*3995 1. L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135, followed.
2. A determination of a profit upon the sale of land and turpentine rights within about a month after acquisition of a fee simple title, which determination makes an arbitrary allocation of the respective values of the land, timber, and turpentine rights which is at variance with the known facts, must be disapproved.
*961 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the years 1918 and 1919 in the respective amounts of $13,812.07 and $41,879.47. The issues raised by the petition are: (1) Whether invested capital should be reduced on account of tax liabilities for preceding years; (2) whether earnings during the year, available for distribution, should be reduced by a tentative tax in computing invested capital; and (3) determination of profit on the sale of land and turpentine rights. The petitioner, at the hearing, conceded the first issue.
FINDINGS OF FACT.
*3996 The petitioner, during the taxable years involved, was an Alabama corporation engaged in the manufacture and sale of lumber. On August 14, 1919, it entered into a contract with the Bagdad Land & Lumber Co. for the purchase of 7,200 acres of timber land located in Oxaloosa County, Florida, in consideration of $150,000, represented by $50,000 cash paid on August 14, 1919, and three notes, aggregating $100,000, executed at that time, which notes were paid during the year 1919. The contract contained no agreement allocating the *962 purchase price to land, timber or turpentine rights, and there was no such agreement between the parties. Prior to August 14, 1919, the date of the above contract, one D. P. Ray, held an option to purchase the tract in question, and to secure the release of this option, petitioner, on August 14, 1919, paid to Ray $25,000 and by contract granted him the right to enter upon and work for turpentine for a period of three years on 1,040 acres of the land.
In addition to the above-mentioned expenditures, petitioner, during 1919, also paid items representing commissions, attorneys' fees, interest and taxes in connection with the purchase of the Bagdad*3997 tract, aggregating $6,128.85. On September 23, 1919, petitioner, reserving the timber to itself, entered into a contract with certain individuals to sell to them, or to a corporation to be created by them, the land in the Bagdad tract, excepting the right to cut the timber, which right was reserved to the petitioner for ten years, and excepting the turpentine rights of Ray on 1,040 acres for the three-year period. The consideration for such contract was $125,000, represented by $65,000 cash and two notes of $30,000 each.
Petitioner's principal business was that of manufacturing lumber, and the Bagdad tract was purchased on August 14, 1919, with the intention of immediately selling the land and the turpentine rights, and retaining the right to cut and remove the timber. At the time of purchase officers of the petitioner estimated the pine timber standing on the Bagdad tract to be 36,000,000 feet board measure. There was no change in the fair market value of the land, the timber or the turpentine rights in the Bagdad tract between August 14, 1919, and September 23, 1919.
On October 9, 1919, the Bagdad Land & Lumber Co. executed a deed conveying the 7,200 acres of land to the*3998 petitioner.
On December 15, 1919, the individuals with whom the contract of September 23, 1919, was made, assigned to the Blackman Naval Stores Co., a corporation organized by them for the purpose of taking over the timber land, all their rights under the contract of purchase of September 23, 1919, with petitioner, the assignment providing that petitioner should be requested to convey the property direct to the Blackman Naval Stores Co., and that that corporation would assume the liability of the individuals on the notes given to petitioner. The individuals who had contracted with the petitioner on September 23, 1919, controlled, managed and held 80 per cent of the capital stock of the Blackman Naval Stores Co.
On February 19, 1920, pursuant to the contract of September 23, 1919, and the assignment of December 15, 1919, petitioner conveyed the land and turpentine rights in the Bagdad tract (subject to the right of D. P. Ray above) to the Blackman Naval Stores Co.
*963 Petitioner kept its books on the accrual basis. It set up on its books as the cost of the Bagdad timber, the amount of $56,113.39, and when the said timber was cut, which occurred subsequent to 1919, *3999 it computed its depletion for the purposes of its accounts and its Federal income taxes upon the basis of such cost.
The respondent, in determining a deficiency for the year 1919, determined that a profit had been realized from the sale of the land and the turpentine rights in the amount of $44,960, arrived at by the following computation:
| 7,200 acres of land | $30,040.00 | |
| Turpentine rights on 25,000,000 feet of timber at $2 per thousand | 50,000.00 | |
| 25,000,000 feet of box timber at $4 per thousand | 100,000.00 | |
| Total cost | 180,040.00 | |
| Selling price of land and turpentine rights | 125,000.00 | |
| Allocated cost: | ||
| Land | $30,040.00 | |
| Turpentine rights | 50,000.00 | |
| 80,040.00 | ||
| Profit to be reported | 44,960.00 |
In using the stumpage of 25,000,000 feet, the respondent adopted the information originally furnished by the petitioner. In a bill of particulars filed in this proceeding, the petitioner alleged the correct stumpage to be 20,000,000 feet; in an amended bill of particulars, that the log scale was 40,000,000 feet and the evidence taken in the proceeding showed that the mill tally was approximately 44,000,000 feet. In allocating a cost of $180,040 to land, *4000 timber and turpentine rights the respondent used an approximate value of $30,040 for the land, and divided the balance of $150,000 between the timber and turpentine in the ratio of 2 to 1.
