*1093 Where more than 75 percent of the purchase price of personal property was placed in escrow as security for petitioners' agreement to refrain from entering a competing business, and the escrow agent was instructed to release one fifth of the escrow funds each year provided the vendor had not entered a competing business, the vendor is entitled to report the profits resulting from the sale on the installment basis, and receipt of the balance of the purchase price by the escrow agent does not constitute constructive receipt to the vendor, even though the latter has the right to invest and reinvest the funds held in escrow.
*624 These proceedings involve deficiencies in income taxes as follows:
| Docket No. | Year | Deficiency | |
| Rebecca Murray | 40174 | 1926 | $6,637.34 |
| Rebecca J. Murray | 58857 | 1927 | 1,577.46 |
| Edward J. Murray | 40176 | 1926 | 6,452.82 |
| E. J. Murray | 58858 | 1927 | 1,635.31 |
*625 The proceedings were consolidated as there is one issue common to each, that is, whether the sale of certain*1094 stock in 1926 was a closed transaction in that year, or whether it was a sale on the installment basis. Dockets 40174 and 40176 contain nine allegations of error, but each allegation in each petition is grounded upon the issue aforementioned, and a decision on this issue will dispose of each and every error alleged in these dockets. Docket 58858 contains two additional allegations of error, one relating to a loss sustained by the petitioner upon the demolition of a building, and the other relating to a claimed deduction because of rental commissions paid by petitioner during the calendar year 1927. At the hearing petitioner abandoned claim for a loss resulting from the demolition of the building and respondent conceded the other deduction, which leaves but the one question for us to decide.
FINDINGS OF FACT.
The petitioners are husband and wife, who, prior to October 1926, were engaged in the publishing business at Klamath Falls, Oregon, and were the owners of the capital stock of the "Herald Publishing Company of Klamath Falls, Oregon."
On or about October 14, 1926, the petitioners entered into an agreement with Bruce Dennis, of Oregon, whereby they deposited a bill of*1095 sale, together with certificates of stock, duly endorsed, representing 120 shares of the capital stock of the Herald Publishing Co., of Klamath Falls, with the Crocker First Federal Trust Co. of San Francisco, California; Dennis deposited $95,900 in cash and his promissory note for $35,000 with the trust company, securing the note by certain collateral deposited therewith. In addition to the above, petitioners and Dennis executed and delivered to the trust company certain escrow instructions. The parties to the agreement covenanted and agreed that they would abide by these escrow instructions; that the properties described in the bill of sale were free from all encumbrances except as specified therein; that $65,000 in cash and the note should remain in escrow as security for the following covenant on the part of the petitioners: "That they [petitioners], will not, for the period of five years, from the 1st day of October, 1926, engage in any manner or form in the printing or publishing business, or in the printing or publishing of a newspaper or newspapers or invest in any business engaged in printing or publishing, in the County of Klamath, State of Oregon, and in the event that*1096 the parties of the first part, or either of them, should engage in any form in such printing or publishing business, as hereinabove set forth, they will surrender all right to have delivered to them any *626 portion of said sum of Sixty Five Thousand Dollars, or said promissory note of the said Bruce Dennis, or any of the proceeds of said note so deposited in escrow with the Crocker First Federal Trust Company of San Francisco, California. The foregoing Agreement is made in view of the fact that the party of the second part is paying a large sum of money for the aforesaid plant, equipment and newspapers, and it is recognized that the good will of said business would be wholly destroyed or impaired by the re-entering of the parties of the first part into said publishing business within said restricted period of time."
The agreement further provided for the payment of all outstanding bills and claims by the petitioners and delivery of the business free and clear, except for one certain mortgage specifically mentioned; that the petitioners would pay all income taxes against the corporation to the date of transfer, and that they would resign as directors of the corporation and*1097 turn the corporate seal and records over to Dennis.
The escrow instructions were contained in a letter addressed to the trust company, bearing date of October 14, 1926, which lists the items deposited in escrow as follows: bill of sale, dated October 14, 1926, executed by the petitioners to Bruce Dennis; 120 shares of capital stock of "Herald Publishing Company of Klamath Falls, Oregon"; $80,900 in cash; a cashier's check in favor of E. J. Murray for $15,000; a promissory note signed by Dennis made payable to the trust company in the sum of $35,000, the payment of which was secured by collateral consisting of notes, Liberty bonds, bank and telephone stocks. The escrow instructions authorized the trust company, after searching the title, to deliver the 120 shares of stock to Dennis, to pay E. J. Murray $15,900 in cash and turn over the cashier's check to him, and to hold the remainder of the cash, $65,000, and the promissory note in escrow subject to the following instructions; quoting only that portion thereof which is pertinent to these proceedings:
2. In the event that said note, or any part thereof, is paid either by voluntary payment or by suit or foreclosure, as hereinbefore*1098 provided, you are to hold the proceeds of said note subject to the same provisions as we are hereinafter setting forth for the handling of said sum of $65,000.00, and as though the proceeds of said note were a part of said sum of $65,000.00.
