1941 BTA LEXIS 1510">*1510 Petitioner on May 15, 1929, agreed to transfer certain properties to the F. A. Gillespie & Sons Co., the capital stock of which was held in trust for herself, her husband, and their sons for the period of their lives, with remainder to petitioner's grandchildren. As part consideration the transferee company agreed to pay petitioner two annuities totaling $25,000 annually. Held, the cost basis of the annuities to be used in computing the tax due under section 22(b)(2) of the Revenue Act of 1934 is the cost of these annuities from an insurance company and not the value of the transferred properties, which was in excess of that cost. F. A. Gillespie,38 B.T.A. 673">38 B.T.A. 673, distinguished.
43 B.T.A. 399">*400 The respondent has determined a deficiency in income tax for the calendar year 1935 in the amount of $1,476.55, which results from his inclusion in petitioner's income of the sum of $17,666.25 received by petitioner during the taxable year from F. A. Gillespie & Sons Co.
Questions presented are (1) whether the whole sum of $17,666.25 should1941 BTA LEXIS 1510">*1511 be excluded from income as a return of capital to petitioner; (2) whether that whole sum may be included in petitioner's income under section 2(b)(2) of the Revenue Act of 1934 as an annuity and, if so, whether that section so applied is unconstitutional; (3) whether only that portion of $17,666.25 which is not in excess of 3 percent of the fair cost on May 15, 1929, of an annuity which would produce $25,000 annually may be included in petitioner's income; and (4) Whether $2,666.25 of the $17,666.25 must be excluded from petitioner's income in any event as the proceeds of a loan.
Certain of the facts involved have been stipulated and are so adopted as our findings. The material portion of them is set out hereinafter with our other findings.
FINDINGS OF FACT.
Petitioner is an individual, residing at 712 North Roxbury Drive, Beverly Hills, California. She was born on June 9, 1872, and was married to Frank A. Gillespie, born August 27, 1868, in 1892. They had three sons, B. A. Gillespie, L. A. Gillespie, and P. A. Gillespie, and six grandchildren.
On April 4, 1920, F. A. Gillespie & Sons Co., a corporation, hereinafter called the company, was organized under the laws of1941 BTA LEXIS 1510">*1512 Oklahoma, with a capital stock of $1,000,000, divided into 10,000 shares of the par value of $100 each. The shares were issued 9,980 to F. A. Gillespie and 5 each to petitioner and B. A. Gillespie, L. A. Gillespie, and P. A. Gillespie. By an instrument executed on February 9, 1921, F. A. Gillespie, in consideration of the fact that equitable title to some of the properties transferred to the company for the issuance of its stock to him had theretofore been conveyed to petitioner and B. A. Gillespie, L. A. Gillespie, and P. A. Gillespie, thereby declared that he held 9,975 of the shares of the company in trust in equal shares for the four named individuals and F. A. Gillespie. The trust term was limited to the life of the last surviving beneficiary and the corpus was made distributable among the surviving children or grandchildren of petitioner and F. A. Gillespie or among their heirs. The 43 B.T.A. 399">*401 beneficiaries were entitled to receive currently all dividends paid on the stock and accretions thereto. On the death of petitioner or F. A. Gillespie within the trust period, the surviving children were to become entitled to the current distributions and on their death similarly1941 BTA LEXIS 1510">*1513 within the term of the trust this right was to pass to the grandchildren. The trustee was given broad powers of management and investment, and surviving trustees were designated.
