Opinion
Docket Nos. 9012 9013.
1947-08-29
PAULINA DUPONT DEAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.J. SIMPSON DEAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Laurence Graves, Esq., and Bruce Caldwell, Esq., for the petitioners. E. M. Woolf, for the respondent.
In the taxable year 1939, Nemours, a personal holding corporation on a cash basis, distributed certain assets in kind to its two stockholders. In determining the earnings and surplus of Nemours available for dividends in the taxable year, respondent increased its earning and profits per books by certain amounts. The inclusion of certain items and the exclusion of other items is contested. The respondent also increased the gross income of the respective petitioners by (a) the pro rate share of $12,000, which he fixed as the rental value of property owned by Nemours and occupied in the taxable year by petitioners as their residence, and (b) the pro rate share of $8,755.32 representing expenditures of Nemours in connection with ‘hunter horses‘ as personal expenses of petitioners. Held:
(1) In computing earnings and profits for the taxable year, reserves for contingent liabilities are to be included; the appreciation in value of the assets distributed in kind is not to be included; and the accrued but unpaid Federal income taxes for prior and current years are not to be excluded.
(2) The gross incomes of the respective petitioners were erroneously increased by an amount designated ‘personal expense.‘ The assumed rental value of residential property, less disbursement for painting, is taxable to petitioner J. Simpson Dean as additional compensation. Laurence Graves, Esq., and Bruce Caldwell, Esq., for the petitioners. E. M. Woolf, for the respondent.
These consolidated proceedings involve income tax deficiencies for the calendar year 1939. In Docket No. 9012, respondent determined a deficiency of $560,210.90 against petitioner Paulina duPont Dean. In Docket No. 9013, respondent determined a deficiency of $123,340.92 against petitioner J. Simpson Dean. Petitioners claim overpayments in the respective amounts of $103,752.99 and $22,057.87. The issues submitted are:
1. The extent to which the respective petitioners received taxable dividends upon the distribution to them, as stockholders of Nemours Corporation, of certain of its assets in kind having a fair market value of $1,032,832.41 on the distribution date of December 26, 1939.
2. Whether the respondent properly increased each petitioner's income by the pro rate share of $12,000, fixed as the rental value of property owned by Nemours Corporation and occupied by petitioners as their residence in the taxable year.
3. Whether the respondent properly increased the incomes of the respective petitioners in the taxable year by the pro rate shares of expenditures of Nemours Corporation for maintaining ‘hunter horses.‘
Many of the material facts were stipulated and are so found. Other facts are found from the evidence.
FINDINGS OF FACT.
The petitioners are husband and wife, residing at Montchanin, Delaware. Their Federal income tax returns for the taxable year 1939 were filed with the collector of internal revenue for the district of Delaware. Nemours Corporation (hereinafter referred to as ‘Nemours‘) is a personal holding corporation, organized under the laws of the State of Delaware in 1924. Its total issued and outstanding stock consisted of 36,172 shares, of which 28,923 shares were held by petitioner Paulina duPont Dean and 7,249 shares were held by petitioner J. Simpson Dean. Its books and records were kept on a cash basis. In the taxable year J. Simpson Dean was president and received a salary of $25,000. Paulina duPont Dean was vice president. She received no salary.
On December 21, 1939, the board of directors of Nemours adopted the following resolution:
RESOLVED, that the corporation distribute to its stockholders of record on December 23, 1939, in proportion to their stockholdings, the following assets owned by it; such distribution to be made on December 26, 1939:
100 shares Anaconda Copper Common
216 shares E. i. duPont de Nemours, Com.
2956 shares General Motors, Common
100 shares U. S. Steel, Common
100 shares Inland Steel Co., Common
5850 shares U. S. Rubber Co., Pfd.
1000 shares Electric Auto Lite Co., Com.
540 shares Delaware Steeplechase & Race Association, Pfd.
60 shares Delaware Steeplechase & Race Association, Common
82 shares Natrona Alkali Co.
