author: Mellott :

text:
    Elverson Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93281.
    Promulgated October 6, 1939.

      Ellsworth 0. AVoord, Esq., Mger B. Chapman, Esq., Karl Rieoner, Esq., and Floyd F. Toomey, Esq., for the petitioner.

      Thomas H. Lewis, Jr., Esq., for the respondent.
   OPINION.

Mellott :

The principal question is, What was the amount of taxable income realized by petitioner during the year 1934 from the acquisition of 136,000 shares of the common stock of the Inquirer Co. of Delaware, hereinafter sometimes referred to as the pledged collateral? Petitioner contends that it is limited, as a matter of law, to the amount by which the face amount of the canceled notes ($3,488,750) exceeded the cost of such notes ($3,453,750) or $35,000; that the pledged collateral was acquired by it in payment of the outstanding purchase money notes; and that in accepting this collateral in payment of said notes it merely became a purchaser thereof for their face amount. Respondent insists that the agreement of April 3, 1934, as carried out, resulted in taxable gain to petitioner, measured by the difference between the fair market value of the pledged collateral on the date it was acquired by the petitioner and the cost to it of the notes. Both parties concede that the agreement of April 3, 1934, resulted in the ultimate acquisition by petitioner of the stock in October of the same year. A brief resumé of the facts may lead to a better understanding of the contentions of the respective parties.

Prior to March 4, 1930, Raymond Patenotre owned 151,000 of the 191,000 outstanding shares of the common stock of the Inquirer Co. of Delaware, and all of the outstanding stock of the Inquirer Co. of Pennsylvania. On that date he sold his entire holdings in these two companies to the Curtis-Martin Newspapers, Inc. (which later became and will hereinafter be referred to as Public Ledger, Inc.), for a total consideration of $10,500,000, one-half of which was paid in cash and the remainder in notes of the purchasing company bearing 6 percent interest and payable in equal quarterly installments over a period of years.

On the same date, March 3, 1930, an indenture of trust was made between Public Ledger, Inc., and the Bankers Trust Co. of New York under which the 151,000 shares of common stock of the Inquirer Co. of Delaware were deposited with the Bankers Trust Co., as trustee, to secure the payment of principal and interest on the notes. The indenture provided for the release of part of the pledged collateral after specified amounts had been paid, and directed the trustee, upon default in the payment of principal or interest on any of the notes which continued for a period of 30 days after the due date, to sell the collateral when requested to do so by the holders of the defaulted notes, to apply the proceeds thereof to the payment of the notes and costs, and to pay over the surplus, if any, to Public Ledger, Inc. It also provided that the principal of all notes and accrued interest thereon should become due and payable in the event of default and sale of the collateral, and stated that the exercise of any of the remedies provided therein in the event of default should jn no way impair the right of the holder or holders of the notes to recover from the maker or endorser any deficiency on account of principal or interest over and above the amount realized from the sale of the securities deposited with the trustee.

Prior to April 3, 1934, petitioner had acquired, by purchase, all of the outstanding purchase money notes. On that date these notes totaled $3,488,150, and 136,000 shares of the common stock of the Inquirer Co. of Delaware remained on deposit with the trustee as collateral security. The notes falling due on March 4, 1934, were not paid. Public Ledger, Inc., requested an extension of time for the payment of all the notes falling due in 1934. This request was granted upon terms and conditions contained in an agreement dated April 3, 1934, signed by the four interested parties — the petitioner, Public Ledger, Inc., the trustee under the indenture, and the endorser of the notes.

The principal commitments of Public Ledger, Inc., under the agreement were to transfer to the Inquirer Co. of Delaware the morning and Sunday editions of the Public Ledger; to execute and deliver to the trustee for the account of petitioner $1,400,000 principal amount of income bonds; and, upon default in the payment of principal or interest on the notes, to surrender to petitioner all of its right, title, and interest in the pledged collateral, including any equity of redemption. The principal commitments of petitioner were to extend the time of payment of all notes falling due in 1934; to release and discharge Public Ledger, Inc., and the endorser of the notes from all liability thereon; and to cancel the income bonds, if, upon default in the payment of principal or interest, the pledged collateral should be surrendered for its benefit. Petitioner also agreed, in the event of the surrender of such collateral, to purchase from Public Ledger, Inc., at $53.75 per share, but in an amount not in excess of $600,000, such number* of shares of the common stock of the Inquirer Co. of Delaware then owned by Public Ledger, Inc., as would enable tbe latter corporation to discharge its indebtedness to the Inquirer Co. of Delaware. It was also given the option to purchase from Public Ledger, Inc., within 90 days from the surrender of the collateral, any other shares of the common stock of the Inquirer Co. of Delaware owned by Public Ledger, Inc., at a “fair value”, to be determined by mutual agreement or arbitration.

Public Ledger, Inc., failed to pay the interest due on September 4, 1934, and on October 16, 1934, all of its right, title, and interest in the pledged collateral was surrendered to the petitioner. On the same date the petitioner delivered the notes and the income bonds to the trustee, with instructions that they be canceled and destroyed, and its nominee purchased 10,550 shares of the common stock of the Inquirer Co. of Delaware from Public Ledger, Inc., at $53.75 per-share.

The parties agree that the transaction is controlled by the agreement of April 3, 1934, but differ in their interpretation of its provisions. According to petitioner’s interpretation, it acquired the pledged collateral in payment of the outstanding purchase money notes, thereby becoming a purchaser of such stock for the face amount of the notes. It urges that by the agreement of April 3, 1934, the parties, dealing at arm’s length, fixed the value of the pledged collateral at an amount not exceeding the face amount of the outstanding notes, and that Public Ledger, Inc., was, in effect, given an option to sell this collateral to the petitioner at any time for the amount of the notes. Petitioner thus arrives at the conclusion that it realized no gain in excess of the difference between the face amount of the notes and their cost to it.

Respondent asserts that the position taken by petitioner is based upon a misconception of the purport of the agreement of April 3, 1934. He urges that the intention of the parties must be determined from a consideration of the contract as a whole (Black v. United States, 91 U. S. 27) rather than from a consideration of the forfeiture clause only, and that what actually happened was that the parties entered into an enforceable contract for an extension of the time of payment of certain notes, the consideration for such extension being an absolute obligation on the part of the debtor either to make payments not previously required of it (to pay the $1,400,000 income bonds), or, to give up property having a value greatly in excess of the face amount of the notes. Inasmuch as petitioner received the property (i. e., the pledged collateral, enhanced in value by the morning and Sunday editions of the Ledger), respondent contends that it realized taxable income measured by the difference between the fair market value of such property and the cost of the notes.

In support of its contention that in accepting- the pledged collateral it became a purchaser thereof for the face amount of the notes, petitioner cites and relies on Betty Rogers, 37 B. T. A. 897; affd., 103 Fed. (2d) 790; Suisman v. Eaton, 15 Fed. Supp. 113; affd., 83 Fed. (2d) 1019 (C. C. A., 2d Cir.); certiorari denied, 299 U. S. 573; Carlisle Packing Co., 29 B. T. A. 514; and E. F. Simms, 28 B. T. A. 988. The cited cases hold that the transfer of property by a debtor to a creditor in satisfaction of a debt is to be treated as a sale of the property for the face amount of the obligation. Petitioner’s contention is that if the debtors in the cited cases made sales, the creditors made purchases of the property for the face amount of the debts. It therefore argues that, by a parity of reasoning, it was a purchaser of the stock of the Inquirer Co. of Delaware.

Ordinarily the purchase of property does not result in a deductible loss or a taxable gain, even though the price paid is more, or less, than the value of the property acquired. Palmer v. Commissioner, 302 U. S. 63; Hadley Falls Trust Co. v. United States, 22 Fed. Supp. 346; Taplin v. Commissioner, 41 Fed. (2d) 454; Commissioner v. Van Vorst, 59 Fed. (2d) 677; Grigsby v. Commissioner, 87 Fed. (2d) 96; Delbert B. Geeseman, 38 B. T. A. 258. If petitioner’s interpretation of the transaction is correct, the taxable income realized by it is limited to the amount by which the face amount of the notes exceeded their cost.

Petitioner concedes that if Public Ledger, Inc., had paid the notes and the income bonds and had retained the pledged collateral, it would have realized taxable gain. It urges, however, that when, upon default, it received the pledged collateral, the transaction was precisely the same as if the collateral had been surrendered to it on April 3, 1934, before the execution of the agreement. Such a construction ignores some of the important changes in the rights of the parties under the agreement. Under the note indenture, the trustee upon default was to sell the pledged collateral, apply the proceeds to the payment of the outstanding notes, and surrender any excess to the maker of the notes. If such a sale resulted in a deficiency, the creditor (petitioner) was given the right to collect it either from the maker or endorser. Under the agreement of April 3, 1934, there was to be no sale of the pledged collateral upon default; so there was no possibility that the debtor would ever receive any sum, regardless of how valuable the collateral should become. In addition, the debtor was required to enhance the value of the pledged collateral very substantially by transferring to the Inquirer Co. an asset which witnesses for both parties valued at more than a million dollars, viz., the morning and Sunday editions of the Public Ledger, and to surrender its equity of redemption.

