Jordan Creek Placers v. Commissioner , 43 B.T.A. 131 ( 1940 )

JORDAN CREEK PLACERS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Jordan Creek Placers v. Commissioner

Docket Nos. 98057, 99210.

United States Board of Tax Appeals

43 B.T.A. 131; 1940 BTA LEXIS 846;

December 19, 1940, Promulgated

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1. Petitioner, organized as a mining partnership under the laws of Idaho, held to be an association taxable as a corporation.

2. Capital stock tax returns not filed within the statutory period held valid in the absence of prior returns filed either by petitioner or respondent.

3. Certain percentage payments made to the transferors of the option under which petitioner acquired the mining property held payments for the acquisition of a capital asset not deductible as operating expenditures.

Clyde C. Sherwood, Esq., John V. Lewis, Esq., and Albert H. Davidson, Esq., for the petitioner.

Arthur L. Murray, Esq, for the respondent.

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OPPER

These proceedings were brought for a redetermination of deficiencies in income and excess profits taxes for the years 1935 and 1936 as follows:

	1935	1936
Income tax	$1,071.65	$3,347.59
Excess profits tax	389.69	3,889.08

Petitioner has conceded that it is not entitled to any deduction in 1936 for Idaho State mining license tax. The issues outstanding are (1) whether petitioner, during the years in question, was an association taxable as a corporation or a partnership under the applicable revenue laws; (2) whether a delinquent filing of capital stock tax returns satisfies the statutory requirement; and (3) whether accruals on petitioner's books during the taxable years, in accordance with the terms of the option agreement through which it acquired its properties, represented capital expenditures.

FINDINGS OF FACT.

The case was presented upon a stipulation of facts and oral testimony. The facts are found as stipulated and those facts hereinafter appearing which are not from the stipulation are facts found from the record made at the hearing.

Petitioner is a mining partnership, created under the laws of Idaho, composed of Irving W. Bonbright, Sr., Irving W. Bonbright, Jr., O. B. Perry, and R. F. Lewis. It has its principal offices in San Francisco, California. In 1934 Bonbright, Sr., took over options on land at Jordan Creek, Idaho. These options were options held by Robert Bell and his wife to acquire certain properties from the owners. Bonbright, Sr., took these options under an agreement dated June 8, 1934, which was amended October 17, 1934. They were procured by R. F. Lewis and between the time of the original agreement and the amendment thereto the property was prospected by O. B. Perry. In May 1935, Lewis proceeded to Boise, Idaho, to exercise the options. The money for exercising the options was furnished by Bonbright, Sr. Pursuant to the agreement deeds from the owners to Bell and from Bell to Bonbright, Sr., were placed in escrow in a bank at Boise pending receipt of the cash. Lewis deposited funds in the bank, which were thereafter paid by the bank to the parties entitled to them under the escrow agreement. On settlement Lewis took delivery of the deeds.

In the agreement with Bells they were designated as the "sellers" and Bonbright, Sr., as the "buyers." The agreement originally provided for "a royalty of Fifteen percent (15%) of the net proceeds recovered from the mining operations," the buyer being entitled to a deduction of 4 cents a cubic yard for each yard dug until the amount so retained should equal the buyer's total capital investment. The modification of October 17, 1934, provided that the royalties should be 10 percent and increased the allowance to the buyer to 6 cents per cubic yard. Under the agreement the buyer agreed that if a dredge for operating the property was not built the property would be "reconveyed" to the Bells. The buyer was obligated to operate a dredge having a rated minimum capacity of 2,000 yards per day as continuously as reasonable working conditions would permit until the property was worked out. It was also provided:

* * * that if through act of God, loss or injury to the dredge, interference with Buyer's operations of the property by any Government authority or any other cause whatsoever the operations of the Buyer hereunder become unprofitable to him, he may, upon notice in writing to the Sellers of his election so to do, terminate and annul this agreement, in which event the Sellers shall be entitled to a reconveyance of the property from the Buyer and may retain as rental and liquidated damages all royalty or cash theretofore paid to them, and in such event, the Buyer will have the right to remove all plant machinery and equipment placed upon the property by him, such right to removal to be exercised within one year after having given the notice mentioned above in this paragraph.

In February 1935, Lewis urged the advisability of forming a partnership rather than a corporation and pointed out that the mining partnership form could be used. This was subsequently approved by Bonbright, Sr. Perry and Bonbright, Sr., had been business associates in approximately twenty mining enterprises over a period of about fifteen years. Two or three of these enterprises were incorporated and the remainder were conducted as partnerships.

