Opinion
Docket No. 56400.
1958-02-26
ARTHUR SORIN AND HENRIETTA A. SORIN, PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Mason G. Kassel, Esq., and Ralph L. Concannon, Esq., for the petitioners. Charles B. Markham, Esq., and Martin D. Cohen, Esq., for the respondent.
Mason G. Kassel, Esq., and Ralph L. Concannon, Esq., for the petitioners. Charles B. Markham, Esq., and Martin D. Cohen, Esq., for the respondent.
1. Reliance at the hearing on section 117(m), I.R.C. 1939, held, not ‘new matter’ shifting the burden of proof to respondent is a proceeding where the deficiency was determined generally under the provisions of I.R.C. 1939. Thomas Wilson, 25 T.C. 1058, distinguished.
2. Petitioners held, on the facts, not to have proved that amounts received were not distributions from a collapsible corporation under section 117(m), I.R.C. 1939. Raymond G. Burge, 28 T.C. 246; J. D. Abbott, 28 T.C. 795.
3. Basis of stock upon which the distribution was made, held, on the facts, to be the amount claimed by petitioners.
Respondent determined a deficiency in petitioners' income tax of $22,049.67 for the calendar year 1950. The only question is whether $50,000 received by petitioner Henrietta A. Sorin is taxable as ordinary income as a distribution from a collapsible corporation under section 117(m), I.R.C. 1939. Other adjustments in the notice of deficiency are not contested.
FINDINGS OF FACT.
Certain facts are stipulated and are hereby found.
Petitioners Arthur Sorin and Henrietta, husband and wife, filed their 1950 joint income tax return on a cash receipts and disbursements basis with the collector of internal revenue for the second district of New York. Arthur and Henrietta reside at New York City as do Arthur's brother, Murray Sorin, and Murray's wife, Patricia Sorin.
During and prior to the taxable year, an air-conditioning firm employed Arthur and Murray on a full-time basis as executives. Prior to 1949 neither Arthur nor Murray had any experience in the building or construction business.
During 1944, Murray purchased vacant land located in Forest Hills, New York, for $60,000. In 1948, Murray acquired an adjoining plot of unimproved land for $40,000. Arthur furnished 37 per cent of the total purchase price of $100,000.
The Federal Housing Administration, henceforth referred to as F.H.A., was created to encourage and develop the expansion of privately owned and privately financed housing. Upon the termination of World War II and the subsequent release of veterans from the Armed Forces, a shortage of housing facilities existed in the United States.
In 1948, Murray, the guiding force behind the project, first heard that the F.H.A. was interested in encouraging construction of housing. The Sorins learned that F.H.A. rules allowed owners to lease their land on a long-term basis to a building corporation. They decided to have apartments constructed on their Forest Hills property under F.H.A.-INSURED financing to make the land produce continuing income. Before the F.H.A. project, the land, vacant from 1944 to 1949, had not been productive.
The F.H.A. procedure for insuring mortgages under section 608 of the National Housing Act included the following:
(a) The proposed mortgagor first applied to a lending institution for a loan;
(b) The proposed mortgagor arranged for temporary financing by building loan agreement and for permanent mortgage financing by a lending institution;
(c) In its application to a lending institution for a loan, the proposed mortgagor submitted a site plan containing a sketch of the project, detailed information showing the plan of construction and operation, an estimate of rental income and operating expenses, and an estimate of replacement cost of the property;
(d) The proposed mortgagee then submitted the detailed information to the F.H.A. whose architectural, valuation, and mortgage risks examining sections then examined and evaluated it;
(e) The proposed mortgagee then applied to the F.H.A. for mortgage insurance and on approval, construction commenced. The F.H.A.-INSURED mortgages of up to 90 per cent of the total estimated replacement cost of the property, but not in excess of $1,800 per room, later $8,100 per apartment; F.H.A. employees inspected the construction; insured building loan advances could be disbursed by the lender with F.H.A. consent, and rents were frozen at the amount determined by the F.H.A.;
(f) The F.H.A. received from the mortgagee an examination fee of three-tenths of 1 per cent of the principal amount of the mortgage and an annual insurance premium of one-half of 1 per cent of the existing mortgage indebtedness.