The fundamental rule in tbe construction of contracts is to ascertain the intention of the parties. Canal Co. v. Hill, 82 U. S. 94, 100. This intention is to be collected from the entire instrument, viewed in the light of the subject with which it deals, and not from single words, phrases, or sentences. Green County, Kentucky v. Quinlan, 211 U. S. 582, 594. As we view the agreement of April 3, 1934, petitioner granted its debtor an extension in the time of payment of the notes due in that year under such terms and conditions that it would be assured of receiving, upon the completion of the contract, either (1) $3,488,750, plus interest, and $1,400,000 principal amount of income bonds; or (2) 136,000 shares of the common stock of the Inquirer Co. of Delaware, enhanced in value by the morning and Sunday editions of the Public Ledger. It is not necessary to characterize the agreement as a contract of purchase, sale, or exchange. It was, as the parties intended it to be, a substitute for their earlier agreement. The condition which was to give rise to the receipt of the first consideration was the payment of the notes and interest as they became due. In the event of default in the payment of principal or interest, petitioner became entitled to receive the second, or alternative consideration. The alternative consideration was received and, in our opinion, resulted in taxable income to petitioner.

The conclusion which has been reached accords with the underlying principle of such cases as Salvage v. Commissioner, 76 Fed. (2d) 112; affd., 297 U. S. 106; Beals’ Estate v. Commissioner, 82 Fed. (2d) 268, 270; and Cox v. Helvering, 71 Fed. (2d) 987. In Salvage v. Commissioner, an officer and employee of a corporation was permitted to purchase 1,500 shares of its stock for $100 per share, which had a value at the time of the purchase of $1,064.70 per share. The shares were sold to the officer at less than their real value in consideration of his agreement not to engage in any competing business and to permit the corporation to repurchase part of it at $100 per share. The court held that the officer made a “bargain purchase” of the shares and that the portion thereof which represented the consideration for his covenant not to compete, was taxable income in the year the shares were received. In Cox v. Helvering, it was held that an amount paid by a purchaser of the business of a corporation in consideration of an agreement of its stockholders to refrain from engaging in a competing business for a limited period was taxable income, and a similar conclusion was reached in Beals' Estate v. Commissioner. Cf. Albert Russel Erskine, 26 B. T. A. 147; W. M. Ritter Lumber Co., 30 B. T. A. 231, 274.

In the cited cases the courts included in the taxpayers’ gross income the consideration received for the covenant to do, or to refrain from doing, some act. They pointed out that such consideration came squarely within the exceedingly broad statutory definition of gross income, being gains, profits, or income derived from dealings in property or growing out of its ownership. The same definition of gross income is contained in the Revenue Act of 1934. (Sec. 22 (a).) If, therefore, it can be said that petitioner received a consideration for granting an extension of time and forbearing from demanding payment of the notes due, the consideration so received should be included in its gross income. This is the essence of respondent’s contention and the theory under which the deficiency was determined.

Petitioner contends that the granting of the extension of time was relatively unimportant; that the important consideration for the contract of April 3,1934, from the standpoint of the debtor, was that it and the endorser of the notes were released from liability under their respective contracts; that its right to receive the pledged collateral was the consideration for releasing the maker and endorser; and that it agreed to accept the pledged collateral in full payment of the notes only because of the transfer of the morning and Sunday editions to the corporation whose stock was pledged.

While petitioner’s argument is not without substance, we are of the opinion that the basic consideration for the commitments made by the debtor in the agreement of April 3,1934, was, as stated therein, “an extension of time for the payment of the principal of certain notes, * * * agreed to by Elverson Corporation upon the terms and considerations stated in this agreement.” The essence of the terms and considerations, as we have pointed out above, was that the debtor would do one of two things — pay an additional $1,400,000 or surrender the collateral, enhanced in value by the morning and Sunday editions of the Ledger. The latter was done and we think it resulted in taxable income to petitioner to the extent that the value of the property surrendered exceeded the cost of the notes. We therefore affirm the respondent in his determination of a deficiency. He erred, however, in ascribing too large a value to the stock.

There is no definite formula by which fair market value can be determined. Crawford v. Helvering, 70 Fed. (2d) 744. It is a question of fact to be determined from all of the evidence. Heiner v. Crosby, 24 Fed. (2d) 191. The generally accepted definition of “fair market value” is the price at which a seller, willing to sell at a fair price, and a buyer, willing to buy at a fair price, both having reasonable knowledge of the facts, will trade. As a general rule, the best evidence of fair market value of stock is the price at which it is bought and sold on the open market; Rice v. Eisner, 16 Fed. (2d) 358; certiorari denied, 273 U. S. 764; Grant Co. v. Duggan, 94 Fed. (2d) 859; Hazeltine Corporation v. Commissioner, 89 Fed. (2d) 513; T. W. Henritze, 28 B. T. A. 1173; Susan T. Freshman, 33 B. T. A. 394; William S. Gordon, Trustee, 33 B. T. A. 460; but market value may exist independent of sales. Benedict Crowell v. Commissioner, 62 Fed. (2d) 51; Old Colony Trust Co. v. Commissioner, 59 Fed. (2d) 168; French Dry Cleaning Co. v. Commissioner, 72 Fed. (2d) 167. “The value of shares in a commercial or manufacturing company depends chiefly on what they will earn, on which balance sheets throw little light.” Borg v. International Silver Co., 11 Fed. (2d) 147. However, in estimating the value of common stock of a corporation where there are no sales, the value of the net assets of the corporation have an important bearing. Oxford Payer Co. v. United States, 52 Fed. (2d) 1008.

Although petitioner has cited several cases in support of its contention that the stock of the Inquirer Co. had no fair market value on October 16, 1934, only one, Houghton v. Commissioner, 71 Fed. (2d) 656; certiorari denied, 293 U. S. 608, deals with the valuation of stock of a corporation established in business for years and showing a record of consistent earnings. In that case the Circuit Court of Appeals for the Second Circuit affirmed the decision of this Board, holding that the common and preferred stock of a corporation held by members of one family had a fair market value. The court pointed out that a “fair market value” does not always exist, citing Helvering v. Walbridge, 70 Fed. (2d) 683, wherein it was held that an interest in a newly created partnership did not have any market value. It emphasized, as the factor which distinguished the case from other cases (some of which are relied upon by petitioner), the fact that it was not then considering an untried venture, but an old, profitable, thoroughly seasoned business, which had paid large dividends and was as stable as such ventures could be, and that the interests of the owners were shares of stock, the commonest form of industrial property.

The Inquirer Co. of Delaware (or its predecessor, the Inquirer Co. of Pennsylvania) had been engaged in the business of publishing a morning and Sunday newspaper in the city of Philadelphia for more than 50 years. The newspaper had been published continuously for more than a century. Its franchise, that is, its publishing opportunity, was, and is, one of the best in the United States. For 30 years immediately preceding 1935 it operated at a profit. During the last 10 years of that period its average annual net income was $731,557, its largest being $1,451,262 in 1929, and its smallest being $289,559 in 1933. In 1935 its net income was $962,314, and for the first five months of 1936 it was $549,820. The average net paid, circulation of its morning edition increased from 161,898 in 1906 to 208,338 in 1933, 258,560 in 1934, and 277,099 in 1935. Its Sunday edition increased from 179,221 in 1906 to 384,923 in 1933, 547,373 in 1934, and 670,251 in 1935. Its advertising lineage, which was 8,808,900 agate lines in 1906, increased to more than 12,000,000 in 1916; and since that time has never dropped below that amount with the exception of 1933, when it was 10,505,658.

In our opinion these facts, together with the financial condition of the company and the testimony of witnesses for both parties, indicate that the stock had some fair market value.

Six witnesses expressed opinions as to the fair market value of the stock on October 16,1934. The four called by the petitioner placed the value at $20, $24.30, $21.50, and $18.59, and the two called by the respondent placed it at $40 and $37.50.

While petitioner’s witnesses differed in their methods of arriving at the values fixed by them, their respective computations indicate that they all considered the value of the common stock to be the equivalent of the net worth of the business, after deducting the preferred stock liability. Its first witness, a publisher and publisher’s counsel, took the amount of the nonpublishing assets as shown on the balance sheet of September 30, 1934, added thereto an amount which he determined to be the value of the working capital plus good will, and $1,000,000 to represent additional value resulting from the merger with the Ledger, deducted from the total the liabilities of the Delaware Co., and thus determined the value of the total outstanding common stock (174,069 shares) of the company to be $3,550,191.05, or $20 per share.

