executed subsequent to June 2, 1924, was not invalid because the five-year period for assessment had elapsed before June 2, 1924. On authority of that decision, petitioner’s plea of limitations is overruled.

This brings us to a consideration of issues (2) and (3) on the merits. Issue (2) is based upon the petitioner’s allegation that in computing the deficiency the respondent erred in failing to include in invested capital at January 1, 1917, any part of the alleged increase of surplus effected on April 30, 1915, through the cancellation of seven promissory notes for $5,000 each, which were executed and delivered to the Oswego Falls Pulp & Paper Co. on February 15, 1914, in connection with the purchase of the Draycott Mill and on April 30, 1915, were canceled, marked “ Paid ” and returned to petitioner without cost.

Petitioner purchased the Draycott Mill in February 1914 for a total consideration of $87,237.29, consisting of the cancellation of its account receivable against the Oswego Falls Pulp & Paper Co. in the amount of $52,237.29 and said seven promissory notes each for the sum of $5,000. No payment was ever made on the notes and on April 30, 1915, they were canceled and returned to petitioner under circumstances which clearly amounted to a donation.

The Revenue Act of 1917 defined and limited invested capital, so far as material here, as follows:

Sec. 207. * * * (a) In the ease of a corporation * * *: (1) Actual cash paid in, (2) the actual cash value of tangible property paid in other than cash, for stock or shares in such corporation * * ⅜, at the time of such payment * * * and (3) paid in or earned surplus and undivided profits used or employed in the business, exclusive of undivided profits earned during the taxable year: * ⅜ *

Admittedly the Draycott Mill was not paid in to the petitioner for shares of its capital stock, and only the amount of $52,237.29 which was actually paid for the property may be included in invested capital, unless the promissory notes in the aggregate amount of $35,000 are shown to have constituted paid-in surplus. By the cancellation of the notes without payment, $35,000 was donated to the petitioner, but such donation did not increase the petitioner’s paid-in surplus unless the donor was a stockholder, or unless the cancellation of the notes resulted in the receipt of taxable income by the donee. The record does not disclose facts necessary to enable us to determine either of those questions. We have heretofore held that property donated to a corporation by a nonstockholder does not give rise to paid-in surplus. A. C. F. Gasoline Co., 6 B.T.A. 1337; Frank Holton & Co., 10 B.T.A. 1317; Watervliet Paper Co., 16 B.T.A. 604.

In the deficiency notice the respondent held that the transaction referred to “represented, in effect, nothing more than the transfer of an operating loss from a parent company to a subsidiary, which would indicate that the subsequent cancellation of the notes was merely an adjustment of the selling price of the plant to its true value. It is further held that, under the circumstances, the original entries on your books by which notes payable were debited with $35,000.00 and the plant account credited with a like amount, was correct and that there is no warrant for allowing this item as invested capital within the meaning of the statute and Income Tax Regulations.”

The burden is upon the petitioner to show that the respondent’s determination is erroneous. This, we think, the petitioner has failed to do. Accordingly, the respondent’s action on this issue is approved.

Issue (3) involves the question whether respondent erred in disallowing the entire deduction for depreciation claimed by the petitioner from its gross income for 1917 on that part of the alleged cost of the Draycott Mill represented by the canceled indebtedness of $35,000. On brief the petitioner states that “ its claim for depreciation should be passed over because of the absence of evidence indicative that any depreciation was sustained during the taxable year 1917.” Respondent’s action on this issue is, therefore, approved.

Reviewed by the Board.

Judgment will T)e entered for the respondent.

Mukdock dissents.