Orange Sec. Corp. v. Commissioner , 45 B.T.A. 24 ( 1941 )

ORANGE SECURITIES CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Orange Sec. Corp. v. Commissioner

Docket No. 104499.

United States Board of Tax Appeals

45 B.T.A. 24; 1941 BTA LEXIS 1192;

September 4, 1941, Promulgated

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">*1192 1. Petitioner is the transferee of one Giles, who in the year 1926 sold certain real property with a basis of $5,720, taking in exchange therefor notes with a face value of $98,700. Giles reported no gain on this transaction. These notes, transferred to petitioner in a tax-free exchange in 1930, were settled by the debtor during the taxable year for $80,000. Held, petitioner must use as basis in computing gain the basis of the property to its transferor. Gain so computed is the difference between $5,720 and $80,000.

2. Payment of $5,000 extra compensation to petitioner's general manager for special services, held, reasonable.

3. Petitioner during the taxable year paid interest on the insurance loans of one of its officers which it had agreed to pay in return for the transfer of properties and funds representative of the loans. Held, such interest payments, made on the debts of another, are not deductible.

Charles M. Trammell, Jr., Esq., for the petitioner.

F. L. Van Haaften, Esq., for the respondent.

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ARUNDELL

">*24 The Commissioner has determined the following deficiencies in income and excess profits taxes:

Fiscal year ended -	Income tax	Excess profits tax
July 31, 1936	$523.97
July 31, 1937	23,860.66	$8,380.25

">*1193 These sums arise in larger part from the following action of the Commissioner: (1) Determination that petitioner realized gain of $74,280 during the fiscal year 1937 on the exchange of certain purchase money notes and mortgages for 80 shares of the stock of the Beeman Investment Co., alleging that the basis of the notes was $5,720; (2) disallowance of $5,000 compensation paid to James l. Giles in the fiscal year 1937 as excessive; and (3) disallowance of interest deductions claimed in both taxable years for payment of interest due on loans negotiated on the insurance policies of petitioner's principal stockholder.

The petitioner contests these determinations of the respondent, raising three issues: (1) Whether purchase money notes and mortgages, acquired in 1926 by James L. Giles and transferred to petitioner in a tax free transaction in 1930, had a basis in his hands of $5,720, the cost to him of the properties sold or, having a fair market value at that time, had a basis in his hands of that value. The respondent contends alternatively that the notes had no fair market ">*25 value in 1926, and, by amended answer, that if they had such value petitioner is estopped to claim">*1194 that value as basis, since no gain was reported on the sale in 1926. (2) Whether the 1937 compensation of James L. Giles was excessive. (3) Whether interest payments of the petitioner on loans negotiated on insurance policies of an individual are deductible.

The facts have been stipulated in part and as stipulated are adopted as our findings. The material portion of them is set out hereinafter with our other findings.

FINDINGS OF FACT.

The petitioner is a corporation organized and existing under the laws of Florida, with its principal place of business in Orlando, Florida. The returns for the periods here involved were filed with the collector for the district of Florida.

Issue Nos. 1 and 2.

James L. Giles, on March 1, 1913, was the owner of 282 acres of land, located near Orlando, Florida, and known as Washington Heights, which had a value on that date of $5,720. During the year 1926 Giles conveyed title to the described realty to Edwin P. Beeman for $98,700, taking therefor six promissory notes signed by Edwin P. and Harry L. Beeman, four of them in the amount of $20,000 each, due on successive anniversaries of the sale and two in the sums of $10,000 and $8,700, ">*1195 due at the end of the fifth year after date. These notes bore interest at 8 percent and were secured by mortgages on the property purchased. It was understood at that time that, although the property was conveyed to Edwin Beeman, Harry L. Beeman was to have a share therein.