41 shares Gulf Elton Land Company
12 shares Selbourne Farms, Inc.
262 shares Cosden Petroleum Co.
Klair Farm
Springer Farm
Dempsey Farm
Mitchell Farm
The assets distributed by Nemours pursuant to the resolution of December 21,1939, had been acquired by that corporation at a total cost or depreciated cost of $532,901.38 and had a total fair market value at date of distribution of $1,032,832.41.
The accumulated surplus and undivided profits of Nemours on December 31, 1938, as shown by its books, were $5,996.61, and on December 31, 1939, they were $313,534.08, before dividend payments and before Federal taxes.
The respondent has made the following adjustments, including adjustments made in the stipulation of facts, increasing the surplus and undivided profits from $313,534.08 to $902,582.33, as shown in the following tabulation:
+-----------------------------------------------------------------------------+ ¦Surplus and undivided profits per books before 1939 ¦ ¦$313,534.08¦ ¦dividend payments ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Addition to Surplus: ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Gas paid for but not taken, per books December 31, ¦$202,027.71¦ ¦ ¦1939 ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Reserve for depletion in excess of cost per books, ¦37,668.17 ¦ ¦ ¦December 31, 1939 ¦ ¦ ¦ +-----------------------------------------------------------------------------+
+-----------------------------------------------------------------------------+ ¦Addition to Surplus-Continued ¦ ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦Reserve for depletion on cost per ¦ ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦books December 31, 1939 ¦$91,013.21 ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦Reserve for depletion December 31, ¦ ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦1939, as revised ¦65,261.14 ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦ ¦ ¦$25,752.07¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Adjustment in cost of Wilmington Trust Stock, ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦account of rights (1929) ¦ ¦524.06 ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦Write-down of farm buildings (1929) ¦ ¦8,475.55 ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Organization expense charged to surplus ¦1,674.60 ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Gain on fire insurance received on barn destroyed ¦2,130.00 ¦ ¦ ¦(1929) ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Reduction of fire loss on farm buildings destroyed ¦275.00 ¦ ¦ ¦(1936) ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Real estate, Rome, Ga., charged off ¦ ¦5,000.00 ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦ ¦ ¦ ¦$283,527.16¦ +--------------------------------------+---------------+----------+-----------¦ ¦ ¦ ¦ ¦$597,061.24¦ +-----------------------------------------------------------------+-----------¦ ¦Less: Increase in cost of General Motors Corporation common stock¦30,912.50 ¦ ¦acquired from J.S. Dean Company ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦ ¦ ¦ ¦$566,148.74¦ +------------------------------------------------------+----------+-----------¦ ¦Deduct cash dividends paid during 1939 ¦ ¦$163,497.44¦ +-----------------------------------------------------------------+-----------¦ ¦Earnings and profits available before inclusion of amount ¦$402,651.30¦ ¦realized by distribution in kind ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Earnings and profits realized by distribution in kind December ¦ ¦ ¦26, 1939: ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Fair market value ¦$1,032,832.41 ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦Cost ¦532,901.38 ¦ ¦ ¦ +--------------------------------------+---------------+----------+-----------¦ ¦ ¦ ¦ ¦499,931.03 ¦ +------------------------------------------------------+----------+-----------¦ ¦Total earnings and profits available for distribution ¦ ¦$902,582.33¦ ¦in kind on December 26, 1939 ¦ ¦ ¦ +-----------------------------------------------------------------------------+
The Federal income taxes paid by Nemours in 1940, for the calendar year 1939, were in the amount of $10,793.87. On June 27, 1941, Nemours paid additional Federal income taxes assessed against it by respondent for the taxable year ended December 31, 1938, in the amount of $2,797.77, which amount is not reflected in the surplus of $313,534.08. None of these amounts was taken into consideration by the respondent in determining surplus and undivided profits as of December 31, 1939.
