Colonial Enterprises, Inc. v. Commissioner , 47 B.T.A. 518 ( 1942 )

COLONIAL ENTERPRISES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Colonial Enterprises, Inc. v. Commissioner

Docket No. 108024.

United States Board of Tax Appeals

47 B.T.A. 518; 1942 BTA LEXIS 682;

August 11, 1942, Promulgated

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1. An amount paid by petitioner in 1936 as interest on deferred payment of the purchase price of certain bonds was in fact interest and not a part of the cost of such bonds.

2. Payments of petitioner's expenses by another corporation in acquiring certain bonds for account of petitioner, such expenses not being charged against petitioner nor such other corporation being reimbursed therefor by petitioner, are not includable in petitioner's cost of such bonds in computing the profit realized by it upon their resale.

3. Petitioner in 1937, while on the cash basis, determined upon complete liquidation and thereupon paid all of its debts except one for current taxes not then ascertainable in amount. Its remaining assets were then distributed to its two stockholders, with exception of an amount in cash less than the actual tax liability. This cash was then deposited in a special account subject to check by these stockholders, who by contract agreed to disburse it in payment of taxes and to pay personally any excess. Held, that petitioner was thereupon completely liquidated and may not be considered as in possession of undistributed profits subject to surtax under section 14(b) of the Revenue Act of 1936.

John H. Wahl, Jr., Esq., and Robert H. Anderson, Esq., for the petitioner.

J. Marvin Kelley, Esq., for the respondent.

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LEECH

Respondent has determined deficiencies for the calendar year 1937 as follows:

Income tax	$2,062.33
Undistributed profits tax	3,550.00
Excess profits tax	1,849.05

Petitioner denies liability and claims an overpayment of $119.88, for which it asks a finding. Four errors are assigned, one of which, the disallowance by respondent of a deduction of $2,925 by petitioner of interest paid by it in the taxable year, respondent confesses. The issues thus left for our determination are (a) whether an item of $9,334.90 paid by petitioner in 1936 represented interest deductible in that year or part of the cost of bonds sold by it in 1937, (b) whether a proportionate part of an expenditure made by another corporation as expense in connection with the purchase of bonds for itself and petitioner represented an item of cost to petitioner of the bonds purchased for its account, and (c) whether the amount of $5,000 deposited by petitioner in a bank upon its liquidation in 1937 and subject to withdrawal by its two stockholders represented undistributed profits held by petitioner as of the close of that year and, as such, subject to surtax.

FINDINGS OF FACT.

The facts pertaining to issues (a) and (c) are stipulated and so found. The facts hereinafter set out and not included in the stipulation and pertaining to issue (b) are found upon the evidence adduced at the hearing.

Petitioner is a personal holding company, incorporated under the laws of Delaware. Its return for the calendar year 1937 was filed with the collector for the district of Florida. It was one of several corporations organized to acquire bonds issued by the penn-Florida Hotels Corporation upon several Florida hotels, that corporation being then in a 77B reorganization and the bonds having been deposited by the holders incident to that proceeding. All of petitioner's stock was owned by two individuals in equal proportions.

On December 1, 1934, petitioner entered into an agreement to purchase certain deposited bonds secured by the Watson Hotel, Miami, Florida, at 50 cents on the dollar of their face value. The agreement was made subject to approval by the court, provided for a down payment of $16,250, and payment of the balance in 90 days without interest, or at the option of the purchaser such "original payment date" might be extended for 12 months upon the deposit of certain security and the payment of "interest" at the rate of 6 percent. The purchaser was given the right, if the date of payment was extended, to "pay the balance of the Purchase Price at any time before the same has become due and payable as above set forth, by payment of the principal amount thereof and interest to the date of payment."

Petitioner exercised the option to extend the payment date and paid on March 23, 1936, shortly before the expiration of the extension, the balance in the sum of $146,444, together with $9,334.90, paid under the denomination of "interest" as stated in the agreement. This latter amount was entered upon its books as interest and deducted as such on its return for 1936. Such payment was one of interest.

Petitioner was one of several corporations formed for the purpose of buying the bonds on various Florida hotels. One S. A. Lynch was the owner of one-half of its stock and the principal party in interest in the other corporations. One of these corporations was the S. A. Lynch Enterprise Finance Corporation, hereinafter referred to as Lynch Corporation. The matter of the purchase of the various bonds was handled by S. A. Lynch and, in this activity, he expended personally the sum of $12,299.24, largely for attorneys, fees. The amount was reimbursed to him by the Lynch Corporation and deducted by the latter on its return as a business expense. On audit of that return by respondent, the deduction was disallowed. It was held to be a cost of the bonds purchased. Respondent determined that only that portion of the total of $12,299.24 applicable to the purchase of bonds bought for account of that taxpayer, could be taken into account by it and then only as a cost of such bonds. On this basis respondent determined that $4,292.43 of the total amount was applicable to the purchase of Hotel Watson bonds and, since 85.5 percent of those bonds were bought for account of petitioner, only 14.5 percent of this amount of $4,292.43 represented a cost to the Lynch Corporation of its purchased bonds.

