Opinion
Docket Nos. 93383 108237.
1943-08-14
NATHAN H. GORDON CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Mark M. Horblit Esq., for the petitioner. James T. Haslam, Esq., for the respondent.
1. In 1922 Nathan H. Gordon and Sarah A. Gordon established trusts for the maintenance, support, and comfort of certain beneficiaries. The trusts were to terminate December 31, 1935. The corpora of the trusts were to revert to the grantors. In 1923 petitioner was incorporated. It was authorized to engage in many forms of business. On March 2, 1931, the grantors agreed to assign their reversionary rights in the trusts to petitioner in consideration of petitioner's assumption of the payment of the monthly allotments for life as scheduled in the trust instruments. Petitioner was permitted to use one of three methods of assuring the payments. Later in that month they executed formal assignments of their reversionary interests to petitioner. On January 2, 1936, petitioner took actual delivery of the trust property. Held, the termination of the trusts on December 31, 1935, with the consequent delivery of the trust assets to petitioner in1936, did not result in income to it in either 1935 or 1936.
2. The trust assets on January 3, 1936, consisted largely of a debt of petitioner to the trusts. The termination of the trusts and acquistion by petitioner of the trust property the debt of petitioner being the principal asset, did not result in income to petitioner on the ground that petitioner's debt was canceled and forgiven.
3. The debt due to the trusts by petitioner included interest on loans made to it. Petitioner kept its books on an accrual basis. The interest was recorded on its books in 1934 and 1935 and the trusts also accrued such interest on their books and reported it in their income tax returns for those years. Held, that such interest items were properly deductible for the years 1934 and 1935.
4. In 1936 petitioner subscribed to the Associated Jewish Philanthropies, Inc., and accrued the contribution on its books. It paid the subscription in 1937. Held, that under the provisions of section 23(q), Revenue Act of 1936, the deduction of such contribution is allowable. Article 23(q)-1 of Regulations 94 held to be invalid in so far as it requires actual payment in the tax year.
5. Various deductions of debts on account of their worthlessness and of losses realized upon sale of securities, allowed or disallowed, according to the facts. Mark M. Horblit Esq., for the petitioner. James T. Haslam, Esq., for the respondent.
The Commissioner determined deficiencies in the taxes of the petitioner as follows:
+--------------------------------------------------------------+ ¦ ¦ ¦Excess profits¦ ¦Personal ¦ ¦ +----+----------+--------------+---------+-----------+---------¦ ¦Year¦Income tax¦tax ¦Surtax ¦holding ¦Penalty ¦ +----+----------+--------------+---------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦company tax¦ ¦ +----+----------+--------------+---------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----+----------+--------------+---------+-----------+---------¦ ¦1934¦$5,534.58 ¦ ¦$6,145.59¦ ¦$1,536.40¦ +----+----------+--------------+---------+-----------+---------¦ ¦1935¦7,205.31 ¦ ¦13,535.55¦ ¦ ¦ +----+----------+--------------+---------+-----------+---------¦ ¦1936¦487,311.91¦$185,297.30 ¦ ¦$260,870.72¦ ¦ +--------------------------------------------------------------+
The issues involved in the years designated are as follows:
1. The inclusion of the value $1,573.290.98, of certain assets of nine trusts known as the Nathan H. Gordon trusts, Nos. 1 to 6, inclusive, and the Sarah A. Gordon trusts, Nos. 1 to 3, inclusive, or any part thereof, in the petitioner's gross income upon the termination of such trusts in 1935, the rights and interests of the grantors to and in such assets having been transferred to the petitioner on March 10, 1931. This, the main issue, was originally asserted as to the year 1936, but by the respondent's amended answer has been made applicable to the year 1935 also. In his brief respondent shifted his position and defends his action as to this item by contending that there was a cancellation of a debt of $1,481,965.41, principal and interest of a loan owned by petitioner to the trusts; and that petitioner derived income from such cancellation, such income to be computed by taking as a basis the value of the securities set aside by the petitioner to provide for the determinable payments undertaken by the petitioner and treating the excess as gain. He also contends that all of the cash received, $86,946.91, constituted taxable income to petitioner.
2. The deductibility of interest amounting to $42,797.03 and $51,165.41 accrued on moneys borrowed by the petitioner from the nine trusts. The issue relates to the years 1934 and 1935, respectively. Respondent's action on this item was based on the ground that the interest was never paid. On brief he links the disallowance of the interest deductions with the asserted cancellation of the loan, urged as to item 1.