On September 17, 1931, Nemours Corporation entered into an agreement with United Gas Public Service Co., a corporation (hereinafter referred to as United). Under this contract Nemours was acting for itself and as agent for Renappi Corporation and Still Pond Co., also a corporation, each of which owned a one-third undivided interest in the gas-producing properties located in the State of Louisiana which were the subject of said agreement. The agreement provided in part:
IV
United agrees to take into its pipe lines, and/or to pay Nemours therefor, subject to the provisions of Article VII of this compromise agreement, at the rate of three (3¢) cents per thousand (1000) cubic feet, natural gas in the following amounts and during the years hereinafter set out, to wit:
A minimum of 2,190,000,000 cubic feet for the year beginning June 25, 1931, and ending June 25, 1932;
A minimum of 2,920,000,000 cubic feet for the year beginning June 25, 1932, and ending June 25, 1933;
A minimum of 3,650,000,000 cubic feet for the year beginning June 25, 1933, and ending June 25, 1934;
A minimum of 4,380,000,000 cubic feet for the year beginning June 25, 1934, and ending June 25, 1935;
And, subject to the provisions hereinafter set out, a minimum of 4,380,000,000 cubic feet of gas per annum thereafter.
All of the above minimums as well as the basis of payment for gas are agreed to be computed on a pressure basis of two (2) pounds per square inch above 14.4 pounds absolute atmospheric pressure.
The vendee shall pay for the quantity above named, less royalty and severance taxes, which shall be paid directly by United to royalty owners and to the State, respectively, whether taken or not (provided, however, the vendor is able, according to the provisions hereinafter set out, to deliver the said minimum); and it is agreed that if the vendee in any year does not take such minimum it shall, nevertheless, pay for the same, but in such case shall have the right, after having taken its minimum in any of the following years, to take credit through gas for the excess paid for in the previous year or years; royalties on gas so taken and severance tax on its working interest to be paid by Nemours.
All payments for gas taken shall be made on or before the 25th day of the month following the taking of such gas. Final payment for each contractual year shall be made on or before the 25th day of July, following the expiration of such contractual year on the 25th day of June immediately preceding. If United shall have failed during any contractual year to take the minimum amount of gas as herein specified for such year, payment covering any such deficiency shall be made at the time of the final payment for the contractual year.
In addition thereto, United agrees that it is indebted unto Nemours for the difference between the purchase price of the gas which it has actually taken from Nemours for the year beginning June 25, 1930, and ending June 25, 1931, and a daily taking of 6,000,000 cubic feet of gas, and with the signing of this act pays to Nemours the sum of Thirty seven thousand seven hundred seventeen 52/100 ($37,717.52) Dollars in full settlement therefor; it being agreed that, with respect to such gas for which it has thus paid but has not taken, it shall have the right to take an equal quantity of such gas during the life of this contract by taking such portion thereof in any year as it may deem fit after it has taken its minimum herein contracted for that year, but in such case Nemours shall pay the royalties on the gas so taken and the severance taxes on its working interest.
V.
This contract shall be effective as of and from June 25, 1931, and shall continue for four (4) years and as long thereafter as Nemours may be producing gas in commercially profitable quantities from its wells in the Monroe field.
VI
It is understood and agreed by the parties that United's requirements are very much larger during the winter months than in the summer months, and it is accordingly agreed that it shall not be required to take the minimum hereinabove stipulated on a ratable monthly basis; but in no case shall it have the right to take daily more than the open flow capacity as hereinafter set out in the next paragraph.
VII.
The obligation of United to take and pay for the minimums hereinbefore stipulated is dependent upon wells of Nemours having a daily deliverable capacity as hereinafter set out, as follows:
For the year beginning June 25, 1931, and ending June 25, 1932, 10,000,000 feet;
For the year beginning June 25, 1932, and ending June 25, 1933, 13,300,000 feet;
For the year beginning June 25, 1933, and ending June 25, 1934, 16,667,000 feet;
For the remaining years of the contract, 20,000,000 feet.