A joint income tax return for the calendar year 1926 was filed by James L. Giles and his wife, Nannie B. Giles, in which no gain was reported by them on the transfer of the Washington Heights property in return for the Beeman notes. No amended return was filed for that year by these taxpayers. The statute of limitations bars the determination of any further deficiency against James L. and Nannie B. Giles for the year 1926. During the year 1927 an internal revenue agent, through an examination of real estate records, became familiar with the conveyance of the Washington Heights property described above, but did not alter the income of Giles or make formal report of his discovery.

In July 1930 James L. Giles formed the Orange Securities Corporation, the petitioner herein, and transferred the notes and mortgage given to him by Beeman in 1926 to it in return for more than 80 percent of its outstanding capital">*1196 stock. This transaction constituted ">*26 a tax free exchange under section 112(b)(5) of the Revenue Act of 1926 and was so regarded by Giles and the Commissioner.

The stock received was directed by Giles to be issued to members of his family, with the exception of one share which was issued to him. Giles relinquished his remaining share in the petitioner and resigned as a director in the year 1934.

The debtor, Harry L. Beeman, died during the year 1929, leaving his assets, 5,899 shares of stock in the Beeman Investment Co., in trust for the benefit of his granddaughter. James L. Giles, the petitioner's general manager, on discovery of this disposition of Beeman's estate, brought suit for petitioner on $80,000 of the notes which had matured and had not been paid and filed on its behalf, and on behalf of other creditors of the estate, a bill in equity seeking to set aside the trust and to subject its assets to the payment of the debts of the estate.

These actions were closely contested by the trustees of the Beeman trust and the proceedings were drawn out over a period of several years, resulting in a judgment for $80,000 in petitioner's favor and a compromise effected">*1197 with the trust and approved by the state court on September 10, 1936. The compromise, which included all of the creditors of the estate, provided for the transfer by the trust to the petitioner of 80 shares of Beeman Investment Co. stock in settlement of its entire claim under the notes.

Giles served the petitioner as its general manager during all the period from 1930 to 1937 and received $8,279.48 as his salary therefor in the fiscal year ended July 31, 1937, of which amount the respondent has disallowed $2,279.48 as excessive. The petitioner acquiesced in this action of the respondent.

On July 27, 1937, the stockholders of the petitioner corporation at their annual meeting voted to pay to James L. Giles $5,000 in addition to his salary for his efforts in perfecting the compromise of Beeman's indebtedness to the petitioner.

The sum of $5,000 paid to Giles for services in connection with the Beeman trust litigation was reasonable compensation for services actually rendered.

Issue No. 3.

Certain loans were negotiated by James L. Giles prior to the year 1930 on life insurance policies owned by him. Funds realized from these loans were used by Giles to purchase properties">*1198 which were transferred to the petitioner in 1930. It was orally agreed between Giles and the petitioner at the time of the transfer that the interest on these loans would be paid by the petitioner as a part of the consideration for the conveyance of the properties in question.

">*27 Subsequent to the formation of the petitioner and at its request Giles borrowed certain additional funds on his life insurance policies and turned them over to the petitioner for use by it in developing its properties. It was understood that the petitioner would pay the interest which became due on these loans.

During the year 1936 the petitioner paid $1,036.76 interest on these loans made on Giles' life insurance, of which $700 was paid on loans made prior to the formation of the petitioner and the remaining $336.76 was paid on loans made after its incorporation.

Similarly, during the year 1937, the petitioner paid $1,487.76 interest on these loans, of which $700 was paid on loans made prior to the formation of the petitioner and the remaining $787.76 was paid on loans made after its formation.

The petitioner was not a beneficiary within the terms of the policies here in question at">*1199 any time during the period here involved.

OPINION.

ARUNDELL: The issue enumerated at the outset are considered here in their order and without restatement.

Issue No. 1.

