1932 BTA LEXIS 1394">*1394 1. Held, that an amount received by the petitioner during the taxable year, in connection with the transfer to other parties of certain corporate stock in which the petitioner was interested, accrued prior to the taxable year and, since petitioner's books were kept on the accrual basis, it does not constitute taxable income to the petitioner for the year in which received.
2. Where the evidence does not show the cost to petitioner of an interest in a business enterprise acquired in 1914, the Board is unable to determine whether the petitioner realized a gain or sustained a loss on the final liquidation of such interest in 1920.
25 B.T.A. 1341">*1341 This proceeding is for the redetermination of a deficiency in income and profits tax of $13,144.20 for 1920.
The matters put in controversy by the petition as amended are (1) the correctness of the respondent's action in including in taxable income the amount of $57,033.55 received by the petitioner in connection with the transfer to other parties of certain corporate stock in1932 BTA LEXIS 1394">*1395 which the petitioner was interested; (2) whether the petitioner sustained a loss on liquidation of its interest in a business enterprise known as Eddy Brothers & Company; and (3) whether the assessment and collection of the deficiency determined by the respondent are barred by the statute of limitations.
In an amended answer filed at the hearing the respondent alleges that the petitioner realized a profit in 1920 on the liquidation of its 25 B.T.A. 1341">*1342 interest in Eddy Brothers & Company and that he erred in failing to include such profit in petitioner's income in determining the deficiency here involved, and asks that the Board redetermine the correct amount of the deficiency, even though such amount be greater than the deficiency heretofore determined by him. At the hearing the petitioner waived the issue relating to the statute of limitations in so far as it relates to the deficiency determined by the respondent, hereby restricting the issue to the question of whether the assessment and collection of the increase in the deficiency as proposed by the respondent are barred by limitations.
FINDINGS OF FACT.
The petitioner is a Maine corporation organized February 4, 1914, and1932 BTA LEXIS 1394">*1396 having its principal office in San Francisco, California. The petitioners was formed to act as a holding company for the assets of the estate of Selwyn Eddy, who died a resident of Michigan on October 12, 1911.
Prior to 1899 Selwyn Eddy, Charles A. Eddy, John F. Eddy and Charles F. Eddy formed a partnership known as Eddy Brothers & Company, located at Bay City, Michigan. The business carried on by the partnership had been carried on formerly by the fathers of the parties. Under date of February 4, 1899, the partners entered into the following agreement:
THIS AGREEMENT, Witnesseth, that it is mutually agreed by and between the several members of the firm of Eddy Bros. & Co. that the death of any one or more members of the firm shall not work a dissolution, but the co-partnership shall continue for such time as may be mutually agreed upon, not less than three years, unless sooner dissolved by mutual consent.
The interest of the deceased partner shall be represented by his legal representatives, who shall have the same voice and vote in the management of the business as the deceased partner should have if living.
No other agreement respecting the continuation of the partnership1932 BTA LEXIS 1394">*1397 after the death of a member was ever entered into subsequent to the above agreement, either by the original partners or by any of them and representatives of deceased partners.
John F. Eddy died about 1900. Thereafter the Eddy Investment Company, a corporation, was organized and acquired his interest in the properties held and business then conducted under the name of Eddy Brothers & Company. From 1903 until 1920 that company was in the process of liquidation.
Upon organization on February 4, 1914, the petitioner took over all the assets and assumed all the liabilities of the estate of Selwyn Eddy and issued in exchange for the net assets its authorized capital stock of $100,000 par value. No other consideration was paid by the 25 B.T.A. 1341">*1343 petitioner for the assets. Included in the assets taken over by the petitioner was a one-fourth interest in the properties held and business conducted by Eddy Brothers & Company. This one-fourth interest was entered on the books of the petitioner at $100,000. Among the liabilities assumed by the petitioner was that of the estate to Eddy Brothers & Company in the amount of $5,330.15. There were no other assets of the estate taken over1932 BTA LEXIS 1394">*1398 or liabilities of the estate assumed which pertained to the estate's interest in Eddy Brothers & Company.
Included in the properties held by Eddy Brothers & Company were 1,703 shares of the capital stock of the Dominion Sugar Company, Ltd., a Canadian corporation, which were carried on the books of Eddy Brothers & Company at their par value of $100 per share, or $170,300. In January, 1915, without consulting the petitioner or its officers, Charles A. Eddy, Charles F. Eddy and the Eddy Investment Company, being three of the members of Eddy Brothers & Company, regardless of whether that company be a partnership or an association at that time, transferred in varying amounts to themselves as individuals and to Ellen A. Eddy, sister of Selwyn Eddy, the stock of the Dominion Sugar Company, Ltd. The stock was transferred at a value of $110 per share. The parties to whom the stock was transferred were creditors of Eddy Brothers & Company and their accounts on its books were charged with an amount equal to $110 per share for the number of shares transferred to each.