If the Nemours wells do not have a deliverable capacity equal to the amounts above stated, and that deficiency exists continuously for a period of thirty (30) days after notice of such deficiency given in writing by United to Nemours, then the obligations of the United with reference to the minimum which it is under positive obligation to take and pay for during that particular year shall be reduced pro rata to the proportion which the actual daily deliverable capacity of the Nemours wells bears to the agreed deliverable capacity for that year as above set out.
Nothing herein shall prejudice the right of Nemours to contest the constitutionality, legality, reasonableness or fairness of any statute and/or regulation of official body respecting withdrawable and/or deliverable capacity of well or wells or the method of determining open flow as the basis therefor.
Nemours shall not be liable for damages of any kind if the deliverable capacity of its wells be less than the amount herein stipulated; the sole penalty being the reduction of the obligation of the United to take from its wells as herein expressly set out.
The deliverable capacity required under the contract was maintained and the amount of gas called for thereunder was available at all times.
The amount of gas taken into its lines by United did not equal the minimum requirements for any year from the beginning of the contract in 1931 to and including the contract year ended June 25, 1942. However, United made payments each year for the minimum requirements under the contract, as is shown in the following tabulation, which lists the MCF (1,000 cubic feet of gas) paid for but not taken, the cash payment under the contract, and the one-third interest of Nemours in said payment:
+--------------------------------------------------------------------+ ¦ ¦Column (1) ¦Column (2) ¦Column (3) ¦ +----------------------+----------------+-------------+--------------¦ ¦ ¦MCF of gas ¦Cash payment ¦One-third ¦ +----------------------+----------------+-------------+--------------¦ ¦ ¦paid for but ¦received for ¦interest of ¦ +----------------------+----------------+-------------+--------------¦ ¦Calendar year ¦not taken during¦contract year¦Nemours ¦ +----------------------+----------------+-------------+--------------¦ ¦ ¦contract ¦June 26 to ¦Corporation in¦ +----------------------+----------------+-------------+--------------¦ ¦ ¦year, June 26 ¦June 25 ¦column 2 ¦ +----------------------+----------------+-------------+--------------¦ ¦ ¦to June 25 ¦ ¦ ¦ +----------------------+----------------+-------------+--------------¦ ¦1931 ¦1,257,251 ¦$37,717.52 ¦$12,572.51 ¦ +----------------------+----------------+-------------+--------------¦ ¦1932 ¦1,816,132 ¦54,483.96 ¦18,161.32 ¦ +----------------------+----------------+-------------+--------------¦ ¦1933 ¦2,129,909 ¦63,897.27 ¦21,299.09 ¦ +----------------------+----------------+-------------+--------------¦ ¦1934 ¦2,406,712 ¦72,201.36 ¦24,067.12 ¦ +----------------------+----------------+-------------+--------------¦ ¦1935 ¦2,862,714 ¦85,881.42 ¦28,627.14 ¦ +----------------------+----------------+-------------+--------------¦ ¦1936 ¦2,006,223 ¦60,186.69 ¦20,062.23 ¦ +----------------------+----------------+-------------+--------------¦ ¦1937 ¦1,596,535 ¦47,896.05 ¦15,965.35 ¦ +----------------------+----------------+-------------+--------------¦ ¦1938 ¦3,009,988 ¦90,299.64 ¦30,099.88 ¦ +----------------------+----------------+-------------+--------------¦ ¦1939 ¦3,117,306 ¦93,519.18 ¦31,173.06 ¦ +----------------------+----------------+-------------+--------------¦ ¦Total to Dec. 31, 1939¦20,202,770 ¦606,083.09 ¦202,027.71 ¦ +----------------------+----------------+-------------+--------------¦ ¦1940 ¦1,604,821 ¦48,144.63 ¦16,048.21 ¦ +----------------------+----------------+-------------+--------------¦ ¦1941 ¦1,085,660 ¦32,569.80 ¦10,856.60 ¦ +----------------------+----------------+-------------+--------------¦ ¦1942 ¦209,393 ¦6,281.79 ¦2,093.93 ¦ +----------------------+----------------+-------------+--------------¦ ¦Total ¦23,102,644 ¦693,079.31 ¦231,026.45 ¦ +--------------------------------------------------------------------+
The annual amounts shown in column 3 above were reported as income by Nemours in its Federal income tax returns, beginning with the year 1933.
