Court Opinion

ID: 4615743
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:33:01.613654+00
Date Added: 2024-06-11T07:54:59.897943
License: Public Domain

W. L. HONNOLD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Honnold v. CommissionerDocket No. 72090.United States Board of Tax Appeals36 B.T.A. 1190; 1937 BTA LEXIS 609; December 28, 1937, Promulgated *609  The petitioner performed services in connection with the promotion of a corporation in 1917 while he and his wife were domiciled in the State of New York, in consideration for which he became a "Permanent Director," and, as such, was to receive a certain percentage of the cash or other corporate assets to be distributed as dividends or otherwise under the contract.  The petitioner and his wife later, but prior to July 29, 1927, became domiciled in the State of California.  Held, the income received in 1930 by the petitioner as such permanent director was from his separate property acquired prior to July 29, 1927.  Therefore, it was his separate income and taxable to him in its entirety.  Ellsworth C. Alvord, Esq., and Karl Riemer, Esq., for the petitioner.  Isador Graff, Esq., for the respondent.  LEECH*1190  The respondent having determined a deficiency in income tax of $1,256.67, for the taxable year 1930, the petitioner brings this proceeding for its redetermination.  While several issues were raised by the pleadings, the sole remaining question, as included in a formal stipulation, is whether $34,620.60, received by the petitioner*610  in the taxable year as a permanent director of Anglo-American Corporation of South Africa, Ltd., is community income divisible between himself and wife, for income tax purposes.  Effect will be given to the stipulation in the recomputation of the deficiency under Rule 50.  FINDINGS OF FACT.  The petitioner, an individual, and his wife, married in the State of California in 1895, were residents of and domiciled in New York, New York, during the years 1916 and 1917 and Los Angeles from and after the year 1924, including the taxable year, but at no time prior to the calendar year 1924.  During 1916 and 1917 the petitioner, a mining engineer and promoter, together with one Oppenheimer, a British subject, aided in promoting and organizing an extensive mining enterprise in South Africa.  A large amount of capital was required and the petitioner was successful in procuring such capital in the amount of approximately $2,500,000.  On September 25, 1917, the Anglo-American Corporation of South Africa, Ltd. (hereinafter referred to as corporation) *1191  was incorporated in the Transvaal under the Companies Act of 1909.  It has existed ever since and has been highly successful.  *611  In consideration of the services rendered by the petitioner - which were limited to securing capital, and which were performed solely in New York, City - it was agreed between him and other interested parties that he should be, and he was, designated a "Permanent Director" of the corporation upon its organization.  There were no written agreements or other documents relating to the permanent directorship other than the memorandum of association (corresponding to the articles of incorporation, or charter, of a domestic corporation), articles of association (corresponding to the by-laws of a domestic corporation), and an agreement of May 1920, by which the percentages of 5 and 2 1/2 originally provided for were reduced to 2 1/2 and 1 1/4, respectively.  The provisions of the memorandum of association, effecting permanent directorships, read as follows: Ernest Oppenheimer and William Lincoln Honnold shall be Permanent Directors of the Company, and each of them shall, subject to the provisions of Article 92 of the Articles of Association registered herewith, hold the office of Director during his life or until he resigns office by notice in writing in accordance with the said Articles*612  of Association.  The said Ernest Oppenheimer and William Lincoln Honnold so long as they respectively remain Permanent Directors of the Company they shall be paid by way of remuneration for their services whenever a distribution of assets is made among the members of the Company by way of dividend, whether in cash or otherwise, as follows, viz.: The said Ernest Oppenheimer cash or other assets as the case may be equivalent to 5 per cent., and the said William Lincoln Honnold cash or other assets as the case may be equivalent to 2 1/2 per cent. of the cash or other assets so distributed among the members.  In the event of the Company being wound up whilst the said Ernest Oppenheimer and William Lincoln Honnold or either of them remains a Permanent Director they shall be entitled in the distribution of the surplus assets of the Company remaining after the return of the whole of the paid up capital of the Company, as follows, viz.: The said Ernest Oppenheimer to 5 per cent., and the said William Lincoln Honnold to 2 1/2 per cent. thereof.  In the event of either of them, the said Ernest Oppenheimer or William Lincoln Honnold, dying whilst he hold the office of Permanent Director, *613  a balance sheet shall be made out as on the date of such death, showing on the one side all the assets of the Company, estimated at their fair value by the Directors of the Company (such estimate to be based on market prices where available, and where not available on a valuation of the Directors), and on the other side all the debts and liabilities of the Company, including its paid up capital, and if it shall appear from such balance sheet that the value of the Company's assets exceeds the amount of the Company's debts, including its paid up capital, then a sum equal in the case of the death of the said Ernest Oppenheimer to 5 per cent. of such surplus assets, and in the case of the death of the said William Lincoln Honnold to 2 1/2 per cent. of such surplus assets, shall be paid to the legal personal representatives of the said Ernest Oppenheimer or William Lincoln Honnold (as the case may be) within two months after the making out of such balance sheet.  *1192  Article 92 of the articles of association, referred to in the aforesaid memorandum of association, provides as follows: The office of Director shall be vacated: (a) If he becomes bankrupt, or assigns his estate*614  for the benefit of his creditors, or suspends payment, or files a petition for the liquidation of his affairs, or compounds with his creditors.  (b) If he becomes of unsound mind.  (c) If he has not duly qualified himself within two months of his appointment or if he ceases to hold the required number of shares to qualify him for office, and on his resignation, as hereinbefore provided.  (d) If he is absent from meetings of the Board for six consecutive months without leave of the Board and is not represented by an alternate Director, provided that the Board shall have power to grant any Director not resident in South Africa leave of absence for any or an indefinite period.  That portion of Sub-section (c) relating to qualification and the whole of Sub-section (d) of this Article shall not apply to the permanent Directors appointed by the Memorandum of Association.  Under the laws of the Union of South Africa, by reason of the fact that petitioner was appointed a permanent director with no express duties assigned to him by the memorandum of association or by the articles of association of the corporation, petitioner could not be required by any shareholder or body of shareholders*615  of the corporation to perform any particular services for the corporation.  Since its organization on September 25, 1917, the petitioner has attended no meetings of the directors and has rendered no services to or for it other than attendance upon an European conference in 1919 and one directors' meeting in 1920.  The following is an excerpt from the address of Ernest Oppenheimer, chairman, at the extraordinary general meeting of the shareholders of the corporation, held at Johannesburg, South Africa, May 6, 1920: There remains the question of the alteration in the fees payable to the Directors.  When the Corporation was originally formed, it was provided in the Articles of Association that a participation in profits should be granted to Mr. Honnold and myself, the percentages being 2 1/2 and 5 respectively.  These participations are of a proprietary nature, and accrue only when a distribution of assets is made among shareholders by way of dividend or otherwise.  When this agreement was made it was felt that the Permanent Directors who had been responsible for the inception of this Corporation were entitled to participate in the success which it was hoped would result.  It cannot, *616  however, be said that the success of the Rand Selection Corporation has been brought about by the individual efforts of either Mr. Honnold or myself, and we therefore feel, under the circumstances, that we should voluntarily agree to our participations in profits being reduced to 1 1/4 and 2 1/2 percent, respectively.  This reduction becomes effective only in the event of the merger between the Rand Selection and the Anglo American Corporation being carried out.  Shareholders in the Rand Selection Corporation evidently regard the proposed merger as sound business, because 218,028 shares have been handed in for exchange.  *1193  The following is an excerpt from the report of Oppenheimer, at the fourth ordinary general meeting of the shareholders of the corporation, held at Johannesburg, South Africa, May 18, 1921: In May (1920) an Extraordinary General Meeting was held for the purpose of authorizing certain amendments to the Corporation's Articles of Association, namely: (1) To increase the authorized capital from Pound 2,000,000 to Pound 4,000,000.  (2) To increase the authorized number of Directors from six to twelve.  (3) To reduce the percentage of profits payable*617  to ordinary Directors from 2 1/2% to 1 1/4%.  (4) To increase the minimum amount of such distribution from Pound 1,000 to Pound 2,500 per annum, and to fix a maximum of Pound 1,250 payable to each ordinary Director instead of an unlimited amount.  (5) To confirm the agreement entered into with the two Permanent Directors whereby the percentages of profits payable to them were reduced from 5 per cent. and 2 1/2 per cent. to 2 1/2 per cent and 1 1/4 per cent respectively.  These amendments were rendered desirable by reason of the agreement whereby the interests of this Corporation and those of the Rand Selection Corporation were merged.  The authority to increase the number of Directors to twelve enabled representation to be offered to certain interests which had become largely concerned in this Corporation through the merger.  The reduction in the percentage of profits payable to the permanent Directors was agreed to voluntarily by Mr. Honnold and myself, as we felt that the enormous increase in the Corporation's interests had increased our possible remuneration beyond what was originally contemplated when the Company was formed.  The petitioner included nothing in his gross*618  income for 1917 representing the value of his interest as such permanent director.  When he opened his books of account, at Los Angeles, on January 1, 1928, he fixed a value for all of his assets, and included such interest at a valuation of $200,000.  He computed this value by ascertaining then the amount by which the fair market value of 1 1/4 percent of the corporation's outstanding shares exceeded par value, and reducing this amount to its value as of January 1, 1928, based on his life expectancy, using a 4 percent interest table.  During 1930 the petitioner received $34,620.60 as such permanent director, which he and his wife treated as community income under the laws of the State of California.  