The second witness, a consulting economist, who had had considerable experience in connection with the valuation of stock for tax purposes, found from the September 30, 1934, consolidated balance sheet that the tangible assets of the company aggregated $9,007,855 and that the consolidated liabilities plus the retirement price of the preferred stock aggregated $10,020,958. He concluded that any value attaching to the common stock would have to depend entirely upon the value of the good will. His first step in the valuation of good will was the ascertainment of prospective earnings. He found the average annual earnings of the enterprise for the five-year period 1930 to 1934, inclusive, before deducting interest paid, to be $1,137,114, and that these earnings were reasonably in prospect for the future. He then divided the earnings, separating those due to the tangible property from those due to good will. He decided that, in view of the continuity of earnings since 1920 and the reasonably safe and certain character of the property, the earnings due to the use of the gross tangibles would be 8 percent of the book value of the consolidated tangible property, or $720,628 (8 percent of $9,007,855). He then subtracted the latter amount from his total estimated annual earnings of $1,137,114, which left $416,487 that he designated as excess earnings attributable to the intangibles of the consolidated companies. This excess he capitalized at 10 percent, or $4,164,870, and thus found the valuation of the good will or intangibles. He then added the good will value so determined to the gross consolidated tangible assets of $9,007,855, subtracted the consolidated liabilities, including the preferred stock at its retirement price, or $10,020,958, and thus arrived at the amount of $3,151,767, which he determined to be the value of the common stock of the Delaware Co. before acquisition of the Ledger circulation, or $18.11 per share. In determining the value of the increment resulting from the merger with the morning and Sunday Public Ledger, he resorted to some extent to subsequent events and found that for the 29-month period from January 1934 through May 1936, which included 2514 months after the merger, the company’s earnings before deducting interest were at the rate of $1,246,783 per year, or $109,669 in excess of the average for the 1930-1934 period. He concluded that this amount represented a reasonable prognostication of additional future earnings due to the merger, capitalized it at 10 percent, and obtained an additional value of $1,076,690 (apparently erred in his computation as amount should be $1,096,690), or $6.19 per share. Adding this $6.19 to the $18.11 value previously found, gave him the figure of $24.30 which he considered to be “the maximum value that can be ascribed to the stock.”

The third witness for petitioner, a newspaper engineer who specialized in the rehabilitation or reorganization of newspaper operations, arrived at a valuation of $21.50 per share in somewhat the same manner as the preceding witness, except that he determined the value for good will by taking the five-year average of daily circulation at $10 per subscriber and adding thereto the five-year average of ¡Sunday circulation at $5 per subscriber. He, however, made very little, if any, allowance for the increase in value resulting from the addition of the Ledger’s morning and Sunday circulation.

The fourth witness for the petitioner, the assistant general manager, secretary, and treasurer of a corporation which publishes 2 newspapers and controls a chain of 16 others through stock ownership, was of the opinion that the value should be fixed “some place between” $11.90 and $18.59 per share. He concluded that if he were a willing buyer he would offer $11.90 per share, and that if he were a willing seller he would demand $18.59 per share. In arriving at these figures, he added together the earnings of the Delaware Co., before deducting interest (except mortgage interest) and taxes, for the 10-year period 1925-1934. To this he added the earnings of the Pennsylvania Co., after eliminating intercompany items, which gave him a total of $10,021,368.10. He then estimated that earnings would increase $175,000 per year because of the merger. In order to reflect this in his 10-year earnings figure, he multiplied it by nine, and added $50,000 more to represent the first 3% months of 1934, prior to the merger. He thus arrived at the figure of $1,625,000 to be added to the 10-year earnings, which resulted in a grand total of $11,646,368.10, or an average of $1,164,636.81 per year. Seven times this, less the notes and preferred stock, represented what in his opinion would be the buyer’s offer, and eight times this, less the notes and preferred stock, the seller’s “asking price.”

In the opinion of respondent’s first witness, a newspaper consultant, the major factor affecting the value of the Delaware Co.’s stock was the earnings which the enterprise would produce for the owner of the stock. He compiled the operating earnings of the business for the nine and three-fourths years from January 1, 1925, to September 30, 1934, i. e., from the net income of the Delaware and Pennsylvania companies for this period he subtracted the investment income received as dividends and interest, and added back the interest, amortization and premium charges on the variable funded debt, an item of stock transfer taxes, and the Federal taxes paid. He thus obtained a consolidated operating income for the period of $11,027,800. In judging the earning power of the Delaware Co., he believed that the nine months of 1934 should be eliminated as an unusual period of transition and as including five and one-half months of merged operation. Eliminating this period gave him $10,472,837 for nine years, or an annual average of $1,163,626. To this he added what he determined to be a reasonable amount to expect as future earnings as a result of the merger. This amount is unstated but apparently was approximately $400,000. From the aggregate thus determined he deducted interest of $450,000 on the consolidated funded debt and Federal income taxes at the 1934 corporation rate, which gave him a net figure of slightly in excess of $1,000,000. He cut this figure down to $950,000 to take care of possible future contingencies and deducted the preferred stock dividend requirements of $76,854, thus arriving at the figure of $873,146 representing the annual earnings available for dividends on common stock, or $5 per share on the 174,069 shares outstanding. Applying the capitalization rate of eight times earnings, he concluded that the value of the stock was $40 per share.

Respondent’s other witness, who had been connected with, an appraisal company engaged in the business of making valuations of industrial, public utility, and commercial properties for 25 years, determined that the average earnings over the nine-year period 1925 to 1933, inclusive, was $1,099,772 before interest charges. He then deducted mortgage interest of $162,000 and note interest on $4,800,000 at 6 percent or $288,000, or a total of $450,000, which left a balance available for preferred and common stock of $649,772. From this amount he deducted the annual preferred dividends on 12,809 shares of preferred stock of $76,854. He divided the remainder, $572,918, by the 174,069 shares outstanding, which gave him a per share average earning for the common stock of $3.29, without giving effect to the merger with the Ledger. He added $1.41 as the Ledger’s earnings which would accrue to the combined companies and arrived at a total per share earning of $4.70. In his opinion a fair rate of capitalization was eight times earnings and he thus arrived at his opinion that the value of the stock was $37.50 per share.

Respondent urges that the lower values arrived at by petitioner’s witnesses result from the use of methods which are basically wrong, and that they failed to differentiate between the problem presented when good will is to be valued and that presented in a case involving the valuation of common stock. He insists that a determination of the net worth of the company in excess of its preferred stock do.es not necessarily demonstrate the value of the common stock, and states that this Board has not accepted the asset value of a long established business corporation, having a consistent record of earnings, as the sole criterion for the valuation of its common stock. In this connection he cites Anson Evans et al., Trustees, 29 B. T. A. 710, 716; May Rogers, 31 B. T. A. 994, 1006; James Couzens, 11 B. T. A. 1040, 1162; Fred L. Dickey et al., Executors, 32 B. T. A. 1283; Williams v. Commissioner, 44 Fed. (2d) 467, 470; Foss v. Commissioner, 75 Fed. (2d) 326, 330; William Rhinelander Stewart, Jr., et al., Executors, 31 B. T. A. 201, 203. He also urges that a value derived from capitalizing earnings, by the methods used by the petitioner’s witnesses, does not reflect the true value of the common stock because a large part of the earnings resulted from the use of borrowed money and of money advanced by the holders of preferred stock having a fixed dividend rate. He points out that such money cost the corporation 6 percent or less, whereas, under the assumptions made by petitioner’s witnesses, it earned 8 percent or more, whether invested in tangibles or intangibles. This, he says, demonstrates the unsoundness of their valuations inasmuch as it ignores the fact that the fund thereby produced belonged to the common stockholders.

Other points stressed by the respondent are that the petitioner’s witnesses failed to differentiate between the value of a block of stock representing control, and the value of a lesser interest, and also failed to include a reasonable amount for increase in earnings due to the merger.

Petitioner agrees with the respondent that the value of the stock of a corporation is seldom to be measured solely by its asset value, but contends that its witnesses did not limit themselves to a determination of asset value as the sole, or even as an important, guide to the value of the stock. It agrees with the respondent that common stock may be valued by capitalizing, at an appropriate rate, tbe earnings available for such stock, but does not concede that every other method is improper. It urges that the rate employed by respondent’s witnesses is too low to suit their method because it does not reflect the necessity for support of the investment in tangible assets, does not properly reflect the risks of the business, and disregards the amount and nature of the prior obligations. According to petitioner, the obligations ahead of the common stock, i. e., the $4,800,000 of 6 percent notes, and $1,280,900 of preferred stock, constituted one of the most important single factors affecting the question of value. It takes exception to the respondent’s statement that its witnesses failed to differentiate between the per share value of a block of stock representing control, and the per share value of a lesser block, and points out that they were asked to express their opinion as to the value of 136,000 shares of stock, “a controlling interest.” Petitioner also takes exception to respondent’s assertion that its witnesses did not include a reasonable amount of increase due to the merger.

Some of the criticisms are probably justified. Each of the witnesses, however, had sufficient qualifications to express an opinion, and it would serve no useful purpose to attempt to point out possible weaknesses in their testimony. We have found as a fact that the fair market value of the stock of the Inquirer Co. of Delaware was $37.50 per share as of October 16, 1934. While this happens to be the same value expressed by one of the respondent’s witnesses, our finding is not based solely on his opinion. Neither have we followed any set rule or formula in arriving at our determination. Great Northern Railway Co. v. Weeks, 297 U. S. 135, 139; Rowley v. Chicago & North Western Railway Co., 293 U. S. 102, 109. We have given special consideration to the earnings of the Inquirer Co. of Delaware and its assets and liabilities, and to the fact that the 136,000 shares of its stock represented a controlling interest; that during the year 1930 it acquired all of the outstanding capital stock of the Inquirer Co. of Pennsylvania for $2,200,000 and in April 1934 acquired the morning and Sunday editions of the Public Ledger, without cost; that during the period between 1930 and 1934, when Public Ledger, Inc., owned the controlling interest in the Delaware Co., it attempted to recover a part of the purchase price of this company’s stock by having it declare and pay large dividends and redeem some of its stock at an excessive price; and that, in spite of this selfish and unwise financial management, the Delaware Co. reduced its outstanding preferred stock from $6,267,500 to $1,280,000; reduced the mortgage from $3,200,000 to $3,000,000; reduced outstanding notes from $6,000,000 to $4,800,000; purchased machinery and equipment at a cost of $471,627; retired 16,931 shares of its common stock; and paid cash dividends of over $2,000,000 — all of which was accomplished at a reduction in the company’s surplus of only approximately $2,000,000.

