text:
    St. Clair Guaranty & Title Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7578.
    Promulgated October 10, 1927.
    Tbe evidence shows that the Commissioner erred in excluding $55,000 from petitioner’s invested capital in connection with property acquired for stock.

      G. E. Poye, Esq., and R. F. Driemeyer, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.

      The Commissioner determined deficiencies of $886.49 and $958.81 for the fiscal years ending August 31, 1920 and 1921, respectively. Petitioner claims that the Commissioner erred in failing to include in invested capital for the taxable years the amount of $55,000 in connection with the issuance of capital stock for property acquired. The Commissioner allowed invested capital in the amount of $145,000 on account of stock issued by petitioner by reason of his holding that $70,000 par value of stock issued to one Schrader was for promotion services rendered the corporation in the sale of its stock and that these services were reasonably worth only $15,000. Petitioner claims that this stock was not issued for services rendered by Schrader but was issued for property purchased from him and that the Commissioner should have allowed an invested capital of $200,000.
    FINDINGS OF FACT.
    Petitioner is an Illinois corporation, the corporate organization of which was completed on July 10, 1919. Its authorized capital stock was $200,000 and a subscription therefor payable in cash was made as follows:

    The purpose of the organization as expressed in its certificate of incorporation was to engage in the business of abstracting titles,- and in the title guaranty business.
    Prior to the organization of the petitioner there were three companies actively engaged in the abstract business in St. Clair County, Illinois, namely, St. Clair Title Office, Donovan-Guignon Land Title Co. and Wolleson & Wolff Abstract Co. The first named had complete sets of abstract books, plats and indices, which extended back as to all lands in St. Clair County to title in the original source. The books of Wolleson & Wolff Abstract Co. were not complete but contained sufficient data so that it was actually and competitively engaged in business with the other two companies.
    William E. Schrader had been, prior to the organization of the St. Clair Guaranty & Title Co., manager of the East St. Louis office of the St. Clair Title Office, a corporation the stock of which, except directors’ qualifying shares, was owned by Frank B. Bowman. Schrader had been for several years working on the matter of the consolidation of the three abstract companies. Prior to the time of the organization of the petitioner, he had, on June 25, 1919, secured from Frank B. Bowman for the consideration of $5,000 cash, an option, good until September 1, 1919, to purchase all of the shares of stock of the St. Clair Title Office for the additional sum of $50,000; he had likewise on June 27,1919, executed a contract with the Belleville Savings Bank, then the owner of the Donovan-Guignon and Wolleson & Wolff abstracting companies, to purchase the same from the bank for $100,000; $75,000 thereof to be paid in cash and $25,000 in bonds secured by a mortgage on all of the assets of the three abstract companies then doing business in St. Clair County and to be absorbed in the organization of the St. Clair Guaranty & Title Co.
    On July 11, 1919, at a meeting of the board of directors of the petitioner, Schrader made a proposition to sell to the petitioner all of the assets of the St. Clair Title Office and of the Donovan-Guignon and Wolleson & Wolff companies, and the directors adopted the following resolution:
    Resolved, Tliat this company accept the proposition to purchase the plants, assets, equipment and paraphernalia and property pertaining to the respective abstract companies, to wit, St. Clair Title Office, Donovan-Guignon Land Title Company and Wolleson & Wolff Abstract Company, and purchase the plants, assets, equipment and paraphernalia and all other articles used and owned by the said companies and pertaining to the transaction of their business for the said sum of $275,000, payable $100,000 of par value of bonds of this company, and $175,000 in cash, and moves the adoption of the resolution.
    Whereupon the question was put by the chairman, shall the resolution offered be adopted, and upon eall of the roll of the directors voted aye, and the resolution is declared duly adopted.
    The stockholders and directors of the petitioner in due form ■authorized the issuance of $100,000, of bonds with which to make payment in part of the purchase price agreed upon, and thereupon transfer of the title of all of the assets of the St. Glair Title Office and of the Donovan-Guignon and Wolleson & Wolff companies was made to petitioner and in addition Schrader delivered to petitioner, United States Liberty bonds of the par value of $30,000, at a then market value of $25,448. One hundred thousand dollars of the bonds of the petitioner were delivered by it to Schrader and he was given credit for the payment of the 1940 shares of stock for which he had subscribed and in addition, at his direction, credit was given for the subscription price of the remaining 60 shares of the capital stock of petitioner subscribed by others. The transaction may be stated as follows:
    Purchase price of assets of St. Olair Title Office and of the Donovan-
    Guignon and Wolleson & Wolff companies_$275,000

    $30,000 par value United States Liberty bonds_ 25,000
    300,000

      Payment was made by petitioner as follows:
    By delivery of bonds of petitioner to Schrader-$100, 000
    By credit of the par value of 1,940 shares of stock subscribed by Schrader_ 194,000
    By credit at the direction of Schrader of the par value of 60 shares of stock subscribed by others_ 6,000
    300, 000
    Certificates for 1,940 shares of stock were issued to Schrader and certificates for 10 shares of stock each were issued to the other subscribers.
    Of the $100,000 in bonds of petitioner, Schrader sold $25,000 to the First National Bank in East St. Louis for that amount in cash, $25,000 to the First National Bank in Belleville for that amount in cash and delivered $50,000 thereof to the Belleville Savings Bank for which that bank gave him credit to that extent on the price he had agreed to pay for the Donovan-Guignon and Wolleson & Wolff companies. Schrader sold $80,000 par value of the stock issued to him at par in each instance and used the proceeds of such sale to pay the obligations that he had personally incurred for the purchase of the St. Clair Title Office and of the Donovan-Guignon and Wolleson & Wolff companies. He also transferred to John Carson and B. W. Hilgard each 250 shares of stock in settlement of an obligation he had incurred to them for assistance rendered him by Carson and Hilgard in procuring the Belleville Savings Bank, of which Carson and Hilgard were officers, to sell the Donovan-Guignon and Wolleson & Wolff companies to him.
    Schrader was able to acquire by purchase the abstract plants of the three companies named at the price which he paid for them because of the fact that by reason of the competition which existed between them the earning capacity of each had been reduced to a bare minimum.
    The personal relationship which existed between Schrader and Bowman, who owned the St. Clair Title Office, was also a determining factor in his acquisition of that business. Bowman had always placed a value of $100,000 on that property, and he had made an offer of $75,000 for the Donovan-Guignon plant 10 years before the organization of the petitioner, which offer he was able and willing to pay but which had been refused. The fact that the value of the assets of the three companies consolidated in one ownership was very substantially more than the price which Schrader paid therefor and were worth the price which petitioner paid to Schrader therefor is demonstrated by the fact that three banking institutions of St. Clair County purchased at par the issue of $100,000 of petitioner’s bonds secured by mortgage upon the assets of the three companies which it had purchased, and by the fact that Schrader was able to and did sell $80,000 worth ox the stock of the petitioner at par. This is further demonstrated by the fact that not only has the petitioner paid and discharged out of earnings all of the issue of bonds which it made before the maturity thereof but it has, in addition, paid a dividend in each year of its existence upon all of its stock outstanding originally at the rate of 6 per cent and for some years past at the rate of 7 per cent per annum. In addition it has accumulated and has a substantial surplus from earnings, which it has invested in a building for its general offices. At the time of the organization of the petitioner it would have required an investment of $300,000 to compile a complete set of abstract books for St. Clair County if, as a matter of fact, a complete set could have been made at that time. Many of the original records had become illegible by reason of the lapse of time. The details relative to the cost of compilation of a set of abstract books appear in the record but are deemed unnecessary to be here set out.
    The Commissioner treated the stock of petitioner issued to Schrader as if issued to him in payment for promotion services, or as compensation for services rendered the corporation by him. The Commissioner allowed as invested capital the sum of $80,000 which was the amount of Schrader’s own stock which he sold for cash. The Commissioner allowed further as invested capital $50,000, being the amount of stock transferred to Ililgard and Carson by Schrader, and the sum of $15,000 as a reasonable compensation for services rendered the corporation by Schrader, making a total of $145,000.
   OPINION.

Littleton:

From the facts as proved we think the determination of the Commissioner was erroneous. While it is true that Schrader was largely, if not wholly instrumental in the organization of the petitioner and in one sense might be termed the promoter of that corporation, the transactions between him and the corporation can not be viewed from the standpoint of promotion services. Before the organization of petitioner, Schrader had acquired a binding option upon the assets of the St. Clair Title Office for which he had paid the sum of $5,000 in cash and he had procured a binding and enforceable contract by which Belleville Savings Bank obligated itself to sell and Schrader obligated himself to buy the Donovan-Guignon and Wolleson and Wolff companies for the sum of $100,000. The properties owned by these companies merged in one ownership were fairly and reasonably worth $275,000. When merger of ownership was effected, competition was eliminated, and an opportunity was afforded to procure reasonable prices for work which had formerly been done at such price as might be necessary in order to get the business. In addition, economies in the reduction of operating expenses could be and were effected. So long as these companies were separately engaged in business and in competition with each other there was not only a duplication, but a triplication of a large amount of work.