Murray engaged a mortgage broker to handle the financial portion of the project, including negotiations with the F.H.A. and lending institutions, and arranging for temporary and permanent financing. The lending institution compensated the broker for its services. The Sorins engaged J. Friedman, a long-time friend of Arthur, active in the construction business, to prepare plans, drawings, and costs for the F.H.A. and to supervise construction. The brothers engaged the broker and Friedman because the air-conditioning business required their full-time attention and they had no construction experience.
Murray retained Friedman's lawyer to advise him as to the legal aspects of the project and the lease of the land. On May 4, 1949, the Sorins organized a corporation, Garden Hills, Inc., to construct and operate a garden-type rental housing project known as Garden Hills, situated in Forest Hills, to consist of 138 apartments in 5 buildings. Garden Hills, Inc., issued preferred stock to the F.H.A. as a prerequisite to obtaining mortgage insurance. It issued 1 share of common stock, each, to Henrietta and Patricia. Henrietta paid $100 for her share. The value of Henrietta's stock has at all times material exceeded 10 per cent in value of the outstanding stock of the corporation. Its main activity throughout its corporate existence has been the construction and operation of the Garden Hills project. The corporation is an accrual basis taxpayer with a fiscal year ended October 31.
Murray and Arthur caused the stock of Garden Hills, Inc., to be issued in the names of Henrietta and Patricia because the husbands wanted to separate their real property from the building corporation and also create property of possible future value for their wives. The Sorins expected that in about 15 years the corporation would show taxable income and then represent a valuable investment. Henrietta and Patricia still own and control Garden Hills, Inc., which still exists.
The Garden Hills ‘closing’ took place, in accordance with F.H.A. procedure, November 17, 1949. On that date, the following events took place: Garden Hills, Inc., leased the land from Murray for $10,880 a year for 99 years, renewable for an additional 99-year term at the same rental. The F.H.A. and the mortgagee had approved the lease on or before August 15, 1949. Garden Hills, Inc., entered into a building loan agreement wit the County Trust Company of White Plains, New York, henceforth referred to as County, under which County agreed to advance $1,156,000 for constructing the Garden Hills project to be secured by a bond and a mortgage insured by the F.H.A. The Sorins and their wives executed a personal indemnity agreement to County. Garden Hills, Inc., executed a mortgage for $1,156,000 on its leasehold in favor of County, which the F.H.A. insured.
The mortgage agreement contained a number of covenants by Garden Hills, Inc., including one to pay indebtedness as it became due, the violation or breach of which would permit County to acquire title to, or sell, the leasehold estate held by Garden Hills, Inc. The F.H.A. insurance commitment and the administrative rules of the National Housing Act contained comparable provisions.
The $1,156,000 amount insured by the F.H.A. had been computed as follows:
(a) The estimated replacement cost as of December 31, 1947, was computed to be $1,314,667, and the estimated replacement cost as of August 10, 1949, was computed to be $1,322,220.
(b) The lower of the two estimated replacement costs, $1,314,667, plus $272,000, the market price of the land, totaled $1,586,667, the replacement cost of the property in fee simple. Ninety per cent of the resulting figure was $1,428.000. From this figure the market price of the land was subtracted, leaving a balance of $1,156,000.
(c) The estimated replacement cost as of December 31, 1947, was computed as follows:
+---------------------------------------------+ ¦Improvements on land ¦ ¦ +-----------------------------------+---------¦ ¦New utilities ¦$35,078 ¦ +-----------------------------------+---------¦ ¦Landscape work ¦19,219 ¦ +-----------------------------------+---------¦ ¦Structures ¦ ¦ +-----------------------------------+---------¦ ¦Dwellings ¦1,035,131¦ +-----------------------------------+---------¦ ¦Garages ¦45,529 ¦ +-----------------------------------+---------¦ ¦Fees ¦ ¦ +-----------------------------------+---------¦ ¦Builder ¦56,748 ¦ +-----------------------------------+---------¦ ¦Architect ¦59,585 ¦ +-----------------------------------+---------¦ ¦Carrying charges; financing ¦ ¦ +-----------------------------------+---------¦ ¦Interest ¦28,900 ¦ +-----------------------------------+---------¦ ¦Real estate taxes ¦3,000 ¦ +-----------------------------------+---------¦ ¦Insurance during construction ¦3,000 ¦ +-----------------------------------+---------¦ ¦F. H. A. mortgage insurance premium¦5,780 ¦ +-----------------------------------+---------¦ ¦F. H. A. examination fee ¦3,468 ¦ +-----------------------------------+---------¦ ¦F. H. A. inspection fee ¦5,780 ¦ +-----------------------------------+---------¦ ¦Title and recording expense ¦10,449 ¦ +-----------------------------------+---------¦ ¦Legal and organization expense ¦3,000 ¦ +-----------------------------------+---------¦ ¦Total ¦1,314,667¦ +---------------------------------------------+
(d) The estimated replacement cost at August 10, 1949, was computed as follows:
+----------------------------------------+ ¦Improvements to land ¦$54,625 ¦ +------------------------------+---------¦ ¦Structures ¦1,087,183¦ +------------------------------+---------¦ ¦Fees ¦117,035 ¦ +------------------------------+---------¦ ¦Carrying charges and financing¦60,377 ¦ +------------------------------+---------¦ ¦Legal and organization ¦3,000 ¦ +------------------------------+---------¦ ¦Total ¦1,322,220¦ +----------------------------------------+
(e) The market price of the land here used, $272,000, is the price at which the F.H.A. could purchase the land if it acquired the corporation's interest pursuant to the National Housing Act. The lease to Garden Hills executed by Murray included the same figure.
