Armstrong Knitting Mills v. Commissioner , 19 B.T.A. 318 ( 1930 )

ARMSTRONG KNITTING MILLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Armstrong Knitting Mills v. Commissioner

Docket No. 30996.

United States Board of Tax Appeals

19 B.T.A. 318; 1930 BTA LEXIS 2425;

March 19, 1930, Promulgated

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The evidence does not establish that the respondent erred in including in income the amount of $15,153.40 paid to and received by the petitioner during the taxable year 1924 in compromise and settlement of certain litigation.

Henry R. Mayo, Esq., for the petitioner.

C. H. Curl, Esq., for the respondent.

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TRAMMELL

This is a proceeding for the redetermination of a deficiency in income tax for the year 1924 in the amount of $1,442.64. The deficiency determined by the respondent results from the inclusion in income of the amount of $15,153.40 received by the petitioner during the taxable year in compromise and settlement of litigation instituted by it. The action of the respondent in treating said amount as income is assigned by the petitioner as error.

FINDINGS OF FACT.

The petitioner is a Massachusetts corporation, with its principal office at Boston. It was originally incorporated under the name of Oakes Knitting Mills Co., which was later changed to Armstrong Knitting Mills, its present designation. It is and since 1912 has been engaged in the business of manufacturing and selling sweaters and other knitted woolen goods.

Prior to 1912 one Owen F. Oakes and his wife, Margaret L. Oakes, as copartners under the firm name of Oakes Knitting Mills, were engaged in the business now carried on by the petitioner. Under date of January 2, 1912, the said Oakes and his wife by written instrument of that date granted, sold, transferred and delivered to the petitioner corporation, then known as the Oakes Knitting Mills Co., "all the machinery, fixtures, tools, implements, supplies, stock and merchandise" connected with or belonging to the business theretofore carried on by said parties under the name of Oakes Knitting Mills; "also the good-will of said business and the right to use the name, Oakes Knitting Mills Co."

Said property was transferred to the corporation in exchange for its capital stock, which was issued to Oakes and his wife apparently in equal amounts. Thereafter, Mrs. Oakes sold her stock for a cash consideration to one Armstrong, who immediately assumed active management of the corporation jointly with Owen F. Oakes. At that time Fulton D. Oakes, a younger brother of Owen F. Oakes, was an employee of the petitioner corporation.

In October, 1912, Owen F. Oakes also sold his stock to Armstrong, but agreed that he would remain as an employee of the corporation until May 15, 1913, and that thereafter he would not enter the business of manufacturing sweaters in the United States at any time prior to January 1, 1918.

In February, 1913, Fulton D. Oakes and another brother, George L. Oakes, began a new business of manufacturing and selling sweaters under the firm name and style of Oakes Brothers.

On April 24, 1917, the petitioner corporation instituted an action of tort in the Superior Court of the Commonwealth of Massachusetts for the County of Essex, at Salem, against Owen F. Oakes and Fulton D. Oakes, alleged to be copartners doing business under the name of Oakes Bros., for the recovery of damages in the sum of $50,000. In the plaintiff's declaration it was alleged that the defendants competed unfairly with the plaintiff and manufactured, and sold to its customers and to the trade in general, sweaters and other knitted woolen goods similar in appearance to the plaintiff's goods, and so marked, advertised, described, and marketed as to mislead the trade and to render easy the substitution of the defendants' goods for those of the plaintiff. The declaration concluded with the following allegation:

And the plaintiff says that by reason of the misconduct of the defendants as above set forth, its business has been seriously interfered with, its profits destroyed, and great loss and damage caused plaintiff, as set forth in its writ.