Schrader sold the properties he had acquired to petitioner at a price which represented their fair market value. That was the end of the transaction so far as petitioner was concerned. Schrader was dealing with a corporation, the stock of which he principally owned, but that fact did not require him to sell to it the properties of the three abstract companies which he owned at less than they were fairly worth, or at less than their market value. The transaction was bona fide.

Schrader sold the bonds of petitioner which had been delivered to him and likewise sold $80,000 of the stock of petitioner which had been issued to him, in order to provide himself with funds to discharge the obligations he had assumed in purchasing the St. Clair Title Office and the Donovan-Guignon and Wolleson & Wolff companies, but such transactions are not to any extent unusual, or subject to criticism. They were his individual affairs and were not transactions which he engaged in or carried on for the account of the petitioner, or in which petitioner was interested in any manner or to any extent, financially or otherwise. The petitioner’s invested capital can not be made to depend upon the obligations which Schrader incurred in the purchase of the properties which he sold to it, nor upon the manner in which he discharged those obligations.

We are of the opinion that petitioner is entitled to an invested capital of $200,000 as claimed, instead of $145,000 as determined by the Commissioner.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Smith and Love.


source: Caselaw Access Project

author: Littleton:

license: Public Domain

text:
    James A. Allen and James N. Linton, Executors, Estate of James Ross, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8690.
    Promulgated October 10, 1927.

      Henry J. Linton, Esq., for the petitioners.

      Robert E. Gopes, Esq., for the respondent.
   Littleton:

The Commissioner determined a deficiency in estate tax of $2,199.61. The executors claim that the Commissioner erred in that he failed to allow as deductions from the gross estate certain items of claims against the estate and administration expenses.

FINDINGS OP PACT.

James A. Allen and James N. Linton are residents of C°lumbus, Ohio, and are the duly qualified and acting executors of the estate of James Ross, who died November 30, 1923. The value of the gross estate of the decedent at the time of his death was $479,592.31. The allowable deductions from the gross estate under the statute are as follows:

Funeral expenses_ $1,213. 73
Administration expenses_ 25,807.70
Debts and claims against the estate_ 35,169. 66
Unpaid mortgages- 49, 000. 00
Support ol dependents_ 10, 000. 00
Specific exemption_ 60, 000.00
Total_171,191.09

leaving a net estate subject to tax of $308,451.22.

In his determination of the net estate the Commissioner refused to allow $6,000 paid as attorneys’ fees and $3,168.20 representing various items of administration expenses paid. The Commissioner also declined to allow $2,819.01 of the total debts, and claims against the estate of $35,169.66. The Commissioner also refused to allow the deduction of $10,000 for support of dependents which was approved by the court and paid by the estate.

The net estate returned by the executors was $290,506.51.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by Smith and Love.


text:
    Whitman-Douglas Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11175.
    Promulgated October 10, 1927.
    The evidence is insufficient to show that the Commissioner erred in his determination of the deficiency involved in this proceeding.

      P. D. Hutchison, G. P. A., for the petitioner.

      Frank 8. Easby-Smith, Esq., for the respondent.
    The Commissioner made his determination of petitioner’s tax liability for the period October 1, 1919, to December 31,1919, and for the calendar years 1920 and 1921. He determined that there was no deficiency for the period October 1, 1919, to December -31, 1919; that there was a deficiency of $993.15 for the calendar year 1920 and that there was an overassessment of $22.60 for the calendar year 1921.
    The petitioner contests the determination for the calendar year 1920 and claims, first, that the Commissioner erred in failing to allow sufficient depreciation on automobiles — the Commissioner computed the allowance for exhaustion, wear and tear of automobiles at the rate of 25 per cent per annum and petitioner claims that he should have used a rate of 50 per cent per annum; secondly, that he erred in “ not finding that the net income for the period of 15 months, ended December 31,1920, was $9,998.96 and by not allocating twelve-fifteenths of this amount, or $7,679.11, as taxable income for the year 1920 ”; thirdly, that he erred in “ not including in statutory invested capital, capital stock issued January 1, 1920, in the amount of $14,000, which was paid for by notes of the parties to whom issued,” and that since this amount of $14,000 should have been included in invested capital, the Commissioner erred in computing the profits tax under the provisions of section 302 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    Petitioner is a North Carolina corporation with principal office at Charlotte and was organized on October 1, 1919. It adopted the calendar year as its taxable year. The corporation did not close its books or take an inventory at December 31, 1919. It tools: an inventory and closed its books for the first time on December 31, 1920, after it had been operating for 15 months. Petitioner valued its inventory taken on December 31, 1920, at $60,124.13. The petitioner’s books do not show the income for the period October 1, 1919, to December 31, 1919, or for the calendar year 1920. Petitioner made a return soon after December 31, 1920, and included therein its income for the 15-month period beginning October 1, 1919, and ending December 31, 1920. The Commissioner audited this return and made an allocation of the income for the 15-month period, the basis of which is not disclosed by the evidence, as between the period October 1, 1919, to December 31, 1919, and the calendar year 1920.
    “Between October 1, 1919, and December 31, 1919, $12,000 of common stock issued, and on January 1, 1920, it was $14,000 common stock issued.” This common stock was issued to Charles B. Douglas, secretary and treasurer of petitioner and one Whitman, for cash and for money due them on salary. None of the common stock mentioned was issued for notes. Twenty-five thousand dollars, par value of preferred stock, was issued for cash as follows: $9,000, March 1, 1920; $6,000, March 10, 1920; $10,000, March 27, 1920.
    For the year 1920 the Commissioner allowed “ invested capital as shown by the books, $12,000,” and added thereto the “ sale of preferred stock for cash prorated from date of sale.” There is no question as to this feature of the Commissioner’s determination. Petitioner claims that the invested capital so determined in the amount of $31,196.72 should be increased by $14,000 on account of the common stock.
    On July 1, 1920, petitioner purchased two Ford coupe automobiles for $1,808.46. These automobiles were used by petitioner’s salesmen. In October, 1921, these automobiles were sold for $850. Petitioner claims an allowance for depreciation of these automobiles at the rate of 50 per cent per annum. The Commissioner computed such allowance at the rate of 25 per cent per annum.
   OPINION.

Littleton:

Counsel for petitioner contends that the taxable income for the 15-month period, October 1, 1919, to December 31, 1920, “ should be prorated on the basis of twelve-fifteenths of the net taxable income for the year 1920 and three-fifteenths taxable for the period October 1 to December 31, 1919, or it should be computed after it has been prorated on the basis of 12 months ending September 30, 1920, and on the period of 3 months ending December 31, 1920.” Petitioner has furnished no evidence as to what portion of the income for the 15-month period ending December 31, 1920, was earned during the period October 1 to December 31, 1919, nor has it ihtroduced any evidence to show upon what basis and in what manner the allocation made by the Commissioner of which it complains was made. The mere statement by counsel that the income should be allocated in a certain manner is not enough. It has not been shown that the Commissioner erred in this regard and his determination is approved.

The evidence submitted is insufficient to support petitioner’s claim for additional invested capital of $14,000 in respect of the common stock issued. The error assigned by petitioner in this regard is that the Commissioner erred “ in not including in statutory invested capital, capital stock issued January 6, 1920, in the amount of $14,000, which was paid for by notes of the persons to whom issued.” The evidence is to the effect that common capital stock in the total amount of $14,000 was issued between October 1, 1919, and January 1, 1920, to Whitman and Douglas for cash and “ for money due Mr. Whitman and myself on salaries ” and that none of the common stock mentioned was issued for notes. We have no way of knowing just what the situation is. The deficiency letter shows that the Commissioner started his computation of the invested capital for the year 1920 with the amount of $12,000, as shown by the books. We have no information as to what that $12,000 represented. It may have represented $12,000 of the $14,000 of common stock issued or it may have represented the total amount paid for the entire $14,000 in common stock issued to Whitman and Douglas “ for cash and salaries.” We can not speculate in this regard and we therefore affirm the Commissioner’s determination as to the invested capital issue.

The evidence fails to convince us that the petitioner’s automobiles had a useful life of only two years and we approve the Commissioner’s allowance for the depreciation thereon at the rate of 25 per cent per annum.

Judgment will be entered for the respondent.

Considered by Smith and Love.


author: Littleton :

text:
    C. E. Van Devender and Linn Mapel Brannon, Administrator, De Bonus Non, Estate of John S. Withers, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent
    Docket Nos. 9069, 9127.
    Promulgated October 10, 1927.
    Rents and royalties received under leases of coal lands constitute gross income, and not proceeds from the sale of a capital asset.

      Jesse L. Gramer, Esq., for the petitioners.

      W. H. Lawder, Esq., for the respondent.
    The Commissioner determined deficiencies in respect of the income tax of C. E. Van Devender and John S. Withers as follows:
    1920 — O. E. Van Devender. John S. Witliers_ $181.36 1, 542.78
    1921 — O. E. Van Devender. John S. Withers_ 113.77 51.41
    1922 — O. E. Van Devender. John S. Withers_ 260. 08 123.38
    and an overassessment of 83 cents in respect of the tax of John S. Withers for the calendar year 1923. Van Devender and Withers were during the taxable years, and had been since 1911, engaged in business as partners. It is claimed in each of these proceedings that the Commissioner erred in including in gross income of each of the petitioners for the taxable years that portion of the distributive share of the income of the partnership of Withers and Van Devender represented by the receipt of royalties under leases of coal lands.