First for consideration is the basis for computing gain or loss on the settlement of the Beeman notes in the taxable year 1937. The value of the stock received in settlement, it is agreed, was $80,000; the division between the parties is the basis of the notes, whether $98,700, their face value, as contended by the petitioner, or $5,720, as argued by the respondent. As grounds for its contentions the petitioner claims now that the notes received by Giles in 1926 had a market value at that time equal to their face amounts, and that Giles was in error in failing to then report gain equal to the difference between the cost of the land and the total of the notes. Accordingly, it is contended, the proper basis of the notes in Giles' hands was $98,700, which is also the basis of the petitioner. Furthermore, since the Commissioner's agent became aware of the 1926 transaction before the statute of limitations had run against Giles and failed to compel him to report gain in 1926, it is argued that there is">*1200 no ground for estoppel.

The respondent's answering arguments are that the notes had no fair market value in 1926 and, alternatively, that the petitioner may not now claim value for them since its transferor failed to report gain on the transaction by which he acquired them.

It seems clear that, if the notes had a fair market value in 1926, gain was realized by Giles then in the sum of the difference between the cost of the land sold, $5,720, and $98,700 the amount for which it was sold. Thomas F. Prendergast, Executor,22 B.T.A. 1259">22 B.T.A. 1259; Merritt">*28 J. Corbett,15 B.T.A. 698">15 B.T.A. 698; affd., 50 Fed.(2d) 492; Wray-Dickinson Co.,6 B.T.A. 269">6 B.T.A. 269. The petitioner's evidence is presented in an attempt to show such market value. That evidence, however persuasive in the absence of contradictory proof, need not be considered in the view which we take of this case.

The petitioner's transferor, Giles, in 1926, by his failure to report gain on the sale of the land, in effect declared that the notes had no fair market value at that time. This was a determination of fact which he was in a position to make accurately. Responsibility">*1201 for the error, if indeed there was error, may not be shifted to the Commissioner by a showing that an agent became casually aware of the sale and accepted Giles' treatment of the notes as having no fair market value. In some cases the Commissioner's knowledge and investigation of the facts becomes as broad as the taxpayer's, and his failure to compel adjustment makes the error his as well as the taxpayer's. In those instances we have refused to apply any theory of estoppel. R. E. Baker,37 B.T.A. 1135">37 B.T.A. 1135; affd., 115 Fed.(2d) 987; Estate of William Steele,34 B.T.A. 173">34 B.T.A. 173. See also Helvering v. Williams, 97 Fed.(2d) 810; Hawke v. Commissioner, 109 Fed.(2d) 946. The facts in the instant case do not extend so far.

Having thus dealt with the Government on the position thereby assumed by him, Giles may not now repudiate it in order to reap some tax benefit. Some measure of consistency must be required in transactions such as the present, where a conclusion once reached has a continuing effect in the determination of tax liability in later years. ">*1202 See Larkin v. United States, 78 Fed.(2d) 951; Crane v. Commissioner, 68 Fed.(2d) 640; Askin & Marine Co. v. Commissioner, 66 Fed.(2d) 776. See also Dallas Title & Guaranty Co., 119 Fed.(2d) 211; Doneghy v. Alexander & Jones, 118 Fed.(2d) 521; Robinson v. Commissioner, 100 Fed.(2d) 847. See Ruth B. Rains,38 B.T.A. 1189">38 B.T.A. 1189; Commissioner v. Farren, 82 Fed.(2d) 141. See also Stearns Co. v. United States,291 U.S. 54">291 U.S. 54.