During the contract years ended June 25, 1943, 1944, 1945, and 1946, United took gas in excess of minimum requirements, for which it had previously made payment and which it charged against said previous payments as follows:
+-----------------------------------------------------------------+ ¦ ¦Column (1) ¦Column (2) ¦Column (3) ¦ +-------------+---------------+----------------+------------------¦ ¦ ¦MCF of gas ¦ ¦One-third interest¦ +-------------+---------------+----------------+------------------¦ ¦Contract year¦taken in excess¦Cash charge ¦of Nemours ¦ +-------------+---------------+----------------+------------------¦ ¦ ¦of minimum ¦against previous¦Corporation in ¦ +-------------+---------------+----------------+------------------¦ ¦ ¦requirements ¦payments ¦Column 2 ¦ +-------------+---------------+----------------+------------------¦ ¦1943 ¦1,434,114 ¦$43,023.42 ¦$14,341.14 ¦ +-------------+---------------+----------------+------------------¦ ¦1944 ¦1,612,088 ¦48,362.64 ¦16,120.88 ¦ +-------------+---------------+----------------+------------------¦ ¦1945 ¦1,239,526 ¦37,185.78 ¦12,395.26 ¦ +-------------+---------------+----------------+------------------¦ ¦1946 ¦119,793 ¦3,593.79 ¦1,197.93 ¦ +-------------+---------------+----------------+------------------¦ ¦Total ¦4,405,521 ¦132,165.63 ¦44,055.21 ¦ +-----------------------------------------------------------------+
The severance tax imposed by the State of Louisiana when gas is taken from wells located in that state is at the rate of $.003274642 per thousand cubic feet. All of the gas wells covered by the contract between United and Nemours were located in the State of Louisiana.
The severance tax and the one-eighth royalty payable by Nemours under the contract if United had taken the gas which it had paid for but had not taken up to December 31, 1939, and for which Nemours had received $202,027.71, would have amounted to an aggregate of $47,305.74; $22,052.28 for severance tax, and $25,253.46 for the one-eighth royalty.
In determining the accumulated earnings and profits of Nemours as of December 31, 1939, respondent computed the depletion allowable for prior years on the cost basis. In doing so, no deduction for depletion for gas paid for but not taken was allowed, nor were Louisiana severance taxes on such gas allowed as a deduction.
On December 18, 1939, Nemours declared a dividend payable in cash on December 21, 1939, in the amount of $4.52 per share, a total cash distribution from earnings and profits of $163,497.44. As a result of this distribution, petitioner Paulina duPont Dean received $130,731.96 and petitioner J. Simpson Dean, $32,765.48, which they reported as dividend income in their Federal income tax returns.
As the result of the distribution of the properties in pursuance of the resolution of the board of directors of Nemours on December 21, 1939, the petitioners were advised by Nemours that it had distributed its remaining earnings and profits and that they had received additional dividend distributions as follows: Paulina duPont Dean, $148,215.53, and J. Simpson Dean, $37,147.40, which they also reported as dividends in their 1939 tax returns.