During the year 1918 petitioner declared and paid cash dividends upon its outstanding shares as follows:
| September 1, 1918 | $50,000 |
| September 6, 1918 | 50,000 |
In determining the amount of current earnings available for the payment of dividends declared and paid during the year 1918, the respondent computed and set aside out of such current earnings a tentative tax upon the income for that year of $19,307.01, resulting in a reduction of invested capital for the calendar year 1918 in the amount of $16,087.56.
On June 10, 1919, petitioner declared and paid a cash dividend of $100,000. In determining the amount of current earnings available for the payment of this dividend, the respondent computed and set aside out of such current earnings a tentative tax upon the income for 1919 of $66,382.14, resulting in the reduction of invested capital for the calendar year 1919 in the amount of $18,038.58.
*964 In computing petitioner's invested capital for 1919 the respondent, *4001 under article 845 of Regulations 45, reduced petitioner's invested capital in the amount of $8,637.63, such amount being the pro rata part of the sum of $20,439.17, the latter figure representing the amount claimed by the respondent as petitioner's total liability for Federal income and profits taxes for the year 1918.
OPINION.
SIEFKIN: The petitioner has conceded the correctness of the action of the respondent in reducing invested capital because of tax liabilities for preceding years under article 845 of Regulations 45, and section 1207 of the Revenue Act of 1926. In that respect, therefore, we approve the determination of the respondent.
The respondent concedes that the facts with respect to the reduction of invested capital for the year 1918 in the amount of $16,087.56 and the year 1919 in the amount of $18,038.58 bring such action of the respondent within the principle of the decision of this Board in , and other similar cases. In that respect, therefore, we hold that invested capital was improperly reduced by such amounts.
The sole remaining issue in the proceeding relates to the action of the respondent in determining*4002 a profit on the sale of land and turpentine rights in 1919. The petitioner was in the lumber business and purchased the fee simple title to the Bagdad tract and the option rights of D. P. Ray with a view to immediately selling the land and the turpentine rights, reserving to itself only the right to cut the timber. In acquiring the properties with that end in view, it expended $181,128.85 and at substantially the same time realized $125,000. The petitioner's contentions are that during 1919 it thus acquired timber for the amount of $56,113.39; that the land, timber and turpentine rights constituted a single unit which was not severable and as to which no segregation could be made, and that no profit could be realized until an amount in excess of the total cost had been received; that the respondent erred in computing the profit on the sale of the land and turpentine rights by not including in the cost thereof the granting of the turpentine rights on 1,040 acres to Ray; and that the fair market value of the timber at the time of purchase by the petitioner was less than that of the turpentine rights, or than the amount used by the respondent in his allocation of cost for the purpose*4003 of computing the profit realized from the sale in question. The respondent, on the other hand, insists that the method of allocating the cost of turpentine rights purchased together with land and timber had been recognized by the Board in , and .
*965 We reject petitioner's contention that the land, timber and turpentine rights were not severable. Petitioner's own contention rests upon the fact that they were severable, as we believe the evidence shows that they were.
This leaves for consideration the question as to whether the respondent's allocation, which resulted in the profit, is improper in the light of the facts in the case.
A timber valuation engineer testified for the respondent in explanation of the computation which resulted in the profit here in question. His testimony was based upon his general knowledge of similar timberlands, upon the condition of the timber, land and turpentine market during the year 1919, and upon a personal inspection of the tract in question in January, 1927. His opinion as to the values of the timber, turpentine rights, and land was reflected*4004 in the computation of the respondent set forth in our findings of fact above. He gave as his opinion that the fair market value on August 14, 1919, of the fee simple title acquired by the petitioner on that date was $278,500, although the petitioner paid $181,128.85. He divided such total valuation into separate valuations for the turpentine rights and land of $98,500, and timber of $180,000. He further arrived at the amount of $98,500 by placing the value as of August 14, 1919, of $62,500 on the turpentine rights, and $36,000 on the land.
It should be noted that the valuations upon which the proposed deficiency rests are not only based upon after-acquired knowledge, since, in such valuations, the amount of timber actually cut is taken rather than the amount estimated in 1919, but the assumptions as to value are contrary to the known facts. One assumption is that although the fee simple title to the property was acquired for approximately $181,000 in August, 1919, it was, in fact, worth $278,500. Another assumption is that the land and turpentine rights (excepting those transferred to Ray) were of a fair market value of $80,040 on August 14, 1919, although they sold, about*4005 one month later, for $125,000. These assumptions are made in spite of the facts and not because of them. There is nothing in the record to suggest that the purchase price of $181,000 was not a transaction at arm's length and for a fair consideration upon the facts known at that time. It is further clear that the market value did not change materially, if at all, within the period of August 14, 1919, and September 23, 1919, and the respondent's engineer so admitted.
Upon all the proof in the proceeding we are satisfied, not only that the respondent's action was erroneous, but also that the petitioner was correct and that its computation was based upon the actual facts as evidenced by an arm's-length transaction, and the tract on *966 the date of purchase was worth no more than on the date of sale, regardless of the severance of the various elements.
In our opinion the cases cited by the respondent as authority for the action taken in this case are in no sense authorities under such facts, and the determination of the respondent, in so far as a deficiency is asserted on account of the $44,960 profit, must be disapproved.
Reviewed by the Board.
Judgment will be*4006 entered on 15 days' notice, under Rule 50.