Petitioner and F. A. Gillespie on May 15, 1929, entered into two agreements by the first of which, after reciting that they were living separate and apart and wished to settle their rights in their properties, they agreed mutually on the disposition of the property which they owned jointly and released each other reciprocally of all claims for support or inheritance. With the exception of certain personal and real property which was set aside for the contractors individually, the bulk of the property, it was agreed, was to be conveyed to the F. A. Gillespie & Sons Co. By the terms of the second agreement, which was executed by petitioner, F. A. Gillespie, and the company, the two first named conveyed to the company the following property, of the values indicated, which they owned jointly:
| Value | |
| U.S. First Liberty Loan bonds and Port of New Orleans, Louisiana, state bonds | $1,172,000.00 |
| Empress Building, Tulsa Oklahoma | 150,000.00 |
| Sundry lands and lots located in Oklahoma | 22,512.00 |
| Cash and accounts receivable | 94,365.22 |
| Sundry stocks | 25,363.00 |
| Total | 1,464,240.22 |
1941 BTA LEXIS 1510">*1514 The cost of the above property to F. A. Gillespie and petitioner equaled or exceeded the above fair market value.
As part consideration for the conveyance of these properties the company agreed to pay to F. A. Gillespie and petitioner, each respectively, the sum of $15,000 per year for life and guaranteed to petitioner, in addition, that she should receive annually as dividends an amount equal at least to $10,000. If funds were not available for the declaration of dividends in this amount, the company agreed to pay such sum to the petitioner. F. A. Gillespie agreed in addition that he would not sell any of the shares of the company which he held in trust without the consent of a majority of the company's directors.
The conveyances of property by petitioner to F. A. Gillespie & Sons Co. in accordance with such tripartite agreement were made for two purposes, namely, first, as a purchase of the specified annuity to herself during her life, to the extent of the fair cost thereof, and, secondly, as a gift of the excess of the value of such properties over such cost for the benefit of her children and grandchildren.
43 B.T.A. 399">*402 At a meeting of the board of directors of the1941 BTA LEXIS 1510">*1515 company duly called on February 18, 1932, the contract executed by the company on May 15, 1929, under which the parties had been acting, was adopted and ratified in view of the fact that "the acquisition by this Company of the properties and assets referred to in said contract are [sic] of great value and largely in excess of the amounts provided to be paid under the terms of said contract by this corporation." It was acknowledged by further resolution of the directors that the company had received all the properties agreed to be transferred to it under the contract.
On the same date, February 18, 1932, deeds transferring the realty identified above as the Empress Building, and the Gillespie residence in Tulsa, included above in sundry Oklahoma lands, were executed to the company. A final deed covering lands agreed to be conveyed in Oklahoma was executed on June 25, 1934.
During the year 1932 petitioner and the company became involved in certain litigation in which the company asserted a claim for debt against petitioner in the amount of $17,845.05. This controversy was settled by the petitioner's agreement to pay the company onehalf of this claim, less certain minor1941 BTA LEXIS 1510">*1516 deductions, out of the $10,000 which should become due to her from the company on May, 15, 1932, and by the transfer to the company of certain realty in Santa Monica, California, owned by petitioner. The company agreed to pay to petitioner at once $10,000 owed by it under the contract less $2,000 for attorneys' fees and $2,000 already paid to petitioner.
On June 22, 1932, certain lots of real property of undetermined value owned by petitioner and located in Santa Monica, California, were transferred to the company.
Petitioner, on November 16, 1933, in view of the depleted financial condition of the company, agreed to the suspension of the dividend payments of $10,000 annually for three years or for such shorter period as the company was unable to make them. This agreement was made contingent on the suspension by F. A. Gillespie of his right to receive $10,000 annually from the company, the funds thereby freed to be used in building up the concern. It was also made contingent on the payment to petitioner of one-half of the "net refund on Federal taxas" received by F. A. Gillespie in December 1932. It was stated that petitioner owned a building in Los Angeles, a $15,000 second1941 BTA LEXIS 1510">*1517 mortgage on which she was obligated to discharge at the rate of $2,500 annually, and that the funds to be received from F. A. Gillespie were to be applied on this obligation.
