*645 Reservations by decedent and her husband of voting rights and of possession as pledgees, of corporate stock, and of a stipulated "salary" from the corporation during their lifetime, held, to require inclusion of the stock in decedent's gross estate, notwithstanding its inter vivos transfer to decedent's children.
*807 Respondent determined a deficiency in estate tax of $17,087.79. These proceedings were brought to contest its correctness in three respects, but one of the issues has now been conceded. Those remaining are the propriety of including certain stock as part of decedent's estate, and, in the alternative, its value on the date of death.
*808 FINDINGS OF FACT.
Pamelia D. Holland, hereinafter sometimes called the "decedent," died on May 17, 1939, a resident of Texas at the time of her death. Her estate tax return was filed with the collector of internal revenue for the second collection district of Texas at Dallas, Texas.
A part of the decedent's gross estate included a tract of 444 acres*646 of land located near the south city limits of Dallas, Texas, and known as the Hollandale farm.
In her estate tax return said tract was reported as having a value of $80 per acre. In the notice of deficiency the respondent determined the value of said tract to be $150 per acre.
The property is located about a mile and a half south of the city limits of Dallas, Texas, on a main thoroughfare. As of May 17, 1939, the property had three cottage homes thereon, barns, tool houses, and general farm improvements. Besides its farm possibilities, the property as a whole is a desirable building site. The property was worth $150 per acre as of the date of decedent's death.
The Texas Farm & Ranch Publishing Co. (hereinafter sometimes referred to as the company), a Texas corporation, was organized in 1883 with a capital stock of $50,000 divided into 500 shares with a par value of $100. The company publishes farm journals known as Farm & Ranch and Holland's Magazine, both of which enjoy wide circulation.
The 500 shares of said company stock were owned by Frank P. Holland, Sr., and his wife, this decedent, 125 shares thereof as her separate property and 375 shares as their community*647 property.
On July 31, 1920, the assets of Texas Farm & Ranch Publishing Co. exceeded the liabilities by $126,669.96, including $50,000 capital stock and $76,699.96 undivided profits. No substantial changes in the financial condition of the Texas Farm & Ranch Publishing Co. took place between June 24 and July 31, 1920.
On June 24, 1920, a contract was entered into between Mr. and Mrs. Frank P. Holland, Sr., and their five children the pertinent parts of which contract read as follows:
That we, Frank P. Holland, Sr., and his wife, Mrs. Pamelia D. Holland, parties of the first part, hereinafter called Vendors, for and in consideration of the sum of $1.00 to each of them paid by Frank P. Holland, Jr., Reginald V. Holland, J. Porter Holland, Gussie Holland Jones, Wife of Fred A. Jones, and Marsh W. Holland, parties of the second part, hereinafter called Vendees, and in further consideration of the limitations, stipulations, reversions and the covenants of Vendees hereinafter contained, and also in consideration of the sums of money hereinafter guaranteed to be paid to the Vendors in the manner and form and for the length of time provided herein, have Sold, Assigned and Set Over*648 and Delivered, all of the capital stock amounting to $50,000.00 par value of the said Texas Farm & Ranch Publishing Company, and evidenced by *809 certificates Nos. to , inclusive, each for $10,000.00 of capital stock, unto the said Vendees in the proportion as follows:
To Frank P. Holland, Jr., $10,000.00 of said capital stock evidenced by Certificate No. 36
To Reginald V. Holland, $10,000.00 of said capital stock evidenced by Certificate No. 37
To J. Porter Holland, $10,000.00 of said capital stock evidenced by Certificate No. 38
To Gussie Holland Jones, $10,000.00 of said capital stock evidenced by Certificate No. 39
To March W. Holland, $10,000.00 of said capital stock evidenced by Certificate No. 40
This transfer and assignment of said stock, however, is made upon the following expressed conditions:
1. Each of the said Vendees shall endorse to Frank P. Holland, Sr., and Mrs. Pamelia D. Holland and attach hereto as security herefor as hereinafter provided all of the shares of stock evidenced by his or her certificate of stock aforesaid, each of which certificates shall contain a memorandum written across its face, and also across the stub in the stock book*649 from which it is detached, the following notation:
"These shares of stock and these certificates are subject to the terms of a written contract between Frank P. Holland, Sr., and his wife, Mrs. Pamelia D. Holland, on the one part, and Frank P. Holland, Jr., Reginald v. Holland, J. Porter Holland, Gussie Holland Jones, joined by her husband Fred A. Jones, and Marsh W. Holland, of the second part, dated the 24th day of June, 1920, the original of which contract is in the possession of Frank P. Holland, Sr., and a copy of which contract is on file with the Secretary of the Texas Farm & Ranch Publishing Company.