Eddy Brothers & Company submitted annual statements to its members. When Edwin M. Eddy, secretary-treasurer of the petitioner, 1932 BTA LEXIS 1394">*1399 early in 1916 received the annual statement for 1915 he discovered that the 1,703 shares of stock of the Dominion Sugar Company, Ltd., were not included in the assets. He thereupon wrote for an explanation and was informed that the stock had been transferred as heretofore set forth. He protested the disposition thus made of the stock and in the summer of 1916 went from San Francisco to Bay City, Michigan, to discuss the matter with the members of Eddy Brothers & Company residing there. One or two conferences were held, at which were present Charles A. Eddy; Fred G. Eddy, representing his father Charles F. Eddy; Robert B. Eddy, representing the Eddy Investment Company; and Edwin M. Eddy, representing the petitioner. Edwin M. Eddy on behalf of the petitioner contended that the stock had not been transferred at a fair price, since it was worth more, and that the parties who had received it should return it to Eddy Brothers & Company. This, however, was not done.
At the time of these negotiations the petitioner was indebted to Eddy Brothers & Company in the amount of $17,188.71 on open account. The other parties present at the negotiations suggested to 25 B.T.A. 1341">*1344 Edwin M. Eddy1932 BTA LEXIS 1394">*1400 that the controversy be settled by giving the petitioner credit for this amount on its open account, thus canceling the obligation of the petitioner to Eddy Brothers & Company. This plan of settlement was agreed to by Edwin M. Eddy. Under date of July 18, 1916, a journal entry, which was signed by the interested parties, was made on the books of Eddy Brothers & Company, crediting the petitioner with the amount of $17,188.71 and charging the parties who received stock with amounts equal to $10.09319 additional for each share of stock received by them. The explanation of the entry thus made is as follows: "As differences have arisen with reference to division of the Dominion Sugar Co., Ltd. Stock made January 28, 1915 the above entry is made to settle such differences." There was otherwise no payment of the amount to the petitioner.
At the time of the negotiations and settlement the petitioner's representative had no personal information regarding the true value of the stock of the Dominion Sugar Company, Ltd. His uncle, Charles A. Eddy, was a member of the company's finance committee and he relied absolutely on the representations of his uncle when he agreed to he settlement.
1932 BTA LEXIS 1394">*1401 After the settlement of July 18, 1916, Edwin M. Eddy proceeded to New York. En route he obtained certain information which led him to believe that the stock of the Dominion Sugar Company, Ltd., was worth more than that employed in making the above mentioned settlement. He then returned to Bay City and informed his uncle, Charles A. Eddy, that the settlement of July 18, 1916, was not just to the petitioner and that he was not satisfied with it. He insisted that the petitioner should received a substantially larger amount if the matter were to be settled in that manner. He also employed an attorney and threatened to bring suit. At this time he found that Charles A. Eddy was failing mentally and was not competent to transact business. Charles F. Eddy had been incapacitated for transacting business for some time. He discussed the matter with Fred G. Eddy, representing Charles F. Eddy, and Robert C. Eddy, representing the Eddy Investment Company. They admitted to him that the petitioner had not been paid enough on account of the stock and that it was entitled to receive more. They agreed to "fix it up" when Charles A. Eddy got over his mental condition or after his death. They1932 BTA LEXIS 1394">*1402 also wanted to consult J. W. Eddy, a brother of Robert B. Eddy, in connection with the action to be taken. Financial statements of the Dominion Sugar Company, Ltd., as at January 1, 1915, were sent for. With negotiations in this state Edwin M. Eddy left Bay City. Negotiations drifted along and once or twice each year Edwin M. Eddy would return to Bay City for further discussions of the matter. In the meantime he had several conferences in 25 B.T.A. 1341">*1345 connection with the matter with his cousins and members of the family. Some time prior to 1920 Charles A. Eddy and Charles F. Eddy died. Thereafter and prior to 1920 a settlement of the controversy was reached between Edwin M. Eddy and the interested parties, wherein it was agreed that the petitioner was to receive an additional payment based on the value of the stock of the Dominion Sugar Company, Ltd., on January 1, 1915. On some undisclosed date thereafter Stanley Eddy, representing the estate of Charles A. Eddy; Fred G. Eddy, representing the estate of Charles F. Eddy; Robert B. Eddy, representing the Eddy Investment Company; and Edwin M. Eddy, representing the petitioner, had a conference in Bay City, at which the amount to1932 BTA LEXIS 1394">*1403 be paid the petitioner pursuant to the settlement agreement was computed to be $57,033.35. On October 14, 1920, the petitioner received payment of that amount.