On November 17, 1949, petitioners, as well as Murray and Patricia, jointly and severally guaranteed to County the performance by Garden Hills, Inc., of all obligations with respect to the completion of buildings and improvements. Each agreed to indemnify County up to $125,884.30, for costs incurred or damages suffered by reason of Garden Hills, Inc.‘s failure to perform. The guaranty covered completion of the project according to the drawings and specifications, and defects appearing within 1 year following completion, including damage resulting from faulty materials or workmanship. The guaranty continued in effect through 1953.
On November 17, 1949, the corporation deposited with County $46,185, borrowed from its stockholders, the estimated funds required to complete the project over and above the mortgage proceeds. According to the agreement, these funds were to be used in the construction before the mortgagee advanced any mortgage money. Before, advancing any mortgage proceeds, the mortgagee returned the $46,185 which had been placed in escrow. The corporation returned this sum to the stockholders.
Garden Hills, Inc., erected Garden Hills. J. Friedman Construction Co., Inc., a company owned by Friedman and henceforth referred to as Construction, did the construction work.
After construction began around November 17, 1949, County regularly filed monthly requests for the insurance of mortgage advances with the F.H.A. Each such application advised the F.H.A. that County had received a request for mortgage moneys from Garden Hills, and certified that a sum was payable. A contractor's requisition accompanied each request which indicated the total amount due to date on account of the construction contract, the percentage of work completed, and the amount due with that monthly requisition. The request also included a project inspection report signed by F.H.A. officials and indicating the status of construction.
On December 8, 1949, Murray conveyed to Arthur, as tenant in common, an undivided 37 per cent interest in the land in recognition of the interest which Arthur had in the land by having furnished 37 per cent of the total purchase price.
Construction proceeded slowly and weeks passed without activity at the building site, Friedman spent much time out of town, and Murray could obtain no satisfaction from the Construction superintendent. Murray retained an architect to check on the progress of the job.
At the infrequent conferences with Friedman, he sought payment for Construction's losses on the project and all extra costs, and to have Garden Hills, Inc., waive the contract penalty clause of $100 a day for late completion. On November 17, 1950, Garden ills, Inc., had $100,036.65 in its bank account, including a $79,278.42 advance of mortgage moneys received from County on October 25, 1950. In November 1950, Garden Hills, Inc., owed Construction a substantial amount of money.