3. The deductibility of a bad debt of $3,500 due from Louis I. Prince, claimed to have become uncollectible in 1935.
4. The deductibility of $7,350 on account of the worthlessness of Seaboard Utilities Corporation stock in 1935.
5. The deductibility of $5,945.50 on account of the worthlessness of Bankstocks Corporation of Maryland in 1935.
6. The deductibility of $108,784.84 as a loss realized from the sale of certain stocks and bonds at brokers' auction.
7. The deductibility of $7,319.96 as a bad debt due from Irving L. Wallenstein (1936).
8. The deductibility of $1,150 as a bad debt due from I. Nick Gordon (1936).
9. The deductibility of a charitable contribution of $3,668 accrued in 1936 but not paid in that year.
10. The imposition of a penalty for the delinquent filing of a personal holding company return for the year 1934.
11. In its reply to the respondent's amended answer the petitioner asserts that the claim for the inclusion of the reversionary property in its income for the year 1935 is barred by the statute of limitations.
FINDINGS OF FACT
The petitioner is a corporation organized in 1923 under the laws of Massachusetts and has its usual place of business in Boston. It filed its income tax returns for the taxable years with the collector of internal revenue for the district of Massachusetts.
The petitioner's capital stock consisted of 1,000 shares of common stock of no par value. On November 8, 1937, its authorized capital stock was increased to 3,000 shares of common stock of no par value and 5,000 shares of class A stock. The corporation was authorized to deal in mortgages, stocks, bonds, real estate, and other assets, and to engage in a general brokerage and financial business. During the year 1931 and the taxable years before the Court all of the petitioner's outstanding stock was held by the Nathan H. Gordon Foundation Trust, hereinafter called Foundation. On December 31, 1931, the petitioner owned assets valued at $3,828,337.58 and its liabilities, consisting of loans and accounts payable, totaled $1,750,159.50.
On May 2, 1922, Nathan H. Gordon established six trusts by six separate indentures of trust, identical except as to the beneficiaries. On September 1, 1922, Sarah A. Gordon, wife of Nathan H. Gordon, established three trusts by three separate indentures of trust, identical except as to beneficiaries. Bernard L. Gorfinkle was named as trustee of all nine trusts and served as such from 1922 until their termination on December 31, 1935.
Each trust instrument provided that the trustee should semiannually pay to or apply for the benefit of the beneficiary the whole or such portions of the trust income as he should in his discretion determine to be necessary for the maintenance, support, and comfort of the beneficiary. The trusts further provided that if the entire amount of the dividends and income received by the trustee during any calendar year should not have been so paid or applied, then such balance might, with the written consent of the trustor, be invested in property which would thereafter become part of the corpus.
The indentures provided that the trusts should terminate on December 31, 1935, and the corpus should revest in the grantors. All nine trusts terminated and the corpora thereof, with accrued income thereon, reverted to the grantors. The corpora of the nine trusts at the time of their creation consisted of Olympia Theatres, Inc., common stock aggregating 45,000 shares. On December 31, 1935, the assets of the nine trusts had an aggregate net value of $1,568,912.32, of which $1,481,965.41 represented loans receivable from the petitioner, $3,618.38 in cash, and $87,910.56 in stock and bonds, with liabilities of $4,582.03. No portion of such sum of $1,568,912.32 was reported by the petitioner as taxable income for the years 1931, 1935, or 1936.
On July 9, 1924, Nathan H. Gordon and his wife established the Nathan H. Gordon Foundation Trust. The principal beneficiaries were to receive three-fifths of practically all the income (the remaining two-fifths thereof to be paid to Mrs. Gordon) and the entire corpus of the trust upon its termination. In 1931 the trustees of Foundation owned all of the outstanding capital stock of the petitioner, and Nathan H. Gordon and his wife were two of its six trustees. In 1937 the trustees of Foundation exchanged the 1,000 shares of petitioner's common stock for the 3,000 shares whose issuance was then authorized. Three thousand shares of class A stock were issued to other persons.
On March 2, 1931, Nathan H. Gordon executed a written contract in which he agreed to assign to the petitioner all of his right, title, and interest in and under the six trusts in consideration of the assumption by the petitioner of the payments of certain monthly allotments for life in the aggregate amount of $33,541, of which $12,000 were payable to Nathan H. Gordon and a like sum to his wife. The remainder was payable to persons related by blood or marriage to either Nathan H. Gordon Or Sarah A. Gordon. On the same day Sarah A. Gordon executed a similar agreement respecting the three trusts, with specific payments aggregating $21,300, of which $6,000 were payable to her. The petitioner paid no consideration to Gordon and his wife for their reversionary interests except the assumption of the obligations stated in the contracts. The monthly payments were to begin January 1, 1936.