No part of the amount of $57,033.35 thus received by the petitioner was reported as income in its 1920 return. In determining the deficiency here involved the respondent included the amount as taxable income to the petitioner for 1920.
In 1920 the assets and liabilities of Eddy Brothers & Company were taken over by a corporation known as Eddy Brothers, Ltd., formed in 1920 for that purpose. In final liquidation of its interest in the properties held by Eddy Brothers & Company, the petitioner received stock of a par value of $124,500 of the corporation, or one-fourth of its capital stock.
No amount was reported by the petitioner in its 1920 return as a profit resulting from the liquidation of its interest in Eddy Brothers a profit resulting from the liquidation of its interest in Eddy Brothers & Company.
The petitioner's books of account were kept on an accrual basis and its 1920 return was made on that basis.
The petitioner filed its 1920 return with the collector of internal revenue for the first collection1932 BTA LEXIS 1394">*1404 district of California on March 15, 1921. The petitioner and the respondent have executed the following instrument with respect to the extension of the period of limitations:
INCOME AND PROFITS TAX WAIVER
For taxable years ended prior to January 1, 1922
Sept. 14, 1925.
IT:CA 2554-2
In pursuance of the provisions of existing Internal Revenue Laws The Selwyn Eddy Company, a taxpayer of San Francisco, Calif., and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the year (or years) 1920 and 1921 under existing revenue acts, or under prior revenue acts.
25 B.T.A. 1341">*1346 This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended1932 BTA LEXIS 1394">*1405 by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board.
[Signed] THE SELWYN EDDY CO.
Taxpayer
By EDWIN M. EDDY, Treas.
D. H. BLAIRCommissioner
Commissioner
If this waiver is executed on behalf of a corporation it must be signed by such officer or officers of the corporation as are empowered under the laws of the State in which the corporation is located to sign for the corporation, in addition to which, the seal, if any, of the corporation must be affixed.
The notice of the deficiency involved herein was mailed by the respondent to the petitioner on October 4, 1926, and on November 29, 1926, the petitioner filed its petitioner with the Board.
OPINION.
TRAMMELL: The parties are not in accord as to the relationship existing between Charles A. Eddy, Charles F. Eddy, the Eddy Investment Company, and the petitioner from the organization of the petitioner in February, 1914, down to 1920. The petitioner, apparently relying upon the agreement of February 4, 1899, between the members of the then existing partnership and set out in our findings of fact, takes the view that the partnership1932 BTA LEXIS 1394">*1406 was continued on down into 1920. The respondent, relying on certain decisions of the Supreme Court of Michigan, takes the view that the partnership was dissolved by the death of John F. Eddy, which occurred about 1900; that thereafter the surviving partners were trustees for the purpose of winding up the affairs of the partnership; that the Eddy Investment Company and the petitioner never became members of the partnership and that they merely acquired equitable interests in the properties of the former partnership held by the surviving partners as trustees. In view of our disposition of the issues presented by this proceeding we do not deem it necessary to decide which, if either, of the above views is correct. Irrespective of the legal relationship existing between the parties, properties were held and business was conducted under the name of Eddy Brothers & Company. Our decision would be the same regardless of whether Eddy Brothers & Company were a partnership or some other form of organization.
The respondent has included in the petitioner's taxable income for 1920 the amount of $57,033.35 received by the petitioner in that 25 B.T.A. 1341">*1347 year in connection with the final settlement1932 BTA LEXIS 1394">*1407 of the controversy as to the transfer of the stock of the Dominion Sugar Company, Ltd., as set out in our findings of fact. The respondent's position is that the petitioner's capital investment in its one-fourth equitable interest in this stock, together with its investment in the other properties held by Eddy Brothers & Company, was returned to it by the payments in cash and stock which it received from Charles A. Eddy and Charles F. Eddy or their representatives as surviving partners; that the amount received by the petitioner in settlement of the controversy relating to the stock was income to the petitioner for the year in which petitioner's claim was finally adjusted; and that the amounts which the petitioner was to receive was not finally ascertained until 1920. The petitioner contends that the amount of $57,033.35 constituted a return of capital, but that if it was taxable income it accrued prior to 1920 and therefore is not to be included in income for 1920.