Before concluding our discussion of the fair market value of the Delaware Co.’s stock, brief reference will be made to petitioner’s alternative contention that it could not have been sold on October 16, 1934, for $37.50 per share, and that, if this amount is the minimum fair price for the pledged collateral on that date, it had no “fair market value.” In support of this contention petitioner refers to the fact that the $4,800,000 10-year 6 percent coupon notes which were outstanding on that date had been issued pursuant to an indenture of trust which provided that, in the event the Curtis-Martin interests relinquished control of the company, the holders of the notes would have the option of requesting full payment within 5 months. Petitioner argues that any prospective purchaser of the 136,000 shares of the common stock of the Inquirer Co. of Delaware, which represented control of the company, must have been prepared to face the necessity of raising an additional $4,800,000 to refinance the notes in order to retain the control purchased, and that no purchaser could have been found for the pledged collateral at a price of $5,100,000 (136,000 X $37.50) under such circumstances.

We do not believe that the existence of the note liability and the possibility that it would have to be refinanced would have prevented the sale of the stock for $37.50 a share. Obviously any prospective purchaser would take into consideration the possibility that the notes might have to be refinanced. However, that would not have been an insurmountable obstacle to a sale. In 1930 a purchaser was found who paid $8,300,000 for 151,000 shares of the common stock of the Inquirer Co. of Delaware and $2,200,000 for all of the capital stock of the Inquirer Co. of Pennsylvania. It is true, as petitioner points out, that at that time the Delaware Co. did not have an outstanding note liability of $4,800,000. It should not be overlooked, however, that these notes were originally issued in the amount of $6,000,000 for the purpose of raising funds to retire 56,694 shares of preferred stock at $57.50 a share, or $3,374,905, all of which were outstanding at the time of the purchase in March 1930, and to purchase for $2,200,000 all of the capital stock of the Pennsylvania Co. which the Delaware Co. did not own in March 1930. We doubt that a purchaser on that date would have hesitated to pay approximately $8,300,000 for 151,000 shares of the common stock of the Inquirer Co. of Delaware if the corporation at that time had increased its assets by $2,200,000 and decreased its preferred stock liability by $3,374,905, even though in doing so it incurred a note liability of $6,000,000. While we believe that this is sufficient answer to petitioner’s argument, it may not be amiss to mention that in 1936 a corporation purchased all of the outstanding stock of petitioner for $2,515,835.46 when it had liabilities of $7,158,864.44 and when its only assets consisted of 136,000 shares of the common stock and $3,400,000 principal amount of notes of the Inquirer Co. of Delaware. In other words, the effect of this transaction was that the purchaser paid nearly 10,000,000 for 136,000 shares of the Delaware Co. stock and $3,400,000 principal amount of notes, which was equivalent to a payment of $46 per share for the stock which we have valued at $37.50.

In attempting to prove that no purchaser could have been found who would pay $37.50 per share for the stock, petitioner introduced evidence showing that certain unsuccessful efforts were made by Public Ledger, Inc., between September 4 and September 18, 1934, to sell its Inquirer Co. stock or to refinance its indebtedness to petitioner. The record does not disclose the price Public Ledger, Inc., asked for the stock nor the price a prospective purchaser would have been willing to pay. It is reasonable to assume that Public Ledger, Inc., was seeking a purchaser willing to pay an amount sufficient to retire its note liability of $3,488,750, plus accrued interest, to pay the $628,230.50 indebtedness due the Inquirer Co. of Delaware, and to undertake the payment of the $1,400,000 income bonds. None of these liabilities could have been escaped. Their total exceeded $5,100,000. Nor is it surprising that the bankers, who evidently were familiar with the debtor’s record, should refuse to refinance it, knowing that it was burdened with the onerous extension agreement of April 3, 1934, and that it was then in default for the interest due on September 4, 1934.

The remaining questions are whether petitioner is subject to tax as a personal holding company under the provisions of section 351 of the Revenue Act of 1934, and, if so, whether it is subject to the 25 per centum addition to tax prescribed by section 291 of the same act for failure to file a personal holding company return.

Section 351 provides that a surtax of 30 per centum shall be levied upon the undistributed, adjusted net income of every personal holding company not in excess of $100,000 and 40 per centum on the amount in excess of $100,000. In so far as here material a “personal holding company” is defined as meaning:

* * * any corporation, * * * if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.

Assuming for present purposes, though not deciding, that during the last half of the taxable year more than 50 per centum in value of petitioner’s outstanding stock was owned, directly or indirectly, by or for not more than five individuals, was 80 per centum of petitioner’s gross income derived from the sources specified in subparagraph (A) ?

Respondent contends that three kinds of taxable income were derived by petitioner: (1) $35,000 gain from the receipt of more than the cost of the notes (this amount is the difference between the face of the notes, $3,488,750 and their cost $3,453,750); (2) $67,864.79, the gain derived from interest which accrued on the notes from June 4, 1934, to October 16, 1934; and (3) the gain derived from the receipt of the consideration paid for the extension of time. The last two, he says, were clearly personal holding company income, the second being interest eo nomine, and the third being interest, though not so designated by the parties.

We have determined that petitioner’s dealings with its debtor during the year 1934 resulted in a profit to it of $1,646,250, this amount being the difference between the cost of the notes ($3,453,750) and the fair market value of the stock received ($5,100,000). It is apparent that this amount includes the $35,000 referred to in subdivision (1) of the preceding paragraph. The $67,864.79, referred to in subdivision (2), even though denominated interest by the debtor and the creditor, was properly excluded from petitioner’s gross income; for before the end of the taxable year it became perfectly obvious that the amount would never be collectible. Corn Exchange Bank v. United States, 37 Fed. (2d) 34; Turners Falls Power & Electric Co., 15 B. T. A. 983; Francis Ward Paine et al., Executors, 25 B. T. A. 764; Estate of George Herder, 36 B. T. A. 934; Commissioner v. Brown, 54 Fed. (2d) 563; certiorari denied, 286 U. S. 556. Indeed petitioner’s right to collect it terminated when it took over the stock and surrendered the notes for cancellation.

In its income tax return filed for the year 1934 petitioner reported gross income of $87,677.86 from interest and dividends after deducting a capital loss of $2,000. If the profit of $1,646,250 constituted “personal holding company” income within the purview of section 351, supra, petitioner was required to file a personal holding company return on form 1020 H (art. 351-8, Regulations 86), as this profit constituted more than 80 per centum of its gross income for the taxable year 1934. No contention is made that it was derived from royalties, dividends, annuities or the sale of securities and it obviously was derived from none of these sources. Respondent, however, contends that it was derived from interest.

In support of his contention, respondent cites several cases holding that the consideration paid for an extension of time constitutes interest within the purview of state statutes against usury. He also cited several cases, such as Jones Syndicate v. Commissioner, 23 Fed. (2d) 833, and E. C. Gatlin, 34 B. T. A. 50, holding that a taxpayer may deduct, as interest, amounts paid under a contract which was devised as a cloak to hide usury and does not correctly describe the relationship of the parties.

The principle of the cited cases does not seem to be applicable to the present facts. Petitioner and its debtor entered into a contract under which petitioner made a substantial profit. We have held that such profit constituted income within the broad statutory definition of that term. But we do not believe that it can, or should be, designated interest. Interest, as generally understood, means simply the “compensation allowed by law, or fixed by the parties, for the use or forbearance of money, or as damages for its detention”; “the compensation which is paid by the borrower of money to the lender for its use”; “the price or rate of premium per unit of time, paid by the borrower of money to the lender for its use.” 33 Corpus Juris 118; Joseph W. Bettendorf, 3 B. T. A. 318, 383; Bouvier’s Law Dictionary; Webster’s New International Dictionary; Anderson & Co., 6 B. T. A. 713, 716. “The usual import of the term is the amount which one has contracted to pay for the use of borrowed money.” Old Colony Railroad Co. v. Commissioner, 284 U. S. 552, 560. Congress apparently used the word in its usual and commonly accepted sense, DeGanay v. Lederer, 250 U. S. 376, and there is nothing in the legislative history to indicate that it was to be construed otherwise. Avery v. Commissioner, 292 U. S. 210. (See Keport No. 704, Ways and Means Committee, 73d Cong., 2d sess., p. 11, and Beport No. 558, Senate Finance Committee, pp. 13, 16.) “If there were doubt as to the connotation of the term, and another meaning might be adopted, the fact of its use in a tax statute would incline the scale to the construction most favorable to the taxpayer. Gould v. Gould, 245 U. S. 151; United States v. Merrimi, 263 U. S. 179; Bowers v. Lighterage Co., 273 U. S. 346; United States v. Updike, 281 U. S. 489; Burnet v. Niagara Falls Brewing Co., 282 U. S. 648.” Old Colony Railroad Co. v. Commissioner, supra.