On the said date, to wit, April 24, 1917, the petitioner herein, as plaintiff, also filed an action in the court above mentioned against Owen F. Oakes and Margaret L. Oakes, as defendants, to recover damages in the amount of $50,000 for alleged breach of contract. In June, 1924, the plaintiff filed an amended declaration in lieu of the original declaration, and in the latter pleading confined its complaint to the actions of Margaret L. Oakes, then deceased, under whose will Owen F. Oakes was alleged to be the duly qualified executor. The said amended declaration set forth that Margaret L. Oakes had impliedly covenanted with the plaintiff that she would not interfere with the enjoyment of the property sold to the plaintiff (petitioner here) on January 2, 1912, as evidenced by the written instrument of that date; that, nevertheless, she had thereafter ignored her obligations under said instrument and had interfered with the good will of the business so purchased by the plaintiff; that she had directly and indirectly entered the business of manufacturing and selling sweaters and other woolen goods in competition with the plaintiff, and had aided directly and indirectly such a business "conducted by Oakes Bros., so-called." Said amended declaration concluded with the following allegation:

and said Margaret L. Oakes has by her interference with the business of the plaintiff and her improper and illegal methods of conducting, aiding and advising in the conduct of business in competition with the plaintiff caused serious and great damage to the plaintiff as set forth in the plaintiff's writ.

The above entitled causes of action were consolidated and referred to an auditor, who heard the evidence of the parties and made a separate report to the court of his findings in each suit. Thereafter, in the latter part of 1924, the consolidated suit came on for trial before the court sitting with a jury, and while the trial was in progress the litigation was settled by an agreement between the parties out of court. The two cases were compromised and settled by the defendants' paying to the plaintiff, petitioner here, the net amount of $15,153.40, exclusive of expenses and attorney's fees. Said amount was paid to and received by the petitioner in December, 1924, within the taxable year.

The petitioner in its return for 1924 did not report said amount as income but disclosed therein its receipt of said amount, which, upon audit of the return by the respondent, was included in computing the petitioner's net income. This resulted in the deficiency complained of.

OPINION.

TRAMMELL: The issue in this proceeding is whether or not the amount of $15,153.40, paid to and received by the petitioner in cash during the taxable year 1924 in compromise and settlement of the litigation pending in the Massachusetts state court, under the circumstances set out in our findings of fact above, constitutes taxable income. The amount was not reported as income by the petitioner, but disclosure thereof was made in its return.

The respondent urges that said amount was income to the petitioner when received, for the reason that it represented damages paid to replace profits of which the petitioner had been wrongfully deprived by the defendants in said litigation. The petitioner contends that said amount was paid as damages for injuries to its good will, a capital asset, and therefore can not be said to be income.

The amount in question was paid to the petitioner in compromise and settlement of two suits, and there is no evidence to indicate in what proportion the amount could be allocated between the actions. Also, there is no evidence to establish the specific purpose for which the money was paid, other than that it was paid as a lump sum in compromise and settlement of the litigation. Whether the amount represented damages for wrongful injury to the petitioner's good will, or whether it represented damages for loss of profits, or indeed whether the amount was simply paid by the defendants to avoid further expense and harassment resulting from long continued litigation, does not definitely appear.

However, upon examination of the declarations in the two actions referred to, we are unable to conclude that the plaintiff there was seeking damages only for alleged injury to its good will. In the suit against the Oakes Brothers, based primarily upon unfair trade practices, it was alleged that by reason of the misconduct of the defendants, the plaintiff's business had been seriously interfered with and its profits destroyed. Again, in the action brought originally against Oakes and his wife, and later amended to make the estate of the deceased wife the sole defendant, the burden of the complaint seems to have been directed to the alleged action of Margaret L. Oakes in interfering "with the business of the plaintiff and her improper and illegal methods of conducting, aiding and advising in the conduct of business in competition with the plaintiff," which was asserted to be the cause of the injury and damage complained of.

If we assume that the amount in controversy was paid as agreed damages on account of the acts of the defendants set out in the declarations, we must regard it as representing compensation for loss of profits. An amount paid in compromise of litigation, which represents compensation for loss of profits, constitutes taxable income. . Cf. .

In any event, respondent has determined said amount to be income, and the burden is upon the petitioner to show by a preponderance of the evidence that the action of the respondent is erroneous. The petitioner has not, in our opinion, discharged its burden. Accordingly,

Judgment will be entered for the respondent.