Iceland, Inc. v. Commissioner , 23 B.T.A. 15 ( 1931 )

ICELAND, INCORPORATED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Iceland, Inc. v. Commissioner

Docket No. 38060.

United States Board of Tax Appeals

23 B.T.A. 15; 1931 BTA LEXIS 1935;

May 4, 1931, Promulgated

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">*1935 The petitioner was sued for an unpaid balance of rent in the amount of $29,000. It settled the suit for $20,000. Part of this amount had been properly accrued and deducted on returns for prior years and should not be deducted again. Part had been accrued but the accruals reversed within the year under circumstances which would not permit the amount to be taken as a deduction for the year. This latter amount was a proper deduction in the year of settlement. The difference between the $29,000 and the $20,000 was never accrued or deducted as rent and was not income in the year of settlement.

Harry B. Skillman, Esq., for the petitioner.

John D. Kiley, Esq., for the respondent.

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MURDOCK

">*16 The Commissioner has determined a deficiency of $2,366.37 in the petitioner's tax liability for the year 1924. The petitioner's assignments of error are:

(a) The Commissioner erroneously included $9,000 in its income representing the difference between the amount for which it was sued on a certain lease and the amount for which the suit was finally settled.

(b) The Commissioner erroneously disallowed a deduction of $20,000 paid in settlement of a suit.

">*1936 FINDINGS OF FACT.

The petitioner is a corporation with its principal office and place of business in New York City. It is engaged in the business of conducting an ice skating rink. It keeps its books on an accrual basis.

On April 18, 1916, it entered into a lease contract with the administrators of the estate of Amos F. Eno, deceased, for certain premises at Broadway and 52nd Street, New York City. The building on this property was old and not in good condition. The petitioner, realizing that it would have to repair the building and put in equipment for ice skating, desired a lease for five years to enable it to recoup for the necessary expenditures. The lessors were not permitted by the probate court to lease for longer than one year. The lease was designed to satisfy the petitioner on this point as nearly as was possible.

The lease was "for the term of one year from the fifteenth day of July, 1916, to the fifteenth day of July, 1917, at the yearly rent or sum of Fifteen thousand dollars ($15,000) to be paid in equal quarterly payments in advance, the first payment to be made on the signing hereof, and the remaining payments to be made on the fifteenth day of October, ">*1937 January and April, during said term."

The lessors had the right to require the tenant to execute four successive renewals for one year each at the following rentals for the respective years:

1st renewal	$20,000
2nd renewal	25,000
3rd renewal	45,000
4th renewal	45,000

">*17 In order to exercise each of these renewal rights, the lessors were required to give the tenant notice at least ninety days prior to the end of the current term. The lease further provided:

The parties hereby acknowledge that the tenant has required a five years' lease of said premises at a total rental of One hundred and fifty thousand dollars ($150,000) for said five years, but the landlords herein named, being authorized to lease said premises for one year only, it has been agreed, as appears from said provisions with respect to renewals, that if because of the failure of the landlords to require and grant renewals, as above set forth, the tenant shall not be able to occupy said premises for such period, then the tenant shall only be required to pay as rental the amounts as above set forth for the term or terms during which the landlords shall make it possible for the tenant">*1938 to rent said premises. The tenant, on the other hand, has agreed that if at any time before the landlords fail to exercise any right hereinbefore granted to require and grant any such renewal, the tenant shall make any default in any of its obligations under this lease, or any renewal thereof, because of which the landlords shall terminate this lease, or any renewal thereof, that then the landlords shall be entitled to receive, and the tenant obliged to pay, rental at the rate of Thirty thousand Dollars ($30,000.) per annum from the 15th day of July, 1916, to the end of the term in which such default on the part of the tenant shall occur.

In order to make this agreement effective the tenant has deposited with Lawyers Title & Trust Company concurrently with the execution and delivery hereof, the sum of Three thousand seven hundred and fifty dollars ($3,750.), and agrees to deposit the like sum of Three thousand seven hundred and fifty dollars ($3,750) on the fifteenth day of October, 1916, and on the fifteenth days of January and April, 1917, and if said first renewal hereof shall be granted said tenant agrees to deposit the sum of Two thousand five hundred dollars ($2,500.) on">*1939 the 15th days of July and October, 1917, and the fifteenth days of January and April, 1918, and if said second renewal shall be granted said tenant agrees to deposit the sum of One thousand two hundred and fifty dollars ($1,250.) on the fifteenth days of July and October, 1918, and the fifteenth days of January and April, 1919, and if the tenant shall make default in depositing any one of said sums upon said dates, as herein above set forth, this lease, or any renewal thereof which may then be in force, together with the term by this lease or such renewal demised, shall, if such default be followed by written notice from landlords so declaring, thereupon immediately terminate and end and this lease shall terminate on the day and hour specified in said notice, anything herein contained to the contrary notwithstanding. The sum or sums so deposited or to be deposited, shall be held by said Lawyers Title & Trust Co. upon the following terms and conditions:

1. If the tenant shall fail, when called upon, to take any renewal term hereinbefore provided for, or to make any additional deposit hereinabove, required at the times and in the manner above specified, then and in any such event">*1940 the whole of said sum or sums then deposited shall immediately be paid over to the landlords.

2. If the tenant having committed no default, the landlords shall fail to require the tenant to take, or shall fail to grant, any one of the renewal leases hereinbefore provided for, then all of said sum or sums then deposited shall immediately be paid over to the tenant.

3. If the tenant having committed no default hereunder, or under any renewal, the landlords shall have required, and the tenant shall have taken each one of ">*18 the renewal terms hereinabove provided for, the said sums, which will then equal a total of Thirty Thousand dollars ($30,000) shall be paid over to the landlords at the following times and in the following amounts.

On the 15th day of October, in the term demised by
the fourth renewal above referred to	$7,500
On the 15th day of January in said term	11,250
and -
On the 15th day of April in said term	11,250

But in such event the tenant shall be credited with the payment of rental on account of the rental for said fourth renewal term in amounts equal to the amounts so paid over to the landlords, but without being so credited">*1941 with any interest which may have accrued on said sums.

The petitioner took possession under this lease and continued to occupy the premises for a number of years.

During 1916 the petitioner accrued on its books and paid $7,500 into the trust fund and $7,500 to the lessor. On its income-tax return for that year it deducted rent in the amount of $15,000. It also paid and accrued on its books the amount of $3,750 due to the trust fund on January 15, 1917, and $3,750, the amount due the lessors on that same date. The lessors notified the petitioner that they elected to require the petitioner to renew the lease for another year, from July 15, 1917, until July 15, 1918, in accordance with the provisions of the lease. During 1917 the petitioner accrued on its books and paid into the trust fund $12,500 as required by the terms of the lease. During 1917 and 1918 the petitioner did not pay the quarterly installments due on the dates and in the amounts shown below, but it did accrue these amounts on its books as shown in the following table:

		Amount
Date due	Date accrued	Rent account	Trust fund account
1917	1917
Apr 15	Apr. 30	$3,750
July 15	Oct. 31	5,000
Oct 15	Oct. 31	5,000
1918	1918
Jan. 15	Jan. 15	5,000	$2,500

">*1942 On its income-tax return for 1917 the petitioner deducted rent in the amount of $30,000.

Beginning on December 29, 1917, and continuing through the early months of 1918, the petitioner, having defaulted in the payments required under the lease, wrote a number of letters to the lessors, explaining that it was unable to pay the required rent because of the effect of the war on its business and suggesting cancellation of the old lease and any payments due thereunder and execution ">*19 of a new lease at a lower rental. This subject was discussed by the parties. The lessors never suggested that the petitioner should vacate the premises. On March 25, 1918, the petitioner directed that the trust fund be paid to the lessors. For each of the months July, August, and September, 1918, the petitioner accrued and paid to the lessors rent in the amount of $1,500. On October 7, 1918, the parties entered into a new lease of the same premises for one year from October 1, 1918, to October 1, 1919, at an annual rental of $18,000, payable $1,500 a month.

During the latter months of 1917 and the early months of 1918 the lessors sent monthly statements to the petitioner setting forth">*1943 the rent due and unpaid under the first lease. After the new lease was entered into in October, 1918, the statements no longer contained any reference to any amount owing to the lessors under the first lease. The petitioner's officers believed that any amount due and unpaid under the first lease had been cancelled when the new lease was executed.

The petitioner's ledger contains reversing entries under date of October 5, 1918, crediting to profit and loss the unpaid but accrued trust fund item of $2,500 and the unpaid but accrued rent items totaling $18,750.