The following payments were made under the agreement of May 15, 1929, by the company to petitioner and F. A. Gillespie on the dates indicated:
| Petitioner | Gillespie | |
| 1932 | $34,894.01 | $54,375 |
| 1933 | 25,000.00 | 15,000 |
| 1934 | 20,000.00 | 15,000 |
| 1935 | 17,666.25 | |
| 1936 | $19,000.00 | |
| 1937 | 15,000.00 | |
| 1938 | 15,000.00 | |
| 1939 | 15,000.00 |
43 B.T.A. 399">*403 Of the amounts paid in 1932, $15,394.01 received by petitioner and $39,375 received by F. A. Gillespie represent adjustment of amounts remaining due under the contract for the years 1929, 1930, and 1931.
Of the amount received by petitioner during 1935, the taxable year, $2,666.25 is noted on the books of the company as a loan. However, petitioner did not sign a note nor give security for this amount. No interest was agreed on and up to the time of the hearing in this proceeding no payment of principal or interest had been made.
An annuity upon the life of a male individual born in the United States on August 22, 1868, which would have paid $15,0001941 BTA LEXIS 1510">*1518 per annum to him for his life could have been purchased form a reputable life insurance company doing business in the United States on May 15, 1929, for the sum of $153,750.
An annuity upon the life of a female individual born in the United States on June 9, 1872, which would have paid the sum of $15,000 per annum to her for her life could have been purchased from a reputable life insurance company doing business in the United States on May 15, 1929, for the sum of $196,537.50. An annuity upon the life of a female individual born in the United States on June 9, 1872, which would have paid the sum of $20,000 per annum to her for her life could have been purchased from a reputable life insurance company doing business in the United States on May 15, 1929, for the sum of $262,050. An annuity upon the life of a female individual born in the United States on June 9, 1872, which would have paid the sum of $25,000 per annum to her for her life could have been purchased from a reputable life insurance company doing business in the United States on May 15, 1929, for the sum of $327,562.50.
OPINION.
HILL: The substantial question which we are called on to decide here is the nature1941 BTA LEXIS 1510">*1519 of the contract entered into between petitioner and F. A. Gillespie and the company on May 15, 1929. The petitioner argues initially (1) that it constituted a sale of the properties transferred, with payment to be made in annual installments, and the annual payments, therefore, constituting a return of capital, may not be taxed as income. (2) It is contended in the alternative that if the amounts agreed under the contract to be paid to petitioner are considered annuities, their taxation under section 22(b)(2) of the Revenue Act of 43 B.T.A. 399">*404 1934, 1 is unconstitutional, since the statute, in making an arbitrary division between return of capital and income, taxes the former as income. This result, it is contended, is beyond the limits of the power conferred by the Sixteenth Amendment. (3) Petitioner argues further that, if the amounts in question are held taxable as annuities, the cost basis to be used in applying section 22(b)(2), supra, must be only the cost from a reputable insurance company of the annuity payable to the petitioner. It is agreed by both parties that the petitioner was the owner of one-half the properties transferred, the value of which was in excess of1941 BTA LEXIS 1510">*1520 the fair cost of annuity agreed to be paid to petitioner. This excess, it is contended, did not constitute consideration for the annuity but was a gift to the petitioner's children through the agency of the company and thus may not be included in the base on which the 3 percent taxable return is to be computed. (4) Finally, it is argued that $2,666.25 of the amount in question may not be taxed as income in any event, for the wholly separate reason that it represented the proceeds of a loan.
1941 BTA LEXIS 1510">*1521 (1) We may dispose of the first argument of the petitioner without extended consideration. The contract of May 15, 1929, may not, in our view, be interpreted as an ordinary sale or exchange of capital assets with payment to petitioner extended over several years. The distinguishing peculiarity of an annuity - that its continuance is dependent entirely on the life of the recipient of the payments - is here present. By statute, amounts received under contracts of this nature are made taxable to a limited degree and the direction of the statute may not be ignored. It can make no difference, in our opinion, that the consideration for the annuity was the transfer of property rather than money, and in this view we are sustained by Florence L. Klein,6 B.T.A. 617">6 B.T.A. 617, and Guaranty Trust Co. of New York, Executor,15 B.T.A. 20">15 B.T.A. 20.