It is our conclusion from the foregoing that petitioner did not derive at least 8Q per centum of its gross income for the year 1934 from royalties, dividends, interest, annuities, and gain from the sale of stock or securities, and that it was not a personal holding company and as such required to file a personal holding company return. It follows therefore that it was not subject to the surtax prescribed by section 351, supra, and is not liable for the 25 per centum addition to tax: imposed by section 291 of the Revenue Act of 1934 for failure to file a return on form 1020 H.

Reviewed by the Board.

Judgment will he entered u/nder Bule 50.


source: Caselaw Access Project

author: Murdock: Oppee, DxsNet,

license: Public Domain

text:
    Alfred C. Berolzheimer, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edwin M. Berolzheimer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 89259, 89267.
    Promulgated October 6, 1939.

      Mark Eisner, Esq., for the petitioners.

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

Murdock:

The Commissioner determined deficiencies in income tax of the petitioners for 1934 by including in their income the income of trusts which they had created. The only issue for decision in each case is whether the income of the trusts is taxable to the grantors. The facts are found as stipulated by the parties.

Alfred C. Berolzheimer created a trust on May 2, 1932, for the benefit of his son born on April 25, 1925. The trust was irrevocable but was to terminate on January 2, 1941, or upon the death of the grantor or the beneficiary, whichever should occur first. The grantor named himself trustee. The trustee was to apply to the use of the son “at such times, in such amounts and in such manner as said Trustee may in his uncontrolled discretion decide, so much of the net income from this trust fund as in the sole and absolute discretion of the Trustee may be necessary and proper for the maintenance, education and well-being of said Kenneth Berolzheimer and shall accumulate the balance of such net income for said Kenneth Berolzheimer, if any.” The trustee could also use principal, if necessary, for the needs of the beneficiary. The accumulated income was to go to the beneficiary upon termination of the trust and the corpus was to go to the grantor or his estate. Stock dividends, rights, capital disbursements, and proceeds of sales or dispositions of assets were to be a part of the corpus.

The trustee was given power to manage, invest, reinvest, retain, sell, exchange, vote, and otherwise deal with the assets of the trust as he thought best. He was not limited to the investments by fiduciaries fixed by the laws of New York and he was not to be liable for loss resulting from the investment or retention of the trust funds.

The donor transferred property to the trust in 1932 and all of the income of the trust for the year 1934 was paid to or accumulated for the beneficiary. The gross income for 1932 consisted of interest in the amount of $4,224.98 and dividends in the amount of $10,270. The net income was $13,919.17, of which $9,600 was distributed for the use of the beneficiary and reported by him, and the remainder was retained as accumulations by the trust and reported by it.

The Commissioner, in determining the deficiency, included the $13,919.17 of trust income in the income of the grantor, with the explanation that his action was in accordance with section 166 of the Revenue Act of 1934.

The respondent, in his brief, makes no argument that section 166 has any application here. The section applies to revocable trusts and clearly does not apply to this trust. The first argument of the respondent is that no trust was created and the instrument was a mere device to reduce taxes. Not only has he failed to cite authorities to support this argument, but the facts in the record also fail to support it. The provisions of the trust instrument upon which he relies to show that in reality there was no trust are those giving control over the corpus to the trustee, those permitting the trustee to take securities in his individual name, those including capital gains in corpus, and those relieving the trustee from liability. Such provisions are not unusual in trusts. This trust was not an empty one like those in Benjamin F. Wollman, 31 B. T. A. 37; William C. Rands, 34 B. T. A. 1107; and Warren H. Corning, 36 B. T. A. 301. Not only was a valid trust created under the laws of New York, but the trust must be recognized for income tax purposes, since it changed materially the interest of the grantor in the income of the corpus. Cf. Jay C. Hormel, 39 B. T. A. 244; Clifford v. Helverinq, 105 Fed. (2d) 586.

The only other argument made by the respondent is that the trust was for the support, maintenance, and education of a minor son and, since the income was to discharge an obligation of the grantor, it is taxable to him under the principle of Douglas v. Willcuts, 296 U. S. 1; Helvering v. Schweitzer, 296 U. S. 551; Helvering v. Blumenthal, 296 U. S. 552; Commissioner v. Grosvenor, 85 Fed. (2d) 2; and Hill v. Commissioner, 88 Fed. (2d) 941. This case comes within the authority of those cases. The grantor was the trustee. So much of the income of the trust as he deemed necessary was required to be used for the “maintenance, education and well being” of his minor son. It thus was designed to discharge an obligation which the petitioner owed to the recipient and was not given for the use and benefit of the recipient without any restriction as to its use. Cf. Henry A. B. Dunning, 36 B. T. A. 1222; Ralph L. Gray, 38 B. T. A. 584; Jay C. Hormel, supra. Nine thousand six hundred dollars was distributed in this year for the “maintenance, education, and well being” of the minor son and we are unwilling to hold that any less amount is taxable to the father, although he testified that $2,500 would have been sufficient to properly support, educate, and maintain the son during the year. Commissioner v. Grosvenor, supra. The remainder, which did not have to be so used and was not so used, is not taxable to the petitioner. Martin F. Tiernan, Trustee, 37 B. T. A. 1048; E. E. Black, 36 B. T. A. 346.

Edwin created three trusts on February 23, 1931, one for the benefit of his wife, one for the benefit of his son, and one for the benefit of his daughter. The trusts were similar, for present purposes, to the trusts created by Alfred, except that the income of the one for his wife was not restricted as to use. The son was over twenty-one years of age in 1934 and the father owed him no duty of support, education, and maintenance. The income of those two trusts was not taxable to Edwin. Henry A. B. Dunning, supra; Ralph L. Gray, supra; Jay C. Hormel, supra; Shanley v. Bowers, 81 Fed. (2d) 13; Clifford v. Helvering, supra. The daughter became twenty-one years of age on September 4, 1934. Not more than $3,425.47 of the income of her trust was used to discharge the obligation óf her father to support her, and that amount is taxable to him, since he failed to prove a lesser amount.

Keviewed by the Board.

Decisions will be entered under Rule 50.

Oppee,

concurring: I am still of the opinion that Jay C. Hormel, 39 B. T. A. 244, was erroneously decided, and I can not distinguish this case from that one. I therefore concur in the result reached but not in the prevailing opinion.

I recognize, of course, that the majority believe the cases to be distinguishable. Yet that distinction seems to me less than substantial. In the Hormel case it was conceded that the permitted use included maintenance and education, so that in fact we had a trust which created a discretionary expenditure for education, maintenance, “use and benefit.” Here the income is to be expended “as said Trustee [this petitioner] may in his uncontrolled discretion decide * * *” for the “maintenance, education and well-being* of the beneficiary. Of course no claim is or could be made that the wife in the Hormel case was any more adverse in her interest than is this petitioner. Thus, the majority appear to have decided that “benefit” is not synonymous with “well-being.” For that is the only difference that I can see on the essential facts.

DxsNet,

dissenting: I agree with the majority opinion that section 166 of the Revenue Act of 1934 is inapplicable, the trusts specifically stating that same are irrevocable, and agree further that there was no liability upon the trustor, Edwin Berolzheimer, for the support of his son after majority and, therefore, the income of the trust is not taxable to him. Moreover, I think the principle of Douglas v. Willcuts, 296 U. S. 1, was properly applied as to $9,600 of the income of the trust set up by Alfred Berolzheimer. But 1 am unable to agree in the other conclusions of the majority. The broad powers given to the trustor-trustee, his freedom from legal restriction as to investments and from all liability, except for willful wrongdoing, destroyed reality of the trust, in my opinion. I can not reconcile the conclusion here with those in Benjamin F. Wollman, 31 B. T. A. 37, and William C. Rands, 34 B. T. A. 1107, as to breadth of powers remaining in the trustor, for the essential elements of the trusts therein and herein differ in no real sense. As to freedom from legal restrictions and liability, petitioners seek to nullify the exculpatory clauses by reference to state decisions involving litigation between parties to trusts and indicating unenforce-ability of such clauses. The question as to whether trusts might be unenforceable between parties in the state tribunal is not controlling here upon a question of reality of trust where grantor is trustee. Lyeth v. Hoey, 305 U. S. 188, summarizes the rule as follows:

In dealing with the meaning and application of an act of Congress enacted in the exercise of its plenary power under the Constitution to tax income and to grant exemptions from that tax, it is the will of Congress which controls, and the expression of its will, in the absence of language evidencing a different purpose, should be interpreted “so as to give a uniform application to a nationwide scheme of taxation.” Burnet v. Hormel, 287 U. S. 103, 110. Congress establishes its own criteria and the state law may control only when the federal taxing act by express language or necessary implication makes its operation dependent upon state law. * * *

In Morgan v. Commissioner, 103 Fed. (2d) 636, it was held that the definition of a power of appointment within the meaning of section 302 (f) of the Revenue Act of 1936, as amended, is a matter of Federal law and not of state law. We, therefore, in interpreting the Federal statute as to a trust, should not be bound by state decisions. In Equitable Life Assurance Society v. Bowers, 87 Fed. (2d) 687, it is said:

* * * But generally speaMng our revenue statutes make their own definitions, and are not to be assumed to accommodate themselves to local variants. * * *

I think that Congress addressed itself, in the revenue law, to real trusts and not shams, and that we should not follow or approve something which has the mere habiliments, but not the body, of a trust, the mere name of trust without the elements of responsibility and good faith regard for a beneficiary for which equity has regard.

