author: Murdock:

text:
    Meridian & Thirteenth Realty Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101968.
    Promulgated July 3, 1941.

      Luden L. Dunbar, Esq., and Merlin M. Dunbar, Esq., for the petitioner.

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

Murdock:

The Commissioner determined a deficiency of $2,910.06 in the income tax of the petitioner for the calendar year 1936. Two issues are presented for decision: (1) Whether the Commissioner erred in failing to allow a deduction of $1,800 for interest paid on so-called preferred stock, and (2) whether the petitioner is entitled to a credit under section 26 (c) (1) or (c) (2) equal to adjusted net income in determining undistributed net income. The parties have stipulated all of the facts which they deem material and the Board adopts the stipulation as its findings of fact. The testimony of one witness was introduced, but no findings have been made based upon his testimony, since the parties requested none.

The petitioner was incorporated in November 1922, under the laws of Indiana, solely for the purpose of acquiring, owning, improving, and renting a certain piece of property in the city of Indianapolis. It was without power to transfer or encumber the property except with the written consent of the preferred stockholders. Its authorized capital stock consisted of 2,000 shares of common stock and 2,250 shares of preferred stock, each share having a par value of $100. The petitioner agreed to redeem each share of preferred stock on a fixed date at par value, plus accumulated dividends, and it reserved the right to redeem at an earlier date by the payment of a premium. Each share of preferred stock became immediately redeemable upon failure of the petitioner to comply with any of its obligations and agreements with respect thereto and, if the petitioner should fail upon demand to redeem the same with accrued dividends, then the holder thereof became entitled to require the liquidation of the company. The holder of each share of preferred stock was entitled to receive cumulative dividends at the rate of 6 percent per annum, payable in equal quarterly installments. No amount could be set aside for or paid to common stockholders until all current obligations on the preferred stock had been met.

All of the preferred stock was sold under an underwriting agreement with Wild & Co. dated November 13, 1922. The agreement recited that the petitioner was about to acquire the real estate and to erect a building thereon to cost approximately $250,000, and desired the assistance of Wild <¾ Co., party of the second part, in financing the cost of the improvements. The petitioner was to issue all of its common and preferred stock. The agreement recited the conditions for the retirement of the preferred stock and the payment of dividends thereon. The majority of the common stock was to be delivered to nominees of the party of the second part so long as any of the preferred stock should be outstanding, so that the nominees could vote the stock whenever and so long as the petitioner should be in default in the performance of any of its obligations to its preferred stockholders.

The agreement further provided that the petitioner should obtain a lessee, approved by the second party, to join in a lease of the premises “for the period from January 1, 1928, to and including January 1, 1937, at a rental at least sufficient to pay all dividends on said preferred stock and all installments of the principal thereof at the times fixed therefor, all taxes levied or imposed on the first party or upon its property by whatever authority, all insurance premiums and all costs, charges and expenses whatsoever, of said Realty Company to the end that said Realty Company shall at all times have available net revenue ample to meet all of its obligations to its preferred stockholders as the same shall become due.”

The agreement also contained the following provisions:

8. So long as any of said preferred stock shall remain outstanding, said Realty Company shall:
(a) Pay no salaries to its officers and no dividends on its common stock, except after there has been first set aside, as surplus, an amount equal to the preferred stock obligations for the next succeeding twelve months;
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(d) Not transfer, convey or encumber said real estate;
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(g) Not incur, after the completion of said new improvements, any floating indebtedness in excess of $5,000.00 other than for current taxes and municipal assessments not delinquent.
*******

The second party agreed to purchase, subject to the performance of all of the terms of the agreement, all of the preferred stock of the par value of $225,000 at 95 percent of the par value thereof, to pay out the proceeds for the erection of the new building, and to pay 3 percent interest on all undue balances of the proceeds from January 1, 1923.

All of the preferred stock was thus issued. Thereafter, the quarterly dividends were regularly paid and the stock was retired in accordance with the terms of the- certificates and the agreement. Preferred stock having a par value of $30,000 was outstanding at the beginning of the taxable year 1936 and was all to be retired on January 1, 1937. “Dividends” in the amount of $1,800 were paid on that stock during 1936 and $20,000 par value of that stock was retired on December 31,1936, leaving 100 shares of the par value of $10,000 outstanding at the close of 1936. That $10,000 par value was to be retired in accordance with the terms of the stock and agreement on January 1, 1937, and was actually retired on March 4, 1937.

The first question is whether the preferred stockholders made investments in the petitioner so that the payment of $1,800 to them in the taxable year was a dividend, or whether they made loans to the corporation upon which it paid them interest at the rate of 6 percent. All such questions have to be decided upon the facts in the particular case. Dayton & Michigan Railroad Co., 40 B. T. A. 857. There are certain facts in this case which must be given due consideration but do not serve to determine the issue. These include, on the one hand, the use of the words “preferred stock” and “dividends”, the subordination of the rights of the preferred stockholders to those of general creditors, and, on the other hand, absence of voting rights in the preferred stock. Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11; Wiggin Terminals, Inc. v. United States, 36 Fed. (2d) 893; Commissioner v. Proctor Shop, Inc., 82 Fed. (2d) 792, afiirming 30 B. T. A. 721. But this preferred had other and more significant characteristics. Each share had a fixed maturity date upon which it became payable; the common was held by nominees for the protection of the preferred; the holder of' a share of preferred could enforce payment of the entire sum due as a debt in case of default; and the payment of the 6 percent was not dependent upon profits, but was payable and could be demanded in any event. The fact that the 6 percent was payable even in the absence of profits is shown by the following provision of the articles of association and by a similar provision printed on the certificates:

On liquidation of the Company, the holders of the shares of preferred stock shall be entitled to receive the par value of such shares, plus all accumulated dividends, and no more, before any sum whatever shall be paid upon the common stock.

The so-called preferred stock actually represented an indebtedness and the $1,800 paid thereon in 1936 was interest. United States v. South Georgia Railway Co., 107 Fed. (2d) 3; Commissioner v. O. P. P. Holding Corporation, supra; Palmer, Stacy-Merrill, Inc. v. Commissioner, 111 Fed. (2d) 809, affirming 39 B. T. A. 636; Jones Syndicate v. Commissioner, 23 Fed. (2d) 833; Richmond, Fredericksburg & Potomac Railroad Co., 33 B. T. A. 895; affd., 90 Fed. (2d) 971.

The petitioner next claims that it is entitled to a credit under section 26 (c) (1), which relates to contracts restricting payment of dividends and allows credit of “An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1,1936, which provision expressly deals with the payment of dividends.” The petitioner relies upon the underwriting contract dated November 13, 1922. That contract was written, was executed by tte corporation prior to May 1, 1936, and contains provisions expressly dealing with the payment of dividends. The issue is thus narrowed to the question of whether the petitioner could have distributed any amount as a dividend in 1936 without violating the provisions of that contract.

The contract contained a provision that so long as any preferred stock remained outstanding the company could pay no dividends on its common stock, “except after there has been first set aside, as surplus, an amount equal to the preferred stock obligations for the next succeeding twelve months.” Three hundred shares of preferred stock of the par value of $30,000 were outstanding during most of 1936. The obligation of the petitioner was to retire those shares by January 1, 1937, and to pay the quarterly dividends thereon. If it could not declare a dividend on its common stock during 1936 except after it had first set aside from income of 1936 an amount equal to the preferred stock obligations for the next succeeding twelve months, then it is entitled to the credit which it claims, since its income for 1936 was less than $30,000.

The petitioner at the beginning of 1936 had a surplus, accumulated from earnings of prior years, in the amount of $116,174.11, which it increased to $133,475.88 at the close of 1936 by adding some of the earnings of 1936. The respondent argues that this surplus was far in excess of the obligations on the preferred stock for the next succeeding twelve months and, therefore, the petitioner could have paid a taxable dividend on the common stock without violating the terms of the contract. He says it could have paid a cash dividend in the amount of $10,906-by using cash on hand at the end of 1936'in the amount of $5,906.62 and by borrowing $5,000, as permitted under the contract. He is not concerned about a dividend payable in common stock, since that would not be taxable to the common stockholders, but he says a taxable dividend of preferred stock could have been distributed to the common stockholders and in this way all of the earnings of 1936 could have been distributed. The petitioner had authority to issue only 2,250 shares of preferred stock. The maturity date of all of those shares, save the 300 heretofore mentioned, had already passed and the petitioner had no authority to reissue any of those shares or to issue any other preferred shares. The case must stand or fall on the question of whether or not the petitioner could have distributed a cash dividend without violating the terms of the contract.