County advanced mortgage proceeds to Garden Hills, Inc., on the following dates, in the following amounts:
+----------------------------+ ¦Feb. 9, 1950 ¦$78,336.04 ¦ +---------------+------------¦ ¦Mar. 8, 1950 ¦57,871.00 ¦ +---------------+------------¦ ¦Apr. 10, 1950 ¦68,367.00 ¦ +---------------+------------¦ ¦Apr. 25, 1950 ¦55,526.00 ¦ +---------------+------------¦ ¦May 24, 1950 ¦144,587.80 ¦ +---------------+------------¦ ¦June 26, 1950 ¦201,179.27 ¦ +---------------+------------¦ ¦July 26, 1950 ¦102,483.72 ¦ +---------------+------------¦ ¦Aug. 28, 1950 ¦89,157.19 ¦ +---------------+------------¦ ¦Sept. 28, 1950 ¦87,194.21 ¦ +---------------+------------¦ ¦Oct. 25, 1950 ¦79,278.42 ¦ +---------------+------------¦ ¦Dec. 1, 1950 ¦30,840.11 ¦ +---------------+------------¦ ¦Jan. 4, 1951 ¦25,303.27 ¦ +---------------+------------¦ ¦Mar. 19, 1951 ¦9,218.20 ¦ +---------------+------------¦ ¦Apr. 23, 1951 ¦126,657.77 ¦ +---------------+------------¦ ¦Total ¦1,156,000.00¦ +----------------------------+
Each advance included the total purchase price of uninstalled materials plus the cost of portions of work acceptably completed, as approved by County and the F.H.A., less 10 per cent and less prior advances. The final advance on April 23, 1951, included the retained 10 per cent. As of November 16, 1950, the total advances out of the mortgage proceeds to Garden Hills, Inc., totaled $963,980.65.
In addition to its other services, Construction prepared and approved all requisitions for advances of the mortgage loan. Friedman had access to and was familiar with the books of account of Garden Hills, Inc. He also arranged for the disbursement of corporate funds, including disbursements to Construction, and he intimately knew the affairs of Garden Hills, Inc.
The F.H.A. project inspection report dated November 16, 1950, and approved November 28, 1950, indicated that as of November 16, 1950, the Garden Hills project was 97 per cent complete. This percentage equaled the total cost amount shown on the trade-payment breakdown attached to the building loan agreement divided by the amount of costs approved on the project inspection report. The inspection report indicated that only the excavation was then 100 per cent complete. All 33 other construction items comprising the project varied from 80 to 99 per cent completion. Percentages of completion of each item were based upon the contractor's requisition prepared by Construction which accompanied the inspection report. The costs compared did not include extras paid to the contractor, nor additional expenditures required to conform project with plans and specifications.
On November 17, 1950, the contractor reported that previous payments of mortgage advances to Garden Hills, Inc., totaled $970,100.
On November 17, 1950, Garden Hills, Inc., distributed $100,000 in cash to its common stockholders in proportion to their stockholdings. Henrietta and Patricia each received $50,000. Only $10,036.65 in cash remained in the corporation after the distribution. Murray decided to distribute $100,000, and Arthur acquiesced, without consultation with anyone with respect to tax or other aspects of the distribution.
It is stipulated that on November 17, 1950, Garden Hills, Inc., had no earnings or profits accumulated after February 28, 1913, nor any earnings and profits in the year of distribution, and that the distribution was not out of increase in value of property accrued before March 1, 1913, and was not a distribution of partial or complete liquidation of Garden Hills, Inc.
The corporation's accountants advised the Sorins that the distribution should not have been made because the corporation had no surplus, as required by State law. Murray did not want to return the amount distributed. The accountants suggested that surplus might be created by obtaining an appraisal of the leasehold interest since such an appraisal might indicate that market value of the leasehold exceeded its cost.
It is stipulated that:
During the year of the distribution referred to in paragraphs 3 and 8 hereof, Garden Hills, Inc. wrote up on its books the value of its leasehold interest by an amount which was in excess of the distribution. The amount of such write-up ($285,318.84) was credited on the corporation's books to an account denominated ‘Capital Surplus'. The leasehold interest, the value of which was written up, is still owned by the distributing corporation.
Under its building loan agreement of November 17, 1949, Garden Hills, Inc., promised to complete construction within 13 months. Construction of the Garden Hills project was completed on January 24, 1951. On March 15, 1951, the district director of F.H.A. reported that as of March 14, 1951, the buildings were occupied, all utilities were installed and connected, and safe ingress and egress provided. The F.H.A. then approved the final advance of mortgage proceeds on April 11, 1951. On April 23, 1951, the mortgagee certified to the F.H.A. that construction was complete and requested final endorsement of the credit instrument for insurance of $1,156,000. The mortgagee required that $11,304 be held in escrow until certain work was done satisfactorily.
In addition to the work which required the escrow deposit, the Sorins discovered that certain work performed by Construction had to be redone or corrected. The Sorins engaged other contractors to perform these tasks. Between January 24, 1951, and October 31, 1955, Garden Hills, Inc., capitalized expenditures of $8,739.20 for heating system, plumbing, foundation patching, roofing, painting, and retouching.