      The proceedings were consolidated for hearing and decision. The facts are found as stipulated.
    FINDINGS OF FACT.
    For a number of years prior to 1909 and until the death of John S. Withers in 1924, John S. Withers, of Buckhannon, W. Va., and C. E. Van Devender, of Parkersburg, W. Va., were partners in business under the firm name of Withers & Yan Devender, each owning a one-half interest in the partnership and the partnership assets. Prior to 1909 the partnership of Withers & Yan Devender had acquired certain coal lands lying in Gilmer and Braxton Counties, West Yirginia, underlaid with a seam of merchantable coal known as the Pittsburg seam. By means of three separate deeds of lease and agreement, one executed in 1909, one in 1910, and another in 1911, all of the merchantable coal contained in the Pitts-burg seam underlying these tracts was leased, let and demised by Withers and Yan Devender, as parties of the first part, to certain other persons, as parties of the second part, for terms of 25 years in the case of two of the leases and 35 years, in the case of a third for a consideration of 10 cents per gross ton, there being a stipulation in each case for the payment of a minimum royalty. These leases were all substantially the same and so far as material here provided—
    Witnesseth: That the said parties of the first part, in consideration of the rent herein reserved and royalties to be paid, and of the several covenants and agreements by the party of the second part, and upon the conditions and snibject to the reservations hereinafter contained, all as hereinafter set out, do lease, let and demise unto the said party of the second part, for the term of twenty-five (25) years from the date hereof, subject to the terms, stipulations and agreements hereinafter contained, for coal mining and coke making purposes only, all the merchantable coal in that certain seam - or vein locally known as the Pittsburg Seam or Vein, in, under and upon the following tract or parcel of land, situate near Gilmer Station, on the Coal & Coke Railway, in the County of Gilmer, and State of West Virginia, on the Little Kanawha River, and bounded and described as follows, * * *.
    Together with the right to dig, mine, manufacture into coke and carry away all of the said coal from the said seam, within the said boundary, during the continuance of this lease, without being required to provide or leave support for the overlying strata or surface of the structures thereon, or to springs, wells, cisterns or water-courses therein, or thereon, by reason of mining and removing the whole of the said coal, and all necessary rights and privileges upon the surface for the convenient drainage and ventilation of the mine, and the right to make, maintain and use a track, roads and ways in and to said mines for the transportation, ventilation and drainage of the said coal, and free from all damage by smoke and heat arising to the surface or growing crops from the manufacture of the said coal into coke.
    The parties of the first part do also, as appurtenant thereto and not otherwise, lease, let and demise unto the party of the second part, for so long a time as this lease may remain in life, for the purposes of opening and operating the said coal and the construction of dwelling houses, stores, offices, barns, stables, coke ovens, track sidings, tipples and other structures necessary for the operation of the said coal and the manufacture of the same into coke, so long as the said plant is operated under the conditions herein provided, either under this agreement, or a renewal thereof, or substitute therefor for the working of the coal herein described, and no other purpose, the surface of that part or parcel of lands embraced within the boundaries more particularly bounded and described as follows: * * *.
    And, the said party of the second part shall pay an annual rental, for the use and occupancy of the said last described tract of land, including houses, barns, tipples, &e., and the same shall be paid as follows, viz., twelve dollars and fifty ($12.50) cents at the end of each quarter.
    But, it is always understood that the aforesaid grants, and each of them, are subject to the right, here reserved to the lessors and their assigns, to enter upon, cut, manufacture and remove all timber thereon, and to occupy so much of the surface of said land as may be necessary for such roads, tram roads and railroads necessary for the removal of same and for the removal of any other timber then owned or thereafter acquired by the grantors herein or any of them, or by their assigns, on any adjoining lands or land in that general locality, so long as the same may not unreasonably interfere with said second party’s operations under this lease. * * *
    But, it is always understood that the said party of the second part shall, upon the compliance with the provisions of this lease, have the full right to mine, take and carry away said coal from said Pittsburg seam within the boundaries first herein set out, free, clear and fully discharged of all and any liability of the first parties for any damages which may result or happen to said tract of land or to the improvement thereon, by reason of the mining, taking and carrying away of said coal, as well as any loss or damage that may happen or occur to any spring or springs of water veins by reason of said mining, taking or carrying away of said coal.
    And, the party of the second part, in consideration of the premises covenants and agrees that he will immediately commence the work of developing the said seam as a coal-producing property, and that he will prosecute the work of development continuously and with diligence; and, further covenants and agrees, during the term aforesaid, unless this lease shall be sooner terminated, under some provision herein, and in such case until such termination, to pay to the said John S. Withers and G. E. Van Devender the following rents and royalties and to do the following things, for the use of the said demised premises and said coal, viz; To pay to the parties last aforesaid fifty ($50.00) dollars per year for the use and occupancy of the surface of the second tract of land hereinbefore described; further, to provide a grade crossing over his railroad track and a convenient road way for the use of said first parties, in going from their lands adjoining said tract to the river, and to allow said first parties, free of charge, use of said roadway, and, in addition thereto, to pay to the said John S. Withers and G. E. Van Devender Ten (10) cents per ton for each gross ton of twenty-two hundred and forty (2240) pounds run-of-mine on all coal mined from said premises, said rents and royalties to be paid monthly, that is to say, on or before the twenty-fifth (25th) day of each month succeeding the end of the month for which royalty is charged; and, the said party of the second part further covenants and agrees that said rents and royalties shall not be less than six thousand and fifty ($6,050.00) dollars for the first year, and seven thousand five hundred and fifty ($7,550.00) dollars for the second and each succeeding year of the term of this lease, same to be made up at the end of each month of this lease and paid within twenty days thereafter. But, it is expressly agreed and understood that when in any year royalty on coal actually mined on said leased premises at the rates specified does not equal the amount of the minimum rate for said year, then said lessee may, during the next suceeding years, mine (if in excess of the quantity necessary to produce the minimum of such succeeding year) a sufficient quantity of coal without charge to compensation at said royalty rates for such deficiency.
    Upon the termination of this lease by the expiration of the term thereof, the party of the second part, may, if all rents and royalties have been fully paid and not otherwise, remove within ninety (90) days next thereafter, but not later, all pit cars, engines, machinery and other movable property placed thereon by them, together with all rails, mining or other machinery, and all houses, buildings, tipples, fixtures and other structures.
    And, the said parties of the second part further agree to keep accurate and correct books of account, showing all coal mined or shipped from and coke made upon or shipped from said premises, and in what manner shipped, to which books the lessors, their agents or assigns, shall at all reasonable times have access for the purpose of examination of same and verification of the statement hereinafter provided for; and, the lessors and their agents for like purposes are hereby authorized to demand and require of any railroad eompany transporting the product off said premises, whether coal or coke, an inspection of their books and records showing the detail, weight and quantity of all such products, and pertinent information thereto; and said carriers and their agents are hereby authorized and requested to show to said lessors and their agents all such records when requested and to furnish all such information on request.
    It is further agreed that as to all coal shipped by railroad the railroad weights shall be taken as the basis of settlement for royalties, subject to any correction for any errors at any time found therein; and, in event said coal, or any part of it, shall be marketed or disposed of otherwise, the quantity shall be ascertained by such fair method as may be mutually agreed upon. And the lessee, for himself, his successors and assigns, agrees, on the 25th day of each succeeding month following the ones for which royalty is made up, to furnish to the lessors, or their agents, an accurate statement showing the quantity of coal mined and coke made during each month, such statement to be always subject to revision and correction by the lessors where error be found.
    And, it is further understood and agreed that the lessors may, by themselves, or agents, at all reasonable times, go upon said premises and into said mines, and if desired, survey the same for the purpose of determining the quantity of coal mined and coke manufactured and the manner of conducting the mining operations aforesaid.
    And the lessee, for himself, his successors and assigns, agrees to conduct said operations in a skillful, provident and workmanlike manner, and in accordance with the laws of the State of West Virginia, and in such manner as to secure the largest yield of coal from said premises and the least loss possible from drawing pillars and from creeps or squeezes or otherwise.
    And it is hereby further agreed that if at the expiration of the term of this lease, twenty-five (25) years, all the coal in the said seam so demised shall not have been worked out, then the lessee, at his option, shall have the right to purchase all the coal remaining therein at a price equal to ten ($0.10) cents per gross ton of twenty-two hundred and forty (2240) pounds computed on the basis of the average gross tonnage per acre paid for the coal theretofore mined and removed, the quantity to be determined by accurate survey of the residue satisfactory to both parties, and thereupon the lessor shall convey the coal so remaining to said second parties, together with the rights herein granted as appurtenant, as aforesaid, save and except said surface right shall continue so long and so long only as said property shall continue to be operated as a coal plant, and said rental of fifty ($50.00) dollars per year shall be paid. And, it is further agreed in event the said second party shall, at the end of said term, purchase and pay for said coal, in that event, and not otherwise, he shall own the improvements he may have placed on said premises for so long a time and no longer as he shall use said surface for said operations and pay said rental therefor, and, in such case, if all obligations to the lessors shall have been satisfied, and not otherwise, he may, on abandonment of said plant for mining purposes, within three (3) months thereafter, and not otherwise, remove the said improvements, fixtures, and machinery, but, in default of such removal within said period, such improvement shall be and remain the property of the lessors without further claim by the lessee.
    The said lessee shall employ a competent mining engineer who shall keep all the mine surveys, entries, etc., and make an accurate map, showing the same, from the starting of the mining, which map shall be at all times subject to inspection by the said lessors or their duly authorized agent, who shall also at all reasonable times have the right to enter said mines or have surveys made thereof to determine if all the terms of this lease are fully complied with and for these purposes to use freely the means of access to the said mines and' works without hindrance or molestation, and, further shall upon request furnish to said lessors or their agents, copies of said map and all additions thereto from time to time made.
    It is further understood and agreed that all taxes during the continuance of this lease assessed upon the said premises shall be borne as follows: The taxes upon the land (not including the improvements) by the lessors, and the taxes upon the improvements thereon, by the lessee, and the taxes on the coal, in the earth, before removal therefrom, by the parties of the first and second part, equally; it being understood and agreed that all such taxes in the first instance be paid promptly by the lessee, he to have the right to deduct from royalties accruing so much of said taxes as the first named parties are entitled to pay and no more. And it is further understood that if either shall at any time pay the taxes hereunder chargeable to the other, which they or either of them may do, then in such case they or either of them shall have recourse therefor upon the party hereunder liable, and the same may be added or deducted from the rents and royalties, as the case, may be.
    It is further understood and hereby expressly agreed that the lessee herein, as one of the conditions of this lease, shall not engage in the sale of intoxicating liquors upon said premises, or permit such business or sales thereon without the written consent of the parties of the first part.
    No assignment, transfer or encumbrance of this lease and agreement, or the leasehold estate thereby created, or any reletting or sub-letting of said premises or any part thereof, shall in any wise release the second party of any obligation here imposed upon or assumed by him, or impair any right or remedy of the first parties as lessors herein against him as a tenant or against such assignees, transferees, or subtenants, or the property of any of them; nor shall the acceptance of rent or royalty from such assignee, transferee or subtenant in any wise operate or be construed to impair or alter the obligations of any of them or liability of the lessee named herein, unless otherwise in writing expressly so agreed by the first parties.
    And, it is further agreed that the lessors may from time to time, by writing served on the lessee, appoint to act for them under this lease an agent who shall have the power in his own name, or that of the lessors at his option, to collect, sue or distrain for rents and royalties from time to time accruing under this lease, and to do all other things in regard to the management and control of the demised premises and interests therein which the lessor might do, and with like effect; the authority of any such agent to continue until notice in writing to the lessee to the contrary; but, this clause is not intended to authorize such agent to change or vary the terms of this lease or to waive any of the provisions thereof.
    And, it is further agreed that if said lessee shall fail to pay any installment of rent or royalty when due as hereinbefore provided, that then all rights and remedies accorded landlords under the laws of West Virginia may be resorted to by said lessors; it being understood that the moneys hereinbefore designated as royalties are to be treated as rents reserved herein, and may be distrained for, and the leasehold estate hereby created is made likewise subject to lien for unpaid rents and royalties and is made liable to distrain, levy and sale in like manner as distrainable property upon said premises.
    And, for the purpose of increasing the output of the mines, the said lessee further covenants and agrees, within twelve (12) months from this date, to expend at least the sum of five thousand ($5,000.00) dollars on the leased premises in improving and equipping the mines, which sum so to be expended for equipments and improvements shall be other than the ordinary expenses incident to the mining and removal of coal.
    And it is further agreed that if default in the payment of any rents or royalties shall continue for the period of two (2) months after the same becomes due, or the lessee shall fail or refuse to keep and perform each and every one of his covenants and agreements herein contained, then in either event the lessors may, at their option, terminate this lease and without further notice re-enter upon and take possession of said premises and every part thereof, and hold and possess the same in like manner as if this lease had never been made, except that such action shall in no wise impair the lessors’ right to royalty and rents up to the time of such re-entry, but none shall be charged for any period thereafter. In such cases however, the lessee may within thirty (30) days thereafter remove such removable property placed thereon by him as may then remain upon said premises provided any balance of rents and royalties to such date be first paid; but, such re-entry shall not prevent levy upon sale of any such property for any such balance if said lessors so elect. And the parties of the first part do hereby warrant generally the title to the leasehold estate and the coal in the property above described.
    The total net income of Van Devender as finally adjusted and the exemption to which he was entitled for the years 1920 to 1922, inclusive, were as follows:

    The total net income of John S. Withers as finally adjusted and the exemption to which he was entitled, and the dividends and interest on United States obligations included in such total net income for the years 1920 to 1923, inclusive, were as follows:

    There has been included in the net incomé of each of the petitioners, as above stated, for the respective years, Ms one-half interest in the net amount of royalties collected from the three coal properties after deducting depletion upon actual production, the rate of which had been established at 3y3 cents per ton of coal mined, as set forth in the following tabulation:
    ROE THE YEAR 1920

    EOR THE YEAR 1921

    EOR THE YEAR 1922

      POR THE YEAR 1923

    The amount of royalties and rents received under the leases was included by the Commissioner in gross income of the partnership and treated as a part of the distributive share of the profits of the partners, the petitioners herein.
   OPINION.

Littleton :

Petitioners claim that the royalties received under the coal leases did not represent income but represented the return to them of capital and that the leases constituted a sale of the coal which constituted a part of the real estate. Petitioners refer to numerous court decisions which they claim support their contention in this regard. We deem it unnecessary to enter into an extended discussion of othe contentions advanced, since this question has been before the Board in the proceeding of Henry L. Berg, 6 B. T. A. 1287, and of John, T. Burkett, 7 B. T. A. 560, wherein a similar contention was advanced. In those cases we held that rents and royalties received under oil leases constituted income and that the Commissioner was correct in so holding. See Rosenberger v. McCaughn, 20 Fed. (2d) 139, District Court, Eastern District of Pennsylvania. We think the Commissioner’s determination, which is questioned in these proceedings, was also correct. Compare United States v. Ludey, 274 U. S. 295.

Judgment tmll be entered for the respondent.

Considered by Smith and Love. .


text:
    Hamilton Ward, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11322.
    Promulgated October 10, 1927.

      Hamilton Ward, Esq., pro se.

      Bruee A. Low, Esq., for the respondent.
   Littleton:

The Commissioner determined deficiencies of $189.49 and $1,303.72 for the -calendar years 1920 and 1921. Petitioner claims that the Commissioner erred in refusing to allow him to deduct certain amounts for railroad fare, automobile hire, telegrams, telephone calls, and meals when away from home on business, as ordinary and necessary business expenses paid in connection with his profession as an attorney at law.

FINDINGS OF FACT.

Petitioner is a resident and citizen of Buffalo, N. Y., where he has been engaged in practicing law for more than 34 years. During the taxable years he incurred and paid in connection with his professional duties the amount of $500 in the year 1920 for railroad fare, telegrams, and long-distance telephone calls. For the year 1921 he expended for business purposes $450 for railroad fare, telegrams, and telephone tolls and $125 for meals while away from home on business, and $150 for a'utomobile hire. Petitioner kept a record of these business expenditures, which record was produced at the hearing of this proceeding and was supported by his testimony as to the detailed items making up the amounts mentioned. The Commissioner disallowed the deductions of the amounts claimed.

The above-mentioned amounts were proper deductions from gross income for the years in which paid as an ordinary and necessary business expense.

Judgment will be entered for -petitioner upon the issue raised on 15 days'1 notice, under Rule 50.

Considered by Smith and Love.


text:
    Joseph W. Woods & Sons Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9156.
    Promulgated October 10, 1927.
    1. Tbe evidence shows that $4,200 paid by petitioner to one of its employees was additional compensation for services rendered.
    Tbe amount was therefore a proper deduction from gross income.
    2. The evidence in this proceeding is not sufficient to show that . the Commissioner’s disallowance of a certain portion of the cost of remodeling a building as an ordinary and necessary expense was erroneous.

      Benjamin E. Messier, Esq., for the petitioner.

