*4270 1. Taxpayer who was on a cash receipts and disbursements basis held not to have been in receipt of income which was credited to him on the books of a corporation.
2. Certain partnership losses disallowed.
3. Where the Commissioner, by amendment to his answer, asserts the fraud penalty provided by section 250(b) of the Revenue Act of 1918, held, the burden rests on him to prove the same, and, further, that respondent has failed to meet this burden.
*1236 This proceeding involves deficiencies in income tax for the years 1919 and 1920, in respective amounts of $4,298.83 and $13,659.86. At the hearing, petitioner amended his petition, and by his petition, as amended, assigns the following errors: (a) Inclusion by respondent in petitioner's gross income for the year 1919 of a dividend of $10,000, and the inclusion in such income for the year 1920 of a dividend of the same amount; (b) refusal of respondent to permit a deduction from gross income for 1920 of the whole of an operating loss*4271 of a partnership; (c) refusal of respondent to permit the deduction from gross income for 1920 of money paid by petitioner in liquidation of the same partnership; (d) error in computing the gain arising from the sale of an oil and gas lease made in 1920, and (e) error in computing income of petitioner on an accrual rather than on a cash receipts basis.
At the hearing, petitioner waived contention (e) and it was stipulated by the parties that petitioner realized a profit on the sale of the oil and gas lease referred to in contention (d) of $6,386.75, instead of $16,662.82 as computed by respondent.
At the conclusion of the hearing, respondent amended his answer and requested the imposition of the fraud penalty provided by section 250(b) of the Revenue Act of 1918.
FINDINGS OF FACT.
Petitioner is an individual and resides at 616 South Boulder St., Tulsa, Okla. Petitioner was on a cash receipts and disbursements basis, he kept no books of account, and he determined and returned his income and losses from bank books, check stubs, and certain documents which he had retained.
*1237 In 1918, petitioner, J. T. Forster, and Guy M. Davis, formed a partnership into which*4272 petitioner paid the sum of $15,000. The partnership purchased from Fred Shaw, his Buick and Goodyear contracts, a lease on a building, and his entire stock of automobiles, tires, and fixtures. Thereafter, on April 16, 1918, these persons, together with Fred L. Gordon, executed articles of incorporation of the Forster-Davis Motor Corporation, and on April 26, 1918, filed the articles with the Secretary of State of the State of Oklahoma, who, on said date, issued a certificate of incorporation. The articles provided for a capital stock of $150,000 divided into 1,500 shares of the par value of $100 each. Petitioner, Feed. L. Gordon, Guy M. Davis, and J. T. Forster, each subscribed for one share of stock. These stockholders held their first meeting on April 29, 1918, and elected the following directors: J. T. Forster, Guy M. Davis, and petitioner. On the same day the board of directors met and elected J. T. Forster president, petitioner, vice president, and Guy M. Davis, secretary and treasurer, and adopted, among others, the following resolution:
Resolved, Further, that for the purpose of increasing the business of this company and the energy and efficiency of its representatives, *4273 that a bonus of Five Thousand Dollars ($5,000.00) be paid to the President, the Vice-President and Secretary and Treasurer, and an additional bonus of Five Thousand Dollars ($5,000.00) to each of the directors for each year.
The corporation did not pay nor did petitioner receive during the years 1919 and 1920, the amounts or any part thereof voted him under the above resolution.
On the same day the partnership offered to sell and transfer their assets and business to the corporation in consideration of 1,496 fully paid-up and nonassessable shares of the capital stock of the corporation. This offer was presented first at the stockholders' meeting and then at the directors' meeting. At each meeting, a resolution accepting the offer was carried, all the stockholders and all the directors voting therefor. The sale is proposed, was consummated in August, 1918, and petitioner received 486 shares of stock for his share in the partnership.