The contracts contained the following provisions:
3. Said corporation may, at any time and/or from time to time, at its option, relieve itself, pro tanto, from the obligations to make said monthly payments assumed by it under paragraph numbered ‘2‘ hereof, to the extent that it shall provide for and secure the continuity of such payments by one or more of the following methods, to wit:
(a) By obtaining from some insurance company or insurance companies, in good standing and authorized to do business in Massachusetts, a contract or contracts, in writing (of the classification generally known as annuity contracts), whereby such insurance company or insurance companies shall be obligated to pay monthly to persons named in said Schedule, the respective payments set forth in said Schedule opposite their respective names; and/or
(b) By depositing, with a bank or banks, or with some other institution or institutions in good standing and authorized by law to act as Trustee in said Commonwealth, or by setting aside stocks, bonds or other securities or property, to be held in trust for the purpose of applying the income toward making payments specified in said Schedule ‘A‘ to persons therein named.
It is hereby specifically agreed and understood, however, that only to the extent that said corporation shall establish trusts as specified in said subsection ‘(b)‘ of this paragraph, or shall obtain annuity contracts as provided in subsection ‘(a)‘ of this paragraph, * * * shall said corporations be relieved of the obligation to make and to continue making said payments, hereby assumed by it.
4. Said corporation further hereby agrees to provide security under section 3 before January 1, 1939, and to issue and deliver, after the termination of said three trusts, and after the receipt of said corporation of the property thereof, to the Trustees of Gordon Foundation Trust, a trust duly established and existing under and by virtue of an Indenture of Trust dated July 9, 1924, certificates of capital stock of said corporation representing such number of shares as shall equal, in value, the difference between (a) the fair value of the aggregate property constituting the reversion of said three trusts as of the date of termination thereof, and (b) the aggregate cost, as of such date, computed according to the rates of some insurance company then in good standing and authorized to do business in Massachusetts, of fully paid annuity contracts which would obligate such insurance company to pay monthly, to each, respectively, of the persons named in said Schedule ‘A‘ the sum therein set opposite their respective periods indicated in said Schedule ‘A‘ with respect to the respective persons named therein, or (c) in place of said annuity contracts, the value of the securities deposited or set aside by it, in trust, as provided in paragraph ‘3(b)‘ hereof.
The contract further provided that in the event of its liquidation the petitioner should be obligated to make provision for the continuation of the payments pursuant to the requirements of paragraph 3 of the contract.
In the Sarah A. Gordon contract, the schedule attached designated her three children as beneficiaries and directed that upon the death of any of them the monthly installments payable to the children should be paid to the issue thereof. All of the beneficiaries designated in both contracts of March 2, 1931, were living on January 1, 1936. Mrs. Gordon's daughter, Marion G. Wildberg, was born on August 8, 1910; her son, Alvin J. Gordon, was born on May 5, 1912; and her son, William J. Gordon, was born on September 9, 1919.
On March 10, 1931, Nathan H. Gordon and his wife executed formal transfers of their reversionary interests in the corpora of the nine trusts. On January 2, 1936, the petitioner took actual delivery of the property of the nine trusts and made certain entries on its books to set up the receipt of the reversionary interests of Nathan H. Gordon and Sarah A. Gordon. It charged itself with all items constituting such property under the designation ‘Contracts Obligations.‘
At the inception of the contracts of March 2, 1931, with petitioner corporation it was not the intent of Nathan H. Gordon, or his wife, or of the officials of the petitioner, that the petitioner should derive gain or profit therefrom. The purposes of Nathan H. Gordon and his wife in making the contracts with the petitioner were to take care of their beneficiaries, to make certain that the schedule of payments in the contracts would be properly made; to relieve Nathan H. Gordon and Sarah A. Gordon from the responsibility of the management of the property comprising their reversionary interests in the trusts; and to lessen their income tax.
The contracts of March 2, 1931, and the formal assignments of March 10, 1931, pursuant thereto were executed for the purpose of enabling the petitioner to act as a medium for securing the payment of the benefits and to issue its stock to Foundation to the amount by which the reversionary property should exceed the amount required to provide for the annuities for the beneficiaries.
On January 10, 1936, the petitioner established a trust known as Contracts Securities Trust, and hereinafter called Securities. The trust instrument recited that under the provisions of the contracts of; March 2, 1931, the assets of the nine trusts had been delivered to the petitioner and that it was, therefore, obligated to assure the making of the periodical payments as set forth in those contracts (1) by purchasing annuity contracts, or (2) by depositing securities whose income was to be used for the purpose, or (3) by setting aside in its own hands securities in trust for the same purpose.