      Harold Allen, Esq., for the respondent.
    The Commissioner determined a deficiency in income tax of $1,698.49 for the calendar year 1919. Petitioner claims that the Commissioner erred in refusing to allow (1) a deduction of $4,200 paid to one of its employees as additional compensation for services rendered during the taxable year, and (2) a deduction of $5,514.10 as an ordinary and necessary expense for the taxable year representing repairs to a residence building situated on a tract of land purchased hy petitioner during the year 1919.
    Two other errors assigned by petitioner relating to the refusal of the Commissioner to allow certain additional depreciation, and a loss in respect of certain stock were withdrawn at the hearing.
    The position of the Commissioner is that the amount of $4,200 paid by petitioner to its general manager was a gift and not compensation for services rendered, and that the amount claimed as a deduction for repairs to rental property was a capital expenditure or at least a greater portion of the amount claimed represented the cost of additions and betterments and the evidence does not justify an allocation as between repairs and permanent improvements.
    FINDINGS OF FACT.
    Petitioner is a Massachusetts corporation engaged in the business of bleaching, dyeing and printing cotton goods with principal office at Boston. During the taxable year 1919 the petitioner was affiliated with the Asbestos Fabric Co., Ltd., and the Glenwood Works, corporations with principal offices at Boston, and the deficiency here involved was determined upon the basis of the consolidated net income and invested capital of these three corporations. During the year 1919 and for 24 years prior thereto, petitioner had in its employ one George H. Perkins, who was also during the taxable year and for several years prior thereto, a stockholder. The principal stockholders of the petitioner during the year 1919 were as follows:

    A few shares were held by other employees of petitioner. Arthur, James, Joseph and Herbert Woods were sons of Joseph Woods, deceased. The preferred stock paid 6 per cent dividends and had equal voting rights with the common stock, and dividends were also paid upon the common stock. George H. Perkins was general manager of the entire business and in active charge of the business of petitioner. He was also chairman of the board of directors and president of the Glenwood Works, a subsidiary of petitioner. His fixed salary during the year 1919 was $12,000. During 1919 the total dividends paid upon the preferred and common stock to the stockholders of petitioner, above mentioned, follows:

    Arthur Woods gave only a very small portion of his time to the business. He was engaged primarily in other pursuits. James H. Woods gave none of his time to the affairs of the corporation other than to attend directors’ meetings. Joseph Woods gave all of his time to the attention of petitioner’s business at Boston, and Herbert Woods was actively engaged in looking after the affairs of petitioner at its New York office. Arthur Woods was paid no salary; James H. Woods was paid a salary of $1,500; Joseph Woods was paid a salary of $10,000, and Herbert Woods was paid a salary of $11,500. During the year 1919 the directors, who were the individuals hereinbefore mentioned, discussed the matter of paying George H. Perkins additional compensation for that year and decided that in view of the services being rendered by him he should receive a bonus or additional compensation of $4,200 for the year 1919. In authorizing the additional compensation for Perkins for the taxable year, the directors and officers of the petitioner desired to avoid establishing a precedent of allowing additional compensation or bonuses to employees by a resolution about to be adopted, so they authorized the compensation to Perkins by resolution adopted February 19, 1919, in the following language:
    It was moved and voted that the Directors for themselves and in the name of the principal stockholders, express their thanks to Mr. George H. Perkins and that they ask him to accept four thousand two hundred dollars ($4,200.00) as a token of their appreciation of his conduct of the business; this sum to form no part of any present or future salary and distribution which may be voted and paid.
    The $4,200 was paid to Perkins during the taxable year and was charged upon the books and deducted by the corporation as a business expense. The amount was specifically intended as additional compensation. Perkins reported the amount as income in his individual income-tax return for the year 1919 as salary. For the year 1920 the directors paid Perkins the amount of $4,200 additional compensation for services rendered during that year, which was authorized by a resolution the same as the resolution above mentioned. The total amount of $16,200 paid Perkins in the year 1919 constituted no more than reasonable compensation for services actually rendered by him.

      • For several years prior to 1919, petitioner had been obtaining its water supply from a lake located upon a 21-acre tract of land near its plant. In 1919, in order to avoid being deprived of its available water supply, petitioner purchased this tract of land and lake for $21,000. The lake practically covered the entire acreage. The only building upon the property purchased was an ancient colonial residence of wood with stone foundation containing eight rooms and cellar. This building was more than 100 years old and was in a very dilapidated condition although it was being occupied at the time by two families. The house was really unsafe due to its dilapidated condition, extreme age, and neglect. Many stones had fallen out of the foundation walls, the cellar had only a dirt floor, window casings had rotted away and 50 per cent of the window glass was missing, the cellar stairs had completely rotted and had to be replaced, floor timbers were in dangerous condition due to decay, and had to be replaced. Certain of the first-floor beams had completely broken down and a portion of these rotten beams had fallen through and were resting on the cellar floor. Practically all window sills had completely decayed; almost all the plastering which had been placed throughout the interior of the house had fallen off. The exterior and interior of the house all lacked paint and wall paper. The ceilings were in bad condition, the floor in the hallway was gone, as well as a considerable portion of the stairway leading to the second floor. The stone chimney was practically without foundation; there were large openings in the chimney from top to bottom, the hearths had fallen through and had to be rebuilt. The roof timbers had decayed and sagged; there was practically no roof on the building. The house contained an unfinished attic. Many of the clapboards were off on the outside walls and others were badly rotted. The house contained no plumbing and no light nor heating system. The ancient structure was in fact such a complete wreck that one of petitioner’s witnesses stated that “It was a wonderful thing that it ever stood up.” Petitioner had considerable doubt at first as to whether the cost of attempting to rehabilitate the house would be at all justified. The work Avas finally undertaken in the year 1919' under the direction of a man employed by petitioner for the purpose and continued for about six months. The work of practically rebuilding the house and constructing a four-room brick addition thereto was completed in the year 1919 at a total cost of $11,029.10. There Avas no general contractor for the work. Petitioner purchased all necessary materials and supplies, and paid for the labor by the day. In the process of reconditioning the house the work necessary to remedy the conditions hereinbefore mentioned was done. This involved the complete replacement of much of the original construetion, including window casings, frames and glass, floor beams, floor boards, new stairways, plastering, and an entirely new roof of a more expensive and lasting character. A new concrete floor was constructed in the basement. The attic was completely finished with new flooring where none had been before. In addition to the above complete plumbing and heating systems were installed throughout the house, including the construction of two complete bathrooms. A complete steam or hot water system was installed in the house, including two boilers, all of which was new material. Electric light, including fixtures, was also added.
    Petitioner divided the house into two apartments with separate kitchens. In so doing a new brick addition containing four rooms was added to the structure making a building of twelve rooms and basement. The yard was graded, cement and gravel walks were laid, and a brick retaining wall along the street was constructed. The house was painted outside and painted, calcimined and papered throughout its interior. Columns were added in the basement for the support of the first floor.
    The cost of this work was not segregated upon petitioner’s books as between repairs and additions or new construction so as to indicate that portion which might be classified as repairs and that portion which might be classified as additions and betterments. About six months after the completion of the work a rough estimate was made by one of petitioner’s officers “ without having anything accurate to go on ”; after considering the entire cost of lumber and materials he concluded to treat one-half of the total cost as repairs and one-half as a capital expenditure. This was done and $5,514.10 was charged to expense and deducted from gross income in the return for 1919. The balance was charged to capital account. At least one-half of the total amount expended was for new material.
   OPINION.

Littleton :

We think the claim of the petitioner that the item of $4,200 was a proper deduction as compensation for services rendered is correct. Two of petitioner’s officers and directors testified fully concerning this item and we are satisfied from this evidence that the amount was allowed and paid as additional compensation for services and was a proper deduction as an ordinary and necessary business expense. The language of the resolution authorizing the additional compensation, that the same should “ form no part of any present or future salary and distribution which may be voted and paid ” was intended to prevent the establishment of a precedent in the matter of paying bonuses or additional compensation to employees. The Commissioner erred in holding that the amount dn question was a gift.

The Board can not agree with petitioner’s claim that one-hall of the amount expended in practically reconstructing the house located upon the land purchased in 1919 was deductible as an ordinary and necessary expense for the taxable year. The house was rented at the time petitioner purchased it and petitioner continued to rent it after the improvements had been made. So much new material was purchased and used and so many additions and improvements were made to the old house, other than in the construction of the new brick addition thereto, -that it appears evident that the greater portion of the total cost represented an “ amount paid out for new buildings or for permanent improAuiments or betterments made to increase the value of any property or estate.” Section 235 of the Revenue Act of 1918. We have insufficient evidence to show the cost of the new addition of four rooms to the old house and the evidence submitted is insufficient to enable the Board to make an intelligent allocation of the remaining expenditures on the old house and the grounds as between repairs, and permanent improvements and bet-terments. Much of the work, consisting of replacements and renewals, had a life of several years and the cost thereof should be returned to petitioner through the annual allowance for exhaustion, wear and tear. The Board does not feel justified from the meager evidence in hazarding a guess as to what portion, if any, of the total amount claimed might be classified as an ordinary and necessary business expense. We, therefore, affirm the Commissioner in this regard.

Judgment will he entered on 15 days1 notice, under Rule 50.

Considered by Smith and Love.


author: MoRRis:

text:
    A. C. Lineberger, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8689.
    Promulgated October 10, 1927.
    1. Petitioner having failed to produce sufficient evidence as to the incorrectness of the amount of salaries determined by the respondent, the determination of the respondent is approved.
    2. Deduction claimed as business expense disallowed.

      J. L. Elliot, Esq., for the petitioner.

      R. A. Littleton, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income taxes for the years 1920 and 1921 of $2,489.88 and $5,066.74, respectively.