The total capitalized cost of constructing the Garden Hills project as of January 24, 1951, as ascertained from books and records of Garden Hills, Inc., amounted to $1,095,68.16 which represented direct costs incurred and carrying charges to the date of completion. The basis, exclusive of the writeup for the leasehold, would have been approximately $1,095,000 for the entire project. The costs include no charges for officers' or employees' salaries.
Construction received a total sum in respect to the project which included the 5 apartment buildings, the garages, the heating system, refrigerators, stoves, and other fixtures inside the buildings. Garden Hills, Inc.‘s original contract with Construction called for a fixed sum of approximately $980,000.
The corporation took no depreciation deduction on the writeup in value of the leasehold interest.
The cost of curbs, gutters, sidewalks, trees, planting strips, sewers, and water mains amounting to $40,025 was not charged to Garden Hills, Inc., but Patricia individually guaranteed payment in a contract with Construction dated November 1, 1949, and which provided for completion of this construction within 14 months. Such costs are not included in the general contractor's total in the F.H.A. analysis of project cost, prepared exclusively from the corporate books and records and reflecting only costs to Garden Hills, Inc. The contract between Construction and Garden Hills, Inc., related to the construction of the buildings and the garages, as well as to the heating system and all fixtures inside the buildings. It was impossible for the Sorins to know until final settlement what exact construction costs would be.
The $100,000 distributed to Patricia and Henrietta on November 17, 1950, represented part of the substantial amount then due Construction. Final payment to Construction on May 15, 1951, of $125,123.10 resulted in an overdraft of $65,208.36 in the Garden Hills, Inc., bank account. Final payment to Construction followed the final advance of mortgage proceeds on April 23, 1951, of $126,657.77.
Garden Hills, Inc., borrowed $75,000 from its bank on a short-term basis to satisfy the overdraft. Henrietta and Patricia individually guaranteed repayment of the loan. Arthur and Murray also guaranteed repayment of the loan and agreed that securities owned by them and held by the bank would secure the loan to Garden Hills, Inc.
After several short renewals of the $75,000 loan and its partial repayment, Garden Hills, Inc., paid the balance of its indebtedness in 1952 at the insistence of the bank. Henrietta and Patricia each advanced $25,000 to Garden Hills, Inc., to repay the then outstanding loan of $50,000. The corporation never repaid these loans which are still shown as an indebtedness on the corporate books.
It is stipulated that:
In their joint income tax return for 1950, the petitioners treated the distribution received by petitioner, Henrietta A. Sorin, in the amount of $50,000.00 as a distribution under Section 115(d) of the Internal Revenue Code. Schedule D of the return— the schedule of gains and losses from sales or exchanges of property— reported as net long-term capital gain the amount of $49,900.00, said sum being the difference between the distribution of $50,000.00 and the $100.00 cost basis of the stock upon which the distribution was made.
At the date of the distribution, Henrietta had owned her stock in Garden Hills, Inc., for more than 6 months. She did not hold the stock as stock-in-trade or other property of a kind properly includible in inventory if on hand at the close of the taxable year, nor did she hold it primarily for sale to customers in the ordinary course of her trade or business.
In his notice of deficiency, respondent determined that the distribution received by Henrietta for 1950 of $50,000 was ‘fully taxable to you (the petitioners) at ordinary income tax rates under the provisions of Internal Revenue Code of 1939.’ He adjusted the long-term capital gains reported by deducting the gain of $49,900.
During the construction of the Garden Hills project, neither Arthur, Henrietta, nor Patricia rendered any services to Garden Hills, Inc. The services rendered by Murray consisted exclusively of conferences with Friedman devoted to attempts to make the contractor perform its contractual duties. Since completion of the Garden Hills project, an operating agent has managed it.
Garden Hills, Inc., was formed or availed of principally for the construction of property with a view to the realization by its shareholders of gain attributable to the property through a distribution to its shareholders, before the realization by it of a substantial part of the net income to be derived from the property.
The gain on the distribution of $50,000 to Henrietta Sorin is taxable to her at ordinary income tax rates in 1950 to the extent it exceeds the adjusted basis ($100) of her stock in Garden Hills.
OPINION.