3. Said sum of $65,000.00 shall be invested and reinvested by you in such securities as may be designated and selected by the said E. J. Murray and the said Rebecca Murray, provided that said securities are either of Strauss & Company or securities listed on the New York Stock Exchange, and you are to pay over the income therefrom to the said E. J. Murray, except as hereinafter provided, provided, however, that except as hereinafter provided, the *627 said E. J. Murray shall have the right to receive upon the 1st day of October, 1927, and upon the first day of October of each succeeding year until all of said securities are delivered to him $20,000.00 face or par value of said securities to be selected by the said E. J. Murray and the said Rebecca Murray, provided, however, that in no event shall the total securities delivered to the said E. J. Murray in any one year be of greater market value at the time of such delivery than the sum*1099 of $20,000.00.
4. In the event that at any time when securities or cash mentioned in Paragraph III of this Agreement are still on deposit with you the said Bruce Dennis shall present to you an affidavit stating that either the said E. J. Murray or the said Rebecca Murray, either as a proprietor, or as a principal, or as employee, or otherwise, has engaged in the business of printing or printing or publishing a newspaper or newspapers and/or has engaged in the printing or publishing business anywhere in Klamath County, Oregon, you are to immediately cease paying over to the said E. J. Murray any of the income from said securities then on deposit with you, and you are to hold all of said securities then on deposit with you, and any of said cash then on deposit with you which has not been invested in securities or constituting the proceeds of any of said securities, until the rights of the said Bruce Dennis and of the said E. J. Murray and the said Rebecca Murray have been determined by some court of competent jurisdiction.
5. Any investment made by you at the direction of E. J. Murray and Rebecca Murray shall be without responsibility on your part.
During 1926 the petitioners*1100 received $30,900 in cash under the above agreement.
The petitioners exercised their right under the above escrow instructions to invest and reinvest the funds placed in escrow by purchasing, during November 1926, various securities at a total cost of approximately the sum held in escrow. Additional purchases and numerous sales of securities were made by the petitioners through the escrow holder during the years 1927, 1928, 1929 and 1930.
During the taxable years in question the petitioners were to and did receive the income from the securities and the interest on the promissory note of $35,000 which was held in escrow by the trust company, and beginning in 1927 they received the annual payments provided for in the escrow agreement.
Petitioners elected to report the profit derived from the sale of the capital stock upon the installment basis, and their returns for 1926 reported such profit in the amount of $13,953.18 for E. J. Murray and $13,953.19 for Rebecca Murray. The respondent held that the sale was a closed transaction in 1926, and that the entire gain resulting from the sale, $117,184.14, was taxable income in 1926.
For the calendar year 1927 the respondent, in*1101 order to protect the interests of the Government, has asserted deficiencies against each of the petitioners upon the theory that the profits were to be reported on the installment basis. In so holding he increased the taxable income of each petitioner by $24,833.60, but at the hearing he admitted *628 that the profit realized by each in 1927, if the profit is to be reported on the installment basis, was $9,031.19.
OPINION.
MARQUETTE: The controversy here is whether the profit derived from the sale of the capital stock of the Herald Publishing Co. should be reported on the installment basis, or should be reported entirely in the year 1926 upon the theory that the sale was a closed and completed transaction in that year.
Section 212(d) of the Revenue Act of 1926 authorizes taxpayers to report income on the installment basis in certain circumstances, viz.:
* * * In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) * * *, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, *1102 be returned on the basis and in the manner above described in this subdivision. As used in this subdivision the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.
Respondent contends that the sale of the stock was completed in 1926, and that the funds placed in escrow, together with the promissory note, were constructively, if not actually, received by the petitioners. The petitioners contend the transaction was a casual sale of personal property; that less than 25 percent of the purchase price was received in 1926, and that they reported income on a cash receipts and disbursements basis; that the contract was executory in that it had five years to run from October 1, 1926, and that they did not have unrestricted benefit of management or unqualified use, control or disposition of the unpaid balance. They further contend the trust company was not in theory of law the agent of the petitioners, and that income derived from securities was paid to them in lieu of interest on the promissory note; that they had the responsibility of any*1103 loss resulting from the investment of the escrow funds; and that under the terms of the agreement there was a possibility that Dennis would derive some profit from the management of the trust.