Where a taxpayer keeps its books on the accrual basis its income is to be reported in the year in which it accrues, irrespective of the fact that it is received in a subsequent year. 1932 BTA LEXIS 1394">*1408 . The parties are in agreement that the petitioner kept its books on the accrual basis. Consequently, if the amount in controversy accrued prior to 1920 it may not be included in income for that year. The evidence shows that in 1916 the petitioner's right to receive further payment on account of the stock was admitted. It also shows that some time prior to 1920 a settlement of the controversy was reached between the interested parties, where in it was agreed that the petitioner was to receive an additional payment based on the value of the stock of the Dominion Sugar Company, Ltd., on January 1, 1915. This agreement not only definitely fixed the petitiioner's right to receive an additional payment, but also fixed the basis for computing the amount or extent of such payment. The petitioner's right to receive such payment and the basis upon which it was to be made were no longer an open question. It was thenceforth entitled to receive the amount disclosed by a computation based on the agreement.
The basic idea underlying the accrual system of accounting is that the books shall immediately reflect obligations and expenses1932 BTA LEXIS 1394">*1409 definitely incurred and income definitely earned. It is not necessary that the amount of such items be exactly ascertained in order to accrue them, if a mere calculation or computation based on ascertained factors is all that ermains to be done. . In the instant case we are not informed as to when the computation of the amount received by the petitioner was made. However, that is not important since we know that the right to receive such amount became fixed and determined prior to 1920. In 25 B.T.A. 1341">*1348 our opinion the petitioner's right to receive the payment here involved accrued prior to 1920. Consequently, the amount accrued prior to that year, even though it may not have been exactly ascertained until during 1920. Since the amount accrued prior to 1920, it becomes unnecessary to determine whether it constitutes income as contended for by the respondent or was a return of capital as contended by the petitioner. In any event, it would not be taxable in 1920.
In an amended answer filed at the hearing the respondent alleges that the petitioner realized a profit on the liquidation of its interest in Eddy Brothers & Company in 1920, 1932 BTA LEXIS 1394">*1410 and seeks to have the amount of the deficiency increased by including in the petitioner's income the amount so realized. The burden with respect to the issue thus raised is upon the respondent.
In his brief the respondent contends that the amount of income realized by the petitioner on the liquidation of its interest in Eddy Brothers & Company was $101,765.85, which he computes as follows:
| Fair market value of petitioner's interest at the time acquired on February 4, 1914 | $165,954.83 | |
| Cash or its equivalent received by the petitioner between 1914 and 1920 and representing a return of petitioner's investment in its interest | 87,344.59 | |
| Unreturned basis on January 1, 1920 | 78,610.24 | |
| Received in 1920: | ||
| Cash | $3,000.00 | |
| Stock of Eddy Brothers, Ltd., of a fair market value of | 177,376.09 | |
| 180,376.09 | ||
| Profit realized in 1920 | 101,765.85 |
To sustain his contention the respondent relies very largely upon entries contained in the petitioner's books of account.
To determine whether the petitioner realized any profit on the liquidation of its interest in Eddy Brothers & Company it is necessary for us to known the cost to the petitioner of such interest1932 BTA LEXIS 1394">*1411 at the time of acquisition on Februay 4, 1914, as well as the amount of money and the fair market value at the time of receipt of property received by the petitioner in liquidation. The record shows that upon organization on February 4, 1914, the petitioner took over all the assets and assumed all the liabilities of the estate of Selwyn Eddy and issued therefor its authorized capital stock of $100,000 par value. With the exception of the estate's interest in Eddy Brothers & Company, which the evidence indicates was its principal asset, and its liability of $5,330.15 to that company, we are not informed as to the assets taken over by the petitioner or their value, 25 B.T.A. 1341">*1349 nor are we informed as to the liabilities or the amount thereof. No evidence was offered as to the market value of the stock issued in exchange for the net assets taken over, and, even if we knew such value, we are still uninformed as to the amount of stock issued for the interest in Eddy Brothers & Company. Assuming that the stock had a value equal to the fair market value of the net assets received therefor and that the cost to the petitioners of its interest in the association was the fair maket value thereof1932 BTA LEXIS 1394">*1412 at the time of its receipt, we will examine the respondent's computation of profit in the light of the evidence. The evidence shows that when it acquired its interest in Eddy Brothers & Company on February 4, 1914, the petitioner set such interest up on its books at a value of $100,000. The secretary-treasurer of the petitioner, under whose supervision the books were kept, testified that in placing the interest on the books at that amount no thought was given to values, but there was just "the question of putting these things on the books, any item that came into my head. That is the way the books were started; it was not done as a matter of valuing those upon the books."