The petitioner then made a declaration of trust stating that it had set aside and was holding the securities described on schedule A (consisting of 43,324 shares of Standard Acceptance Corporation preferred stock and $300,000 in Paramount Pictures, Inc., bonds) in trust for the purpose of applying the income therefrom towards making the payments specified in the contracts of March 2, 1931. All income not required to make such payments was to be paid over and belong to the petitioner.
The trust was to continue until all contractual payments should have been made or until the regularity and community of the payments should have been provided for in accordance with any other method specified in paragraph 3 of the contracts. The corpus of the trust was expected to provide sufficient income to make the payments during the year 1936. Securities has kept its own books and maintained its own bank account. Since January 10, 1936, the petitioner has set aside additional securities whenever the income from the trust corpus was inadequate to provide for the scheduled payments.
From time to time the petitioner has considered the purchase of annuity contracts as set forth in paragraph 3 of the contracts of March 2, 1931. The petitioner would have been required to pay $868.516 on January 1, 1936, in order to provide for the scheduled payments to the nine beneficiaries. Of that sum $453.973 was applicable to Sarah A. Gordon trusts. At that time it was impossible to include the amounts required to be paid to the unascertained and unborn issue of the grantors, due to the uncertain number and ages of the unborn issue, the date of the parents' respective deaths, and the current interest rates at such death.
The petitioner has bought no annuity contracts, has deposited no securities with a Massachusetts bank, and has issued none of its capital stock to Foundation, as provided in the March 2, 1931, contracts. In 1936 the income from the securities held in trust by Securities was more than the required payments. The excess was paid to the petitioner and included in its income tax return.
The Commissioner added $1,568.912.32 to the taxable income reported by the petitioner for the year 1936, and by his amended answer has pleaded that such amount should be added to the petitioner's taxable income for the year 1935, if it is not so taxable in 1936.
The petitioner keeps its books and files its income tax returns on an accrual basis. The trustee for the nine trusts filed income tax returns for the taxable years on the same basis. He reported all income accrued to the trusts, including the amount of interest accrued during each year from the petitioner. The Commissioner disallowed the deduction of such interest on the ground that the interest was never paid and when the petitioner came into possession of the properties and books of account of the trusts its liability ceased to exist. The petitioner filed a delinquent personal holding company return (Form 1120H) for the year 1934. It reported thereon a loss of $1,533.10.
On February 1, 1933, the petitioner purchased from Nathan H. Gordon a note for $3,500 executed by Louis I. Prince. It paid therefor the face amount of the note. Prince renewed the note and pledged as collateral security 299 shares of stock of the J. H. Rubin Shoe Co., of which Prince was the treasurer. The stock had value at that time. The petitioner's treasurer induced Prince to make payments on the note. Prince died in 1934 or 1935. His estate was duly probated, and in 1935 the petitioner learned that no payments therefrom would be made to the creditors. In the same year the petitioner learned that the J. H. Rubin Shoe Co. was in financial difficulty and that the hypothecated stock was worthless. The petitioner's officers also discussed the matter with the debtor's son. The petitioner thereupon in 1935 determined the debt to be worthless and charged it off on its books. The balance due and unpaid at that time was $3,500. No part of such amount so charged off by the petitioner has ever been paid.
In October 1929 the petitioner bought 700 shares of stock of the Seaboard Utilities Shares Corporation for $7,350. On April 11, 1935, a receiver was appointed for that corporation upon petition of a creditor. Upon investigation it was discovered that a major portion of Seaboard's assets had been misappropriated by a brokerage firm; that the person responsible for the manipulations had committed suicide; and that the brokerage firm was in bankruptcy and was unable to make restitution. In 1935 the petitioner wrote off the cost of the stock. In December 1940 Seaboard had over $130,000 cash on hand.
The petitioner acquired 100 shares of preferred stock and 50 shares of common stock of Bankstocks Corporation of Maryland. That corporation was thrown into receivership prior to 1935. On January 18, 1935, a suit brought against its directors for negligence and malfeasance was decided in their favor. Thereupon it was learned that the stockholders would receive nothing. On December 9, 1935, the petitioner sold its 100 shares of preferred and 50 shares of common stock of Bankstocks Corporation for $54.50.