In Stoddard v. Eaton, 22 Fed. (2d) 184, we read:

The contention of the plaintiff is that the so-called “trust agreements” worked no severance of the trusteed securities from the corpus of the plaintiff’s property, and that these securities, whether in the hands of the trustees or not, were always his own assets, and therefore that the losses sustained on their sale were proper items of deduction from his gross income. Be says that the verbal form of the transaction does not necessarily control the construction to be placed upon it; that the envvrommg conditions — the motivation, the reactions of the parties to the situation thus integrated and to its developing phases — all have a significance which the law must evaluate before the genuine relation of the transactions to the Income Tax Act may be ascertained. With this suggestion, stated in these general terms, I am disposed to agree. For we are not here concerned with the rights of contracting parties who may evoke a rule of estoppel to prevent the change of a comma in the written bond, nor are there innocent third parties involved who have relied upon a title or upon an authority expressed in writing.
After all, the word “trust” as used in section 219 of the Revenue Act of 1918 (Comp. St. § 6336-1/8Ü), can hardly have been intended to comprehend every instance in which a trust is recognized in equity. A trust ex maleficio, a resulting trust, or a constructive trust are examples of trusts which do not fit into the frame of the statute. A trust, as therein understood, is not only an express trust, but a genuine trust transaction. A revenue statute does not address itself to fictions. [Italics supplied.]

Petitioners, when they take refuge behind the idea that the courts do not recognize the exculpatory clauses involved in the trusts herein, tacitly admit that the instruments herein violate the essential law of trusts. "We should not be so wedded to the mere term “trust” as applied to an instrument as to disregard the essential requirements of trusteeship.

It seems to me also that section 167 (a) (1) of the Revenue Act of 1934 clearly applies here. The trust instrument provides that “all proceeds of the sale, redemption or other distribution of assets included in the principal of the trust shall be received, held and considered byi him [the trustee] as part of and in addition to the corpus”, and the corpus at the end of the trust period under the instrument goes to the trustor. It is true that the provision as to proceeds of sale or disposition of assets being considered corpus is subject to the expression, “all, however, to the extent permitted bylaw”, etc., but we know of no law prohibiting a trust from providing that the net income to be distributed shall not include profits from sale of corpus, so that the above provision of section 10 of the instrument is not eliminated by the reference to “the extent permitted by law”, etc. Of course the fact that such trust provisions are permitted by law does not mean that the income from such trusts can not by the revenue law be attributed to and taxed to the trustor. Both sections 166 and 167 apply to trusts which may be entirely effective for purposes other than income taxation. Petitioner points out section 17 (a) of the Personal Property Law of New York, but that section affects only stock dividends, stating that, unless otherwise provided in a trust instrument, they shall be corpus. We are here concerned with sale or disposition of trust assets. We held in William C. Rands, supra, that the trustor therein in legal effect accomplished only an assignment of future income, for he provided not a full and complete transfer of the corpus to the trustee, so that the beneficiary should receive all of the benefits of such corpus, but a specific limit upon such benefits by deleting therefrom what might well have been the more important part, to wit, profits from sale or disposition of corpus, retaining these for himself when same, as corpus, were delivered to him upon the termination of the trust. We held therein that in this he retained such a highly important attribute of ownership as indicated that the trust lacked substance and reality. Since the trust instrument retains by a specific provision, as corpus, the proceeds of sale or disposition of trust assets, and provides that such corpus is to be paid to trustor at termination of trust, it is plain that the instrument does in fact provide, in the words of the statute, that:

* * * income of a trust—
(1) is * * * held or accumulated for future distribution to the grantor. * * *

In Henry A. B. Dunning, 36 B. T. A. 1222, we relied in part upon the fact that corpus was not retained for distribution to grantor, in holding the trust effective for income tax purposes. Petitioner contends, however, that under the law of New York proceeds of sale or disposition of trust assets were corpus, and that we are, therefore, bound so to hold. As above discussed as to meaning of trust, the fact that state law denominates such funds as corpus is not conclusive when, as here, we are interested in whether such funds are “income of a trust” within the purview of section 167. If, although called, corpus by the state law, the proceeds of sale or disposition of trust assets are income of the trust, then it is plain that they are under the ban of section 167 (a) (1), as being held or accumulated for future distribution to petitioner. Such proceeds do constitute income of the trust — Arthur Letts, Jr., 30 B. T. A. 800; affd., 84 Fed. (2d) 760; Old Colony Trust Co. et (A., Executors, 38 B. T. A. 828. In Preston B. Bassett, 33 B. T. A. 182, 185, we said that “capital-gain, although under local law not ‘income’ of the trust, would clearly be income under the Federal statutes.” Moreover, in Commissioner v. Morris, 90 Fed. (2d) 962, wherein section 167 of the Bevenue Act of 1928 was considered in connection with the question as to whether capital gains from sale of trust assets were corpus or trust income, the court points out that, although section 167 of the Bevenue Act of 1928 did not apply to income from such capital gains absolutely distributable as principal at termination of trust, the same would not be true under section 167 of the Bevenue Act of 1932 — which is the same as in the 1934 Act.

In my opinion, trust income was accumulated for the grantor, and he, for that additional reason, is taxable upon the income involved herein. I dissent.

       But see Webster’s New International Dictionary, 2d Ed.: “Benefit * * * whatever promotes welfare; * * “Wekfaiíe * * * state or condition in regard to well-being; * * *.”


author: Murdock;

text:
    Estate of Jose Simon, Deceased, Jose P. Simon and Julian Yebenes Munoz, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91840.
    Promulgated October 6, 1939.

      Chester Bohrlich, Esq., and Edward J. Boss, Esq., for the petitioners.

      L. A. Spalding, Jr., Esq., and Thomas H. Lewis, Jr., Esq., for the respondent.
   opinion.

Murdock;

The Commissioner determined a deficiency of $44,429.13 in estate tax. The only issue for decision is whether the Commissioner erred in including in the decedent’s gross estate all, instead of one-half, of the personal property situated in the United States belonging to the conjugal partnership of the petitioner and his wife. Most of the facts have been stipulated and the stipulation is adopted as a part of the findings of fact.

The decedent was a native citizen of the Republic of Spain and a nonresident alien of the United States at the time of his death on April 14,1986. He was married in Cuba in 1901. The Spanish Civil Code was then in force in Cuba. He had practically no property at that time. He and his wife did not execute any matrimonial agreements in regard to property. The couple resided in Spain following their marriage. A conjugal community of partnership was created under the Spanish Civil Code by their marriage and was dissolved by the death of the husband. The property of the conjugal community of partnership included, at the death of the husband, stocks, bonds, and cash, situate in the United States, having a value of $420,617.88. The Commissioner, in determining the deficiency, held that all of the property in the United States above described was a part of the gross estate of the decedent and explained:

The Bureau holds that under the laws of Spain the interest of a surviving spouse in community property is inchoate, a mere expectancy, and therefore, for the purpose of the Federal estate tax, the entire value of the community property may be included in the gross estate of the deceased husband.

The Board finds as a.fact from the stipulation, including excerpts from the Spanish Civil Code, from the testimony of expert witnesses, and from citations of authorities on the Spanish Civil Code, that the property of this conjugal partnership belonged equally to the husband and the wife at the time of his death and the wife had a vested interest in her one-half of that property at that time.

The Revenue Act of 1926, in section 302, as amended by section 404 of the Revenue Act of 1934, includes in the gross estate all property “to the extent of the interest therein of the decedent at the time of his death.” This decedent at the time of his death had only an undivided one-half interest in the property in question under the law of Spain, the country in which he and his wife were domiciled at the time of his death. His interest is determined under that law as the parties agree. Cf. Lang v. Commissioner, 304 U. S. 264; United States v. Goodyear, 99 Fed. (2d) 523. The foreign laws have been proven in this case by stipulation, by expert witnesses, and by citations of authorities agreed upon by the parties. Cf. Columbian Carbon Co., 25 B. T. A. 456; W. J. Burns, 12 B. T. A. 1209; Havana Electric Railway, Light & Power Co., 29 B. T. A. 1151; Slater v. Mexican, National Railroad Co., 194 U. S. 120. This proof is all one way and leaves the Commissioner with no proof to support his determination. He relies upon certain decisions of a Louisiana court and a court of New Mexico, but the decisions were later reversed by higher courts, which pointed out that the lower courts had incorrectly interpreted the Spanish law. We hold that the Commissioner erred and should have included only one-half of the property in the gross estate of this decedent. Cf. Sanchez v. Bowers, 70 Fed. (2d) 715; Estate of Jose M. Tarafa y Armas, 37 B. T. A. 19.

Decision will be entered under Rule 50.


author: MuRdock :

text:
    Abrams Sons’ Realty Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Harry Abrams, Deceased, Clara Pliskin, Louis Grossberg and Morris E. Lasdon, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92751, 96595.
    Promulgated October 6, 1939.

      Benjamin E. Shove, Esq., for the petitioners.