43 B.T.A. 399">*405 (2) Adverting to petitioner's argument that the application of section 22(b)(2) to the facts presented is unconstitutional, we deem this contention without substantial basis. The scheme devised by Congress for taxing amounts received as annuities may not, in the light of its legislative history, be considered arbitrary, 1941 BTA LEXIS 1510">*1522 see Title Guarantee & Trust Co., Executor,40 B.T.A. 475">40 B.T.A. 475, 40 B.T.A. 475">480-482, or a tax on capital, see F. A. Gillespie,38 B.T.A. 673">38 B.T.A. 673. It is rather a method reasonably arrived at, which in the great majority of cases will result fairly for both the taxpayer and the tax gatherer. In a situation where the division between income and a return of capital is difficult, if not impossible, some latitude must be allowed to the lawmaker and the possibilities for an arbitrary result in isolated cases must be appraised against the necessity for taxing the transaction in question both as a means to revenue and as a means to discourage or prevent tax avoidance. In the light of the circumstances requiring the enactment of the statute in question, which are set out more at length in the cases cited above and in Anna L. Raymond,40 B.T.A. 244">40 B.T.A. 244, we can not say that it is unconstitutional as sought to be applied here by the Commissioner. Accordingly, petitioner must fail in this contention.
(3) The alternative argument of the petitioner presents essentially a question of fact: Whether the consideration for the annuity agreed to be paid to her under the contract1941 BTA LEXIS 1510">*1523 of May 15, 1929, was the entire property transferred by her under that agreement, or only that portion of the property required to purchase those annuities from a reputable insurance company.
This identical question as it related to the tax liability of F. A. Gillespie, cotransferor with petitioner under the agreement of May 15, 1929, was before us in 38 B.T.A. 673">F. A. Gillespie, supra, and we held there that the entire properties transferred were consideration for the annuities, in view of the provisions of the contract and in the absence of other evidence explaining the purpose of the transferors in conveying properties in excess of the fair cost of such annuities. In the present case that excess has been explained and the deficiency in evidence supplied. In her deposition petitioner has testified that her purpose in making transfer of the excess properties was to benefit her children or grandchildren and to safeguard their future income. This she thought best to accomplish by transferring all but a small portion of her properties to the company, instigating thereby a similar transfer by her husband. Since the children were then the beneficial owners of the larger part1941 BTA LEXIS 1510">*1524 of the company and were, by virtue of the 1921 trust agreement, to become the sole owners of the company, along with the grandchildren, this transfer secured to them the properties then owned by their parents. The last possibility of 43 B.T.A. 399">*406 the diversion of any of it away from them was precluded by the provision of the contract of May 15, 1929, that F. A. Gillespie might not sell any of the stock of the company held by him as trustee without the consent of the directors of the company. Petitioner testified in this proceeding, in effect, that she gave her properties to the company to safeguard her children and grandchildren, subject to the provision that certain sums be paid to her annually during her lifetime, and that she considered the remainder of the value of the property over the cost of such annuity to be a gift or contribution for the benefit of her children and grandchildren. This evidence, fitted with the circumstances of the instant case, compels the finding that the properties transferred to the company by petitioner in excess of the fair cost of the annuity secured to her thereby did not constitute consideration for that annuity. In the present circumstances it1941 BTA LEXIS 1510">*1525 becomes unnecessary to go further and decide whether the excess amount was paid to the company as a gift, as in 40 B.T.A. 244">Anna L. Raymond, supra, or as a contribution to capital, see Robert H. Scanlon,42 B.T.A. 997">42 B.T.A. 997. In neither event may this excess amount be included in the cost basis of the annuity required for computation of the tax due under section 22(b)(2).