In 1937 the only property owned by petitioner was the bonds of the Hotel Watson it had thus acquired. These were sold early in that year for a total consideration of $239,707.20. It was thereupon decided to liquidate petitioner. All of its debts were paid except taxes. These were not yet due or determinable in amount. The balance of the assets, representing cash, with the exception of $5,000, was distributed to its two stockholders. This amount was deposited in bank under an agreement executed by those two stockholders that it was to be subject to their disbursement on checks signed jointly by them as president and treasurer of petitioner and was to be used to first pay the taxes of the current year and any balance remaining to be theirs. They in turn agreed to be personally liable for any taxes in excess of the deposited amount. In accordance with this agreement the sum of $2,561.03 was paid in 1938 to the collector to cover the taxes shown on the income tax return of petitioner for 1937 and an additional amount in that year of $45.20 was paid for social security taxes. The balance of $2,393.77 is still held in the account pending the determination of this proceeding.

OPINION.

LEECH: Petitioner contends under issue (a) that the sum of $9,334.90 paid by it in 1936 as interest and so treated on its books and in its return for that year in fact constituted a cost of the bonds purchased. Consequently, it argues that the gain computed for 1937 on the sale of these bonds should be reduced by this amount. We do not agree. The facts stipulated establish that the item in question was interest. The purchase price was fixed and did not include this sum, which was paid as interest on such purchase price and for the period during which petitioner withheld payment.

Under issue (b) petitioner contends that the sum of $3,670.03 paid by the Lynch Corporation as expenditures in connection with the acquisition of Hotel Watson bonds for petitioner should be treated as a part of its cost of the bonds and the profit on their sale in the taxable year correspondingly decreased. This expenditure was not by petitioner but another corporation. No part of it is shown to have been charged to petitioner, nor does the record indicate that it constituted a liability of petitioner to any corporation or individual. No intent that Lynch Corporation should be reimbursed is established. On that record we hold that this expenditure was not a part of the cost of petitioner of the bonds acquired.

The remaining issue (c) involves the deficiency of $3,550 in undistributed profits surtax determined with respect to the sum of $5,000 deposited in 1937 to meet taxes not yet ascertainable in amount when petitioner ceased business and was liquidated. The circumstances are set out in the findings.

Of course, if petitioner distributed all of its assets in complete liquidation during 1937, then it had no undistributed profits at the close of that year upon which the contested surtax could be laid. This would be so whether or not petitioner had a technical existence thereafter. ; reversed on another point, .

Petitioner contends that the arrangement effected its complete liquidation in 1937 and that no amount was retained from distribution. Had petitioner been on an accrual basis of accounting, no question would arise. The taxes for the current year are shown to have been substantially in excess of $5,000, and the accrual of this amount would thus necessarily be sustained. Petitioner, however, was on a cash basis. It insists, however, that, 1937 being its final year of operation, in which complete liquidation was carried out, accrual of its one remaining liability is proper because otherwise a distortion of income results. It is argued also that such accrual is authorized by section 43 of the Revenue Act of 1936.

It is true that a necessary condition precedent to the application of the cash system of accounting, if income or expense is to be properly and consistently reflected, is that there must be a future year in which expenses incurred in connection with income produced in the current year but not then paid, may be deducted when the expenditure is actually made. In the present case we have an unusual situation. It is the last year of operation. An agreement is effected for the complete liquidation of petitioner and carried out in detail. Every debt is paid except the current taxes which, although to be paid in respect of this year, are not ascertainable in exact amount until after the close of the year. There will be no future year of operation or another item of income or capital against which the payment of the tax liability may be offset when made.

The petitioner admittedly distributed in 1937 all of its assets except the one item of $5,000 in cash. That amount it then set aside, earmarked and placed in trust for payment of the taxes which subsequently exceeded that sum. The stockholders. Who were trustees of the fund, have assumed personal liability for the payment of that excess. We think that the deposit in trust of the $5,000 item was a distribution of that amount and thus actually completed the liquidation of petitioner's assets in 1937. On this issue we hold for the petitioner.

Decision will be entered under Rule 50.