Regardless of the terminology that the parties have used in designating the character of this sale, that is, whether it be called a "closed transaction", a "completed sale", or a "casual sale", we are convinced that this is the type of transaction that the Congress had in mind when it provided an election for reporting income from the sale of personal property when less than 25 percent of the *629 purchase price was paid as an initial payment or payments. The facts are undisputed that during the year 1926 the petitioners received $30,900 in cash as the initial payment on stock which they sold for $130,900. The balance of the purchase price was placed in escrow, the receipt of which by the petitioners was conditioned upon their remaining out of the newspaper and publishing business for a stated period of time.
Respondent lays great stress upon the fact that there was nothing for the petitioners to do under the contract except to await the passage of a period of time, but the value*1104 that the purchaser placed upon this portion of the contract is measurable by the amount of security that he required to be held in escrow in order to protect his interest. It is clearly stated in the agreement that Dennis was paying a large sum of money and that the good will which he was acquiring would be wholly destroyed or impaired if he could not prevent the petitioners from reentering the field in a competing business. We believe that this condition was a vital part of the contract; definite, real, and not dependent in any way upon the whim or caprice of the petitioners, such as existed in the case of . The condition is virtually the same as that found in , where Liberty bonds were placed in escrow, payable so much per year for five years, providing the petitioner had not entered into a competing business. In that case we held that the amounts received in each year were income to the extent that they exceeded the capital investment in the business sold.
In *1105 , the petitioner in 1925 deposited certain certificates of stock in escrow, duly endorsed, receiving the purchase price in 1926. The purchaser had deposited the purchase price in escrow in 1925, and the question arose as to whether the loss sustained by the petitioner was realized in 1925, when the deposits were made under the escrow agreement, or whether the loss was realized in 1926, when the purchase price was paid. The Board held that the loss was sustained in 1926 because the petitioner had neither actually nor constructively received the purchase price as a result of delivery to the escrow agent. To the same effect is our decision in , affirmed on another point in .
In , certain interests in oil properties were sold for a consideration of $200,000, to be paid out of the proceeds from oil produced from the land. The oil proceeds were to be placed in escrow at a designated bank and the bank was to pay the vendors $50,000 per year beginning in 1921. The land proved to be very productive*1106 and the proceeds in 1921 amounted to *630 practically the full purchase price. The petitioners reported the income from the transaction on the installment basis and each claimed a deduction for depletion. The respondent disallowed the deduction and the petitioners appealed, contending that the income was taxable to them in the years in which the proceeds were deposited with the escrow agent. The Board held that the proceeds constituted income to the petitioners for the years in which received and that, having made their election to report income on the installment basis, they could not change and report on a different basis, when so doing would result in throwing a large part of income back in a prior year for which assessment and collection would be barred by the statute of limitations. To the same effect is (certiorari denied, ), reversing the Board in ; and , reversing the Board in *1107 .
In these proceedings the petitioners have elected to report income from the sale of the stock and their newspaper business upon the installment basis, as provided for in the above quoted section of the Revenue Act of 1926. It must be admitted that they realized no more income in 1926 than the amount which they reported, unless it can be said that the receipt of the money and note by the escrow agent constituted receipt by the petitioners themselves. We find no justification in the agreement for holding that the trust company acted as agent for either party to the exclusion of the other; rather we believe that the trust company acted in its proper capacity as a disinterested party obligated to see that the terms of the agreement were performed, and upon performance by the parties pay over to either or each of them the property specified in the agreement. Until there was performance by the party of the agreed conditions, there could be no transfer by the escrow agent; upon performance the escrow agent was required to turn over the property specified to the party entitled thereto, and, therefore, as each annual payment was made by the*1108 escrow agent to the petitioners, they realized a profit upon the sale made in 1926.
In view of the foregoing discussion and cited cases, it is our opinion that the petitioners have properly reported income from this sale on the installment basis, and that they should be taxed accordingly.
In determining the petitioners' tax liability for 1927 due regard should be given to the stipulation relating to the amount of profit received by each petitioner in 1927 and to the error conceded by respondent with respect to the disallowance of a deduction for rental commissions.
Decision will be entered under Rule 50.