In the early part of 1922, F. G. Romain, an accountant, was called in to audit the accounts of the corporation and reconstruct its books. At this time, the company's ledgers were missing; there were in existence from four to six cash books of*4274 which parts were missing, the company's minute books and certain balance sheets. From this data Romain constructed a journal and a ledger in which he made entries, which, in his judgment, properly reflected the past transactions of the corporation. The accountant determined that the face value of the stock issued in payment for the assets of the *1238 partnership exceeded the value of the latter and that petitioner was, by reason of this fact, indebted to the corporation for his stock in the sum of $25,614.20, and thereupon he entered on the ledger a charge therefor against petitioner. The accountant next credited the said charge of $25,614.20 with a dividend of $10,000 as of the year 1919, and with a further dividend of the same amount as of 1920, these being the amounts provided by the resolution of April 29, 1918.
The Forster-Davis Motor Corporation did not declare or pay petitioner during the year 1919, a dividend of $10,000. It did not during the year 1920, declare or pay to petitioner a dividend of $10,000. Petitioner did not take an active part in the management of the corporation; he was not consulted with reference to its affairs; he did not frequent its place*4275 of business nor examine its books. Petitioner was not indebted to Forster-Davis Motor Corporation during the years 1919 and 1920, except for current monthly bills for tires, gasoline and repairs.
At a time not shown, petitioner and one Ellis, entered into an oral agreement of partnership by the terms of which petitioner was to furnish the capital and Ellis was to go into the oil fields and purchase oil and gas leases and dispose of them. The profits were to be equally divided between the parties. In 1920, the partnership suffered an operating loss of $13,003.16, which was paid by petitioner. Respondent permitted petitioner to deduct one-half of this loss, or $6,501.58, but refused to permit a deduction by him of the other half. Ellis died in June, 1920, and subsequent to his death, and in 1920, petitioner paid in liquidation of the partnership, $6,577. Of this amount, $2,630.59 was paid as rental on oil and gas leases. At the death of Ellis, the partnership owned oil and gas leases in wild-cat territory in Texas, a secondhand automobile, and a desk. The only asset left by Ellis, other than his interest in the partnership, was an accident policy of $5,000. This policy was*4276 contested by the insurance company and the controversy was finally settled with the widow of Ellis.
On March 15, 1920, petitioner made and verified his income-tax return for the calendar year 1919, filed it with the collector of internal revenue for the district of Oklahoma, and on March 17, 1920, paid the amount of tax shown due thereon, to wit, $51.53. On this return he reported as dividends from corporations the amount of $961. During the calendar year 1919, petitioner received, in addition to the amounts reported, two dividends from corporations, one of $4,838.95 and the other of $4,578.84. On March 15, 1921, petitioner made and verified his income-tax return for the calendar year 1920. *1239 He filed this return with the collector of internal revenue for the district of Oklahoma and on March 28, 1921, paid the tax shown due thereon, to wit, $93.75. Petitioner reported as dividends received from corporations during said year, the amount of $1,791.50. During the calendar year 1920, the petitioner received, in addition to the amounts so reported, a dividend of $9,157.20. Thereafter, petitioner made no formal amended return disclosing these items, but he did, thereafter, *4277 furnish a revenue agent a paper similar to a return which showed the receipt by petitioner in 1919 and 1920, respectively, of the above dividends. Respondent has included said dividends in petitioner's gross income in the years in which they were received and these inclusions are not contested by petitioner in this proceeding.
OPINION.
MILLIKEN: The issues in this proceeding are: (1) Whether petitioner was in receipt of a dividend of $10,000 in the year 1919, and also of a dividend of the same amount in the year 1920; (2) whether petitioner is entitled to deduct from his gross income for 1920, the remaining half of the operating losses incurred by the partnership composed of himself and Ellis, and also the total amount paid by petitioner in said year in settlement of certain liquidating losses of the partnership; and (3) whether the fraud penalty provided by section 250(b) of the Revenue Act of 1918 should be imposed.
With respect to the first issue, respondent contends that since petitioner rendered no service to the corporation, the resolution of April, 1919, should be construed as providing for a distribution of profits, and, therefore, anything credited to petitioner*4278 thereunder should be considered in the nature of a dividend. How he would apply the credits to the other officers, who did perform services, is not explained. Without deciding this question, it is sufficient to point out that petitioner was on a cash receipts and disbursements basis, and, further, that there is no evidence to the effect that these two amounts were credited to petitioner in 1919 and 1920, respectively, on the books of the corporation. The accountant, who reconstructed the books, does not appear to have relied on any book entries made in said years, since the books which recorded items of this character were lost, but on the resolution of the board of directors. Even if these amounts had been credited to petitioner during the respective years involved, he would not, under the facts as found, have been taxable thereon as income then received, since he was on a purely cash basis. See ; ; and .