Respondent objects to the consideration of the evidence noted on two grounds: It is argued, first, that the "issue that a part of the property transferred to the corporation was a gift" was not properly raised in the pleadings or at the hearing. This "issue" we regard as properly presented under petitioner's contention that only the fair cost of the annuities acquired may be used in computing the 3 percent limitation placed on the tax by section 22(b)(2). It forms an integral part of that argument and need not be pleaded as a separate issue. In the second place, respondent has moved to strike petitioner's entire testimony on this point on the ground that it is immaterial and that it conflicts with the parol evidence and best evidence rules. 1941 BTA LEXIS 1510">*1526 At the hearing ruling on this motion was reserved for disposition in this opinion. The materiality of the testimony to the issues presented we deem apparent. The parol evidence rule applies only as between the parties to the agreement and can not, therefore, apply in the instant case. See Bertelson & Peterson Engineering Co. v. United States, 60 Fed.(2d) 745; Indianapolis Glove Co. v. United States, 96 Fed.(2d) 816. Moreover neither rule may apply where there is ambiguity in the written language; here the terms of the two agreements entered into on May 15, 1929, conflict. In one the payment of annuities is described as "consideration" and in the other as "part consideration" for the transfer of the properties. The resultant confusion of meaning may properly be dispelled in this instance by the testimony of petitioner. See Bertelson & Peterson Engineering43 B.T.A. 399">*407 Co. v. United States, supra, at page 747. Cf. A. L. Wilson Co.,24 B.T.A. 1056">24 B.T.A. 1056. This conflict of terms was noted in 1941 BTA LEXIS 1510">*1527 F. A. Gellespies, supra, at page 677, but in the absence of any explanatory evidence the presumption favoring the Commissioner compelled the result reached there. Respondent's objections and motion are accordingly overruled.
(4) The final point of controversy on which we must rule here is the petitioner's claim that $2,666.25 of the amount received from the company was intended as a loan to be used to discharge a portion of the mortgage on petitioner's property, together with accrued interest. The evidence shows, however, that no note was executed as evidence of that loan, that no interest was agreed on or paid, and that no repayment of principal has been made. Neither was the loan reflected in the balance sheet of the company as an asset. In these circumstances, we think the petitioner has failed to make adequate proof that such an amount constituted a loan. The impression that it was paid as a part of the amount due under the agreement of 1929 is gained and strengthened by the fact that the company was a closely held corporation and that petitioner had shortly before the taxable year relinquished the right to receive a portion of her annuity in return for1941 BTA LEXIS 1510">*1528 the payment of an installment on the mortgage in question from another source. Accordingly, we hold that no part of the $17,666.25 received by petitioner during the taxable year was a loan and that the entire amount was paid as an annuity under the contract of May 15, 1929.
There remains the determination of the amount of income taxable to petitioner. This is to be computed on the basis of 3 percent of the cost of an annuity of $25,000 purchased by petitioner on May 15, 1929, from a reputable insurance company. The $25,000 figure must be taken in preference to the $15,000 sum contended for by petitioner, since the former amount was that for which the properties were transferred. Subsequent relinquishment of a portion of the annuity can not alter the determination of the amount which was transferred under the 1929 contract as consideration for the annuities receivable by petitioner. No argument is made, it should be noted, that the $10,000 guarantee of the dividends to be received annually by petitioner did not in itself constitute an annuity. Both parties seem to concede that it falls in a class with the $15,000 annuity and we have so treated it.
Since the parties have1941 BTA LEXIS 1510">*1529 stipulated that the cost of such an annuity is $327,562.50, petitioner's taxable income in 1935 is held to be 3 percent of that amount, or $9,826.88.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 22. GROSS INCOME.
* * *
(b) EXCLUSION FROM GROSS INCOME. - The following items shall not be included in gross income and shall be exempt from taxation under this title:
* * *
(2) ANNUITIES, ETC. - Amounts received (other than amounts paid byreason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be exclued from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation under paragraph (1) or this paragraph. ↩