As of May 27, 1935, Bonbright, Sr., his son, Irving W. Bonbright, Jr., Perry, and Lewis executed a "Partnership Agreement" creating a "mining partnership under the laws of Idaho."

The agreement, inter alia, provided:

The management and control of the partnership rests with the majority in interest, as evidenced by units owned. There will be a managing partner and a treasurer; these positions to be filled by vote of the partnership. The duty and responsibility of the managing partner will be to supervise and direct the mining operations and to employ and advise the mine manager, who will reside at the mine and have charge of actual operations. The manager's authority to incur indebtedness will be limited to the purchase of supplies, equipment and power; the payment of labor and taxes. He will always be subject to orders of the managing partner and the partnership. The managing partner will receive from the manager detailed monthly statements of operations. All proceeds from sale of bullion will be forwarded to the treasurer, to be applied by him for the benefit of the partnership. The treasurer will have the custody of the partnership funds and records and will keep the partnership books.

The liability of a partner for debts of the partnership is that fixed by the laws of Idaho governing mining partnerships. Units or interests in the partnership may be sold, and will, upon the death of a partner, pass to his heirs or executors, without dissolution of the partnership. The purchaser will acquire all the rights and privileges of the retiring partner, and the heir will succeed to all the rights and privileges of the deceased partner. No transfer of a partnership certificate will be completed, or recognized, until the outstanding partnership certificate has been surrendered to the treasurer or his authorized representative, and a new certificate has been issued to the incoming partner.

It was also recited that each partner was expected to interest himself personally in the conduct of the business; that a vote of the partners could be taken by means of communications addressed to the managing partner; and that title to all partnership real property was to be vested in Bonbright, Sr., and held in trust for the partnership. By vote of all the unit holders a manager and treasurer were elected, Perry being elected manager and one Garnier, who was in Perry's office in San Francisco, being elected treasurer. Garnier received no compensation from the partnership. Bonbright, Sr., was informed of the details of the operation and took an active interest in the conduct of the business as did Lewis.

Shortly after signing the agreement petitioner's accounts showed that the parties had furnished $125,000 in capital in the following amounts:

Irving W. Bonbright, Sr	$112,500
Irving W. Bonbright, Jr	5,000
O. B. Perry	5,000
R. F. Lewis	2,500

Certificates were issued to the parties showing their ownership of proportionate units in the mining partnership.

Petitioner operated under the May 27, 1935, agreement throughout the years in question.

There was no actual distribution of profits made by petitioner during the year 1935. During the year 1936 petitioner made distributions of $12,500 each on May 9, June 6, September 10, and November 6.

For the calendar years 1935 and 1936 petitioner filed partnership returns on Form 1065. On January 17, 1939, respondent sent the notice of deficiency in excess profits tax for 1936. On February 2, 1939, petitioner filed a capital stock tax return, Form 707 (with rider for the taxable year ended June 30, 1936, and on April 17, 1939, filed the petition herein. On March 15, 1939, respondent sent the notice of deficiency in excess profits tax for 1935. On June 8, 1939, petitioner filed a capital stock tax return, Form 707 (with rider attached) for the taxable year ended June 30, 1935, and on June 12, 1939, filed the petition herein.

No capital stock tax returns for the taxable years ended June 30, 1935, and June 30, 1936, other than those above mentioned, were filed by petitioner, nor did respondent prepare or execute any capital stock tax returns for petitioner.

During the years in question petitioner kept its books on an accrual basis and in 1935 accrued the sum of $1,602.18 and in 1936 the sum of $4,116.67 to the Bells under their agreement.

OPINION.

OPPER: Petitioner first contends that, having been organized as a "mining partnership" under Idaho law, it is a partnership, and not an association taxable as a corporation. For this conclusion it relies principally upon . It seems to us, however, that the distinction from that case will readily appear from a quotation taken from the opinion at page 867. "Petitioner in this case did not conduct its business upon the methods and forms used by incorporated bodies. It had no capital stock or certificates of interest in its ownership; no officers, trustees or directors; it had no charter and was not created by declaration of a trust or writing of any kind. All of the members of the petitioner actively engaged in the operation of the business and each had a voice in its management."

In the present case petitioner had certificates of interest which it is specifically provided must be canceled and new certificates issued before any transfer of ownership in the enterprise is to be recognized. It had officers consisting of a "managing partner" and a treasurer. It was created by a formal written document setting forth the relationship of the parties to each other and to the enterprise. And only the managing partner was actively engaged in the operation of the business, although, it is true, the other participants had a right to be heard on questions relating to the conduct of the business and were kept advised of its progress.