The petitioner purchased certain securities on the dates and for the prices following:
+-----------------------------------------------------------------------------+ ¦ ¦Date of ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦Security ¦purchase ¦Price ¦ ¦Cost ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦22,000 United Post Offices Corporation 5 1/¦Mar. 17, ¦100 ¦ ¦$22,000¦ ¦2s of 1935 ¦1927 ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦600 shares Commonwealth Associates ¦(Jan. 16, ¦100 at 90 ¦)¦59,000 ¦ ¦ ¦1928 ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦ ¦(Jan. 31, ¦500 at 100 ¦)¦ ¦ ¦ ¦1928 ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦234 shares Realty Holding & Investment Corp¦Nov. 30, ¦Obtained in¦ ¦35,000 ¦ ¦ ¦1931 ¦ ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦ ¦ ¦exchange ¦ ¦ ¦ ¦ ¦ ¦for ¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦ ¦ ¦real estate¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦ ¦ ¦investment.¦ ¦ ¦ +-------------------------------------------+-----------+-----------+-+-------¦ ¦Total cost ¦ ¦ ¦ ¦116,000¦ +-----------------------------------------------------------------------------+
At an advertised public auction held on December 9, 1936, at the Boston Real Estate Exchange the petitioner, through its broker, F. S. Mosely, sold the 22,000 United Post Offices Corporation 5 1/2s for $4,335.20, the 600 shares of Commonwealth Associates stock for $2,888, and the 234 shares of Realty Holding & Investment Corporation stock for $10, making a total of $7,233.20. Since the sale the petitioner has at no time owned any such securities. Gorfinkle, the treasurer of the petitioner, advanced the money with which one Berman purchased the stocks sold as heretofore set forth, and they were to share the profits, if any, equally. The petitioner had no part in that arrangement.
On October 10, 1931, the petitioner purchased for $8,690.99 from F. S. Mosely, broker, an account in the form of a note due to the broker from I. L. Wallenstein, secured by 500 shares of stock of McLellan Stores. That stock was sold on February 13, 1940, for $1,302.28, which was credited on the Wallenstein note. Wallenstein made interests payments of various amounts up to and including October 20, 1932. On that date he paid $68.75. On April 16, 1934, he paid $68.75, which was credited on the note, leaving an unpaid balance of $7,319.96. On May 12, 1936, the petitioner charged that amount to profit and loss.
At the time of petitioner's purchase of the note of Wallenstein he was employed as a customers' man by Clark Childs & Co., a brokerage firm. That firm was reorganized and Wallenstein continued in its employ at a reduced salary. An officer of the petitioner and Wallenstein discussed the latter's financial status many times. Wallenstein stated that he did not have sufficient funds to pay the note. He was married and had one child. The officer could find no property owned by Wallenstein. He had other debts. In 1936 and 1937 he was still employed at less t an $75 a week. Wallenstein's child was the beneficiary of Foundation under a provision granting $1,200 a year for its education. On November 4, 1935, the petitioner paid Wallenstein over $300 for ‘investment advice.‘ Wallenstein was the husband of Nathan H. Gordon's niece.
I. Nick Gordon is a nephew of Nathan H. Gordon. On December 18, 1929, the petitioner issued its check for $1,500 to I. Nick Gordon and received his note therefor. Payments aggregating $350 were made March 17, 1930, and March 23, 1931, leaving a balance of $1,150 on the latter date. That amount was written off on the petitioner's books as a bad debt on December 31, 1936.
I. Nick Gordon was a lawyer practicing in New York City. officer of the petitioner was constantly in contact with him and saw him occasionally. He considered the debtor ‘all right‘ and believed that he would ultimately pay. In 1936 a letter written by I. Nick Gordon to his uncle came to the attention of petitioner's treasurer. In that letter the writer said: ‘Collections are poor, my clients are all broke * * * and everybody is crying poverty. * * * ‘ Thereupon the petitioner's treasurer investigated the debtor's situation and discovered that he had no property, had got into difficulty, had been disbarred, had left New York City, and could not be located. On December 31, 1936, the petitioner wrote off of its books as a bad debt the $1,150 due from I. Nick Gordon.
The Commissioner disallowed the deductions claimed under issues 3, 4, 5, 6, 7, 8, and 9.
On October 30, 1936, the petitioner subscribed the sum of $3,668 to the Associated Jewish Philanthropies, Inc., and accrued that contribution on its books. The petitioner paid the pledge in 1937. The Commissioner disallowed the deduction claimed because ‘such deductions are not allowable under section 23(q) of the Revenue Act of 1936.‘
OPINION.