OPPER, Judge:
Although other matters are argued by each party, it seems evident that the crux of the present controversy is one of burden of proof. If the facts bringing petitioners' situation within section 117(m) as a ‘collapsible corporation'
must be shown by respondent, the inferences as to several of the essential conditions of that section are too weak to permit him to prevail. If, on the other hand, the presumptive correctness of respondent's determination places upon petitioners the onus of proving the absence of any one or more of the operative provisions, we must hold, under the circumstances concededly present here, that petitioners have failed to sustain that burden. Raymond G. Burge, 28 T.C. 246, on appeal (C.A. 4); J. D. Abbott, 28 T.C. 795, on appeal (C.A. 3).
SEC. 117. CAPITAL GAINS AND LOSSES.(m) COLLAPSIBLE CORPORATIONS.—(1) TREATMENT OF GAIN TO SHAREHOLDERS.— Gain from the sale or exchange (whether in liquidation or otherwise) for stock of a collapsible corporation, to the extent that it would be considered (but for the provisions of this subsection) as gain from the sale or exchange of a capital asset held for more than 6 months, shall, except as provided in paragraph (3), be considered as gain from the sale or exchange of property which is not a capital asset.(2) DEFINITIONS.—(A) For the purposes of this subsection, the term ‘collapsible corporation’ means a corporation formed or availed of principally for the manufacture, construction, or production of property, or for the holding of stock in a corporation so formed or availed of, with a view to—(i) the sale or exchange of stock by its shareholders (whether in liquidation of otherwise), or a distribution to its shareholders, prior to the realization by the corporation manufacturing, constructing, or producing the property of a substantial part of the net income to be derived from such property, and(ii) the realization by such shareholders of gain attributable to such property.(B) For the purposes of subparagraph (A), a corporation shall be deemed to have manufactured, constructed, or produced property, if—(i) it engaged in the manufacture, construction, or production of such property to any extent.(ii) it holds property having a basis determined, in whole or in part, by reference to the cost of such property in the hands of a person who manufactured, constructed, or produced the property, or(iii) it holds property having a basis determined, in whole or in part, by reference to the cost of property manufactured, constructed, or produced by the corporation.(3) LIMITATIONS ON APPLICATION OF SUBSECTION.— In the case of gain realized by a shareholder upon his stock in a collapsible corporation—(A) this subsection shall not apply unless, at any time after the commencement of the manufacture, construction, or production of the property, such shareholder (i) owned (or was considered as owning) more than 10 per centum in value of the outstanding stock of the corporation, or (ii) owned stock which was considered as owned at such time by another shareholder who then owned (or was considered as owning) more than 10 per centum in value of the outstanding stock of the corporation;(B) this subsection shall not apply to the gain recognized during a taxable year unless more than 70 per centum of such gain is attributable to the property so manufactured, constructed, or produced; and(C) this subsection shall not apply to gain realized after the expiration of three years following the completion of such manufacture, construction, or production.For purposes of subparagraph (A), the ownership of stock shall be determined in accordance with the rules prescribed by paragraphs (1), (2), (3), (5), and (6) of section 503(a), except that, in addition to the persons prescribed by paragraph (2) of that section, the family of an individual shall include the spouses of that individual's brothers and sisters (whether by the whole or half blood) and the spouses of that individual's lineal descendants.
This central issue arises as follows: Respondent determined in the deficiency notice that the distribution in controversy ‘is fully taxable to you at ordinary income tax rates under the provisions of the Internal Revenue Code of 1939.’ Petitioners contend that this is essentially identical with what happened in Thomas Wilson, 25 T.C. 1058, where the deficiency determined was that the amount received (p. 1062) ‘was ordinary income under section 22(a),’ I.R.C. 1939, and later resort to section 117(m) was held to place the burden on respondent. We think the situations are radically different and that W. H. Weaver, 25 T.C. 1067, 1085, decided on authority of Thomas Wilson, supra, and on which petitioners also rely, in fact, more nearly supports respondent's position.
It is one thing for respondent to pinpoint the basis of his determination as he did in the Wilson and Weaver cases. In that situation it is not reasonable to permit him, without notice, to rely on some different and previously undisclosed ground. Helvering v. Wood, 309 U.S. 344. He is required under those circumstances to amend his answer sufficiently in advance of the trial if he wishes to raise a new issue. Because of the original determination is not broad enough to include the new ground, its presumptive correctness does not then extend to such new matter, which he is required to raise affirmatively in his answer. Under the Tax Court rules, the burden of proof as to it is expressly placed upon respondent. Rule 32, Tax Court Rules of Practice (Jan. 15, 1957).