On the other hand, the conclusion that petitioner is taxable as a corporation is necessitated by more recent cases dealing with the subject, particularly that of . There all of the essential characteristics of the petitioner were present. Here, as in that case, title to the property was taken by one of the individuals "to be held in trust for the partnership." The interest of the parties was represented by shares or certificates which were transferable without terminating the enterprise. There was centralized control. And death of the participants did not effect a dissolution. It is true that complete limitation of personal liability, which is a normal attribute of the corporate form, is not necessarily present here, but neither was it in Both this , and the court concluded that this was insufficient to remove the taxpayer from the corporate class.

In the present case a perhaps more simple criterion presents itself. The participants in the enterprise expressly constituted themselves a mining partnership under Idaho law. In order to determine the characteristics of such an entity it is hence not unreasonable to be guilded by the provisions of Idaho statutes and the pronouncements of Idaho courts as to their meaning. For this purpose one reference will suffice. In ; , these statutory provisions were analyzed in detail. The court said:

* * * In short, a mining partnership, by virtue of our statute, in all its essential elements is precisely like a corporation. To make this fact perfectly apparent, let us paraphrase out statute. * * * Let us suppose a corporation owning a woolen factory, and regularly organized. Compare the principles announced with our mining partnership.

The court then proceeds to paraphrase the sections of the Idaho Revised Statutes dealing with mining partnerships, substituting "the word 'corporation' for 'mining partnership' and the words 'corporate property' for 'mine'" and concludes "They are the same principles that govern all corporations, to the extent of the control and management thereof."

Since the parties must be considered to have imported this decision, as an authoritative interpretation of Idaho law, into their contract which set up the enterprise under these very statutory provisions, we conclude that the agreement of the parties alone would be sufficient to demonstrate that this was more nearly like a corporation than other forms of organization. On this issue respondent is sustained.

The second point involves the effectiveness of capital stock tax returns filed by the petitioner after the deficiency notice had been sent but before these proceedings were instituted by the filing of petitions. Allegations of petitioner's action in filing the returns are set forth in the petition and their efficacy is placed in issue by appropriate denials in the answer. Under these circumstances we are of the opinion that the returns, although late and subject to delinquency penalty, were effective in the absence of a prior filing either by petitioner or by respondent in petitioner's behalf. See

In , the Board had before it the question whether a foreign corporation could obtain the benefits of filing an income tax return for the first time after the proceeding had been commenced and the pleadings completed, and where no issue as to the filing of the returns was raised by an amendment prior to the hearing. In ruling that it could not, the first ground relied upon by the Board (p. 702) was that "* * * the controversy between the parties respecting the effect of the filing of the returns does not represent an issue presented by the pleadings." It was on this ground alone that two Members concurred in the prevailing opinion. There can be no question that the case at bar is distinguishable in this respect, since, as has been noted, the present pleadings leave no doubt that the parties have properly joined issue on the question. The Board's decision in the Taylor case, however, is not limited to that phase of the controversy but also rules that the return was too late since it was filed subsequent to the deficiency notice. In reaching that conclusion the opinion states (p. 703):

* * * By section 233 the allowance to foreign corporations of the credits and deductions ordinarily allowable is specifically predicated upon such corporations filing returns. In view of such a specific prerequisite it is inconceivable that Congress contemplated by that section that taxpayers could wait indefinitely to file returns and eventually when the respondent determined deficiencies against them they could then by filing returns obtain all the benefits to which they would have been entitled if their returns had been timely filed. Such a construction would put a premium on evasion, since a taxpayer would have nothing to lose by not filing a return as required by statute.

We think that this reasoning is not applicable to the proceeding at bar. The purpose of the requirement of a capital stock tax return is not so much to advise the Commissioner of the true facts as to the taxpayer's income, as in the case of a foreign corporation, as it is to record the taxpayer's election of the value to be placed upon its capital stock. See . Petitioner had already filed returns of income as a partnership. The failure to file the capital stock tax returns was the result of a bona fide belief that, since petitioner was not an association taxable as a corporation, the returns were not called for by the statute. When it was advised that respondent's position was to the contrary, it filed the returns as the only method open to it of protecting its position should respondent be sustained in his claim. There had been no previous return of this nature by petitioner. Cf. . We see no reason, therefore, why Congress should have intended that under the circumstances here present the capital stock tax return should not be treated as petitioner's "first return" under the section. See

A capital stock tax return, even though delinquent by many months, is effective in the absence of a prior return, at least if filed previous to the deficiency notice. . It seems anomalous to conclude that the notice, which has the effect of apprising the taxpayer for the first time of the Commissioner's position that a return is permissible, should be the very instrument which precludes it from taking action to file one.