      The two questions involved in this proceeding are: (1) The amount of salaries received by the petitioner in the years 1920 and 1921, and (2) whether or not certain expenditures made by the petitioner are allowable deductions.
    FINDINGS OF FACT.
    A. C. Lineberger is an individual residing at Belmont, N. C. During the calendar years 1920 and 1921 he was employed by various corporations in the vicinity of his home. He drew salaries and bonuses in varying amounts from each of these corporations. He kept a small notebook in which he recorded the checks received by him when they were deposited in the bank, from which record he made his income-tax returns for the years in question. During the years in question the taxpayer received from the following corporations the sums set opposite their names:

    All of the above corporations were located within three-quarters of a mile of each other. The petitioner owned an automobile which he used to some extent in his business. He did not drive his automobile himself but employed a chauffeur for that purpose and for the purpose of doing certain work at the petitioner’s home.
   OPINION.

MoRRis:

The petitioner alleges that he received salaries for the year 1920 in the sum of $54,760.85 instead of $56,625.20 as determined by the respondent and that his salaries for the year 1921 amounted to $45,703.24 instead of $47,819.76 as determined by the respondent. It appears from the testimony that the petitioner received $54,-760.71 in the year 1920 and $39,744.94 in 1921 from five mills, but the evidence is not clear whether these amounts represent the total compensation received and for 1921 the amount received is at variance with the amount alleged in the petition. The petitioner’s deposition relating to the subject of salaries received contains the following questions and answers:

Q. Were you connected with any other mills in 1920 and 1921 other than the five mills named above and the China Grove Mill?
A. Yes.
Q. Did yon draw a salary from them in 1920 and 1921?
A. I don’t think I drew any money.
Q. Were you an office holder of the China Grove Mill in 1920 and 1921?
A. I don’t recall.

The petitioner must submit such evidence in support of the allegations in his petition as will overcome the prima facie correctness of the respondent’s determination, and not having done so, the findings of the respondent are sustained.

The petitioner relies upon section 214(a) (1) of the Revenue Act of 1918 in support of his second allegation of error. The pertinent part of that section reads as follows:

That in computing net income there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *

The petitioner kept no record of the amount claimed as a deduction nor did he offer sufficient evidence to support the allegation that said expenditures were made in carrying on his trade or business. The action of the respondent in disallowing these deductions is therefore sustained.

Judgment will be entered for the respondent.

Considered by Trammell and Littleton.


text:
    George B. Friend, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5000.
    Promulgated October 10, 1927.
    1. Salaries paid held to be reasonable.
    2. Partial loss due to fire denied where evidence failed to show that the amount received as insurance was inadequate to compensate for the damages sustained.
    3. Expenses for entertaining and operation of automobile disallowed.

      H. J. Myerson, Esq., and Mawrice T. Weinshenk, Esq., for the petitioner.

      Philip M. Clark, Esq., for the respondent.
    The petitioner brings this proceeding for the redetermination of deficiencies in income taxes of $5,460.13 for 1918; $5,682.69 for 1920; $2,127.08 for 1921; and $3,031.69 for 1922. The errors alleged are the disallowance of deductions for salary paid to petitioner’s wife for the years 1920, 1921, and 1922; disallowance of deductions for entertainment and automobile expenses for 1918, 1920, and 1921; and the disallowance of a deduction for loss because of fire in 1921.
    FINDINGS OF FACT.
    Petitioner is a Chicago retail merchant handling ladies’ wearing apparel and has been so engaged since 1905. He married on or about September 1,1907, and since then and through 1922 has had his wife associated with him in business. Prior to her marriage, Sarah Friend, wife of petitioner, had been employed as manager and buyer in a similar business. She received $50 or $60 per week as compensation for such services. Subsequent to her marriage she assisted her husband in his store at 1282 Milwaukee Avenue. Some time in 1917 the petitioner opened another establishment and devoted his time and attention to it, so that during the years 1920, 1921, and 1922 his wife acted as manager and buyer for the Milwaukee Avenue store.
    In managing the store, Mrs. Friend was required to supervise the pricing and selling of merchandise, the taking of inventories, conducting sales and handling the routine work incident to a going-business concern. She had an assistant manager who worked under her direction and carried out her instructions and ideas, receiving as compensation therefor $75 per week. Her duties as buyer for the store required her to visit the manufacturing establishments in and around Chicago in search of new styles and dress creations which would attract the public. She not only selected and purchased new styles but altered and created designs of her own which would appeal to the trade. Two or three times during each of the four seasons she went to New York to select new styles and obtain ideas for creations of her own. Much of her time was spent away from the store, but she kept in touch with her assistant who looked to her at all times for instructions and decisions as to business policy. She operated the business without interference from the petitioner.
    Petitioner and his wife had an oral understanding during the taxable years 1920, 1921, and 1922 that she would have a drawing account, ranging from $100 to $125 per week as compensation for her services. From time to time, as needed, and in varying amounts, she made withdrawals which were charged against her. For the year 1920 she withdrew $8,055; for 1921, approximately $6,100 and the same amount for 1922. The withdrawals were made by various means — sometimes by checks signed by her husband, sometimes by the payment of her bills which were presented at the store, and sometimes by cash withdrawals, for which vouchers were given. The compensation received by Mrs. Friend was used for personal, household, and any other expense which she might incur. Petitioner’s wife lias always drawn compensation for lier services and even prior to her becoming sole manager and buyer, she received between $75 and $100 per week for assisting her husband.
    In 1912 the petitioner and his uncle purchased a three-story brick building situated on two lots at 1467 and 1469 South Michigan Avenue, Chicago. One of the lots was purchased outright with the building. A long-time lease was purchased on the other, the lease having a remaining life at date of purchase of 89 years. The property cost $78,000 and was paid one-fourth by petitioner and three-fourths by his uncle. The value allocated to the building by the owners was $60,000. The structure was 40 feet by 160 feet with a large freight elevator located approximately 100 feet back, which was used to lift automobiles to the second and third floors. In November, 1921, the building was partially destroyed by a Are that started near the elevator, completely destroying it and extensively damaging the rear of the building. The fire burned through the second and third floors and the roof, causing the second and other floors to cave in upon the first. Water so weakened the walls and foundations that the sagging floors and their own weight caused the exterior walls to bulge outward over the adjoining property. The basement which contained the heating plant was filled with debris and water, ruining the heating system and causing the abandonment of the basement. After the fire an architect estimated that the cost of replacing the building in its condition prior to the fire, would be approximately $15,000.
    Insurance amounting to $50,000 was carried on the building by a number of companies and in attempting to arrive at an adjustment, the owners held out for the estimate given by the architect. The insurance companies refused to allow more than $9,231.10, which was finally accepted by the owners. The actual cost of restoring the building was greater than either of the estimates, amounting to $24,520.81. The work was done by the Great Lakes Construction Co. on a time and material plus 10 per cent basis. In the construction of the building it was necessary to wreck the walls in the rear of the building and then rebuild. In so doing the bricks and beams which could be salvaged were used in rebuilding. After reconstruction, the dimensions of the second and third floors were 40 feet by 80 feet. The elevator was not rebuilt and the basement was abandoned. A new heating plant had to be installed on the main floor. Approximately 60 per cent of the roof had to be rebuilt and the balance had to be freshly tarred and graveled. An itemized account of the expenditures in restoring the structure is as follows:

    The bills for the work done were first approved by the architect and then paid by the owners.
    During the taxable years an automobile belonging to the petitioner was used to some extent in the business, such as to go and come from the store, deliver packages and to exchange packages between the stores. Petitioner estimated that the expenses incurred thereby were $600 in 1920 and a like sum in 1921. Petitioner likewise estimated that his entertainment expenses amounted to $600 in 1919, $1,000 in 1920, and $1,000 in 1921. These estimated expenses were deducted from gross income for each of the respective years.
    The respondent disallowed the deductions taken for salaries, the deduction for petitioner’s pro rata share of the loss by fire which the petitioner alleged was $5,904.92 and also disallowed the estimated expenses for use of the automobile and entertaining.
   OPINION.

MoRRis:

The first question relates to the deduction of salaries paid to the petitioner’s wife as compensation for services during 1920, 1921, and 1922. The evidence contained in the record of the duties performed by petitioner’s wife, and the testimony of competitors as to the value of services performed and salaries paid therefor to others who performed similar services, convinces us that the amounts withdrawn by Mrs. Friend during each of the years were not unreasonable for the services which she rendered. The volume and the earnings of petitioner’s business are not in the record, but there is testimony sufficient to sustain our decision without a showing of these facts which, although important, are by no means solely determinative of the question of reasonableness of salaries paid.

The second issue is the deductibility of an alleged loss sustained by petitioner because of fire. We can not determine from the record the cost or the March 1, 1913, value of the parts of the building or equipment which were destroyed or damaged or abandoned. There must be some measure of the damage sustained before the amount of the loss can be‘.determined. Petitioner would have us measure the loss by the cost of reconstruction less the amount of insurance allowed. It seems apparent to us that a loss could not be determined upon such a basis for the reason that depreciation sustained between the date of acquisition and the date of the fire is not taken into consideration, and for tlie further reason that some of the items entering into the cost of reconstruction represent capital additions. We therefore approve the determination of the respondent. Cf. Treat Hardware Corporation v. Commissioner, 6 B. T. A. 768.