Secretary."
2. Vendors expressly hereby reserve their right to vote said stock in person or by their respective proxies in the proportion aforesaid, * * * as long as both of said Vendors shall live and all of said stock shall be voted by the survivor of said Vendors as long as he or she may live.
3. During the life of either of said Vendors no one of the Vendees shall have the right to sell, assign, mortgage, pledge, hypothecate or in any manner dispose of any of said stock.
4. Vendors shall elect the Board of Directors of said Texas Farm & Ranch Publishing Company*650 as long as they both shall live and the survivor of Vendors, after the death of one of them, shall continue to elect said Board of Directors as long as such survivor may live, and Frank P. Holland, Sr., shall be elected President of said Company as long as he lives and should he predecease his said wife, then his said wife, Pamelia D. Holland, shall be elected President of said Company; and the salary of the said Frank P. Holland, Sr., shall be $25,000.00 per annum payable at such times as he may elect to draw the same, which said salary shall continue during his entire life, and should he predecease his said wife, the same salary, to-wit, $25,000.00 per year shall be paid to his said wife, Pamelia D. Holland, during her entire life, same to be paid at such time and in such manner as she may elect; salary of Mrs. Pamelia D. Holland to begin immediately upon the death of Frank P. Holland, Sr., should he predecease her; and Vendees hereby expressly and respectively guarantee that the said salaries shall be voted by the Board of Directors of said Company and paid to the said *810 Frank P. Holland, Sr., and to his wife, Mrs. Pamelia D. Holland, should she survive him, in the manner*651 and form hereinbefore provided annually. But it is expressly understood and stipulated that upon the death of both said Frank P. Holland and Mrs. Pamelia D. Holland, all previous payments having been made to them respectively as hereinbefore provided and all conditions of this contract having been fully kept and performed and all guarantees having been made good by the Vendees, then and in that event, upon the death of both of the Vendors, the title of said Vendees to said stock evidenced by their said certificates respectively shall become absolute.
5. In the event that any part of the annual salary to be paid by Texas Farm & Ranch Publishing Company to the said Frank P. Holland, Sr., during his life time, or to his wife, Mrs. Pamelia D. Holland, should she survive her said husband, in the sums aforesaid and guaranteed hereby by the Vendees, remain unpaid for a period of four months after the expiration of the year for which the salary accrued, this assignment shall be, at the option of Vendors, or the survivor of them if one be dead, null and void, and the said stock shall be entirely reinvested in the Vendors, * * * the survivor of them shall succeed to all the rights of the*652 deceased one under this contract and in said stock and a like option shall exist in Vendors, or the survivor of them, at any time that as much as six months default is made during any current year in paying any part of the salary during said current year, estimating that the same shall be paid at least monthly pro rata for the entire year.