Each reported one-half, or $17,310.30, in a separate return, filed with the collector at Los Angeles, for that year.  The respondent determined that the entire amount should have been included in the gross income of the petitioner.  The petitioner's income tax returns and those of his wife have all been made on the cash receipts and disbursements basis.  OPINION.  LEECH: The petitioner's case rests solely on whether or not the income received by him in 1930 from the corporation*619  was community income.  To be such it must have been derived from community property acquired subsequent to July 29, 1927, or from salaries, *1194  wages, and fees earned by him on and after that date.  Civil Code of California, sec. 161(a); . The position of the petitioner is that the income which he received represented "compensation for some consideration equivalent or similar to services, currently rendered by or passing" from him "to the company" and not, as the respondent has held, and as he here contends, "from a capital asset owned by him since 1917." It would seem to beg the question to argue that the compensation received by the petitioner in 1930 was consideration for something "equivalent or similar" to services.  In order to constitute community income such amounts must have been derived from community property acquired subsequent to July 29, 1927, or from salaries, wages and fees, not "equivalent or similar" to, but as such, which must have actually been earned after that date.  The stipulated facts are that the petitioner not only rendered no services in 1930 but that he could not even have been*620  required to do so.  Therefore, we see nothing in the record upon which to predicate any reasonable conclusion that such amount was "earned" by him after July 29, 1927.  . Petitioner argues that the contract under which he was made a permanent director of the corporation did not create a property right in him but merely provided for a continuing relationship between the corporation and him, similar to that existing between a lawyer and his client, because of which relationship petitioner currently earned the contested funds.  He says such contract created no property right because of the limitations and uncertainties as to his receipts thereunder and the restrictions against assignability.  Undoubtedly certain such conditions affecting petitioner's rights under the contract were there imposed.  But those conditions did not change the legal status of the right petitioner received as such under the contract.  They did no more than measure its quantum.  See ; affd., *621 . The relationship between petitioner and those interested in the organization of the corporation, and later the corporation itself, may have been similar to that of lawyer and client, but the so-called contingent fee petitioner was to receive for services was paid in 1917 when those services, which were all that petitioner ever rendered or agreed to render, were completed.  That payment consisted of a then created property right.  See . That they called it a permanent directorship does not alter that fact.  Thus we have no doubt that the petitioner acquired a valid, enforceable, property right in 1917 and that the income, in its entirety, which the respondent here seeks to tax to him, flowed directly from that right.  *1195  The record shows that the petitioner was a mining engineer and promoter; that he, and another, aided in the promotion of the corporation; that these services of petitioner were performed at his domicile, New York, New York, in 1917; that in consideration of such services he was to become, and in fact did become, a permanent director of that corporation, organized in September*622  of that year, and that while there were no written agreements, as such, in the beginning, relating to that relationship, the memorandum of association provided that he should hold that office in recognition of such services "during his life or until he resigns office", for which he was to receive "cash or other assets, equivalent to 2 1/2 per cent. of the cash or other assets" distributed among its members.  This amount was later changed by agreement to 1 1/4 percent.  In this connection it is significant to observe that this reduction was brought about by the voluntary consent of Oppenheimer, who was another permanent director, and the petitioner.  So we find, long prior to taking up his domicile in the State of California, and prior to the effective date of the community property statute of that state - which, for tax purposes, authorizes the division of income from community property - the petitioner performed valuable services, in consideration for which the corporation carved out and vested in him a definitely specified percentage of the corporation's net assets, when distributed as dividends or otherwise under the contract. *623  The right to these assets was defeasible only by (a) unprofitability of the venture or, perhaps, by reason of two other conditions, pertaining to the office of "director", as shown in article 92 of the articles of association, i.e., bankruptcy or insanity.  None of these conditions appears to have occurred.  Whether property is that of the community or the separate spouse depends not upon the time of the vesting of the property in the husband, or the receipt of the income therefrom, "but the time of the inception of the rights whereby income is earned." . See also ; affd., ; ; ; ; ; affd., , and . The petitioner has cited no law nor court decisions of California - nor do we find any - which would hold the income in question to be that of the community.  We are convinced, therefore, *624  upon the facts, that such income was derived from a separate property right of the petitioner acquired prior to July 29, 1927, and that the respondent correctly so held.  Reviewed by the Board.  Judgment will be entered under Rule 50.