The amounts deducted by petitioner as entertainment and automobile expenses for 1920 and 1921 were arbitrarily fixed by George B. Friend, and represented his estimate as to the amounts actually expended. Petitioner failed to offer evidence to sustain these deductions other than the testimony of Friend that the amounts represented his best guess. In the absence of sufficient evidence to support the petitioner’s allegation the respondent’s determination is approved.

Judgment will he entered on 15 days’ notice, v/nder Bide 50.

Considered by Tkammell and Littleton.


text:
    George Bernard’s, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5410.
    Promulgated October 10, 1927.
    Reasonableness of compensation determined.

      Harry J. Myerson, Esq., and Maurice T. Weinshenh, Esq., for the petitioner.

      Philip M. Ciarle, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income and profits taxes for the fiscal year ended February 29, 1920. of $5,577.02; for the fiscal year ended February 28, 1921, $6,326.44; and for the fiscal year ended February 28,1922, $1,368.70, overassess-ments of $67.15 and $324.45 having been found for the fiscal years ended February 28, 1918, and 1919,-respectively. The sole question presented is the reasonableness of compensation paid to the petitioner’s president.
    FINDINGS OP PACT.
    The petitioner is an Illinois corporation organized in 1917 to engage in retailing ladies’ wearing apparel. All of the capital stock was purchased by George B. Friend, who had one qualifying share issued to his wife and one to his brother-in-law. These three constituted the officers, directors and stockholders of the petitioner. George B. Friend was president and treasurer, his wife was vice president and his brother-in-law was secretary.

      The petitioner’s business is located at 35 South State Street, Chicago. The business is conducted in leased premises 25 by 85 feet, all of which was occupied by the petitioner, who paid as rental therefor during each of the taxable years, the sum of $25,000. The building is apportioned to the various departments in the petitioner’s business as follows: on the first floor was a coat department; on the second, suits and furs; on the third, dresses; on the fourth, the economical sales department and a reception room for “ call packages ”; and on the fifth, the offices, shipping and receiving rooms. The petitioner’s employees numbered between 75 and 125, according to the season.
    The tax returns of the petitioner for the fiscal years showed salai’y deductions for the president and sales as follows:

    The salary paid to the president was credited to him monthly and charged on the books against expense. The amounts he actually withdrew in each of the years was $18,200 for the fiscal year ended February 29, 1919; $25,600 for the fiscal year ended February 29, 1920, and $25,319 for each of the fiscal years ended February 28, 1921 and 1922. For the fiscal year ended February 28, 1922, an adjusting journal entry was made charging the president with the difference between his salary of $15,000 and the amount which he withdrew.
    During the fiscal years involved, George B. Friend devoted his entire time and attention to the petitioner’s business. As buyer and manager his duties required his constant attention to the details of the business from the opening to the closing hours. It was necessary to supervise each department, to see that windows were trimmed, to design merchandise, to reorder stocks of merchandise, to employ help, to conduct sales of various kinds, to engage and prepare the advertising, and to make trips at least once every three weeks to New York for the purpose of purchasing new stocks and supplies.
    The salaries which the petitioner paid to its president Avere determined after consultations between Friend and his wife, the president and vice president, respectively. They considered that the salaries as determined were reasonable in amount and fairly compensated for the services which were performed. The stockholders and the directors did not hold a formal meeting during any of the years in question. Establishments similar in size, volume of business and location to that of the petitioner’s paid salaries of $25,000.to $35,000 per annum to employees performing the same duties as those performed by George B. Friend.
    The respondent allowed salaries for the fiscal years ended February, 1919, 1920, 1921, and 1922 in the following respective amounts: $18,000, $18,000, $25,000, and $10,000. The differences between the respondent’s determination of reasonable salaries and the amounts deducted on petitioner’s return were disallowed as unreasonable.
   otinion.

MoRRis:

Insofar as the fiscal years ended February 28, 1918, and 1919 are concerned, the Board is without jurisdiction to hear and determine petitioner’s claim for the reason that the respondent has not asserted a deficiency as defined by the statute for either of the years. Cf. Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

The reasonableness of salaries paid petitioner’s president for the three succeeding fiscal years remains for our consideration. This issue raises a question of fact which can only be determined in the light of the evidence of each individual case. The record in the instant proceeding sets out with considerable particularity the duties and services performed for the petitioner by its president. It likewise affords the testimony of competing merchants who stated that the usual compensation for such services as Friend performed ranged between $25,000 and $35,000 per annum. We are of the opinion therefore, that $25,000 for the fiscal year 1920, $25,000 for the fiscal year 1921, and $15,000 for the fiscal year 1922, constitute reasonable salaries for the services performed during the several fiscal years.

Respondent stressed certain unsigned memoranda purporting to be minutes of directors’ meetings for the various years in which the amount of salary to be paid the president was stated, and contended at the hearing that these amounts were reasonable and that the minutes evidenced the corporate action of valuing its president’s services. Assuming that such memoranda were properly identified, offered and submitted in evidence, we are unable to agree with respondent’s contention, as it is our opinion that unsigned memoranda such as the ones here under consideration are entitled to but little probative weight. If the directors’ meetings were held, but the amount of the president’s salary was by agreement revised prior to the close of the taxable year, and the amount finally decided upon was reasonable compensation for the services actually rendered, such amount is deductible. Cf. Appeal of H. C. Couch, 1 B. T. A. 103.

Judgment will he ent&red on 15 days' notice, under Rule 50.

Considered by Trammell and Littleton.


text:
    Redlick-Newman Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3537, 10386.
    Promulgated October 10, 1927.
    During the years on appeal, petitioner was regularly engaged in selling personal property on the installment plan. Its accounting records contain sufficient information upon which to predicate a computation of net income under the installment sales method.

      .Held, that petitioner is entitled to have its income from installment sales determined under the installment sales method. L. 8. Weeks Go. v. Commissioner, 6 B. T. A. 300.

      F. Mandelbaum, Esq., for the petitioner.

      George E. Adams, Esq., and George G. Witter, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes for 1918,1919,1920, and 1921, in the amounts of $46,052,53, $19,700.98, $8,487.76, and $5,480.52, respectively. On motion of petitioner, agreed to by respondent, the two appeals were consolidated for hearing. At the hearing, the parties stipulated that the correct deficiencies for 1918 and 1919, if petitioner was not entitled to return its income from installment sales for those years in accordance with section 212 (d) of the Revenue Act of 1926, are $24,259.93 and $16,458.90, respectively, thus removing from controversy all of the issues set out in the petitions other than that as to whether petitioner is entitled to return its income from installment sales, for the four years under consideration, in accordance with the installment sales method as laid down in section 212 (d) of the Revenue Act of 1926.
    FINDINGS OE FACT.
    Petitioner is a California corporation with its principal office at San Francisco, where it is, and was during the years in controversy, engaged in selling, at retail, furniture and household furnishings, for cash and on the installment plan. The accounting records show sales for the years 1918 to 1921, inclusive, as follows:

    It is the custom to allow to purchasers of merchandise for cash a discount of 10 per cent off selling price.

      In the case of sales on the installment plan, the purchasers executed a conditional sales contract which provided, among other things, that title to the property described therein remained in the vendor until full payment therefor was made. The initial payments were usually less than 25 per cent of the purchase price; and the clef erred payments were extended, usually over a period of 12 months or longer. An individual record card was kept for each purchaser, showing the selling price of the merchandise, the dates and amounts of initial and subsequent payments, and, in case of default in payment and of repossession, the estimated resale value of the repossessed merchandise. These individual record cards have been preserved.
    The cost of goods sold for cash was not kept separate, on the books, from the cost of goods sold on the installment plan, and the accounting records do not contain sufficient information upon which to base a segregation of the costs of the two classes of sales. The inventories at the beginning and end of each of the years in controversy, the cost of merchandise purchases made in each year, and the cost of all goods sold in each year are as follows:

    At the close of each of the years in controversy, a summary was made, from purchasers’ individual record cards, of the installment payments received during the year, classified in accordance with the year of the sales to which they related. These summary statements have been preserved as part of the accounting records, and they show installment payments to have been received as follows:

      Installment payments received.

    Prior to and during the years under consideration, the accrual method of accounting was employed by the petitioner in keeping its books of account. All installment sales were considered as closed and completed transactions of the years in which they took place, For all years prior to 1918, petitioner’s income-tax returns were rendered in accordance with the books of account. For the years under consideration, petitioner filed returns purporting to show its income from installment sales in accordance with the installment sales method of returning income. The gross sales shown on the books of account and the gross income from sales reported in the returns are as follows:

    In computing the income returned for each of the years in question, petitioner excluded all payments received during those years which applied to sales made prior to 1918, on the ground that the profit from such sales had been returned for taxation prior to the change to the installment basis of returning income. Also, petitioner included in invested capital, as earned surplus, the unrealized profits from installment sales made prior to 1918 which had been returned as income prior to the change of basis of returning income. Respondent held that petitioner is not entitled to compute its income according to the installment sales method, because such method was not employed in keeping the books of account. The deficiencies asserted are based upon income computed on the straight accrual basis, all installment sales being considered as closed and completed transactions of the years in which they were made.
   OPINION.