But when the determination is made in indefinite and general terms, and is not inconsistent with some position necessarily implicit in the determination itself, the situation is quite different. ‘The petitioner may not, without an expressly pleaded admission or stipulation, treat the notice as an official acquiescence by the Commissioner in all petitioner's propositions as to this item except those expressly determined adversely to him.’ Edgar M. Carnrick, 21 B.T.A. 12, 21. See also Hilbert L. Bair, 16 T.C. 90, 98, affd. (C.A. 2) 199 F.2d 589; Millar Brainard, 7 T.C. 1180; Andrew Geller, 9 T.C. 484, 491; Raoul H. Fleischmann, 40 B.T.A. 672, 682.
What petitioners may do in these circumstances, we need not now determine. It may be that if respondent's position is no nebulous that a petitioner cannot adequately proceed, he may in some fashion compel respondent to a further disclosure. Whether this would ordinarily be by amended answer is extremely doubtful. But, in any event, such a step prior to trial was neither taken nor apparently considered necessary. What petitioners did was to request at the opening of the trial that respondent be required in effect to elect the ground upon which he expected to rely.
He was not asked to and did not amend his answer at that time,
While petitioners did contend at the opening of the trail that any reliance on section 117(m) would be ‘a change from the deficiency notice which is not based on the applicability of Section 117(m),‘ there was no demand that an amended answer be filed. The request was merely that ‘the Court * * * rule that the Respondent's Counsel be required to state in his opening statement the theory upon which he is proceeding; and if he now relies upon Section 117(m), that the Court hold that he was the burden of proving that that section is applicable.’In reply respondent's counsel stated that petitioner ‘is correct in his assumption * * * that we are relying on Section 117(m). If feel that the language set forth in the statutory notice of deficiency is sufficiently broad to cover the position we are taking under 117(m) and therefore Petitioner is not entitled to have the burden of proof shift to the Respondent.’No ruling was made at the trial as to who had the burden of proof, and apparently respondent's statement that he intended to rely on section 117(m) satisfied petitioners. At any rate, any burden cast upon respondent because prior to the trial he has raised new matter in his answer cannot be invoked here.
and it is reasonable to assume that such a request would have been denied. But it would, in any event, have crystallized the situation at that timely moment and not have left the issue of burden to its present contest on the briefs.
An amended answer was in fact filed, but long after the trial and presumably not for any purpose connected with this point:‘(1) Admits the allegations contained in subparagraph (1) of paragraph 5 of the petition (which was '(1) The sum of $50,000.00 received by the Petitioner, HENRIETTA A. SORIN from GARDEN HILLS, INC. was not a dividend within the definition of Section 115(a) of the Internal Revenue Code of 1939; neither was it a distribution out of increase in the value of any property which accrued before March 1, 1913’ and which was denied in the original answer.)‘(m) Denies the allegations contained in subparagraph (m) of paragraph 5 of the petition.‘(n) Admits that the aforesaid $50,000.00 corporate cash distribution constituted ‘other distributions from capital,‘ the amount of which distribution should be applied against and reduce the adjusted basis of the stock in the hands of said Petitioner. Denies the remaining allegations of subparagraph (n) of paragraph 5 of the petition.‘(o) and (p) Denies the allegations of subparagraphs (o) and (p) of paragraph 5 of the petition.’The third statement is a logical progression from the first. It is ‘other distributions from capital’ because it is now admittedly not a dividend, there being no corporate earnings and profits.
Nor can it be successfully argued that the language employed in the deficiency notice directly or by necessary inference excluded the claim upon which at the trial respondent elected to proceed. Not only was there an absence of reference in the notice of any specific section as there was in the Wilson and Weaver cases, but the language used was peculiarly appropriate to a controversy under section 117(m). It was not that this was ordinary income as would be the case with sections 22(a) or 115(a), but merely that it was ‘taxable at ordinary income tax rates.'
This is entirely consistent with section 117(m). And while the distribution in its entirety was the subject of the deficiency, this would be as true under section 117(m) if the stockholder's basis was zero as if the total amount was ordinary income under sections 22(a) or 115(a), or both. The provision that section 117(m) applies to ‘gain’ would require taxation of the entire receipt if the basis is zero. And nothing in that section or anywhere else relieves a taxpayer of the obligation of proving his basis or prevents respondent from assuming that the basis is zero in the absence of a contrary showing. See Helvering v. Gowran, 302 U.S. 238.