The respondent, in making his argument, looks only at the restrictions contained in section 8 (a) of the underwriting agreement. That agreement must be read in its entirety and with due regard for the purpose which it was intended to achieve. The petitioner issued all of its preferred stock and agreed to pay 1 ½ percent quarterly on that stock and to retire each share of it on a specified date. The means whereby it was to accomplish these results was set forth in paragraph 5 of the underwriting agreement. That paragraph required the petitioner to enter into a lease with an approved lessee for the entire period during which the preferred stock would be outstanding. The petitioner’s only asset was the land and building. It was to lease that asset “at a rental at least sufficient to pay all dividends on said preferred stock and all installments of the principal thereof at the times fixed therefor”, taxes, insurance, and all other expenses “to the end that said Realty Company shall at all times have available net revenue ample to meet all of its obligations to its preferred stockholders as the same shall become due.” It complied with that provision and used its net revenues to make the quarterly payments and to retire the preferred stock. The retirement of the preferred stock in this way reduced a liability, gave the petitioner a larger equity in its real estate, and enabled it to show a surplus on its balance sheet. But a surplus represented by a larger equity in the real estate did not give the petitioner any funds with which to meet its coming obligations on the preferred stock. It had no other assets with which it could meet its obligations on the preferred stock for the next twelve months. The contract prohibited the petitioner from borrowing money in excess of $5,000 for any purpose except a temporary borrowing to pay current taxes and municipal assessments. The obvious intent of the parties was to require the petitioner to set aside from current earnings an amount sufficient for the purpose of meeting its obligations on the preferred stock for the next twelve months before it could declare a dividend of any kind. The petitioner could not have declared a cash dividend on the common stock in 1936 in any amount from any source without violating the provisions of the underwriting contract, and it is entitled to the credit which it claims. Since the petitioner is entitled to the credit under section 26 (c)(1), it is not necessary to decide whether or not the credit would also be allowable under section 26 (c) (2). However, the interpretation which we have placed upon the contract, together with the other facts in the case, would appear to entitle the petitioner to the credit under section 26 (c) (2) also.

Reviewed by the Board.

Decision will Toe entered wider Rule SO.

Leech and Turnee dissent on the first point.

Arnold dissents on the second point.


source: Caselaw Access Project

author: Black :

license: Public Domain

text:
    Florence M. Sweet, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101786.
    Promulgated July 3, 1941.

      Francis E. Bussell, Esq., for the petitioner.

      David Hasidn, Esq., for the respondent.
   OPINION.

Black :

In the taxable year 1935, as will be seen from our findings of fact, the Joseph L. Sweet trust had net income from dividends and other sources of $32,878.70, nontaxable income of $2,190.96, and capital gains of $37,912.06. In that year the trustee paid to petitioner, the life beneficiary of the trust, $66,064.93, which amount was made up, according to the books and records of the trust, of dividends and other income of $32,878.70, nontaxable income of $2,190.96, and payment from “principal” $30,995.27.

In her income tax return for 1935 the petitioner included in income $32,678.70 received from the trustee but did not include the payment to her from “principal” in the amount of $30,995.27, and interest from H. O. L. C. bonds in the amount of $200. Petitioner now concedes that the $200 interest from the H. O. L. C. bonds is taxable to her, but contests the respondent’s action in adding to income the amount of $30,995.27 paid to her from “principal.” The only question before us, therefore, is whether the respondent erred in adding to petitioner’s income the amount of $30,995.27 in question.

The petitioner contends that the amount of $30,995.27 represents income for the years 1932 and 1933, to which she was entitled in those years but did not receive until 1935, that it was principal when received, and, therefore, is not taxable to her- in 1935.

The respondent contends that the amount in question was capital gain of the trust in 1935 and is taxable to petitioner as income for that year since it was actually distributed to her. He further contends that the petitioner is estopped to claim that the amount in question should have been taxed to her as income in 1932 and 1933.

The provisions of section 162 of the Revenue Acts of 1932 and 1934 are identical and section 162 of the Revenue Act of 1934 is printed in the margin.

If we assume that the Joseph L. Sweet testamentary trust, of which petitioner was the income beneficiary for life, was one in which the income was currently distributable to her, as respondent has determined in his deficiency notice, it is clear that petitioner has returned all of such income for taxation on her 1935 income tax return except the $200 H. O. L. C. bond interest which she now concedes is taxable to her.

It is true the trust had gains and profits of $37,912.06 from the sale of stocks and bonds in 1935 which petitioner did not return for taxation, but under the laws of the State of Massachusetts capital gains from a trust estate belong to the remainderman and are not distributable to the life benficiary unless there is provision in the trust instrument to the contrary. William v. Milton, 102 N. E. 355; McElwain v. Allen, 241 Mass. 112; 134 N. E. 620; Hemenway v. Hemenway, 181 Mass. 406; 63 N. E. 919; Chase v. Union National Bank of Lowell, 275 Mass. 503; 176 N. E. 508; and see Long v. Rike, 50 Fed. (2d) 124.

It seems clear that there was no provision in decedent’s will in the instant case which authorized the distribution of capital gains of the trust to petitioner. We do not understand respondent to so contend in his brief, though he does contend that the $30,995.27 in question was actually distributed from capital gains. It seems perfectly clear from the facts of record in the instant case that the trustee did not intend to distribute to petitioner the capital gains of the trust for the year 1985 or of any other year, nor did he do so.

The facts seem to us to show clearly that in 1935 the trustee concluded that there was ordinary income of the estate or trust for the years 1932 and 1933 which had not been distributed to petitioner as she might have requested be done. The facts also show that petitioner was anxious to have this income paid over to her in order that she might construct a war memorial bridge for the city of Attleboro, Massachusetts. She made known her wishes to the trustee and the trustee asked advice of his counsel as to whether he had the legal authority to make such a distribution at such late date and counsel gave an affirmative answer.

It is not our function to say whether that answer was correct or not. That is a function for the Massachusetts courts. We have only to decide the tax consequences of such a distribution and, inasmuch as it seems entirely clear that the $30,995.27 in question was not paid from the 1935 ordinary income or from the capital gain of the trust, but from income of the estate or trust in prior years, it is not taxable to petitioner in 1935. And that is true, whether the trust is held to be one where the income is currently distributable to the beneficiary as respondent has determined in his deficiency notice or whether it be held to be one where the income is only distributable within the discretion of the trustee, as petitioner contends and respondent seems to have determined in prior years.

In Anna M. Chambers, 17 B. T. A. 820, the Board, among other things, said:

* * * during the taxable years there was clistributecl to the petitioners not only their distributable share of the income of each of those years, but payments from distributable income of prior years. This seems to us to be of no importance. The law provides that the beneficiary shall include as his income his distributable share of the income, whether or not distributed. Amounts which properly became distributable in prior years were taxable in those years, not in the years of distribution and distribution in the years before us can serve neither to increase the taxable income of those years nor to affect the construction of the will.

If the trust is held to be one where the income is currently distributable to the beneficiary, then all of 1932 and 1933 income was taxable to petitioner in those years, as was held in the Chambers case above cited. If the trust is held to be one where the income is distributable to petitioner only in the discretion of the trustee, then petitioner was taxable only in 1932 and 1933 with the income which was properly paid or credited to her in those years and the balance of tlie income was taxable to the fiduciary. In all events, all of the income of an estate or trust in any one year is taxable either to the fiduciary or the beneficiary in such year, to one or the other, or both, depending upon what kind of a trust it is. See sec. 162, supra; Freuler v. Helvering, 291 U. S. 35.

Whether petitioner owed the increases in taxes for 1932 and 1933 which in 1939 she tendered and paid to the Commissioner, we pass no opinion. Those years are not before us. What we do hold is that, when parts of 1932 and 1933 income of the trust were distributed to petitioner in 1935, such amounts had already become principal of the trust and were not taxable to petitioner in 1935.

The facts in the instant case are distinguishable from those present in Arthur Letts, Jr., 30 B. T. A. 800; affd., 84 Fed. (2d) 760. In the Letts case, the income in question, representing gains and profits from the liquidation of the shares of stock of a corporation, was actually distributed by the trustee as income to the beneficiaries and the court of California having appropriate jurisdiction of the subject matter approved the distribution as income. Under these circumstances we held that we had no cause to treat the distribution as anything else but income and we, therefore, approved the Commissioner’s determination.