VAN FOSSAN, Judge:
In the notice of deficiency respondent determined that the total value of the assets ($1,573,290.98) which reverted to petitioner by virtue of the assignment in 1931 to it by Gordon and his wife constituted income to petitioner when the assets were transferred in 1936. By amended answer respondent cast an anchor to windward and, as an alternative, alleged error on his part in not determining that petitioner received income in 1935 to the extent of the value of such assets on December 31, 1935, the date when the trusts terminated. The figure used as denoting the value of such assets is $1,568.912.32, being an alleged net value after deducting certain liabilities assumed by petitioner.
In his brief respondent apparently abandoned the extreme position above indicated and bases his support of the deficiencies on the argument that when the trusts terminated and the assets transferred to petitioner there was a cancellation of the debt of $1,481,965.41, principal and interest of the loan owed by petitioner to the trusts; that such cancellation created income to be computed by taking as a basis the value of the securities set aside by the petitioner to provide for the determinable periodic payments undertaken by it and treating the excess above such basis as gain. Obviously, the mere transfer of the property to petitioner did not result in income, as originally determined by respondent. If it was transferred without consideration it was in the nature of a gift. If the transfer was based on consideration it would be a purchase and not income. Income would result only from the sale or other disposition of the property given for it rather than upon receipt of such new property.
A complete answer to the present position of the respondent as indicated by the above departure from the theory of his original determination is that the facts do not support his argument. There was no cancellation or forgiveness of the debt. There was an assumption by petitioner of a substantial obligation to make payments to ascertained persons in fixed amounts and to unascertained persons in indefinite and indeterminable amounts. Thus petitioner gave consideration for all it received. Even if the value of the promise to make the periodic payments were not equal to the value of the assets received, there would be no income from receipt of the property until subsequent sale or other disposition. Attention might also be called to the fact that all actual divestment of title took place in 1931, when the assignment of the reversionary rights took place. On December 31, 1935, when the trusts terminated, petitioner's rights fell in and petitioner merely assumed possession of its own property as the reversionary owner.
It is immaterial in what form the reversionary assets happened to be when they were transferred to the petitioner. Their undisputed value was $1,568,912.32. There is no showing that the petitioner's debt to the trusts was not worth its full face value. The responsibility of making the agreed payments had to be met by the petitioner. It could repay its loan in cash, it could furnish equivalent securities, or it could continue to pay interest on the principal of the loan. Its only concern was to see that it had sufficient income with which to pay the current demands as they became due. Had petitioner paid the loan in 1935 the cash thus coming into the hands of the trustee would have reverted to petitioner at the termination of the trusts. This fact would not have altered petitioner's position to its advantage. It still was obligated to make the payments to the several persons.
In reply to respondent's contention that less than the full amount of the assets is necessary to provide for the ascertained payments, it is only necessary to point out that the unascertained amounts that petitioner may have to pay may require all, or more than all, of the assets. Further, we would also point out that among the obligations assumed by petitioner was one to issue to Foundation its capital stock equal in value to the excess of the value of the reversionary property over the amount required to pay the scheduled installments. Thus petitioner would not stand to benefit from any such excess.
We are of the opinion, and hold, that petitioner received no income on the transfer to it of the assets of the several trusts.
In the second issue the respondent denied the right of petitioner to deduct the interest of loans due to the trusts accrued on its books for the years 1934 and 1935 because the interest was not in fact paid. On brief respondent contends, as he did as to the first item, that the debt of the loan and interest was canceled and that the same will never be paid. Our discussion of the facts and principles relating to the loan apply equally to the interest. The unpaid interest was one of the assets of the trusts turned over to the petitioner in 1936. The money had been loaned by the trusts to the petitioner in bona fide transactions, with the obligation on the part of the petitioner to pay interest and repay the principal. In 1934 and 1935 until the termination of the trusts, the trustees could have called upon the petitioner for the payment of interest and principal. Had the petitioner paid both the interest and principal shortly before the termination of the trusts the money would have gone right back to the petitioner as part of the assets of the trusts on termination. Payment under such circumstances would have been a purposeless gesture. On December 31, 1935, the petitioner had an obligation to pay the principal and interest on the loans. Thereafter the corpora of the trusts became the property of the petitioner and the obligation to make actual payment of interest and principal disappeared by reason of the merging of the identities of the parties to the obligation. Petitioner, however, gained nothing by having failed to pay such interest. Its obligation to pay the annuities was the same whether it paid the interest or not and that obligation persisted. The unpaid interest is one of the assets standing back of that obligation. Since petitioner's books were kept on an accrual basis, the interest accrued during the life of the trusts constitutes proper deductions from income.