The present case, so far considered, resembles closely and, we think, is largely controlled by Alamo National Bank of San Antonio, Executor,36 B.T.A. 402">36 B.T.A. 402; affd., 95 Fed.(2d) 622; certiorari denied, 304 U.S. 577">304 U.S. 577. The taxpayers there in 1921 received in the liquidation of a corporation, in which they owned stock, a franchise to bottle and sell Coca-Cola in a specified territory. Liquidating dividends were reported in their returns, but neither the books of the corporation nor the returns made any mention of the franchise. The taxpayers did not pay any">*1203 tax for the year 1921 on account of receiving the franchise as a liquidating dividend. In 1931, in reporting gain on the sale of that franchise, they sought to use as a basis its claimed market value in 1921. We pointed out there that the taxpayers, by ">*29 their failure to report the receipt of the franchise in 1921, had taken the position that the franchise had then no fair market value. Having taken that view, the taxpayers were required to adhere to it in all of its tax consequences. In those circumstances, we declined to pass on whether the franchise had market value in 1921 and held that the taxpayers must use their own previously declared valuation of zero as a basis.

The Circuit Court of Appeals for the Fifth Circuit, in affirming that result, said:

* * * In income taxation what is done in one tax year is sometimes projected into another where the same fact must govern. There being continuity, there ought to be consistency in treatment. If, for instance, a sale is made on deferred payments, and the taxpayer returns it as an installment sale, charging himself only with the cash collection, and the Commissioner acquiesces, the taxpayer could not in later years">*1204 refuse to pay on the deferred collections by asserting that he stated the facts wrongly in the first instance and ought to have paid on all then, unless he should offer to correct also the first tax settlement. * * *

* * * Whether it be called estoppel, or a duty of consistency, or the fixing of a fact by agreement, the fact fixed for one year ought to remain fixed in all its consequences, unless a more just general settlement is proposed and can be effected. * * *

The petitioner argues in part that this reasoning can not apply since Giles' failure to report gain in 1926 was based on his belief that the transaction constituted an installment sale on which no gain need be reported in that year, as provided in section 212(d) of the Revenue Act of 1926 and articles 44 and 45 of Regulations 69. Both parties are agreed that the sale did not fall within these provisions of the law. See 22 B.T.A. 1259">Thomas F. Prendergast, Executor, supra;Walnut Realty Trust,23 B.T.A. 850">23 B.T.A. 850; G.C.M. 12148, C.B. XII-2, p. 57. Cf. ">*1205 E. M. Funsten,44 B.T.A. 1166">44 B.T.A. 1166. Giles, however, made no report whatsoever of the transaction in 1926, and the only evidence on this point is that found in a letter of protest written by petitioner in 1938. The statement there made is none too clear, but it rather indicates that Giles considered the notes as having no fair market value in 1926 and for that reason failed to report the transaction.

Having reached that conclusion, however, there remains the question of whether the present taxpayer is compelled to adhere in 1937 to a basis determined by its transferor's act in 1926. We think that it must be held bound here as Giles would be bound. The petitioner received conveyance of the notes in a tax free transaction within section 112(b)(5) of the Revenue Act of 1928. Its basis became that of its transferor's. See 113(a)(8). That basis we have found to be the basis of the land to Giles. The petitioner literally "stepped into the shoes" of its transferor and must assume all the consequences ">*30 which attach. ">*1206 Portland Oil Co. v. Commissioner, 109 Fed.(2d) 479; Birren & Son, Inc. v. Commissioner, 116 Fed.(2d) 718. The first cited case, indeed, is very similar to the present case and, we think, is largely determinative of the issue here. The taxpayer there acquired in 1930 an installment contract in a tax free transfer. Its transferor had acquired the contract in 1929 as the result of a sale in that year. The contract provided for a number of payments, beginning on January 1, 1930. In reporting the 1929 sale the transferor treated the transaction as an installment sale and consequently reported no gain. The debtor paid up the contract in 1931 and in reporting gain on the settlement the taxpayer claimed that the transferor made a completed sale in 1929, at which time all gain should have been taxed. The taxpayer accordingly claimed a "stepped-up" basis. The court held, in these circumstances, that the transferor would be "precluded from asserting, after the Statute of Limitations has run as to 1929, that the sale actually took place in 1929." It ruled, further, that this applied as well to the transferee-taxpayer:

If Section 113(a)(7) or 113(a)(8) ">*1207 requires the petitioner to take over the contract on the basis as it would be in the hands of the transferor, Bu-Vi-Bar, then petitioner is in no better position than Bu-Vi-Bar to assert that the sale to the Continental Oil Company took place in 1929. This conclusion involves no judicial disregard of the "corporate fiction;" nor is it strictly a case of applying an estoppel against an innocent third person who was not responsible for the representation upon which the estoppel was founded. The conclusion follows, rather, from the statutory requirement of Section 113 that in certain cases where the transferor retained control, as defined, of the corporation acquiring the property, the transferee steps into the shoes of the transferor so far as the tax basis for the property is concerned.

This reasoning applies with equal force here. The basis "as it would be in the hands of the transferor" is clearly the cost of the property to Giles. The petitioner may not treat it otherwise. Cf. Jamieson v. United States,10 Fed.Supp. 321. Accordingly, the respondent's action on this first issue must be sustained.

Issue No. 2.

The payment of $5,000 to James L. ">*1208 Giles by petitioner in 1937, for particular services rendered over a period of some seven years, is questioned by the respondent as unreasonable and excessive compensation. Proof is made by the petitioner of the extended and important character of the services rendered, consisting of securing the settlement of a long standing and overdue indebtedness owed by Beeman to the petitioner. It is shown that the payment of $5,000 special compensation for these activities was approved by the stockholders of the petitioner.

">*31 In view of these facts there appears to be no basis for holding unreasonable the sum paid to Giles for these activities. Salary as general manager was paid to him, it is true, during the taxable year, but the compensation in question was for services of a special nature rendered over several years. Such extra compensation has frequently been approved when the extent and success of the efforts appear reasonably to warrant it. Heywood Boot & Shoe Co. v. Commissioner, 76 Fed.(2d) 586; ">*1209 Guarantee Liquid Measure Co.,20 B.T.A. 758">20 B.T.A. 758; Central Wisconsin Creamery Co.,15 B.T.A. 396">15 B.T.A. 396. Accordingly, our decision on this issue must be for the petitioner.

Issue No. 3.

The final issue is whether interest paid by petitioner during both of the taxable years on loans negotiated by another is deductible by petitioner when it is shown as to certain of the loans that petitioner received properties representing proceeds of the loans under an agreement to pay the interest and as to the remaining loans that they were negotiated at petitioner's request, and that petitioner received the borrowed funds and agreed to pay the interest arising thereon.

The principle that interest to be deductible must be paid on petitioner's own obligations is not here questioned. Helen B. Sulzberger,33 B.T.A. 1093">33 B.T.A. 1093; Morris Plan Co. of Binghamton,26 B.T.A. 772">26 B.T.A. 772. The efforts of the petitioner seem bent toward showing that the payments here in question were made pursuant to its own obligations, and, indeed, we have found that the petitioner gave its promise to pay the interest in question. ">*1210 But it is a different thing to agree to pay interest on the debt of another and to be required to pay interest on one's own debt. Only in the latter case may the interest deduction be allowed. William H. Simon,36 B.T.A. 184">36 B.T.A. 184. Here, the petitioner was not indebted to the recipient of the interest, the insurance company, nor, so far as we have been shown, to Giles. The receipt of the properties representing loans made prior to its organization and of the proceeds of the loans made thereafter did not create an indebtedness; they appear to have been capital contributions in each case. Whether the payment of interest, promised by the petitioner as incidents of these transfers, be regarded as consideration for the transfer and thus a capital outlay, see Automatic Sprinkler Co. of America,27 B.T.A. 160">27 B.T.A. 160, or as a return on petitioner's capital investment, see, e.g., Greensboro News Co.,31 B.T.A. 812">31 B.T.A. 812, it is clear that they were not paid on an indebtedness of the petitioner and, in consequence, their deduction may not be allowed.

Accordingly, our decision on this issue must be for the respondent.

Decision will be entered under Rule">*1211 50.