In the instant case, the trustee did not distribute the $30,995.27 in question as income, but on the contrary he distinctly noted it as a distribution of principal to the beneficiary and in his report to the Massachusetts Probate Court he reported the amount as a distribution of principal. Under these circumstances we think we must hold that it was a distribution of principal and -not of income. Cf. Anna M. Chambers, 29 B. T. A. 971; 33 B. T. A. 1125.

Bespondent strongly argues that petitioner is estopped from claiming that the $30,995.27 in question was not taxable income to her in the year 1935 when she received it from the trust. We fail to see where respondent has established that petitioner is estopped from making the contention which she is making.

Whether the testamentary trust set up by the will of decedent’s husband is one where the income is currently distributable to petitioner or whether it is one where the income is distributable within the discretion of the trustee, is a question of law. The respondent had full opportunity to read the terms of the will and make his own construction of its terms. There is no evidence that petitioner has deceived him. Petitioner has contended all along, both in her protest from which a quotation is taken in our findings of fact and in her brief filed in this proceeding, that the trust is one where the income is distributable to petitioner within the discretion of the trustee and she is taxable only on the income which, is actually distributed to her. We fail to see where these facts show any estoppel against petitioner. Estate of William Steele, 34 B. T. A. 173.

The evidence does show that the trust itself, in filing its fiduciary returns for 1933 and 1935 on Form 1041, made certain incorrect statements about the residue of the income in those years having been paid to the Attleboro Hospital, a charitable corporation for the State of Massachusetts, and the trust filed no income tax return on Form 1040 for those two years and paid no tax. It might well be that, if we had the trust before us as a taxpayer, these statements in regard to income being paid to the Attleboro Hospital in those years, when in fact none was paid, would work an estoppel against it and affect its tax liability adversely. We pass no opinion on that question because we do not have the trust before us as a taxpayer and there is nothing to show that petitioner had any connection whatever with such untrue statements.

Respondent’s plea of estoppel is not sustained by the evidence and we hold against it.

Decision will be entered wider Bule 50.

       SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
      (a) There shall be allowed as a deduction (in lieu of the deduction for charitable, etc., contributions authorized by section 23 (o)) any part of the gross income, without limitation, which pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in section 23 (o), or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit;
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year;
      (c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.


author: Smith : TuRNek,

text:
    Anna V. Gilmore, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 97835-97842.
    Promulgated July 3, 1941.

      Andrew B. Young, Esq., and Richard K. Stevens, Esq., for the petitioners.

      Broohs Fullerton, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: William Maynard Brown; Warren Webster Trust No. 1, Warren Webster, Jr., and Provident Trust Company of Philadelphia, Trustees; Warren Webster, Jr., and Katherine K.-Webster (Husband and Wife) ; Estate of Warren Webster, Sr., deceased, Warren Webster, Jr., and W. Logan Mac-Coy, Executors; E. Kessler Webster; Fannie S. Webster Trust, Warren Webster, Jr., and Provident Trust Company of Philadelphia, Trustees; The Estate of Florence L. Tisdale, deceased, John J. Carrol and Walter Pratt, Executors,

   OPINION.

Smith :

The sole question presented by these proceedings is whether the petitioners, stockholders of W. F. I., are liable to income tax for 1935 in respect of alleged gains made by them upon exchange of their shares of stock in that corporation for shares of stock of Warren Webster & Co. The two corporations were merged in 1935 under the provisions of the New Jersey statutes. The exchanges were made pursuant to the agreement of merger and consolidation and the petitioners contend that under section 112 (b) (3) of the Revenue Act of 1934 the alleged gains are not to be recognized for income tax purposes.

The pertinent provisions of the Revenue Act of 1934 are as follows:

SEO. 112. RECOGNITION OF GAIN OR LOSS.
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(b) Exchanges Soeect in Kind.—
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(3) Stock fob stock on reorganization.—No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
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(g) Definition of Reorganization.—As used in this section and section 113—
(1) The term “reorganization” means (A) a statutory merger or consolidation, or * * * (O) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, * * *
(2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.
SEO. 115. DISTRIBUTIONS BY CORPORATIONS.
*******
(c) Distributions in Liquidation.—Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the dis-tributee resulting from such exchange shall be determined under section 111 but shall be recognized only to the extent provided in section 112. * * *

The respondent does not contend that there was no merger of Warren Webster & Co. and W. F. I. under the laws of New Jersey; for in his brief he states: “On December 2,1935, the two corporations merged in accordance with the laws of New Jersey, in which state both were incorporated.” He contends, however, that the sole object which the parties had in mind in bringing about the merger was to liquidate W. F. I.; that the same objective would have been obtained by direct liquidation of W. F. I.; and that the petitioners should be taxed on the gains from the exchange of their shares in W. F. I. for stock of Warren Webster & Co., the continuing corporation, just as though there had been a direct liquidation of W. F. I.

Respondent argues that the alleged reorganization was a mere device for liquidating W. F. I. and that under the rule of Gregory v. Helvering, 293 U. S. 465, it should be disregarded for tax purposes.

It is to be noted, however, that, pursuant to the merger agreement, the charter powers of Warren Webster & Co. were materially modified. After the merger the stockholders of Warren Webster & Co. held shares of stock in a corporation with different rights and powers from those before held.

The respondent further submits that there was no reorganization of Warren Webster & Co. within the meaning of the statute; that after the merger Warren Webster & Co. had the same number of shares of stock outstanding as it had before the merger and that its assets were not increased as a result of the merger.

The taxing statute carries its own definition of a reorganization. It specifically declares that “a statutory merger or consolidation” is a reorganization. It can not be denied that there was here a statutory merger.

Prior to the merger Warren Webster & Co. and W. F. I. were separate corporations, organized under the statutes of New Jersey, with distinct corporate powers. Both were subject to income tax upon their net income. The merger of the corporations was brought about for two purposes—first, to enlarge the corporate powers of Warren Webster & Co., and, secondly, to eliminate the tax liability of W. F. I. upon its income.

Congress provided in the Revenue Act of 1934 that in the case of a merger or consolidation no gain or loss shall be recognized where securities in a corporation, a party to the reorganization, are exchanged solely for securities of the merged or consolidated corporation. The purpose of Congress was to permit the merger or consolidation of corporations to be effected in a proper case without liability for income tax on the exchange of stock or securities of the constituent corporations for those of the consolidated corporation. Congress has not said that a holding corporation may not be a party to a reorganization and we think that there is no ground for interpreting the statute as excluding them.

The contention of the respondent that W. F. I. was in effect liquidated by the merger of the two corporations seems to us to be immaterial. The practical effect in many cases of a merger or consolidation of corporations is a liquidation of one or all of them. Indeed, in any case of a merger or consolidation one or more of the constitntent corporations cease to exist as legal entities. This, however, does not prevent the merger or consolidation from being a reorganization within the meaning of the income tax acts. See H. B. Leary, Sr., 34 B. T. A. 1206; affd. (C. C. A., 4th Cir.), 93 Fed. (2d) 826; Jacob F. Schoellkopf, Jr., 35 B. T. A. 855; affd., Helvering v. Schoellkopf (C. C. A., 2d Cir.), 100 Fed. (2d) 415; Raoul H. Fleischmann, 40 B. T. A. 672; Commissioner v. Kolb, 100 Fed. (2d) 920; Commissioner v. Whitaker (C. C. A., 1st Cir.), 101 Fed. (2d) 640; Commissioner v. Food Industries, Inc. (C. C. A., 3d Cir.), 101 Fed. (2d) 748.