In view of our decision on the first and second issues, issues ten and eleven require no discussion. There is no net income on which a penalty for delinquent filing for 1934 can be based. The applicability of the statute of limitations has now become moot.
The third, fourth, fifth, sixth, seventh, and eighth issues all involve the deductibility of items asserted to have been worthless and charged off the petitioner's books during the years in which the deductions are claimed. They are essentially issues of fact.
The facts in the third issue support the petitioner's right to the deduction. The petitioner bought the Prince note for $3,500; the debtor was persuaded to make payments on it (obviously credited to the interest due thereon); the debtor died; his estate was insolvent; after his death the Rubin Co. stock became worthless; the petitioner's treasurer determined in 1935 that there would be no recover on the note, and consequently charged it off the petitioner's books as a bad debt. The deduction is allowed.
In the fourth issue the petitioner has not sustained its burden of proving that the 700 shares of stock of the Seaboard Utilities Shares Corporation purchased in 1929 became worthless in 1935. The facts indicate that the value of the stock had decreased materially, but they fall far short of establishing worthlessness. In fact the record discloses that in December 1940 Seaboard had over $130,000 in cash on hand. No financial statement of the corporation was submitted. Thus we are unable to agree with petitioner. The respondent's action is approved.
The petitioner has failed to submit proof of the date of purchase or the price it paid for the stock of Bankstocks Corporation of Maryland to support its claim for deduction under the fifth issue. In such circumstances it is impossible to compute the loss, if any, of the petitioner upon the sale of the 100 shares of the preferred stock and the 50 shares of the common stock of that corporation. The deduction is not allowed.
The sixth issue presents the deductibility of a loss of $108,784.84 sustained upon the sale of bonds of the United Post Office Corporation and stocks of Commonwealth Associates and Realty Holding & Investment Corporation. The petitioner has fixed the dates of purchase and proved the prices paid for these securities. It has also shown that they were sold through customary channels at an advertised public auction for a specific sum to one Berman, who obtained the money for the purchase from the petitioner's treasurer. The Commissioner challenges the bona fides of the transaction and asks the Court to disallow the deduction largely on that ground. This we are unwilling to do.
The record shows that the petitioner had no interest whatever in the purchase of the securities and has not reacquired them since the date of sale. More than a suspicion is necessary as a basis for disallowance. Since no facts contravene the orderly disposition of the securities and the reluctant loss therefrom, the deduction is allowed.
In the seventh issue the petitioner claims a deduction of $7,319.96 as a bad debt due from I. L. Wallenstein. In October 1931 the petitioner purchased from brokers for $8,690.99 an account against Wallenstein secured by 500 shares of McLellan Stores stock. Wallenstein made interest payments in 1931 and 1932. The collateral was sold in 1936 for $1,302.28. Later, on April 16, 1936, Wallenstein paid $68.75, which was credited on the note. On May 12, 1936, the petitioner charged off the balance of $7,319.96 as a worthless debt.
The petitioner was not justified in considering the debt worthless. Although the record shows that an officer of the petitioner could find no property owned by the debtor, it also discloses that Wallenstein was employed at approximately $75 a week during 1936 and 1937; that he had a wife and one child, which child was the beneficiary of Foundation to the extent of $1,200 a year to be used for its education; and that Wallenstein was married to Nathan H. Gordon's niece. If the petitioner had been so inclined and had ignored the family relationship, we have no doubt that it could have secured a gradual decrease in the debt, and perhaps its eventual payment. The deduction claimed is disallowed.
The eighth issue involves the worthlessness of a debt due from I. Nick Gordon. In December 1929 the petitioner lent Nick Gordon $1,500. Gordon repaid $350. The petitioner's treasurer kept in close touch with Gordon until 1936. Gordon was a lawyer practicing in New York City and apparently was doing well. The petitioner had no cause to suspect his ability to pay the debt. However, in 1936, through a letter from the debtor to his uncle, petitioner's financial status was brought into question. Petitioner then discovered that Gordon had no property, had been disbarred, had left the city, and could not be located. At the end of that year it charged off the note as a bad debt.
We have no doubt that the record spells out the basis for the allowance of the deduction. It is possible that the petitioner was too indulgent to Nathan H. Gordon's nephew, but before 1936 it had no reason to to doubt the collectibility of the note. It then proceeded to ascertain the true condition of the debtor's affairs and justifiably came to the conclusion that the debt was worthless.