MoRRis:

Since, during the years in controversy, petitioner regularly sold personal property on the installment plan, and has elected to return the income from sales made on that plan in accordance with the method prescribed by section 212 (d) of the Revenue Act of 1926, it can not be deprived of the right to so return the income from installment sales solely on the ground that its books of account were not maintained on the installment sales basis. Meeting all other requirements of the statute, the petitioner is entitled to return its income from installment sales in accordance with the installment sales method, if the books of account contain sufficient information and were kept so that income can be accurately computed by that method. L. S. Weeks Co. v. Commissioner, 6 B. T. A. 300; Warren Reilly v. Commissioner, 7 B. T. A. 1327.

The petitioner’s books of account contain sufficient information upon which to predicate a computation of income on the installment sales basis; and its income and invested capital, for the years in controversy, should be redetermined upon that basis in accordance with the principles and procedure laid down in the decision of this Board in the Appeal of Blum’s, Incorporated, 7 B. T. A. 737.

Judgment will be entered on 15 days’ notice, under Bule 50.

Considered by Trammell and Littleton.


text:
    E. E. Dickinson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5193.
    Promulgated October 10, 1927.
    1. A yacht purchased by the petitioner held to be a business asset, and the costs of operation to be deductible as ordinary and necessary business expenses.
    2. Rates of depreciation on a yacht determined.

      Barry Mohwn, Esq., for the petitioner.

      A. II. Murray, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income taxes for the fiscal years ended September 30, 1918, and September 30, 1920, in the amounts of $3,180.90 and $2,885.77, respectively. The proceeding results from the disallowance of depreciation deductions on a yacht for each fiscal year, and the disallowance of a deduction for operating expenses of the yacht for the fiscal year 1920.
    FINDINGS OF FACT.
    The petitioner resides in Essex, Conn., on the Connecticut River, six miles north of Long Island Sound. Essex is a small country town of approximately 3,000 inhabitants located in the center of a natural circle of witch hazel brush from which witch hazel is extracted. Dickinson has been engaged in the production of witch hazel for over 40 years, operating as an individual until 1921.
    The production of witch hazel is a highly competitive business as the producer is unprotected by patents, secret processes, or for-mulae. Petitioner has carefully Supervised the manufacture of his product, installing special distilling equipment which has enabled him to receive 5 cents more per gallon on his product than competitors were able to receive. Buyers were encouraged to visit and inspect the plant and its equipment. The lack of amusement fácil-ities in Essex made it necessary for petitioner to provide some incentive for such a visit. Prior to 1916 a small sail boat operated for pleasure purposes by petitioner’s son had been used to great advantage. In 1916 after consulting with his son, petitioner ordered a yacht to be used for entertaining customers and prospects.
    The yacht, known as the Nautilus II, ordered late in 1916, was completed in 1917 at a cost of $18,904.75. The yacht when completed was of the fast cruiser type, 66 feet in length, and constructed for inland water operations. Its power plant consisted of 2 six-cylinder, high speed gasoline engines designed to ’ make 18 knots. The saloon was mahogany trimmed with plate glass windows and doors. There were cabinets, lockers and shelves for books, advertisements and literature relative to witch hazel, and cupboards for samples of witch hazel.
    Before the yacht was completed the Government leased it from petitioner for a nominal rental of $1 per month for such period as the Secretary of the Navy should desire to retain it in Government service. The contract dated June 7, 1917, provided that the Government should reimburse the petitioner in a sum which would restore the vessel to the condition at the date of procurement, ordinary wear and tear excepted. The contract also provided for reimbursement and indemnification for loss of use and depreciation. The yacht went , into Government service immediately upon completion by the builders and acceptance by the purchaser.
    Upon receipt of the vessel the Government stripped it of awnings and various fixtures. The plate-glass windows and doors were removed. Small round port lights and heavy frame work were installed because of the danger of concussion of a 3-pound gun placed on the forward deck. Additional heavy frame work was installed below the dining saloon floor to support the gun. The glass doors on the side of the saloon and the mahogany cabinets and fixtures were torn out to provide ammunition, locker and berth space. A heavy rough pilot house was erected on the bridge deck in the center of the boat. The after deck was removed to install additional tank-age and coal-bin facilities. The after quarters containing the wash room, bathtub, and the like, were torn out and additional sleeping quarters and a heating plant installed.
    The petitioner’s son was made an ensign and from June, 1917, until August 15, 1918, was in command of the yacht. After that date he was assigned to the Naval overseas transportation service and had under his command as lieutenant, junior grade, his father’s boat and six others. The yacht when released by the Government on February 14, 1919, had to be towed to the shipyard by a tug, as it was unable to move under its own power and was badly wrecked. The value of the boat when returned by the Government was approximately $5,000.
    While in Government service the boat was operated continuously except when laid up for repairs. It operated day and night in all kinds of weather. The rudder was snapped off the first night of Government duty during a storm, and in December, 1917, the stern was stove in. Boarding duty required the yacht to lie alongside large steel vessels in rough weather, which subjected it to severe strains. The ice in New York harbor during the winter of 1917-1918 subjected the machinery to exceptional strains and constantly endangered the lives of the crew. The yacht was originally designed for use during the yachting season from May to October, or early November, and with the average use thereof made by a private owner, it would have cruised approximately 2,000 miles per season. The Government ran the boat 25 to 50 or 100 miles per day. The average life of a private yacht under ordinary conditions is 20 years. The remaining life of the petitioner’s yacht after being reconditioned was 10 years. The cost of reconditioning was $11,518.41. The amount paid by the Government under its contract to reimburse and indemnify petitioner was $4,626. The yacht after being reconditioned was returned to petitioner in June, 1919.
    During the summer of 1920 the yacht was used in petitioner’s business to entertain customers during the week ends. The petitioner and his salesmen carried photographs of the yacht and promised trips on the yacht if a customer would visit the plant. If the customer agreed to visit Essex a definite engagement for a week-end trip was made. Customers were entertained .pr-actically every week end during the 1920 season. The boat was only used occasionally during the week, and then primarily for entertaining customers. Once a year the office employees were taken for a moonlight sail, and the mill and warehouse employees were taken on another evening. Friends or relatives of petitioner, or his family, were not entertained on the yacht. The petitioner was accompanied by his wife only when the customer’s wife came down. On one or two occasions during the 1920 season, customers were unable to keep their engagements. In such cases petitioner made use of the yacht as it was already provisioned with supplies which were partly perishable. The petitioner’s superintendent was substituted on one trip when the customer failed him. Petitioner was not a yachtsman nor was he a member of any yacht club. The operating expenses of the yacht for 1920 were $8,627.32.
    The petitioner was allowed a 50 per cent depreciation deduction on the original cost for the fiscal year 1917, and for 1918 he took a deduction of 25 per cent of original cost or $4,726.18. A depreciation deduction is claimed for the fiscal year 1920 of $2,321.75, and in addition thereto, a deduction of $8,627.32 as ordinary and necessary business expenses. The respondent disallowed the deductions, holding that the yacht and the expenses incident thereto were personal expenditures, and therefore not deductible.
   OPINION.

MoRRis:

The question presented is whether the yacht Nautilus II was a business asset upon which depreciation may be taken and the costs of operation may be deducted.

The record convinces us that the yacht was bought and used by petitioner for the purpose of inducing customers and prospective customers to visit petitioner’s plant to the end that the sales of his product would be stimulated. The petitioner felt that his process of manufacture surpassed that of his competitors, and that therefore an inspection of his plant was an excellent sale producer. In addition, pamphlets advertising his plant were placed on the yacht for the use of the guests. The yacht was purchased in anticipation that certain benefits would flow to the business, and petitioner testified that the results have more than justified the outlay. Customers were invariably present when the yacht was in use, except on two annual occasions when the employees were entertained, and when for some reason customers were unable to keep their engagement. We are of the opinion that the yacht was a business asset and that the petitioner is entitled to deduct the operating expenses. For the fiscal year 1920 the operating expenses were stipulated to be $8,627.32.

For the fiscal year 1918, depreciation of 25 per cent is claimed on the yacht and in our opinion the evidence supports the rate claimed. The naval architect in charge of reconditioning the yacht testified with respect to its condition in February, 1919, as follows:

We had a difficult proposition. We had a boat there that was badly wrecked, certain essential members of the boat had been damaged, the essential members of strength, and the engine was practically shot, as we say in business, and we restored the boat as far as it was possible, covering up the damage with paint and varnish and made a boat that was presentable, but actually was just a nice trimming on a very battered framework or hull.

He further testified that the value of the boat as of February, 1919, when returned by the Government was approximately $5,000. Allowing 25 per cent depreciation for the fiscal year 1918 as claimed, leaves an undepreciated cost of $4,726.18, which is in close proximity of the value testified to by the architect.

We are unable to agree with the contention that the depreciation leduction for the fiscal year 1920 should be $2,321.75. The reconditioning cost of $11,518.41 less the $4,626 paid by the Government leaves $6,892.41 as the additional cost of the yacht. The latter figure plus the undepreciated original cost of $4,726.18 amounts to $11,618.59, which should be depreciated over the 10-year remaining life of the yacht.

Judgment will be entered an 15 days’ notice, under Rule 50.

Considered by Trammell and Littleton.