In the Schoellhopf case, above cited, the United States Circuit Court of Appeals for the Second Circuit said:

* *• * Certainly, the liquidation of one of the companies, a party to a reorganization, does not prevent the reorganization from being within the statute: § 115 (c) implies as much, and the courts have so decided. Ahles Realty Corp. v. Commissioner, 2 Cir., 71 F. 2nd 150; Helvering v. Winston Bros. Co., 8 Cir., 76 F. 2nd 381; Gross v. Commissioner, 5 Cir., 88 F. 2nd 567. We cannot therefore say that the reorganization was not real within Gregory v. Helvering, 293 U. S. 465, 55 S. Ct. 266, 79 L. Ed. 596, 97 A. L. R. 1355, because one of the companies disappeared. Nor can we say that it was only a device to escape taxation, assuming that that would be relevant anyway; so far as appears, the transfer of miscellaneous assets to the New York company was not interjected for other than business reasons. It is indeed somewhat startling to conclude that the taxability of the transaction depends on such a trivial incident, but that cannot be a determining consideration. If for example the holding company had held large properties, but had wished to dissolve, we should have no reluctance in reaching the same result. There would then have been an indubitable reorganization, coupled with a liquidation; and the old owners—then shareholders of the subsidiary—would simply be holding all the assets directly instead of holding some part of them through the parent’s ownership of the subsidiary’s shares. Such a change was within the intent of Congress * * * The underlying purpose of the exemptions in §112 is to disregard corporate manipulations which do not substantially affect the shareholders’ interest in the properties. * * *

In General Motors Corporation, 35 B. T. A. 523, 525, the Board said:

* * * But where the liquidation and dissolution are essential to the reorganization because the reorganization is by way of merger in its broad sense, Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462, they do not serve to justify recognition of gain under section 201 [now 115], which escapes by virtue of section 203 [now 112]. “Both can have effect, and if one does somewhat overlap the other the taxpayer should not be denied, for that reason, what one paragraph clearly grants him.” Helvering v. Minnesota Tea Co., supra [296 U. S. 378].

See also North American Utilities Securities Corporation, 36 B. T. A. 320, 325; D. W. Douglas, 37 B. T. A. 1122, 1128.

We do not think that the instant proceedings are controlled by the decision of Gregory v. Helvering, supra. The facts in that case were that Evelyn F. Gregory in 1928 was the owner of all of the shares of stock of the United Mortgage Co. That corporation held among its assets 1,000 shares of the Monitor Securities Corporation. For the sole purpose of procuring these shares for herself in order to sell them at a profit and at the same time to diminish the amount of income tax which would result from a direct transfer by way of dividend, she sought to bring about a reorganization under the provisions of the Revenue Act of 1928. To that end she caused the Averill Corporation to be organized under the laws of Delaware on September 18, 1928. Two or three days later the United Mortgage Corporation transferred to the Averill Corporation the 1,000 shares of Monitor stock, for which all the shares of the Averill Corporation were issued to Evelyn F. Gregory. On September 24, the Averill Corporation was dissolved, and liquidated by distributing all its assets, namely, the Monitor shares, to Evelyn F. Gregory. No other business was ever transacted, or intended to be transacted, by that company. Upon these, facts the United States Supreme Court held that the transaction was without the pale of the reorganization provisions of the Revenue Act of 1928. The Court said:

Wien subdivision (B) [of section 112 (g) of tbe Revenue Act of 1928] speaks of a transfer of assets by one corporation to another, it means a transfer made “in pursuance of a plan of reorganization” (section 112 (g)) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. * * *

No such situation obtains in the proceedings at bar. W. F. I. had been in existence for a number of years and for a purpose germane to the conduct of the affairs of Warren Webster & Co. The object for which W. F. I. had been organized had been accomplished. It became desirable to eliminate the holding company. That elimination was effected through a statutory merger of the two corporations. We think that there was a bona fide reorganization within the meaning of the taxing act and that the petitioners are not liable to income tax in respect of the exchanges of their shares of stock in W. F. I. for shares of stock in Warren Webster & Co.

Reviewed by the Board.

Decisions will he entered under Rule 50.

TuRNek,

dissenting: In my opinion the Board, instead of deciding, has assumed the only issue in the instant case, namely, whether there was a merger of W. F. I. with Warren Webster & Co. within the meaning of clause (A) of section 112 (g) (1), supra, and has devoted its attention chiefly to the proposition that the liquidation of a corporation under section 115 (c) may at the same time constitute a reorganization or a step in a reorganization within the meaning of section 112 of the statute, a proposition so plainly stated in section 115 (c) that discussion thereof or the citation of decided cases seems to me unnecessary. If it be assumed that there was a merger, there is nothing left for decision, for in that case there was a reorganization under section 112 (g) (1) (A), and the surrender by the petitioners of their W. F. I. stock for the stock of Warren Webster & Co. was an exchange within the meaning of section 112 (b) (3) and it matters not that W. F. I. was liquidated thereby. On the other hand, if there was no merger, there was, of course, no reorganization and the gain realized as provided by section 115 (c) on the liquidation of W. F. I. and determined as to amount under sec* tion 111 is in no way subject to the nonrecognition provisions of section 112 (b), but is recognized in full under section 112 (a).

What then is a merger and did a merger of W. F. 1. and Warren Webster & Co. occur? In Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937, one of the early reorganization cases and a basic case with respect to mergers, it was said that “A merger ordinarily is an absorption by one corporation of the properties and franchises of another whose stock it has acquired.” According to Black’s Law Dictionary, “A merger of corporations consists in the uniting of two or more corporations by the transfer of the property of all to one of them, which continues in existence, the others being swallowed up or merged therein.” In Cyclopedic Law Dictionary, it is said that a merger is “The absorption or consolidation of two or more corporations into one corporation which is accomplished by transferring the properties of the absorbed or consolidated corporations to the one corporation which absorbed the others.” In Fletcher’s Cyclopedia of the Law of Private Corporations, vol. 15, p. 8, it is said: “Strictly speaking, a merger means the absorption of one corporation by another, which retains its name and corporate Identity with the added capital, franchises and powers of the merged corporations. It is the uniting of two or more corporations by the transfer of property to one of them which continues in existence, the others being merged therein.”

That the Legislature of New Jersey in enacting its statute with respect to mergers used the term merger in its ordinary sense, and as defined above, is indicated by the following provision quoted by the petitioners from the New Jersey statutes:

When such merger or consolidation is effected, all of the rights, privileges, powers and franchises of each of such corporations, both of a public and private nature, all real and personal property, all debts due on any account, as well for stock subscriptions as all other things in action or belonging to each of the corporations, and all and every other interest, shall vest in the consolidated corporation as effectually as they were vested in the several and respective former corporations. * * * [Laws of 1896, ch. 185, sees. 106-7, p. 310.]

Essential therefore to a merger is the absorption by the continuing corporation of the properties and the franchises of the merged corporation or corporations. In this case we know that no properties of W. F. I. were absorbed by Warren Webster & Co. and it is only by inference that we may conclude that additional rights or powers were acquired.

If in the instant case we were privileged to look no further than the written instrument executed by W. F. I. and Warren Webster & Co. and, if we might further have the privilege of excluding or ignoring article X, we might readily conclude that a merger of W. F. I. into Warren Webster & Co. did occur. The instrument is designated an “Agreement of Merger and Consolidation”, and the words “merged” or “merger” are recurrent throughout, and article III, except for the limitation prescribed by article X, provides that Warren Webster & Co. shall thereafter have and be vested “with all and singular the rights, privileges, powers and franchises of WebsteR Finance & Investment Company, and with all property, real, personal and mixed” and “all property, rights, privileges, powers and franchises, and all and every other interest of WaeRen Webstee & Company.” No argument or discussion is needed, however, to establish the proposition that the calling of an agreement an agreement of merger or a transaction a merger does not make them so. The conclusion sought must be justified by what was actually done and accomplished. The record shows that Warren Webster & Co. never absorbed or acquired any of the properties of W. F. I. and article X indicates that it was never intended that it should. The only property which even momentarily passed from W. F. I. into the possession of Warren Webster & Co. consisted of the 9,003 shares of Warren Webster & Co. stock and those shares were received for the sole purpose of reissue or transfer to the stockholders of W. F. I. in liquidation and the said shares were in fact so transferred and reissued without change. What was done in so far as Warren Webster & Co. was concerned was in effect no different from the receipt by it of other or similar shares for transfer on its stock books from one purchaser to another.

, It is stated in the majority opinion, however, that the charter powers of Warren Webster <& Co. were materially modified and that the stockholders thereafter held shares of stock in a corporation with different rights and powers from those held before. This suggestion is made I suppose to support the conclusion that there wa<= a merger of W. F. I. and Warren Webster & Co. in that there was an absorption by Warren Webster & Co. of the rights, powers and franchises of W. F. I. so as to give it rights and powers which it did not have before. One difficulty with that proposition is that it is mere conjecture to say that the rights and powers of Warren Webster & Co. were substantially changed or modified in any way, even though we assume that the so-called agreement of merger when filed with the Secretary of State for New Jersey did serve to give Warren Webster & Co. powers and rights comparable to those of W. F. I. The record does not show the powers of either corporation and for all we know they may have been actually or in substance the same. Furthermore, assuming they were different, the effect was nothing more than an amendment of articles by Warren Webster & Co. and there was still no merger as indicated by the statute, an essential element thereof being the absorption by the continuing corporation of the properties and business of the merged corporation.