6. To secure the obligation to pay said salary and to secure the guarantee of Vendees to pay the said salary of said Frank P. Holland, Sr., during his life time in the manner aforesaid for each year of his life and a like salary to his wife should she survive her said husband, and to secure all the terms, conditions and covenants of this contract, Vendees hereby transfer, assign and set over to the said Frank P. Holland, Sr., and Mrs. Pamelia D. Holland, all of their right, title and interest in said shares of stock so issued to them in the proportions aforesaid and hereby attached to this agreement all of said capital stock issued to them respectively as aforesaid, and hereby refer to same and make the same a part of this agreement, and hereby covenant and agree with and to the said Frank P. Holland, Sr., and Mrs. Pamelia D. Holland, that the*653 said salaries in the manner and form aforesaid shall be paid to them by the said Texas Farm & Ranch Publishing Company currently as it accrues and in the manner aforesaid regardless of what service may be rendered by them, or either of them, as the President of said Company, and regardless of their ability to serve as President and regardless of their inclination to serve or their activity as said President, it being here agreed and specially understood and stipulated that the Vendors while so acting as such President are not required to perform any specific duty and are to render only such services and at such time as they may see fit, and that neither of the Vendors shall ever be charged with any dereliction in duty by failure to give active attention to the business of said Company, and that the Vendors and each of them, may have such vacation as they may choose without any abatement of salary, it being understood that a Vice-President shall be elected for said company who shall at the option of Vendors be charged with the active management and executive control and powers of said Company.
7. And finally it is expressly understood and agreed that all of the provisions of this*654 contract are to be and always construed to be conditions precedent to the right and title of Vendees in and to the stock of said Company as aforesaid and neither the Vendees or any of them, or their respective heirs, executors, administrators or assigns, shall ever have or claim any right, title or interest in and to said stock except upon full and complete performance of every condition and *811 covenant of this contract and the satisfaction in full of the salaries herein provided for Frank P. Holland, Sr., during his entire life time and of his wife, Mrs. Pamelia D. Holland, should she survive him, and that upon the faithful compliance of all of said conditions and covenants punctually made, then and in that event only, the title to said stock in the Vendees respectively as aforesaid then to become absolute, but upon the default of the said Texas Farm & Ranch Publishing Company to pay said salaries to said Vendors as herein provided, or the failure of Vendees to make good their guarantee of said salaries as aforesaid and in event such default shall continue for the length of time hereinbefore provided, either for the payment of any current annual salary or in the payment of*655 the entire annual salary for any years as hereinbefore provided, then in either event, the option is hereby retained by Vendors, or the survivor of them, and it is hereby granted as a right of Vendors by Vendees and each of them to treat this contract as fully cancelled and to surrender the shares of the stock hereto attached as security herein to the Secretary of the Texas Farm & Ranch Publishing Company, its successors or assigns and to cause the same to be cancelled of record and to be reissued to the Vendors in the propertions as now held, or in the event of the death of either of Vendors at the time of such cancellation, then to cause all of such stock to be issued in the name of the survivor or said Vendors, but this option is not intended and shall not be construed to deprive Vendors of any other remedy they may have.
* * *
The company had been paying Frank P. Holland, Sr., an annual salary of $25,000 per year for his services for some period prior to the date of the contract above set forth, and continued to pay him that salary until his death.
F. P. Holland, Jr., was elected vice president and general manager of the company shortly after said contract was executed, *656 but F. P. Holland, Sr., remained its president until his death in 1928.
The company continued to pay Frank P. Holland, Sr., $25,000 per year as a salary until his death in 1928, and deducted that amount each year on its income tax returns as a business expense for salary paid.
After the death of Frank P. Holland, Sr., in 1928 the decedent was elected president of the company. Although she was not active in the affairs of the company, the decedent attended its corporate meetings and the company paid her an annual salary of $25,000 until December 1, 1937. The company took these annual salary payments as deductions on its income tax returns for the same period.
On December 1, 1937, the decedent and her children entered into a written contract whereby the contract dated June 24, 1920, was amended by reducing the annual salary from $25,000 to $6,000.
From the date of the agreement of December 1, 1937, to her death on May 17, 1939, the company continued to pay the decedent a salary of $6,000 per year. Approximately $6,000 was owed her by the company as of the date of her death.