On December 21, 1921, the lessors filed a complaint against the petitioner in the Supreme Court of New York County. The suit was for unpaid rent for the period from July 15, 1916, to October 1, 1918, under the lease of April 18, 1916. The complainants alleged that the petitioner owed them a balance due of $29,000 for rent for this period, as shown in the following table:

July 15, 1916, to July 15, 1917	$30,000
July 15, 1917, to July 15, 1918	30,000
July 15, 1918, to Oct. 1, 1918	6,250
	66,250
Less credit of amount paid	37,250
Balance due	29,000

The petitioner filed an answer to this complaint">*1944 on or about the twenty-third day of February, 1922, in which it claimed that a balance of $2,250 was due it from the lessors, based upon a computation as shown below.

Rent from July 15, 1916, to July 15, 1917	$15,000
Rent from July 15, 1917, to July 15, 1918	20,000
	35,000
Amount paid by the petitioner to the lessors	37,250
Amount due to the petitioner from the lessors	2,250

">*20 On June 10, 1924, before this action came to trial, it was compromised and settled by the parties in an agreement whereby the petitioner agreed to pay to the lessors $20,000, payable $2,000 monthly commencing on that date, the deferred payments to carry interest. The petitioner gave nine notes each in the amount of $2,000 covering the future payments.

The officers of the petitioner, one of whom was counsel for the petitioner in the action above referred to, believed that the petitioner had a good defense to the complaint. They agreed to compromise the case because they believed that certain financial negotiations which the petitioner was conducting at that time would be seriously interferred with by the fact that a case was pending against it in which it might lose $29,000">*1945 with interest.

On its income-tax return for 1924 the petitioner deducted $20,000 representing the amount agreed upon in the settlement with the Eno estate. The Commissioner in his final determination disallowed this deduction and added to the petitioner's income an additional amount of $9,000, representing the difference between the liability for the balance of rent unpaid and the amount for which the liability was settled.

OPINION.

MURDOCK: The petitioner accrued on its books for 1916 an amount of $15,000, representing payments which it was required to make and which it made under a lease. Likewise, for 1917, it accrued similar items in the amount of $30,000, and eventually paid this amount. These amounts were taken as deductions for rent on its income-tax returns for these respective years. The accruals and the deductions were proper under the circumstances which the record shows then existed.

In 1918 some, but not all, of the payments provided for in the lease were accrued. The petitioner believed during that year that it would never be able to pay the rent in accordance with the terms of the first lease and so notified the lessors. Negotiations were conducted">*1946 for a new lease at a lower rental and such a new lease was entered into. The petitioner constantly maintained during these negotiations that it was unable to pay the unpaid rent due under the existing lease and asked that the slate be wiped clean and a new start made at a rental of $18,000 a year or $1,500 a month. This was the rent agreed upon under the terms of the new lease. For each of the months of July, August, and September, 1918, the petitioner accrued in its rent account an item of $1,500. On October 5, 1918, two days before the new lease was executed, the petitioner reversed the accruals of unpaid rent on its book because it believed it was no longer under any obligation to pay these amounts. Thus, ">*21 at the end of the year 1918 the petitioner was not entitled, in reporting its income for 1918, to deduct any amount representing payments due under the lease which was in effect up to October 1, 1918, for at that time it had already deducted on its income-tax returns for prior years more than the total amounts accrued on its books and not reversed, and more than the total theretofore paid or then believed to have been incurred.

In 1924, the taxable year before">*1947 us, the petitioner agreed to pay $20,000 in settlement of the suit for unpaid rent. This amount just equaled the excess of the total accruals over actual payments, which excess accruals were reversed on October 5, 1918. The petitioner had taken $9,250 of this difference as a deduction from gross income on its 1917 return and there is no reason to hold that this amount should again be deducted for 1924. But the petitioner was never entitled to take the balance of $10,750 as a deduction from its reported gross income for any year prior to the year before us. In 1918 it honestly believed, and not without reason, that it was under no obligation to pay this amount. It reversed the entries on its books accruing the liability. It never thereafter admitted any liability to pay. But in 1924 it definitely agreed to pay in order to compromise and settle a law suit. It was, therefore, proper in that year to accrue this amount on its books and to deduct it on its return.

The $9,000 which the Commissioner added to the petitioner's income for the year 1924, representing the difference between the balance of unpaid rent claimed by the lessor and the amount for which the suit was settled, ">*1948 had never been accrued as a liability on the petitioner's books and the petitioner was never entitled to deduct this amount in computing its income. This amount was not income to the petitioner in the year 1924.

Judgment will be entered under Rule 50.