The petitioners and the Board rely on H. B. Leary, Sr., 34 B. T. A. 1206; Jacob F. Schoellkopf, Jr., 35 B. T. A. 855; affd., Helvering v. Schoellkopf, 100 Fed. (2d) 415; Commissioner v. Kolb, 110 Fed. (2d) 920; Commissioner v. Whitaker, 101 Fed. (2d) 640; and Commissioner v. Food Industries, Inc., 101 Fed. (2d) 748, to support the conclusion reached. As I view this case, however, those decisions not only fail to support the proposition that there was a merger here, but point to a contrary conclusion. In those cases the General Baking Corporation, a Maryland corporation and a holding company, was the owner of practically all of the stock of the General Baking Co., a New York corporation, and approximately $61,000 of miscellaneous assets. It was decided to liquidate the Maryland corporation. Under an agreement between the two corporations the Maryland corporation transferred all of its properties, including the stock of the New York corporation and the $61,000 of miscellaneous assets, to the New York corporation, whereupon the New York corporation delivered to the stockholders of the Maryland corporation in liquidation of the latter common shares of the New York corporation having added voting rights. The question was whether there was a reorganization within the meaning of section 112 (i) of the Revenue Act of 1828, which in so far as is pertinent here reads as follows: “The term ‘reorganization’ means (A) a merger or consolidation (including the acquisition by one corporation of * * * 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 stockholders, or both, are in control of the corporation to which the assets are transferred.” In H. B. Leary, Sr., the Board held, and in its holding was affirmed by the U. S. Circuit Court of Appeals for the Fourth Circuit, that while “there was no statutory merger or consolidation” of the two corporations there was a reorganization under the parenthetical provision of clause (A) quoted above. With respect to the words in parenthesis the Supreme Court said, in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462: “They expand the meaning of ‘merger’ or ‘consolidation’ so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words.” In enacting the Revenue Act of 1984, under which the instant case must be decided, Congress eliminated the parenthetical portion of clause (A) and the scope of that provision is now limited to statutory mergers or consolidations. Accordingly the case of PL. B. Leary, Sr., can not be regarded as authority for the proposition that the transaction herein was a merger under clause (A) of the definition.

In Helvering v. Schoellkopf and Commissioner v. Food Industries, Inc., the United States Circuit Court of Appeals for the second and third circuits, respectively, not only held that the transaction there dealt with was not a merger or consolidation, but held further that it did not even meet the requirements of the parenthetical provisions of clause (A). In that connection the court, in Helvering v. Schoell-kopf, said that the shares of the New York corporation “could not be regarded as property acquired by the New York company, that company was under contract to return them, and did not acquire them.” With further respect to the applicability of clause (A) the court concluded as follows: “To this the taxpayer answers that what was returned was not the old shares, but new ones, which were the price of the old; having a par value and a larger voting power relative to the preferred shares, they were to be regarded as something quite different from their predecessors. No doubt the question is one of degree, but we think that the two issues were so much alike as to be substantially the same. * * * We therefore regard the transfer of the shares as mere form; indeed nobody has been able to put his finger on any reason why it was necessary for any purpose. Subdivision A did not cover the transaction.” It was held in both cases, however, as was true also in Commissioner v. Kolb and Commissioner v. Whitaker, that the transaction by reason of the transfer of the miscellaneous assets of the Maryland corporation to the New York corporation was a reorganization under clause (B). Clause (B) of the 1928 Act is the same as clause (C) of the 1934 Act, but there, is no contention in the instant case that the transaction was a reorganization within the meaning of clause (C). Furthermore, in the instant case, according to the record, there were no assets except the 9,003 shares of Warren Webster & Co. stock, which, in accordance with article X of the agreement, were immediately reissued without any change whatever to the stockholders of W. F. I. in liquidation. Accordingly there was not, under the. cases cited, a transfer of W. F. I. of all or a part of the assets to Warren Webster & Co. so as to make the transaction a clause (C) reorganization.

That the transaction effected the liquidation of W. F. I. is, of course, admitted and, unless there was a reorganization under section 112 (g), the entire amount of the gain realized must be recognized under section 112 (a), supra. If my reasoning above is sound, there is not even literal compliance with the provisions of the statute dealing with reorganizations and, therefore, no occasion to consider the effect of Gregory v. Helvering, 293 U. S. 465, relied on by the respondent. The stockholders of W. F. I. came out of the transac- j tion with exactly the same property they would have received from. / the liquidation of W. F. I. without the deviousness resulting from-' the execution of the so-called “Agreement of Merger and Consolidation,” and in that connection the following statement appearing in the opinion of the court in Commissioner v. Food Industries, Inc., is of particular interest. The court said: “Though the transactions between the two companies are literally within the provisions of section 112 (i) (1) (B), we would not feel bound to hold that the surrender of the stock held by the respondent in the Maryland company and the receipt by it of the stock and debentures of the New York company was a nontaxable exchange if the result to the respondent was that which would have come to pass had the Maryland corporation been dissolved with the consent of its stockholders in the ordinary way and without entering into any transactions or agreements with the New York company.”

It it true that the substance of petitioners’ stock interests remained the same as before the liquidation in that the . elements giving value andi substance to the stock of W. F. I. before the liquidation and to the stock of Warren Webster & Co. received by them as the result of the liquidation continued to be the properties and business of Warren Webster & Co. The same thing may be said, however, with respect to any dissolution of a holding company and the distribution of the stock or securities which it holds to its stockholders in liquidation and, unless we are willing to go so far as to say that any dissolution of a holding company which so results in the distribution to its stockholders of the stock and securities held by it is a merger and therefore a reorganization, even though there is no pretense of or attempted compliance with the reorganization provisions of the statute, it is my opinion that a conclusion contrary to that of the majority must be reached in the instant case. That is not to say that a holding company may not effect or be a party to a reorganization within the meaning of the statute, but, if so, the transaction must be a reorganization as that term is defined by the statute.

For the reasons stated I respectfully note my dissent.

Hill agrees with this dissent.

       SEC. 112. RECOGNITION OE GAIN OR LOSS.
      (a) General Rule.—Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.

         H. B. Leary, Sr.; Jacob Schoellkopf, Jr.; Commissioner v. Kolb; Commissioner v. Whitaker; Commissioner v. Food Industries, Inc., all supra, and Chester A. Souther, 39 B. T. A. 197.


author: TotneR :

text:
    Alexander C. Howe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101426.
    Promulgated July 3, 1941.

      Charles H. Buekley, Esq., for the petitioner.

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

TotneR :

Section 23 (c) (2) of the Revenue Act of 1986 provides in short that “a taxpayer who does not signify in his return his desire to have to any extent the benefits of section 131.” shall be allowed a deduction for income, war profits and excess profits taxes paid to a foreign country. Section 131 provides that if a citizen of the United States signifies in his return his desire to have the benefits of that section, the tax imposed is to be credited with “the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country.”

The petitioner paid during the taxable year, through withholding by Canadian corporations from which he received dividends, $228.36 in income taxes to the Canadian Government. He did not signify in his income tax return filed on March 12, 1938, any desire to have the benefits of section 131, but by reporting only the net dividends received from Canadian corporations had in effect the benefit of a deduction of the said taxes as provided by section 23 (c) (2), supra. The record will not support a finding whether either the petitioner or Miss McManus was aware that the Canadian corporations had not transmitted the face amount of the dividends declared or had withheld the Canadian income tax thereon and had transmitted only the net amount of the dividends. About the most that may be said with certainty is that Miss McManus did not know the amount withheld until a later date. In the absence, however, of the expression by the petitioner “in his return” of a desire to have the benefit of the credit provided by section 131, there can be no question that in so far as the Canadian dividends are concerned the return filed on March 12, 1938, reported and disclosed a correct result. It may not be said therefore that the return was incorrect with respect to petitioner’s income tax liability on the dividends received from the Canadian corporations.

The petitioner, relying on Ralph Leslie Raymond, 34 B. T. A. 1171, and Mead Coal Co. v. Commissioner, 106 Fed. (2d) 388, contends that his claim for credit made in the return filed on June 23, 1938, was a claim “in his return within the meaning of section 181” and that the respondent is in error in his denial thereof. The respondent relies on Shire v. McGowan, decided by the United States District Court for the Western District of New York on May 25, 1939, and Marcy v. McGowan, decided by the same court on May 20, 1940, and contends that inasmuch as the petitioner reported only the net amount of dividends in his return filed on March 12, 1938, which was the only return filed by the petitioner within the statutory period prescribed for the filing of such return, the petitioner in effect claimed the Canadian tax as a deduction and did not comply with the requirements of the statute with respect to the allowance of the Canadian tax as a credit.