After June 24, 1920, the stock of Texas Farm & Ranch Publishing Co. was voted by the five vendees*657 under the contract of June 24, 1920. *812 All dividends paid by the Texas Farm & Ranch Publishing Co. after June 24, 1920, were paid to the vendees under said contract and not to Frank P. Holland, Sr., or Pamelia D. Holland.
After the execution of the contract on June 24, 1920, Frank P. Holland, Jr., was vice president and general manager of the Texas Farm & Ranch Publishing Co., and Frank P. Holland, Sr., and his wife, Pamelia D. Holland, took only a small part in the management and control of the business.
According to the balance sheets of the company as of July 31, 1920, the 500 shares of stock had a book value of $253.40 per share.
Following a reappraisal of the company's assets on June 24, 1937, the 500 shares of stock had a book value per share on the date designated in the following amounts:
| July 31, 1937 | $307.56 |
| July 31, 1938 | 356.45 |
| July 31, 1939 | 291.83 |
The company's income accounts revealed the following:
| Profit or loss from operations | Total net profit or loss | |||
| Year ended July 31 - | Profit | Loss | Profit | Loss |
| 1935 | $1,437.80 | $32,699.57 | ||
| 1936 | $35,966.93 | $11,609.16 | ||
| 1937 | 16,186.90 | 8,252.03 | ||
| 1938 | 3,023.10 | 25,525.31 | ||
| 1939 | 29,008.63 | 3,734.15 |
*658 making a net loss for the last five years of decedent's life of $51,133.60, or an average net loss for the five-year period of $10,226.80.
The company publications relied principally upon advertisements to support them and peoduce their profits. Radio advertising was tending to take this business away from the company in late years.
The 500 shares of stock of the company had a value of $125 per share as of the date of decedent's death.
OPINION.
OPPER: An analysis of the contract by which decedent "sold" this stock to her children creates grave doubt whether it was of any real effect in advance of decedent's death. Internal Revenue Code, sec. 811(c). Endorsement and return of the stock as "security" was called for at once, all voting rights were retained during decedent's life, and the "vendees" were forbidden "to sell, assign, mortgage, pledge, hypothecate or in any manner dispose of any of said stock," until after her death and that of her husband. It is even stipulated in express language "that upon the death of both said Frank P. Holland and Mrs. Pamelia D. Holland [decedent] * * * the *813 title of said Vendees to said stock evidenced by their said certificates*659 respectively shall become absolute," and that "all of the provisions of this contract are to be and always construed to be conditions precedent to the right and title of Vendees * * *."
Petitioner refers to a statute of the state of domicile, Texas, which voids as to creditors and bona fide purchasers reservations of title retained to secure the purchase price, Texas Revised Civil Statutes, art. 5489, and to Harling v. Creech,31 S.W. 357">31 S.W. 357; 88 Texas 300, which seems to hold that such an arrangement is to be construed as no more than a chattel mortgage even as between the parties. The contention is that consequently "The conditions imposed on the sale and the reservations of title, if any, in the contract were absolutely void even as between the parties * * *." In other words, petitioner asks us to disregard the plain language of the contract and the obvious intention of the participants on the ground that they purported to accomplish a postponed transfer which the law of Texas forbids, and hence that the Federal estate tax which would apply if the contract meant what it says is frustrated by local law. This would be a process of reasoning not without*660 difficulty. See Lyeth v. Hoey,305 U.S. 188">305 U.S. 188. We should rather incline to the view expressed by a Federal court sitting in Texas:
* * * the law covering this tax is based upon "the intention of the grantor" * * *. In the case at bar the property was delivered to the grantees but contemporaneously therewith they passed and delivered it * * * in pledge * * *. The Court * * * finds that the several transfers, though not made in contemplation of death, resulted in decedent still holding, during her lifetime * * * the personal estate which she had contemporaneously passed to her children * * *. In substance, the transfers, though in form legal and serving to accomplish their purpose as transfers, could not thereby defeat the tax obligation * * *. [Tips v. Bass (Dist Ct., W. Dist. Texas), 21 Fed.(2d) 460.]