*1240 Next, respondent contends that since it appears from the books, as reconstructed, that petitioner owed the corporation for*4279 stock, and since under the resolution he was apparently entitled to the bonus for each year and since the bonus was in the year 1922 credited as of the years 1919 and 1920 against such alleged indebtedness, it follows that petitioner was in the receipt of said amounts as of the date he should have received them. The major premise for this conclusion is that petitioner was indebted to the corporation for a balance due on his stock. This he denies and his denial is borne out by the fact that the corporation issued to him for his share in the partnership, fully paid up and nonassessable shares. The fact that the value of the assets of the partnership may have been less than the par value of the stock issued therefor gave neither to the corporation nor to the other stockholders, all of whom participated in the transaction, an enforceable demand against petitioner. Cook on Corporations, (8th ed.), secs. 38 and 39. The most that can be said of the book entries made in 1922, is that they constituted an adjustment in that year of the capital stock and surplus accounts, which in no way created taxable income. Cf. *4280 ; 3 Am.Fed. Tax Rep. 3020, and ; 6 Am.Fed. Tax Rep. 6892. Whatever may have been the present effect of the entries made in 1922, such entries could not, under the facts of this proceeding, create taxable income to petitioner in 1919 and 1920. On this point, petitioner is sustained.
Whether petitioner is entitled to take as a deduction the whole of the operating loss of the partnership existing between him and Ellis, and also the whole of the amounts paid by him in the liquidation of that partnership, depends, first, on whether there existed between him and Ellis an agreement to the effect that petitioner was to bear all the partnership losses, and, second, on whether his claim for reimbursement was worthless in 1920. On the first point petitioner testified as follows:
Q. Let me ask you this, Mr. Parish: Did you know the financial condition of Mr. Ellis at the time you formed this partnership with him?
A. I did. Q. What was it? A. He did not have anything.Q. Did you have any specific agreement at that time - anything at all*4281 about losses?
A. I did not.Q. You stated to the Court that you were to stand the losses. Why did you say that?
A. Yes; I understood that I would stand the losses, because he did not have any money.
*1241 By the Member:
Q. Was that because he did not have the money or because you and he agreed to it - which?
A. It was understood that I would stand the losses, because he did not have any money.
Q. Was that the reason for it? A. Yes, sir. Q. Or did you start out with that definite agreement? A. Well, that was the agreement.This testimony is not sufficient to show that the partnership agreement provided that petitioner was to bear all of the losses of the partnership. There remains the question whether petitioner's claim for reimbursement was worthless in 1920.
It is shown that Ellis had an accident policy for $5,000. To whom this policy was payable is not shown, nor is it shown that petitioner could not have participated in its proceeds. It is further shown that on the date of the death of Ellis, which occured in June, 1920, the firm owned oil and gas leases and that subsequent to that date, petitioner paid as rentals on such leases*4282 the sum of $2,630.59. While it is true that petitioner testified that it was his impression that all the leases lapsed in 1920, we can not, in the face of the fact that during and after June, 1920, petitioner paid rentals thereon, hold that petitioner's claim was worthless or was ascertained to be worthless during that year. The action of respondent in this respect is approved.
Since respondent did not deem it proper to impose the fraud penalty provided by section 250(b) of the Revenue Act of 1918, prior to the taking of the appeal in this cause, and presented this claim for the first time at the conclusion of the evidence, in the shape of an amendment to his answer, the burden rests upon him not only to prove that petitioner omitted income from his returns, but that petitioner was guilty of fraudulent concealment. This latter element, we are of the opinion, respondent has failed to prove. It is shown that subsequent to the making of his returns, petitioner furnished a revenue agent with a paper similar to an amended return, which contained the items of income which had been omitted in his original returns and the report of the revenue agent, which was filed in evidence, discloses*4283 that he treated this paper as a return. We are of the opinion that the evidence produced by respondent is not sufficient to justify the imposition of the fraud penalty.
Judgment will be entered on 15 days' notice, under Rule 50.