In 1931 Nemours was indebted to the Chase National Bank in the amount of $600,000. On July 1, 1931, the bank requested that the home owned by Paulina duPont Dean, which had cost her $208,781.72, be transferred to Nemours so as to improve its credit standing. The transfer was made and title remained in Nemours during the year 1939. The property was occupied by the petitioners and their three children. For the taxable year 1939, in arriving at book income of Nemours the following items in connection with such premises were deducted:
+-----------------------+ ¦Repairs ¦$1,356.24¦ +-------------+---------¦ ¦Depreciation ¦4,232.00 ¦ +-------------+---------¦ ¦Water ¦206.23 ¦ +-------------+---------¦ ¦Total ¦5,794.47 ¦ +-----------------------+
This sum of $5,794.47 was added to the book income of Nemours in computing the income reported in its Federal tax returns for that year. The only deduction which was claimed by Nemours in its Federal tax returns on account of said property was for real estate tax for the taxable year, amounting to $435.73.
The respondent added $9,595.16 to the income reported by petitioner Paula duPont Dean and $2,404.84 to the income reported by petitioner J. Simpson Dean, which he describes in the notices of deficiency as ‘rental Value of Residence.‘
The respondent added $7,000.72 to the income of petitioner Paulina duPont Dean and $1,754.60 to the income of petitioner J. Simpson Dean under the classification ‘Other Income,‘ which was explained as follows:
Expenditures of $8,755.32 by Nemours Corporation in connection with ‘hunter horses‘ represent personal expenses and are, therefore, taxable income to you in the amount of . . . . .
Nemours also engaged in breeding, buying, improving, and selling ‘hunter horses‘ for profit. Petitioner J. Simpson Dean often rode the horses for pleasure and occasionally petitioners' children rode them. Petitioner Paulina duPont Dean never used any of them.
In 1940 petitioner Paulina duPont Dean paid the tax of $143,610.13 shown on her 1939 return in four equal installments. On May 14, 1943, she paid an additional amount of $112,462.29 on account of tax and $21,367.84 on account of interest. Petitioner J. Simpson Dean in 1940 paid the tax of $33,796.99 shown on his 1939 return, in four equal installments. On May 14, 1943, he paid an additional amount of $23,945.50 on account of tax and $4,549.65 on account of interest.
The accumulated earnings and profits of Nemours at the close of the taxable year 1939, before any distributions to stockholders, were $566,148.74.
OPINION.
LEECH, Judge:
The first issue is whether petitioners received taxable dividends upon the distribution to them in kind of certain assets of Nemours which had appreciated in value. Petitioners do not contest the rule that dividend distributions in kind are taxable to the extent that the corporation has accumulated earnings and profits in the taxable year available for the payment of dividends. Sec. 115, I.R.C. Petitioners protest the respondent's action in adding to the earnings and profits of Nemours, per books as of December 31, 1939, the appreciated value of the securities distributed in kind in the amount of $499,931.03, representing the difference between the cost and the market value at the time of distribution.
The respondent takes one primary and two alternative positions. His principal contention is that, in determining the earnings and profits of Nemours as of the close of the taxable year in which the distribution in kind occurred, the amount of the appreciation of the distributed property, as of the time of its distribution, over its corporate cost should be included. His first alternative position is that the distribution in kind should be taxable to the petitioners as dividends to the extent of the value of certain specific assets which in a prior year ‘were purchased out of earnings and profits or when earning and profits exceeded cost.‘ His second alternative position is that the distribution in kind was taxable as a dividend to petitioners in an amount determined by taking ‘the ratio that earnings and profits at the date of distribution (without augmentation by the appreciation in value of the distributed property) bears to the cost of the property.‘