The similarity to ordinary income is in fact implicit in section 117(m). In Thomas Wilson, 25 T.C. 1058, 1066, we said that the concept of this section was devised in order ‘to foreclose the use of certain types of corporations as a means of converting ordinary income into capital gain.’
When the time came for trial the missing evidence had still not been produced and all that the parties stipulated was that the schedule attached to the return employed $100 as the basis applicable to the $50,000 distribution.
But this did not have to be assumed by respondent as being the true basis prior to the issuance of the deficiency notice. It follows that taxation of the entire distribution ‘at ordinary income tax rates' was in no way inconsistent
‘In their joint income tax return for 1950, the petitioners treated the distribution received by petitioner, Henrietta A. Sorin, in the amount of $50,000.00 as a distribution under Section 115(d) of the Internal Revenue Code. Schedule D of the return— the schedule of gains and losses from sales or exchanges of property— reported as net long-term capital gain the amount of $49,900.00, said sum being the difference between the distribution of $50,000.00 and the $100.00 cost basis of the stock upon which the distribution was made.’
with the formula of section 117(m).
Petitioners also claim that the statement in the deficiency notice that ‘the distribution * * * does not constitute a return of capital or gain from the sale or exchange of a capital asset’ has a bearing on the respondent's intention to rely on section 117(m). But these words were used in connection with respondent's action in giving petitioners credit for the capital gain they had reported. This item was eliminated from income because the stock of a collapsible corporation is not a ‘capital asset,‘ and gain connected with it is not capital gain. Of course, whether or not it was a return of capital would depend on basis.Incidentally, respondent did not even here deny that the income was from the sale or exchange of ‘property’ as petitioners mistakenly assert. The ‘capital asset’ concept is precisely that of section 117(m).
It is not without significance that the deficiency notices in both the Wilson and Weaver cases included years prior to 1950, the first one to which section 117(m) was applicable. It was accordingly impossible for respondent to base his deficiency notices in those cases on that section as to all the years involved. But in this case only 1950 is covered by the notice and it would be most remarkable if section 117(m) were not in fact a potential ground for its issuance.
We conclude that respondent was entitled to rely on section 117(m) under the terms of the original deficiency notice, that no new matter was asserted when he proposed at the trial to base his contention on that section, and that accordingly the burden of proving any necessary facts to negate the application of section 117(m) was required to be borne by petitioners, and that they have failed to do so. See Raymond G. Burge, supra; J. D. Abbott, supra.
We have concluded that the burden which petitioners are thus compelled to carry has not been borne because the requirements for the application of section 117(m) have not been shown to be lacking nor the limitations to apply, both in general and particularly with respect to the controversies that are expressly argued. Petitioners have not shown that the distribution was not made ‘with a view to’ the described purpose, Raymond G. Burge, supra at 259; J. D. Abbott, supra at 806; see Edward Weil, 28 T.C. 809, on appeal (C.A. 2); nor that it was not attributable to the constructed property, Raymond G. Burge, supra at 262; J. D. Abbott, supra at 807; nor, on the present record, that less than 70 per cent or, in fact, anything less than all of the distribution was so attributable, Raymond G. Burge, supra at 262; J. D. Abbott, supra at 806, 808; nor that it was made after the 3-year period.
Such credible evidence as there is generally tends to sustain respondent, cf. Raymond G. Burge, supra at 262, but we do not and need not say that with the burden on him, he would prevail. It suffices that on this record we are unable to find that with respect to any of the issues petitioners have discharged their obligation of proving their case.
While the question of basis still seems to be in issue, it is almost de minimis, only $100 being involved. Without assuming that the stipulation alone would be sufficient to sustain petitioners' burden, there are other facts in the record, including the par value of the stock. The presumption under local law would require that the stock be issued to petitioner Henrietta for money, labor done, or property actually received. Sec. 69, N.Y. Stock Corp.Law. At least, if there were any suggestion that petitioners or the corporation had proceeded unlawfully, the burden of going forward would be upon respondent. Washington Post Co., 10 B.T.A. 1077; W. H. Weaver, supra at 1081. We have accordingly found as a fact that the basis of the stock upon which the distribution was made was that claimed by petitioners.
Decision will be entered under Rule 50.