The evidence further shows that under date of December 31, 1918, the petitioner made an adjusting entry on its books with respect to the entry by which it had placed on its books its interest in Eddy Brothers & Company at $100,000 on February 4, 1914. In this adjusting entry the petitioner wrote up by $65,954.83 the value at which its interest had been entered on the books on February 4, 1914. The explanation as given in the entry for this write-up in value was that it was to set up the fair value of petitioner's1932 BTA LEXIS 1394">*1413 interest at the date acquired. The amount of $65,954.83 was explained as follows:
| Net worth - 12-31-11 | $663,819.33 |
| 1/4 | 165,954.83 |
| As set up | 100,000.00 |
| Difference | 65,954.83 |
This computation indicates that the net worth of Eddy Brothers & Company at December 31, 1911, was used as a basis for arriving at the amount of $65,954.83, even though the petitioner had not then acquired its interest in that company and did not acquire it until more than two years afterwards.
With respect to the adjusting entry, the petitioner's secretary-treasurer testified that the amount of $65,954.83 was not arrived at as the result of any appraisal, nor was it the result of any investigation on his part, but was based on a statement sent to him. Apparently this statement was sent by those in active charge of the business of Eddy Brothers & Company.
25 B.T.A. 1341">*1350 Relying on the foregoing book entries and on the statement contained in the petitioner's capital-stock-tax return for the fiscal year ended June 30, 1916, that the fair value of the total capital stock for that fiscal year was $162,500, the respondent contends that the cost to the petitioner of its interest in Eddy Brothers1932 BTA LEXIS 1394">*1414 & Company at the time of acquisition on February 4, 1914, was not in excess of $165,954.83.
From what has been said above, we think it is clear that the amount of $100,000 at which the interest was entered on the petitioner's books on February 4, 1914, can not be accepted as representing its fair market value at the time acquired. Nor is the fact that this amount was increased on the books by $65,954.83 at December 31, 1918, of any weight when it is considered that the entry was not based on any appraisal nor upon any investigation made by the petitioner, but apparently upon the financial condition of Eddy Brothers & Company at a date more than two years prior to the date the petitioner acquired its interest therein. There is nothing in the record to indicate that the financial condition of Eddy Brothers & Company was the same on both dates. The statement contained in the petitioner's capital-stock-tax return for the fiscal year ended June 30, 1916, as to the fair value of its stock during that fiscal year does not throw any more light on what the fair market value of the interest was on February 4, 1914, than the other evidence relied on by the respondent. We recognize the1932 BTA LEXIS 1394">*1415 force of the respondent's argument that book entries in and of themselves might be considered to be admissions against interest and, as such, to be some evidence, but the testimony relating to these entries is in our opinion sufficient to deprive that evidence of any evidentiary force. The entries must be considered in the light of the explanations with respect thereto. Considering all the evidence on the point, we are unable to determine the fair market value of the petitioner's interest in Eddy Brothers & Company at the time of acquisition. Being unable to determine this essential fact, we can not determine that the petitioner realized a profit of $101,765.85 or any other amount on the final liquidation of its interest in the association in 1920. The respondent's contention that the petitioner realized a profit in 1920 on the final liquidation of its interest must therefore be denied.
The petitioner amended its petition to allege that it sustained a loss on the liquidation of its interest in Eddy Brothers & Company. Apparently the issue raised by this allegation has been abandoned by the petitioner, since it offered no evidence in support thereof and makes no contention with1932 BTA LEXIS 1394">*1416 respect thereto in its brief. But whatever may be the petitioner's position with respect to the issue, it must be decided adversely to the petitioner for the reason that we are unable 25 B.T.A. 1341">*1351 to determine what the fair market value of the petitioner's interest was at the time of acquisition.
The remaining issue relates to the running of the period of limitations against assessment and collection of the increase in the deficiency as proposed by the respondent at the hearing. Since the proposed increase in the deficiency was based upon the respondent's contention that the petitioner realized a profit in 1920 on the final liquidation of its interest in Eddy Brothers & Company, and as this contention has been decided adversely to the respondent, the issue relating to limitations becomes a moot question which we are not called upon to decide.
Judgment will be entered under Rule 50.