To constitute a dividend there must be a distribution of earnings and profits. Palmer v. Commissioner, 302 U.S. 63. The earnings and profits of a corporation, the distribution of which results in a taxable dividend, are statutory concept. They are not to be determined exclusively by reference to corporate accounting standards. John T. Wilson, 31 B.T.A. 1022; Susan T. Freshman, 33 B.T.A. 394. We have consistently applied the rule that a distribution in kind of stock which had appreciated in value did not result in taxable income to the corporation. Estate of H. H. Timken, 47 B.T.A. 494; affd., 141 Fed.(2d) 625; National Carbon Co., 2 T.C. 57; V. U. Young, 5 T.C. 1251; cf. R. D. Merrill Co., 4 T.C. 955. In the latter case we held that earnings and profits could not be decreased by the depreciation in value of securities. In La Belle Iron Works v. United States, 256 U.S. 377, it was held that the appreciated value of corporate property could not be treated as part of the corporate surplus and profits for the purpose of increasing its invested capital. In V. U. Young, supra, respondent, in connection with the distribution of Theatrical Managers, Inc., stock by Gary Theatre Co. to its stockholders, made the same contention, at least in principle, as that made here. We rejected that theory there and held that the distribution in kind could not be and was not a taxable dividend except to the extent of the corporate earnings and profits, when distributed, without including the increase in value of the corporate assets. We there said:
* * * The Commissioner argues that Gary Theatre Co. realized an additional profit from the distribution of the stock of Theatrical Managers, Inc. He concedes that Commissioner v. Timken, 141 Fed.(2d) 625, affirming 47 B.T.A. 494, holds to the contrary, but he argues that that case was incorrectly decided. The transaction itself did not give rise to any earnings or profits on the part of Gary Theatre Co. Commissioner v. Timken, supra; General Utilities & Operating Co. v. Helvering, 296 U.S. 200. * * *
Nor do we find any merit in the respondent's alternative positions. He argues that certain of the securities distributed in kind were purchased prior to the taxable year at a time when Nemours had earnings and profits accumulated after March 1, 1913, in amounts in excess of the cost of such shares. A similar argument was made by respondent in the recent case of Jane Easton Bradley, 9 T.C. 115. We there held that such fact is immaterial and not determinative. Only to the extent that earnings and profits are available for distribution in the taxable year— and determined without including any increment in the value of the distributed assets— can there be a taxable dividend. V. U. Young, supra; Jane Easton Bradley, supra; Estate of H. H. Timken, supra; R. D. Merrill Co., supra. Aside from the other possible frailties in these alternative contentions, the application of either of them would violate this rule. The cases of Binzel v. Commissioner, 75 Fed.(2d) 989; Commissioner v. Wakefield, 139 Fed.(2d) 280; and Timberlake v. Commissioner, 132 Fed.(2d) 259, upon which the respondent relies are distinguishable. In the Binzel and Timberlake cases, the available earnings and profits were sufficient to cover the distributions, or at least the contrary was not shown. In the Wakefield case, the securities were bought during the taxable year out of earnings accumulated since February 28, 1913, held for a few months, and then turned over in kind. The distribution was made possible by the expenditure of earnings and profits and depleted only its earnings and profits. The corporate earnings and profits of Nemours, per books, as of the close of the taxable year were, as we have found, $313,534.08. After adjustments for increases other than the increment in value of assets distributed (see infra), those earnings and profits were, as we have found, $566,148.74. The distribution in kind, in that amount, is taxable and no more.
Another adjustment made to the earnings and profits of Nemours, which is contested by petitioners, is the addition to book earnings and profits of the amount of $202,027.71 representing ‘Gas paid for but not taken per books December 31, 1939.‘ The petitioners argue this amount represents a liability of Nemours. The amount was shown on the liabilities side of the balance sheet and was recorded in the books of the corporation under an account entitled ‘United Gas Deficit Reserve.‘ Nemours kept its books on a cash basis. This sum of $202,027.71 is a part of the minimum amount paid by United to Nemours for gas pursuant to its agreement. Under the contract Nemours is entitled to retain such moneys absolutely, without any liability whatsoever to repay them. Nemours is required to deliver gas equal to that amount if United ever demands it before the end of the contract. If United makes no demand, there is no obligation resting upon Nemours whatsoever. Hence the obligation of Nemours is purely contingent. We think respondent properly increased Nemour's earnings and profits upon such amount. The petitioners point out that, if Nemours were required subsequently to deliver the gas to the value of $202,027.71, it would be required to pay royalties of $25,253.46 and severance taxes of $22,052.28. They contend that a liability to that extent should be allowed as an indebtedness in determining earnings and profits. The obligation to pay such amounts is equally contingent with the obligation to deliver the gas. Such items would be proper expense deductions when actually made. They are not to be considered in determining the earnings and profits as of December 31, 1939, the specific time here involved.