Shire v. McGowan, supra, relied on by the respondent, is directly in point. In that case the taxpayers undertook to obtain by amended return the benefit of a credit for income taxes paid to the Dominion of Canada instead of the deduction benefit allowed under section 23 of the statute and obtained on the return originally filed. The court held that the taxpayers, having had the benefit of the deduction pro-. vided. by section 23 and not having elected on their return to have the benefit of the credit, were not permitted a new election by means of an amended return. It does not appear that any question was raised as to the possible effectiveness of an amended return filed prior to the expiration of the period for filing a return for the year to which the amended return was applicable, but the facts show that the amended return to which effect was sought to be given was filed after the expiration of such period.

There can be no question that Mead Coal Co. v. Commissioner, supra, relied on by the petitioner, directly supports the proposition for which he contends, namely, that an election to take the credit might be made by amended return filed during the period within which the Commissioner might assess the tax. That case dealt with the provisions of the statute governing the election to take depletion on certain mines and mineral deposits on a percentage basis and the statute governing the election prescribed that the intention to claim depletion on the percentage basis should be signified by the taxpayer in his first return. The taxpayer made no such election in his first return but did so in a second return filed after the period prescribed by statute for filing returns for the year in question had expired. The court, reversing the Board, held that the term “first return” did not mean the first form filed, but included a second return even though filed after the time prescribed by the statute for filing a return for the year in question where the second return was filed for the purpose of amending the return originally filed and to correct a mistake made without any intent on the part of the taxpayer to take undue advantage with reference to tax payments. The difficulty with the petitioner’s reliance on that case, however, is that it has been overruled by the Supreme Court in Riley Investment Co. v. Commissioner, 311 U. S. 55, and is not a proper statement of the law of that case. There the Supreme Court held that a return filed after the period prescribed for filing the return for the year in question was not the first return within the meaning of the statute.

In the instant case the statute requires that the election to take the credit here sought must be signified by a taxpayer “in his return.” It does not .use the word “first” , in conjunction with the word “return” and on first impression certainly it might appear that the situation here is more favorable to the taxpayer than was true in Riley Investment Co. v. Commissioner, supra, and Mead Coal Co. v. Commissioner, supra. In Riley Investment Co., the Supreme Court, after noting that the Treasury has been liberal in accepting amended returns even though filed after the expiration of the period for filing original returns, called attention to the fact that it was not there dealing with a case where a taxpayer was merely demanding a correct computation of his tax for a prior year based on facts as they existed, but, to the contrary, was dealing with an amendment which changed'the basis on which the taxpayer’s income was computed for the taxable year and for all years thereafter. Pointing out that the opportunity to so change the basis for computing taxable income was a matter of legislative grace and that “the election had to be made in the manner and in the time prescribed by Congress”, the Court concluded that the election could be made only “in an original return or a timely amended return” and that an amendment of the character there involved “would be timely only if filed within the period provided by the statute for filing the original return.” “To extend the time beyond the limitation prescribed in the act”, .said the Court, “is a legislative, not a judicial function.”

In this case, as in Riley Investment Co. v. Commissioner, supra, the petitioner asks recognition of an amendment designed not “to correct errors and miscalculations in the original return” but an amendment which, if allowed, would fundamentally change the method of determining petitioner’s taxable income and the basis for determining the amount of his income tax liability. No desire to have the credit for Canadian income taxes as provided by section 131 having been expressed, on the return filed on March 12,1938, that return, in so far as the Canadian dividends were concerned, was a correct return under section 23 (c) (2) and there was no occasion for the filing of an amended return except for the purpose of making a change in the method or basis of computing taxable income, a change which the Supreme Court held in the Riley Investment Go. case was not permissible unless the election therefor was made in the restricted manner and time prescribed by the statute. Such a change was fundamental and was regarded by the Supreme Court as the filing of a new and different return and not an amendment or revision of the return already filed.

It is our opinion that what the Supreme Court said with respect to the filing of a second return to obtain the benefits of the election prescribed by section 114 (b) (4) of the Eevenue Act of 1934 is equally applicable to the provision for the election to take credit for foreign income taxes paid under the provision of section 131, supra, and we conclude that, since the return originally filed by petitioner fo,r 1937 was in effect a correct result under section 23 (c) (2) with respect to the Canadian dividends, the second return filed after the period prescribed by statute for the filing of the return for such year is not effective to change the basis or method for computing the. net income with respect to such dividend.

With respect to Ralph Leslie Raymond, supra, strongly relied on by petitioner, it may be said that in reaching our conclusion there we did not have the benefit of the pronouncements of the Supreme Court in Riley Investment Co. v. Commissioner, supra; but, even so, there are certain factual distinctions between the Raymond case and the instant case which make it unnecessary in reaching our conclusion here to reconsider our holding in that casé.

Decision will be entered for the respondent.

       For cases dealing with the question of what constitutes the return of the taxpayer or a proper amended return under various provisions of the income tax statutes, see Rose v. Grant, 39 Fed. (2d) 340; certiorari denied. 283 U. S. 867; McIntosh v. Wilkinson (Dist. Ct. Wis.), 36 Fed. (2d) 807; John D. Biggers, 39 B. T. A. 480; petition for review dismissed, C. C. A. 6th Circuit, Mar. 12, 1940, involving joint or separate returns of husband and wife; Alameda Investment Co. v. McLaughlin, 33 Fed. (2d) 120; Radiant Glass Co. v. Burnet, 54 Fed. (2d) 718; Safety Electric Products Co. v. Helvering, 70 Fed. (2d) 439, involving separate or consolidated, returns of affiliated corporations; Florsheim Brothers Dry Goods Co. v. United States, 280 U. S. 453; Zellerbach Paper Co. v. Helvering, 293 U. S. 172; National Paper Products Co. v. Helvering, 293 U. S. 183; Union Pacific Railroad Co. v. Bowers, 24 Fed. (2d) 788; certiorari denied, 278 U. S. 601; Northern Anthracite Coal Co., 21 B. T. A. 1116, involving the period of limitations; Automobile Loans, Inc., 36 B. T. A. 809, involving liability for personal holding company surtax; Taylor Securities, Inc., 40 B. T. A. 696, involving the allowability of certain deductions to a foreign corporation; and Haggar Co. v. Helvering, 308 U. S. 389; Scaife & Sons Co. v. Commissioner, 117 Fed. (2d) 572; Jordan Creek Placers, 43 B. T. A. 131; Brockway Glass Co., 43 B. T. A. 267, involving capital stock tax returns.


author: Leech :

text:
    Estate of Frederic E. Baldwin, Deceased, Girard Trust Company, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101134.
    Promulgated July 8, 1941.

      Pierce Archer, Jr., Esq., for the petitioner.

      Albert H. Monacelli, Esq., for the respondent.
   OPINION.

Leech :

The respondent determined a total deficiency in estate taxes against the petitioner of. $1,231.40. The deficiency in so far as here in issue resulted from the disallowance by the Commissioner of the deduction by petitioner of $8,000 in attorneys’ fees from the corpus of a trust estate in determining its value for inclusion in decedent’s estate for estate tax purposes. By amended answer respondent asks that the deficiency be increased by disallowance of certain items deducted by petitioner in valuing the trust estate and allowed by respondent in determining the deficiency as follows:

Trustee’s commissions_½___$4, 573.17
Transfer costs_ 130. 00
Filing costs_1_ 100.00
Deposition costs_ 105. 75
Dr. Westney—witness_ 25. 00

We find the facts as stipulated. They are, briefly stated, as follows:

On June 1,1931, Frederic E. Baldwin, a resident of Atlantic County, New Jersey, executed a will and a revocable deed of trust wherein the Girard Trust Co. of Philadelphia was named as executor of the will and trustee of the trust. Under the will Emily D. H. Mayer was made the sole beneficiary. Under the trust the grantor conveyed to the trustee his personal property, consisting of securities valued at approximately $120,000, excepting certain securities and accrued income amounting to $6,193.92. The income from this trust was reserved to the grantor as long as he lived and, upon death, Emily D. H. Mayer was to receive the trust corpus, together with accrued income. However, in the event that Emily D. H. Mayer predeceased the grantor, the trust corpus and accrued income were to be included in the grantors estate. The grantor predeceased Emily D. H. Mayer. A codicil to the will was executed on September 29, 1932, bequeathing $25,000 to Lucy M. Parker.