      O. G. Holmes, Esq., for the respondent.
   OPINION.

MuRdock :

The corporate petitioner claims that the proceeds of the condemnation never belonged to it but were to go and did go to the creditors of a partnership. It argues that the Commissioner erred in taxing it as if it had sold a piece of its own property at a profit. The respondent contends that the petitioner was the owner of the property and taxable with the gain. The evidence shows that the record title was transferred to this corporation merely for the purpose of benefiting the creditors of the partnership and there never was any intention that the petitioner could benefit from the ownership of the property. It did not benefit and dissolved as soon as its purpose was accomplished. It was a mere trustee or agent to dispose of the property for Harry and Louis Abrams and a conduit to distribute the entire proceeds to their creditors. The following quotation from 112 West 59th Street Corporation v. Helvering, 68 Fed. (2d) 397, is apposite:

In Central Life Society v. Commissioner, 51 E. (2d) 939, 941, the Court of Appeals in the Eighth Circuit, speaking through Judge Stone, said: “Tax laws are essentially practical in their purposes and application, and the federal income tax laws are no exception. While, for purposes of convenience and certainty in collection of such taxes, it is sometimes provided that those who collect income for others shall pay therefrom the taxes thereon, yet a cardinal purpose of the income tax laws is to tax the income to the person who has the right or beneficial interest therein, and not to throw the burden upon a mere collector or conduit through whom or which the income passes.”
We think this is a correct statement of the law. If, therefore, it appears, as we think it does appear, that petitioner was a mere “conduit," and that it never at any time had any legal right to retain the profits from the transaction in question and never at any time had possession of such profits, but that on the contrary the profits in right and in law were always the property of the trust, then it would seem to follow that the liability to pay the tax under the federal income tax laws was solely a liability of the trust and not a liability of petitioner. And this is particularly true when we consider that the former duly reported and paid the tax and no question of bad faith in the organization of petitioner or in its participation in the transaction is or can be attributed to it. The brief of the Commissioner frankly says “there is no fraud here.”
That petitioner on the admitted facts is a mere trustee is beyond question. If the contest, instead of involving a tax, were a contest between petitioner and the trust, it would be unconscionable to argue that, because the property was taken in petitioner’s name, it could claim a beneficial ownership therein. It may well be that at the time of the transaction there was no specific or formal agreement that petitioner should hold the property for the benefit of the trust, but the absence of such agreement or the lack of formality does not alter the obvious intent of the arrangement. No court would in the circumstances we have named permit it to retain the property or the profits in fraud of the real owner. Petitioner is a New York corporation, and the doctrine we have stated is that recognized and enforced by the courts of that state.

See also Stewart Forshay, 20 B. T. A. 537; Moro Realty Molding Corporation, 25 B. T. A. 1135; Thrift Realty Co., 29 B. T. A. 545; Mark A. Mayer, 36 B. T. A. 117. Of. Greenleaf Textile Corporation, 26 B. T. A. 737; Harold B. Franklin, 34 B. T. A. 927. No part of the gain is taxable to the corporate petitioner.

The Commissioner has determined that the net amount realized from the condemnation was $90,777.43 and the basis of the Harry Abrams estate upon its one-half was $31,525. Counsel for the estate concedes that the difference of $13,863.72 between the basis and one-half of the amount realized is gain of the estate from the disposition of a capital asset held for more than two and less than five years, so that 60 percent of the gain, or $8,318.23, would be taxable income. $10,178.11 was reported on the return. He concedes two other adjustments made by the Commissioner and states that the correct deficiency is $9.12. He does not contest the 5 percent penalty under section 406 of the Eevenue Act of 1935.

Decision will he entered under Rule 50.


author: Mellott:

text:
    Bakers’ Mutual Cooperative Association of Newark, New Jersey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 87871, 88985.

    Promulgated October 11, 1939.

      Charles Handler, Esq., for the petitioner.

      C. C. Holmes, Esq., for the respondent.
   OPINION.

Mellott:

Petitioner claims the respondent erred in determining that the amounts paid to the certificate holders constituted dividends rather than interest. It contends that the amounts paid in by the members were “in every sense direct loans to the group by the individuals with a maturity date capable of becoming definite by the parties.” It argues that all of the characteristics of an evidence of indebtedness, which it lists as a definite obligor, definite obligee, definite ascertainable obligation and time of maturity, were present; that the certificates were evidence of the loans and can not be construed to be certificates of stock; that they did not entitle the holders either to vote or to share in the profits; that the income and excess profits returns erroneously listed the amount represented by the certificates as capital; and that, as a matter of fact, no shares of capital stock were ever issued, subscribed for, or purchased.

The following statutes and regulations are particularly applicable to the year 1933:

Revenue Act of 193$.—
SEO. 23. DEDUCTIONS PROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(b) Interest. — All interest paid or accrued within the taxable year on indebtedness, except (1) on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title, or (2) on indebtedness incurred or continued in connection with the purchasing or carrying of an annuity.
SEC. 113. DISTRIBUTIONS BY CORPORATIONS.
(a) Definition op Dividend. — The term “dividend” when used in this title (except in section 203 (a) (4) and section 208 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28,1913.
Regulations 77.—
Art. 141. Interest. — -Interest paid or accrued within the year on indebtedness may be deducted from gross income, except that interest on indebtedness incurred or continued (1) in connection with the purchasing or carrying of an annuity, or (2) to purchase or carry securities, such as municipal bonds, first Liberty loan 3% per cent bonds, or (in the case of a taxpayer not an original subscriber) obligations of the United States issued after September 24, 1917, the interest upon which is wholly exempt from tax, is not deductible. * * *
Art. 621. Dividends.- — The term “dividends” for the purpose of Title I (except when used in sections 203 (a) (4) and 208 (c) (1) comprises any distribution in the ordinary course of business, even though extraordinary in amount, made by a domestic or foreign corporation to its shareholders out of its earnings or profits accumulated since February 28, 1913. * * *

No substantial change was made by the Revenue Act of 1934 or the regulations issued under it.

Neither party contends that petitioner, even though it apparently had not complied with the necessary formalities to make a de jure corporation, should not have filed a corporation income tax return. (Sec. 1111 (a) (2), Revenue Act of 1932; sec. 801 (a) (2), Revenue Act of 1934); Morrissey v. Commissioner, 296 U. S. 344. Nor does petitioner contend that it was exempt from tax under section 103 of the Revenue Act of 1932. The sole question is whether the amounts paid were interest or dividends.

Petitioner cites Northern Fire Apparatus Co., 11 B. T. A. 355; Proctor Shop, Inc., 30 B. T. A. 721; affd., 82 Fed. (2d) 792; Richmond, Fredericksburg & Potomac Railroad Co., 33 B. T. A. 895; affd., 90 Fed. (2d) 971; and Palmer, Stacy-Merrill, Inc., 37 B. T. A. 530. These cases — and others which might be cited — apply the principle that, where a creditor or a seller of property has accepted “guaranteed stock”, i. e., stock carrying with it an agreement that so-called dividends will be paid whether earned or not, or preferred stock which is to be redeemed in cash and upon which dividends are to be paid on dates certain without regard to earnings, it remains a creditor of the corporation or debtor, and such debtor is entitled to deduct the amounts paid as “interest”, even though designated dividends. This is on the theory that the payments are, in reality, interest, the income tax law being concerned with actualities rather than with book entries or designations by the parties.

Many cases have come before the courts or this Board in which the question has been substantially the same as that now presented. Each has turned upon “the peculiar facts and the construction given to the particular document” (Perrine & Buckelew, Inc., 32 B. T. A. 168, 173) and none has undertaken to lay down a general rule of universal application. While the terms used by the parties and the treatment accorded to the instrument by its creator will not lightly be set aside or ignored, Angelus Building & Investment Co., 20 B. T. A. 667; affd., 57 Fed. (2d) 130; certiorari denied, 286 U. S. 562, the name given to the transaction, or to the document under which the payment in question is made, is not conclusive.

In Perrine & Buchelew, Inc., supra, the entire opinion of Mr. Chief Justice Waite, in Cary v. Savings Union, 22 Wall. 38, holding that payments by a bank to certain of its depositors were dividends, was quoted. It is as follows:

A distinction is expressly recognized in the act of Congress between interest and dividends, and the Circuit Court decided that the payments to the depositors were for dividends. The question is whether this decision was correct.
We think it was. The depositors contracted not for a fate of interest to be paid upon their deposits, but for a share of the profits of the business in which their money was, by agreement, to be employed. It is true that the profits of the company were principally to be derived from interest upon loans made, but they were none the less on that account profits. The interest received for the loan of each deposit whs not kept by itself, and paid to the depositors after deducting a charge to cover expenses, but all was placed in a common fund, and when the net result of the business was ascertained, that was divided among the several contributors according to the Value of their contributions. Such a division clearly produces a dividend according to the common understanding of that term. The parties themselves so understood it, for they gave it that name in the contracts, executed when the depositors made their deposits. They stipulated for the payment of dividends land not interest.

It has frequently been pointed out that a creditor is one who has loaned money or its equivalent to his debtor, the contract giving the creditor not only the unconditional right to demand payment of the principal sum at a definite maturity date, but usually, also, the right to demand, and receive, compensation for its use or retention, i. e., interest. A stockholder, on the other hand, is one who risks his money in an enterprise, participates in its profits and management, shares its losses, and is entitled to receive an aliquot portion of its assets in the event of liquidation. Northern Fire Apparatus Co., supra; Elko Lamoille Power Co., 21 B. T. A. 291; affd., 50 Fed. (2d) 595. Petitioner contends that the relationship between it and its certificate holders was that of debtor and creditor; but we hold otherwise.