There is, on the other hand, ground for concluding that some such privilege is necessary if we are not to impute to the lawmakers an intention to impose an unbearable burden upon taxpayers who have been guilty of no more than an innocent mistake. For the effect of the declaration of value in the capital stock tax return for the first year is to fix that value, subject to certain adjustments here immaterial, for all time to come. Absent some provision in a later act permitting the declared value to be changed, a future development of which that Congress could have had no assurance, a taxpayer would be permanently bound by a declaration of value made in the first return. If we were to hold here that petitioner's erroneous but honest belief that such a return was not called for from it is sufficient to bar it forever from filing a return when respondent's contrary view is brought to its attention, we should be imputing to the Congress and intent to penalize such an error by barring the taxpayer for future years as well from the advantages conferred on other taxpayers similarly situated. This we are unwilling to do. "By the rejection of the delinquent return on the ground that it was filed too late, petitioner was denied the right to make a declaration of value which it was the obvious purpose of the statute to give. The words of the statute require no such harsh and incongruous result." For the reasons stated we conclude that effect may be given in these proceedings to the capital stock tax returns filed by petitioner subsequent to the deficiency notice but prior to the filing of the petitions which brought the controversy before this Board.

Finally, petitioners have treated certain payments made by them as ordinary and necessary business expenses and on that theory have taken deductions thereof on their tax returns. The disallowance of these deductions by respondent creates the remaining contested issue.

The payments in question are those made by petitioner as the result of its acquisition of the mine property. They are called for by a contract between petitioner and the holders of an option on the property, to whom we shall refer as the optionors. It appears that these optionors never at any time owned a proprietary interest in the property. Their participation in the transaction consisted merely of acquiring an option to purchase from the original owners and making the contract we have mentioned, which was in effect a conditional assignment of the option to petitioner. This contract provided in substance that if petitioner determined to exercise the option it would pay to the owners the purchase price of the property as fixed in the original option, the owners would deliver a deed to the optionors, "and thereupon and as part of the same transaction" the optionors would deliver one to petitioner. When the transaction actually occurred, this provision was effectuated by an escrow under which the two deeds were placed with a bank and delivered to petitioner upon its payment of the purchase price to the original owners. It is apparent that thus far no proprietary interest ever vested in the optionors, for by the same transaction in which they obtained title they transferred it.

The payments to be made to the optionors - those giving rise to the present question - are specified in the agreement between them and petitioner and are percentage payments continuing apparently so long as mining operations are carried on. It seems to be recognized by both parties that if these are capital expenditures paid for the acquisition of petitioner's capital asset they are not deductible in the form of business expenses. Respondent refers to , as authority for the statement that payments will be construed as capital items if no interest in the property was retained by the payee. See . See also . For all that appears petitioner does not question this principle but maintains that here an interest was retained by the optionors by virtue of the provision of the assignment contract which permits the petitioner to "terminate and annul this agreement in which event the sellers [optionors] shall be entitled to a reconveyance of the property from the buyers [petitioner] and may retain as rental and liquidated damages all royalty or cash theretofore paid to them."

It seems to us that this is a provision for acquisition by the optionors, rather than for retention by them, of an interest. Since, as we have seen, they obtained none in the first instance and since such rights as were conferred upon them by that provision were conditioned upon a termination of the agreement at the election of petitioner, an event which has not happened and may never happen, we can not conclude that the payments to the optionors were the result of any interest retained by them.

But even if this were not so, the payments would still fail to furnish the basis for a deduction as ordinary and necessary expenses. Section 23(a), of the Revenue Acts of 1934 and 1936 provides for the deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including * * * rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken * * * title or in which he has no equity * * *."

If petitioner can be considered to have made these payments to the optionors in order to prevent them from demanding a conveyance of the property, which seems to be the furthest extreme to which petitioner's contention could reach, and if it be granted therefore that these payments were "required to be made as a condition to the continued use or possession" of the property; there would still be no escape from the incontestible fact that petitioner has an "equity" in the property. Title was taken for it in the usual course by deed duly delivered and for all that appears it continues to be held in the same way. Under such circumstances the deduction specified is not available to petitioner. See .

Whether, therefore, the payments in question are thought of as the consideration for the transfer to petitioner of title to the mining property, in the first instance, or as a condition precedent to its retention of that title, the result is the same. When the option was exercised its province as the medium of acquisition of title disappeared. In its place petitioner had acquired a capital asset the cost of which was the original purchase price, together with the payment for the option. The amounts paid to acquire this capital asset are capital expenditures and may not be deducted in the form of business expense. Upon this issue respondent is sustained.

A further issue involving payment of state license tax need not be considered since it is now conceded by petitioner.

Reviewed by the Board.

Decision will be entered under Rule 50.