But, however that may be, there is a further aspect of the transaction which we regard as controlling. In addition to all that has already been detailed, the contract reserved a payment of $25,000 a year to decedent's husband as long as he lived and thereafter to decedent. Even if there was an outright transfer of the title, we see*661 no escape from this reservation of the income for life or from the consequent necessity of including the property in the estate, under the principle of Helvering v. Hallock,309 U.S. 106">309 U.S. 106; Estate of Mary H. Hughes,44 B.T.A. 1196">44 B.T.A. 1196.
True, this payment was denominated "salary" and was not specified as company profits or dividends on the shares. But no services were or could be required in exchange. And at petitioner's request, we have found the value of the company's capital and surplus at that time to have been $125,000. The annual payment would thus approximate a return of 20 percent on the investment. In the absence *814 of evidence of prior earnings in excess of that figure, and there is none, we can not regard it as reasonable that the parties would expect the property to produce a higher average return. This was presumably income of the marital community before the husband's death, and belonged to decedent alone thereafter. The parties raise no question of decedent's continuing interest in this income on the strength of the community property aspect. Hence, without yielding completely to terminology, and viewing the transaction*662 in its essential reality, the income to be expected from the stock was in effect retained by decedent during her life. As the Board said in Mary H. Hughes, supra (p. 1200):
* * * If [decedent] * * * had in 1928 given $945,000 to the children, or someone representing them, and had taken their promise not to use it during her lifetime except to pay her $31,500 a year until she died, this would certainly have been a gift to take effect in possession or enjoyment at or after her death, even though ownership of the fund vested in the children at once * * *.
We take the same view of the present transaction.
Certainly, on an inclusive view of the whole arrangement, this withholding of the income until decedent's death, coupled with the retention of the certificates under the pledge and the reservation of the right to vote the stock and to designate the company officers, is an illuminating instance of the futility of that inquiry into "the technical forms in which interests contingent upon death are cast" which the Hallock case renounces. The very injection, into the discussion, of the nature of the title under the law of the domicile, and of the extent to*663 which the contingencies of the transfer were the conditions precedent of a conditional sale or the conditions subsequent of a chattel mortgage, are reminiscent of the "unwitty diversities of the law of property" represented by the St. Louis Union Trust Co. cases, 296 U.S. 39">296 U.S. 39, 48, but challenged by Helvering v. Hallock. We can not reach our conclusion in reliance upon any such "gossamer distinctions" and accordingly find no error in respondent's inclusion of the stock in decedent's estate.
We agree with petitioner, however, that the valuation placed upon the stock as of the date of death was too high. Book value of corporate assets must be qualified by their earning capacity. It can not be assumed that the figure employed is a liquidating value, and if the appraisal is based upon worth as a going concern it is obvious that anticipated earnings are a controlling factor. See Eleverson Corporation,40 B.T.A. 615">40 B.T.A. 615; affd. (C.C.A., 2d Cir.), 122 Fed.(2d) 295.
As we have recognized in discussing the basic issue, salary paid to decedent and her husband for services of a negligible value was in *815 effect an element of corporate*664 profits, and we think may appropriately be considered as such in analyzing the earnings of the business. By adding these amounts to the profit and loss figures in the company's accounts, we find that total earnings for the five years preceding decedent's death were in the neighborhood of $35,000, or an average of $7,000 a year. But the profits were unstable and fluctuated violently, indicating they were far from assured, with both the figures and the testimony justifying the anticipation of a downward trend. Taking all the factors into account, we have accordingly found a value per share of $125.
The remaining issue relating to the value of certain real property in the estate known as Hollandale Farm has now been abandoned by petitioner and need not be further noticed.
Decision will be entered under Rule 50.