In the ninth issue the petitioner seeks to deduct a contribution of $3,668 ‘made,‘ as it asserts to the Associated Jewish Philanthropies, Inc. The amount of such contribution was accrued on its books in 1936, but not actually paid until 1937. The respondent ‘admits that $3,668 was pledged and accrued in 1936 and was paid in 1937. Therefore, under the provisions of Section 23(q) of the Revenue Act of 1936, the petitioner is entitled to the deduction in 1937 of the amount paid in 1937 subject to the limitation of Section 23(q).‘
The pertinent portions of section 23(q) are as follows:
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing the net income there shall be allowed as deductions:
(q) CHARITABLE AND OTHER CONTRIBUTIONS BY CORPORATIONS.— In the case of a corporation, contributions or gifts made within the taxable year to or for the use of a domestic corporation, or domestic trust, or domestic community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes or the prevention of cruelty to children * * * . Such contributions or gifts shall be allowable as deductions only if verified under rules and regulations prescribed by the Commissioner, with the approval of the Secretary.
Article 23(q)-1, Regulations 94, provides as follows:
Contributions or gifts by corporations.— A corporation is entitled to deduct from gross income for a taxable year beginning after December 31, 1935, contributions or gifts to organizations referred to in section 23(q), whether or not such contributions or gifts constitute business expenses, but only to the extent provided in that section.
Corporations may deduct, for a taxable beginning after December 31, 1935, to the extent provided by section 23(q), contributions or gifts to organizations referred to in that section, only for the taxable year in which they are actually paid, regardless of when pledged and regardless of whether the books and records of the corporation are kept on the cash receipts and disbursements basis or the accrual basis.
Section 23(q) of the Revenue Act of 1938 is identical with the similar section of the 1936 Act with the exception that the phrase ‘payment of which is made‘ is substituted for the word ‘made‘ (following the words ‘contributions or gifts‘).
The petitioner contends that its gift was ‘made‘ in 1936 when it entered an appropriate charge on its books, which were kept on an accrual basis. Such charge reflected its liability to pay the pledge. The pledge was actually paid in 1937.
The respondent couches his objection to the allowance in this language: ‘Since charitable contributions of a corporation are deductible only in the year of payment, the Court will sustain the action of the Commissioner of Internal Revenue in disallowing the deduction of an accrual in 1936.‘ The respondent does not quote article 23(q)-1, Regulations 94, but apparently he has based his assumption on that article.
The change in terminology in the 1938 Act obviously was made for some purpose. We can find no explanation or judicial determination by this or any other court on that subject. We do find, however, the following enlightening comment on page 19 of Report No. 1860 of the Ways and Means Committee, House of Representatives, 75th Congress:
Sections 23(o) and 23(q). Deductions for Charitable and Other Contributions
These subsections provide the basic rule for the allowance of deductions of contributions or gifts for charitable or other purposes in the case of individuals (sec. 23(6) and all corporations (sec. 23(q)).
Under these various revenue acts the deduction for contributions is allowed for the taxable year in which the contribution is made. Hence, a taxpayer on an accrual basis of accounting may claim that he is entitled to a deduction for the amount of a charitable pledge in one year, although he does not actually pay it until a later year, or indefinitely postpones payment. The doubt and confusion in such cases is aggravated by reason of the uncertainty and diversity in the law of the various States on the question as to when the liability of a subscriber to a charitable fund is fully incurred. In the interest of certainty subscriber to a charitable fund is fully incurred. In the interest of certainty in the administration of the revenue laws, it is desirable to dispel the confusion by enacting a clear and uniform statutory rule to govern this situation.
The bill provides that the deduction for contributions or gifts for charitable and other purposes shall be allowed for the taxpayer year in which the contribution is actually paid regardless of whether the taxpayer is reporting income on the cash or the accrual basis. The allowance of the deduction in the year when actually paid will provide a clearer rule without hardship to the taxpayer and will eliminate the uncertainty in the administration of the deduction. Of course the payment of the contribution or gift cannot result in a double deduction.
It would seem clear therefore that article 23(q)-1 does set forth a proper interpretation of section 23(q) of the Revenue Act of 1936.
The 1938 Revenue Act made a change in the law as it existed in 1936. It was not a case of defining the old law. Under the 1936 Act actual payment in the tax year by a taxpayer on an accrual basis was not required. Since the respondent does not question the character of the contribution or the propriety of its deduction (in 1937), we conclude that the petitioner is entitled to the deduction of $3,668, for 1936, representing its liability for the payment of its pledge to the; Associated Jewish Philanthropies, Inc., made and accrued on its books during that year.
Decision will be entered under Rule 50.