Frederic É. Baldwin died on November 3, 1936. His will and the codicil thereto were probated and the estate administered in Atlantic County, New Jersey. His trust was administered under the jurisdiction of the Orphans’ Court of Philadelphia County, Pennsylvania.

On or about February 17, 1937, Lathrop E. Baldwin, a nephew of the testator, acting in behalf of himself and May B. Cameron, a niece, and Florence St. John Baldwin, a sister, all residents of New York, filed a bill in equity in Philadelphia County, Pennsylvania, against the Girard Trust Co., as executor under the will aind codicil and as trustee of the deed of trust. Also, Emily D. H. Mayer, residuary legatee under the deed of trust, and Lucy M. Parker, legatee under the codicil, were named as defendants in the bill. The bill prayed that the deed of trust be declared null and void on the ground that Frederic E. Baldwin, at the time of its creation, was of unsound mind and incapable of performing any legal act.

At or about the time that the above mentioned bill in equity was filed in Philadelphia County, Lathrop E. Baldwin, acting for himself and others, appealed from the admission of the will and codicil to probate by the Surrogate of Atlantic County, New Jersey, also on the ground that Frederic E. Baldwin was of unsound mind and incapable of disposing of his estate at the time of the execution of his will.

The Girard Trust Co. retained a law firm in Philadelphia, Pennsylvania, to represent it in defense of the trust in Philadelphia, and further employed a New Jersey attorney to represent it in the will contest in New Jersey. Both litigations were settled on the day preceding the day fixed for trial of the action before the Court of Common Pleas of Philadelphia County. Accordingly, the proceedings attacking the deed of trust and the will and codicil were withdrawn, and the Girard Trust Co., as trustee and executor, proceeded with its accounting and settlement of its accounts and with the final distribution of the estate under the provisions of the deed of trust, will, and codicil.

The amount of the counsel fees was $8,000, and the entire amount was paid from the trust property. One-half, or $4,000, was paid to the Philadelphia law firm in 1937, and the remaining half to the New Jersey attorney in May 1938.

At the time of the audit of the account of Girard Trust Co. as trustee in the Orphans’ Court of Philadelphia County, Pennsylvania, that court allowed the payment of $8,000 as counsel fees. The court’s adjudication allowing these fees states in part as follows:

In view of the disproportion of the trust estate, which showed a balance of principal in excess of $125,000., as against the small amount in the Executor’s account, the Surrogate of Atlantic County refused to permit the allocation of any, except a portion, of the counsel fee to P. Morse Archer, Jr., to be deducted from this estate, and proportioned the Federal Taxes between the two estates in accordance with their proper ratio.
In view of the fact that the Federal authorities refused to allow counsel fees and expenses as a proper deduction from the estate unless allowed by the Court having jurisdiction over this account, the accountants request an adjudication as to whether, in view of the prolonged litigation and its successful termination, the fees and expenses are proper deductions from the trust estate, so that a final determination of the tax liability of the estate for Federal Inheritance Tax may be determined and the Executors and Trustees be discharged.
Credit is taken in the account for the balance of counsel fee and the expenses incurred in the litigation.
The Accountants charge themselves with the expenses of defending the trust established under the Deed in proceedings brought in Common Pleas No. 5 of Philadelphia County, which proceedings were settled. It was the duty of the trustees to defend the trust, and if they cannot defend the trust without incurring expenses, such expenses for counsel or other matters is [sic] properly payable out of the trust estate.

In determining the value .of the trust estate respondent allowed commissions amounting to $4,573.17, based on 3½ percent of the value of the trust assets turned over to the trustee in 1931. The commissions were payable at the termination of the trust by the death of Frederic E. Baldwin and were actually paid December 18, 1936. He also allowed transfer costs, filing costs, deposition costs, and a witness fee, totaling $360.75, all of which, it is stipulated, were-expenses attributable to the administration of the trust. Respondent now claims this action to have been in error and asks an increase in the value of the trust estate by the total amount of these items and an increase in the deficiency determined.

The value of the gross estate of decedent, exclusive of the trust, was $6,482.67. Attorneys’ fees in the amount of $1,750 were allowed by respondent as a deduction therefrom in computing the present deficiency.

It is conceded that because of the revocability of the trust, the value of its corpus is includable in the gross estate of decedent for estate tax purposes. Revenue Act of 1926, sec.-302 (d).

There are two issues: (1) Whether the petitioner, in determining, the value of a trust estate includable in the gross estate for estate tax purposes under the cited section is entitled to reduce the corpus of such trust by amounts incurred for (a) attorneys’ fees in defending the decedent’s trust, will, and codicil after his death, (b) trustee’s commissions, and (c) other miscellaneous expenses attributable to the administration of the trust;-and (2) whether, in determining decedent’s net estate under section 303 (a) (1) of the Revenue Act of 1926, any or all of the contested items are deductible from the gross estate as administration expenses of the estate.

Under the specific wording of section 302, swpra, it is “The value * * * at the time of * * * ■ [decedent’s] death * * *” which shall be included in decedent’s gross estate- for present purposes. See also United States v. Provident Trust Co., 291 U. S. 272; Lyman v. Commissioner, 83 Fed. (2d) 811.

The record here shows that the attorneys’ fees of $8,000 were expenses incurred after the decedent’s death and were paid entirely out of the corpus of the trust for services in connection with controversies arising subsequent to that death. Therefore, since these attorneys’ fees were not liabilities of the trust at the date of the decedent’s death, they may not be considered in determining the value of the corpus thereof for estate tax-purposes. Farmers Loan & Trust Co. v. Bowers, 98 Fed. (2d) 794; Mayer v. Reinecke, 28 Fed. Supp. 334; Estate of Frederick R. Shepherd, 39 B. T. A. 38.

A different condition exists as to the trustee’s commissions. It is stipulated that this expense represents commissions at 3½ percent on the value of the trust assets turned over to the trustee in 1931. It is further stipulated that these commissions were payable at the termination of the trust by the death of the decedent. Since these commissions had accrued as a liability of the trust at the time of the decedent’s death, they were property deducted in the determination of the value of the trust. Farmers Loan & Trust Co. v. Bowers, supra; Mayer v. Reinecke, supra; Estate of Frederick R. Shepherd, supra.

With regard to the other miscellaneous expenses,- it is stipulated that they -were attributable to the administration of the trust, and, since there is no showing that any of such expenses existed as liabilities of the trust at the time of decedent’s death, we hold that they can not be considered in the determination of the value of the corpus thereof for estate tax purposes. Farmers Loan, & Trust Co. v. Bowers, supra; Mayer v. Reinecke, supra; Estate of Frederick R. Shepherd, supra.

Are any of the items in controversy deductible from the value of decedent’s gross estate as administration expenses of that estate in determining its net value under section 803 (a), supra?

No authority is needed for the rule that estates and trusts are separate entities for tax purposes. And this rule is effective here despite the fact that the executor of the will and the trustee of the trust were the same company, and the actual beneficiaries of the will and trust, the same person.

It has been stipulated that all the contested items except the attorneys’ fees in the sum of $8,000, were administration expenses of the trust. That stipulation, of course, concludes petitioner on all but the excepted item, since they were not expenses of the estate but those of the trust.

Is any part or all of the attorneys’ fees of $8,000 deductible? We think not.

The courts and the Board have held that “administration expenses” must be construed broadly. They have said that though the act provides for the deduction of such “as are allowed by the laws of the jurisdiction”, the term must be construed as meaning such expenses, including attorneys’ fees, “as will ultimately be allowed by the laws of the jurisdiction under which an estate is being administered”, regardless of whether they have in fact been allowed by a competent court, or paid at the time of the hearing of the proceeding before the Board. James D. Bronson et al., Trustees, 7 B. T. A. 127; affd., 32 Fed. (2d) 112; John A. Loetscher et al., Executors, 14 B. T. A. 228 (affirmed in part and reversed in part, 46 Fed. (2d) 835, without affecting the decision of the Board on this point).

The estate of decedent was being administered in a Surrogate’s Court of the State of New Jersey. The decision of the Orphans’ Court of Philadelphia County in allowing the payment of the contested attorneys’ fees from the trust estate indicates that the only attorneys’ fees in controversy here were presented for allowance to the Surrogate Court of New Jersey having jurisdiction of the decedent’s estate, and that court refused to allow them. In any event, this record does not show that these contraverted fees were not presented to and disallowed by that court. The only court, so far as we know, which did allow them was the Orphans’ Court of Philadelphia County, which had jurisdiction of the trust but not the decedent’s estate. And that cou/rt allowed the paywent of the entire amount of these fees as expenses of administration of the trust. They were so paid.