The evidence shows, as we have set out in our findings, that the association in the beginning of its operations paid nothing on the certificates of deposit, as there were no earnings. When it began to operate at a profit, payments equivalent to 6 percent of the face amounts of the certificates were made, but only when authorized by the board of directors. The certificate holders were not entitled to demand a fixed rate of return upon the amounts which they had paid in. The amount to be paid to them was dependent upon whether the association had any earnings: Finance & Investment Corporation, 19 B. T. A. 643; affd., 57 Fed. (2d) 444; Greensboro News Co., 31 B. T. A. 812; Cloquet Co-operative Society, 21 B. T. A. 744, and, even then, their right to receive any sum was dependent upon the action of the board of directors. Cf. Badger Lumber & Coal Co., 23 B. T. A. 362.

The fact that the association kept separate books of account in which the amounts paid on the certificates were referred to as “interest” is immaterial. The terminology used by the association in its records is not determinative of the legal character of the payments. Angelus Building & Investment Co., supra. Whatever significance may be attached to such entries is materially weakened by the designation in the constitution of the same payments as “dividends” and “discount.” They are nowhere referred to in the constitution as “interest.”

Eegardless of the terminology used, the question is: “Were the payments ‘distributions * * * to its shareholders * * * out of its earnings or profits’ or ‘interest paid or accrued * * * on indebtedness’?” We have held they were the former. Several bits of evidence and circumstances clearly so indicate. It will be noted that the certificate holder was “to share in the profits as declared in said by-laws.” This provision of the certificates was always com. plied with; and, if there were no profits the association was not obligated to make, and actually did not make, any payments for the use of the money. Clearly there was no contract under which “compensation was to be paid by the borrower of money to the lender for its use.” 33 Corpus Juris 178; Joseph W. Bettendorf, 3 B. T. A. 378; Anderson & Co., 6 B. T. A. 713. “The usual import of the term [interest]”, says the Supreme Court in Old Colony Railroad Co. v. Commissioner, 284 U. S. 552, 560, “is the amount which one has contracted to pay for the use of borrowed money.”

Petitioner attempts to support its contention that the payments were interest by evidence showing that from time to time payments were made to withdrawing members in amounts aggregating the face of the certificates, less the member’s indebtedness and plus 6 percent. But even in these instances the 6 percent was not paid unless the surrender of the certificate occurred after July 1. As expressed by petitioner’s secretary, “If a man makes an application to withdraw in April or May or June we tell him, ‘If you wait to withdraw until the first of July we will pay you six months interest; otherwise you lose interest from the first of January’.” This evidence, notwithstanding the use of the word “interest”, indicates that both the association and the withdrawing member definitely understood that no unconditional obligation to pay, or right to receive, interest existed.

The fact that no shares of stock were ever issued is immaterial. The members furnished the capital, which enabled the association to do a gross business of nearly a million dollars a year, and, in the event of its dissolution, they clearly would be entitled to receive its assets after its liabilities were paid. According to its balance sheet at the end of the year 1935, it had assets of $314,480.13, its chief liabilities being $180,386.70 due its members, $51,047.55 set aside as surplus, undivided profits, reserve for bad debts and contingencies, and $58,950 mortgage upon its building. During the taxable years the association clearly had “earnings or profits.” Most of them were distributed to the holders of the certificates. Under the circumstances we think such distributions were dividends, within the statutory definition of that term, and that the respondent did not err in disallowing petitioner’s deductions of them as interest.

Judgment will be entered wnder Rule 50.


author: Hill :

text:
    Trust U/W of Carl Hicks White, Deceased, Huston Thompson and Stephen H. Tallman, Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92417.
    Promulgated October 11, 1939.

      Oscair P. Mast, Esq., for the petitioners.

      D. D. Smith, Esq., for the respondent.
   OPINION.

Hill :

Two questions are presented for decision in our redetermination herein — (1) Is the item of $11,420.70 representing expenses incurred in the proceeding to construe the will deductible from gross income ? and (2) Is the item of $17,000 determined by respondent to represent dividends received by petitioners from Sunnyside, Inc., includable in petitioners’ income? We shall consider these questions in the order named.

Petitioners claim that the item in question number (1) is deductible under section 23 (a) of the Revenue Act of 1934. That section in material part is as follows:

In computing net income there shall be allowed as deductions:
(a) Expenses. — All of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *

In other words, petitioners contend that the trust was engaged in carrying on business and that the item of $11,420.70 comprised ordinary and necessary expenses paid during the taxable year in carrying on such business. Respondent contends, on the other hand, (a) that the trust was not engaged in carrying on business, and (b) regardless of whether it was so engaged, the payments comprised in the item in question were not ordinary and necessary expenses paid or incurred in carrying on a trade or business.

A trust whose trustees are invested merely with the power and duty to hold the trust estate and to invest and reinvest the same, collect the income therefrom, and distribute it to the beneficiaries under the trust, is not engaged in carrying on business. City Bank Farmers Trust Co., Trustee, 39 B. T. A. 29; George Vanderbilt Trust, 36 B. T. A. 967; Dorr v. United States (Dist. Ct., Dist. Mass.), 18 Fed. Supp. 92.

On the other hand it is held that “a person of property, who devotes his time to the active management of it and also to active participation in the management of the companies in which his property is invested, and who maintains an office for that purpose where he spends a substantial part of his time, is carrying on business within the meaning of this statute. * * * The line comes between those who take the position of passive investors, doing only what is necessary from an investment point of view, and those who associate themselves actively in the enterprises in which they are financially interested and devote a substantial part of their time to that work as a matter of business.” Foss v. Commissioner, 75 Fed. (2d) 326. See also Washburn v. Commissioner, 51 Fed. (2d) 949; Kales v. Commissioner, 101 Fed. (2d) 35.

If in the light of the cited decisions it be held that the trust was engaged in carrying on business, that business consisted of the activities of the trust through its trustees in the management and control of the trust properties and their participation in the management of the corporations in which the trust had investments. In order, therefore, to render the claimed deduction allowable it must appear that it represented ordinary and necessary expenses paid or incurred in connection with such management and control. In our opinion no such relationship has been shown. The proceeding to construe the will did not involve the question of the powers and duties of the trustees with reference to how the trust estate should be managed and controlled, but involved only questions of the relative rights of the beneficiaries under the trust and the legatees under the will of decedent. The construction of the will was sought as a guide to the trustees in properly interpreting the provisions of the will directing distribution of specific legacies and in allocating the distributable income of the trust property among the various beneficiaries under the trust. The expenses for which the deduction is claimed were incurred and paid not in the management and control of the trust estate but in a proceeding for a judicial determination of the rights of the various legatees under the will and of the beneficiaries of the trust. The only persons financially interested in the proceeding were such legatees and beneficiaries. It was their rights that were thus determined. They were the real parties in interest in the proceeding. The trust in no way benefited therefrom and the cost of such proceeding was not properly chargeable to the income of the trust. We hold, therefore, that the expenses for which deduction is claimed were not paid or incurred by the trust as ordinary and necessary expenses in carrying on a trade or business and hence are not deductible.

For the purpose of our consideration of this point we have assumed that the trust was engaged in carrying on business. In view of our conclusion that the claimed deduction is not allowable regardless of whether the trust was so engaged, it is unnecessary to determine whether the trust was in fact engaged in carrying on a trade or business.

The second question for our consideration is whether the item of $17,000 determined by respondent to represent dividends received by petitioners from Sunnyside, Inc., is includable in petitioners’ income for tax purposes. The petitioners contend that the item is not so includable, for the assigned reason that it represents identical moneys which Sunnyside, Inc., received as dividends from the Health Products Corporation and is therefore income of Sunnyside, Inc., and not income of petitioners. Petitioners further argue that, since those dividends have been taxed to Sunnyside, Inc., it would be inequitable to include $17,000 of the amount of said dividends in petitioners’ income for tax purposes. The respondent’s reply to this argument is that the dividends so received by Sunnyside, Inc., were properly included in its income for tax purposes, and that the $17,000 in question was received by petitioners from Sunnyside, Inc., and constituted dividends from that corporation and is, therefore, includable in petitioners’ income for tax purposes. We agree with respondent’s contention. The fact that the source of the money received by petitioners as dividends from Sunnyside, Inc., was the dividends to that corporation from the Health Products Corporation does not alter the fact that it was taxable income to petitioners. Nor does the fact that Sun-nyside, Inc., paid taxes on the income out of which it paid dividends to petitioners render such dividends nontaxable income to petitioners.

In determining the deficiency herein respondent determined that petitioners received in the taxable year $17,000 of dividends on stock in Sunnyside, Inc. His determination is prima facie correct. There is no evidence in the record and none was offered to the effect that the trust herein did not receive as stockholder of Sunnyside, Inc., in the taxable year the $17,000 in question or that it was not so received as dividends. We, therefore, agree with respondent’s contention on this point and hold that the item of $17,000 is properly included in petitioners’ income for tax purposes.

Reviewed by the Board.

Decision will he entered for respondent.