Petitioners further contend that, in determining the earnings and profits of Nemours for the taxable year, respondent has not taken into the computation unpaid Federal income taxes for prior years, as well as for the current year. We think the respondent's action in not considering accrued by unpaid Federal income taxes in determining earnings and profits of Nemours for the taxable year in question was proper, on the authority of Helvering v. Alworth Trust, 136 Fed.(2d) 812; certiorari denied, 320 U.S. 784. The petitioners urged that the case of Commissioner v. Clarion Oil Co., 148 Fed. (2d) 671; certiorari denied, 325 U.S. 881, is controlling here. The question in the latter case was whether, in determining undistributed income of a personal holding company, Federal income taxes paid or accrued should be taken into consideration. The court held that for such purposes they were to be considered. We think that is a different question than the one here presented. In the Alworth Trust case, supra, the extent of the earnings and profit available for dividends was directly involved. For that reason we follow the Alworth Trust case.
The disposition we have made of the several issues previously discussed will result in establishing the accumulated earnings and profits of Nemours as of December 31, 1939, exclusive of any distributions to stockholders, in the amount of $566,148.74, which we have found as a fact.
The next issue involves the propriety of the respondent's action in taxing as income to the respective petitioners a pro rata share, based on their stock interests, of the amount of $12,000 as ‘Rental Value of Residence.‘ In 1931 petitioner Paulina duPont Dean owned real property which was occupied by petitioners as a residence. At that time Nemours had a large loan with the Chase National Bank. The bank requested that title to the property be transferred to Nemours to improve its credit standing. This was done and Nemours owned the property in the taxable year. We think the assumed rental value of $12,000 for the residential property occupied by petitioner J. Simpson Dean and his family is not properly taxable to the respective petitioner as income, but is properly taxable to him as addition compensation for services rendered to Nemours. Chandler v. Commissioner, 119 Fed.(2d) 623, affirming 41 B.T.A. 165. Petitioner Paulina duPont Dean rendered no services to Nemours and received no fixed compensation. The record discloses that the only deduction allowed Nemours for income tax purposes in the taxable year was the sum of $435.73 which it paid for real estate taxes. Petitioner J. Simpson Dean testified that the estimated cost of maintaining the residential property in fair condition averaged approximately $15,000 per year, consisting principally of wages. The only specific item of expenditure shown was the sum of $1,356.24 disbursed in connection with painting the premises in the taxable year. Upon such showing, only the amount of $1,356.24 may properly be allowed as a deduction against the assumed rental value of $12,000. We, therefore, conclude that the difference between these two items, or the sum of $10,643.76, constituted taxable income to petitioner J. Simpson Dean in the taxable year involved.
The remaining issue relates to the respondent's action in adding pro rata to the respective petitioners' incomes the sum of $8,755.32 expended by Nemours in connection with raising, breeding, buying, and selling ‘hunter horses.‘ Such expenses were disallowed as a deduction to Nemours. The amount of $7,000.72 was added to the income of petitioner Paulina duPont Dean and $1,754.60 was added to the income of petitioner J. Simpson Dean. The evidence discloses that Paulina made no use whatsoever of the horses. Petitioner J. Simpson Dean did frequently ride them. One of the petitioners' children also rode occasionally. It appears that riding the horses was necessary for the health, training, and development of the horses and was thus beneficial to Nemours, which owned them. The fact that petitioner J. Simpson Dean derived great pleasure in riding them is merely incidental to the main purpose for which the horses were kept. We think the fact that Nemours did not contest the disallowance of such maintenance expenses does not furnish a sound basis for adding such amounts to the respective petitioners' incomes. On this issue the petitioners are also sustained.
Decisions will be entered under Rule 50.