The value of decedent’s gross estate, which was administered as such, was $6,482.67. Respondent allowed the deduction of the attorneys’ fees in the sum of $1,750 therefrom. The petitioner has not sustained its burden of establishing that the contested fees here, in the amount of $8,000, or any part thereof, were ultimately allowable by the laws of New Jersey under which the estate was being administered. Accordingly upon that ground, aside from any other, we hold that these fees are not deductible as an expense of the administration of the estate.

Decision will be entered wider Rule 50.

       Sue. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      *******
      (d) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. The relinquishment of any_ such power, not admitted or shown to have been in contemplation of the decedent’s death, made within two years prior to his death but after the enactment of this Act without such a consideration and affecting the interest or interests (whether arising from one or more transfers or the creation of one or more trusts) of any one beneficiary of a value or aggregate value, at the time of such death, in excess of $5,000, then, to the extent of such excess, such relinquishment or relinquishments shall be deemed and held to have been made in contemplation of death within the meaning of this title.

         Sec. 303. For the purpose of the tax the value of the net estate shall be determined,—=
      (a) In the case of a resident, by deducting from the value of the gross estate—
      (1) Such amounts for * * * administration expenses * * *.


author: Disney:

text:
    The Cincinnati Union Terminal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket. No. 97270.
    Promulgated July 8, 1941.

      John H. More, Esq., for the petitioner.

      Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Disney:

The petitioner, under the principles enunciated in Old Colony Railroad Co. v. Commissioner, 284 U. S. 552; and United States v. Boston & Maine Railroad Co., 279 U. S. 732; also West End St. Ry. Co. v. Medley, 246 Fed. 625, had income in each of the taxable years in the amount of $360,000 because of the payment to the petitioner of that amount each year for distribution as dividends upon the petitioner’s common and preferred stock. No question is raised in this regard. For the years 1933, 1934, and 1935 the petitioner in its original returns did not report such income, but each year reported that it was a joint facility, subject to the jurisdiction of the Interstate Commerce Commission, and was so treated in the accounts of tbe seven named railroad companies which, are the owning companies, and that therefore there was no net income to be reported as subject to tax. By amended returns for 1933, 1934, and 1935 and a definitive return ior 1936 the amounts of the distributions and dividends were reported as income and for the first time deduction was claimed for depreciation on the buildings, in each of the taxable years, in the amount of approximately $208,000. This claim of depreciation respondent denied, stating in short that the railroads, for the benefit of which petitioner was operated, assumed the net costs and expenses of every kind, including depreciation and retirement charges; that any losses sustained by the petitioner by retiring the property will be charged to operating expenses or profit and loss and concurrently billed against the proprietary companies in accordance with agreement; and that therefore the assumption of such losses is ground for disallowing deductions for depreciation.

The only question here presented is whether the petitioner is entitled to deductions for depreciation upon its buildings. That there is such depreciation is not questioned, and the life of the buildings, rates, and amounts of depreciation, if allowed, are stipulated. The petitioner keeps its accounts, as a class I steam railroad, on the retirement basis of accounting, in accordance with the.method prescribed by the Interstate Commerce Commission, to the jurisdiction of which the petitioner is subject. It has never set up on its books or reported to the Interstate Commerce Commission the depreciation charges now sought to be deducted, though as to rolling stock it has done so; nor has it, as to buildings, charged depreciation to the seven railroads' which under contract repay to it its net expenses. To a limited extent it has, under the retirement method, charged to the Railroads the cost of retirements upon the buildings here involved. The original returns for 1933, 1934, and 1935 set up no claim for the depreciation now contended for. In 1937 amended returns were filed to claim the depreciation, which was at the same time claimed in the definitive return for 1936. No application to the Commissioner for permission to change petitioner’s system, of accounting, or consent thereto, is shown by the record. About 25 percent of petitioner’s total investment is in the structures as to which it seeks depreciation.

The petitioner of course has the burden of showing error on the respondent’s denial of the deductions sought. The Board has held that a railroad. which has consistently used the retirement method of accounting, in accordance 'with the regulations of the Interstate Commerce Commission, may not deduct for depreciation on its structures. Central Railroad Co. of New Jersey, 35 B. T. A. 501; Chicago & North Western Railway Co., 39 B. T. A. 661. In those cases, as here, the petitioners did not set up the depreciation claimed on their books, nor report it to the Interstate Commerce Commission. The petitioner urges that the cases are distinguishable on the ground, first, that those were ordinary steam railroads, whereas the petitioner has about 25 percent of its investments in buildings or structures, and therefore the reasons for the retirement method do not apply to it; and, second, that the petitioner has in fact consistently used the depreciation method “since it filed its amended return for the year 1983”, and that, though the original return for 1933, 1934, and 1935 did not claim depreciation, those returns showed no net income subject to tax, even without depreciation. Petitioner statéd that the items in connection with buildings which have been charged off under the retirement method “were evidently done by error and can easily be corrected.” As petitioner urges, the fact that the Interstate Commerce Commission requires steam railroads to use the retirement method is not binding here. Old Colony Railroad Co. v. Commissioner, supra; Minneapolis, St. Paul & Sault Ste. Marie Railway Co., 34 B. T. A. 177, 186. The elements of that method have been set forth in our decisions above cited and need not be recited here.

After consideration of the arguments advanced by both parties and the cases cited, we are of the opinion that the petitioner has not shown error in the respondent’s determination. Though some distinction has been indicated between the position of the petitioner and the steam railroads in the cited cases, yet we think the petitioner has not demonstrated that the retirement method does not fairly reflect its income, or that it is not within the rule' of the two Board cases above cited with respect to consistent use of a method different from that under which deduction was claimed. The petitioner has at all times had a contract with the seven tenant railroads requiring them to reimburse the petitioner for “net costs and expenses, iof every kind whatsoever, required for the maintenance of the Terminal or any part thereof, and which shall include proper depreciation and retirement charges.” There is no evidence in the record that such language was not intended' to cover depreciation such as is here involved, and indeed the language seems particularly designed to cover it, for it covers “net costs and expenses of every kind” for “maintenance”, including “depreciation.” Such depreciation is not limited to that on rolling stock, taken by the petitioner, nor is the language limited, as petitioner urges, by other language .requiring the use of accounting methods prescribed by the Interstate Commerce Commission, for the reason that depreciation could have been set up under the retirement system prescribed. The use of depreciation merely affects the amounts used in the retirement method, and though not mandatory in the retirement method, depreciation was permitted.

We see in the fact that the petitioner did not elect to use depreciation no helpful interpretation of the contract with the railroads as not requiring it, as to the buildings here involved. Indeed the petitioner admits that in a limited degree the depreciation in connection with buildings was reflected by retirement charges to the seven companies, but argues that this was “evidently done by error” and can easily be corrected. There is no evidence of error, and we discern not error, but intentional use of the retirement method. This is inconsistent with the contention that the retirement system was not previously used, and therefore no consent from the Commissioner required for a change. Moreover, it can not be urged with logic that there was no change merely because depreciation has been claimed since the filing of an amended return for 1933. This was not until June 1937. Up to that time the depreciation here in issue had not entered into petitioner’s returns, and even now it still does not come into its books of account or its reports to the Interstate Commerce Commission. The fact that, without depreciation for the years 1933, 1934, and 1935, the returns showed no net taxable income, does not affect the fact that depreciation did not enter into the keeping of petitioner’s accounts.

Section 41 of the Revenue Acts of 1934 and 1936 requires computation of net income in accordance with the method regularly employed by the taxpayer.' This has not been done, but we are asked to approve deductions other than under the regular method of accounting. Nor are we shown a violation of clear reflection of income by the method used, and accepted by the Commissioner, for three years prior to any attempt to alter the method. We think there is a change attempted, and no permission is shown to have been asked or granted. The petitioner in our opinion had a clear right under its contract to charge the depreciation here involved to the seven tenant railroads. This has not been done, and is not proposed by the petitioner. It would, in the light of that contract, be anomalous to approve the deduction of depreciation not so charged nor set up in the petitioner’s system of accounting. We find no error on the part of the Commissioner. Therefore,

Decision vMl ~be entered for the respondent.