Hotel Patten Co. v. Commissioner ( 1928 )

HOTEL PATTEN CO., WATTERSON HOTEL CO., UCITA INVESTMENT CO., AND J. B. POUND HOTEL CO., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Hotel Patten Co. v. Commissioner

Docket No. 5792.

United States Board of Tax Appeals

13 B.T.A. 943; 1928 BTA LEXIS 3124;

October 12, 1928, Promulgated

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1. Value of property for invested capital purposes determined.

2. Value of leases determined.

Sam E. Whitaker, Esq., for the petitioners.

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

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VAN FOSSAN

This proceeding is brought to redetermine the income and profits tax of four affiliated companies - Hotel Patten Co., Watterson Hotel Co., Ucita Investment Co., and J. B. Pound Hotel Co. - for the years 1918 and 1919. The petitioners allege generally that the respondent erred in refusing to allow their claim in abatement for the year 1918 to the extent of $45,130.06 and in asserting a deficiency of $10,787.25 for the year 1919.

The respondent challenges the jurisdiction of the Board over the redetermination f the income tax for the year 1918.

Errors are specified by petitioners as follows:

(1) No sum was allowed for invested capital by virtue of a lease on a hotel building acquired by the Hotel Patten Co. from its assignor, the Patten Hotel Co., in exchange for $50,000 of the capital stock of the Hotel Patten Co.

(2) No allowance was made to cover the amortization of the lease obtained from the Patten Hotel Co.

(3) No allowance was made as invested capital for the sum of $36,000, representing the excess value of the assets acquired by the Hotel Patten Co. on January 1, 1918, from the Chattanooga Hotel Co. over the amount of $100,000 in stock issued therefor.

(4) The respondent refused to allow the sum of $51,000 as paid-in surplus representing the excess value of a lease on the Hotel Seminole property acquired by the Ucita Investment Co. in 1907 over the amount of $99,000 of capital stock issued by the Ucita Investment Co. in payment for the said lease.

(5) No allowance was made for the amortization or exhaustion of the lease on the Hotel Seminole property.

(6) Insufficient depreciation was allowed on the Hotel Seminole building owned by the Ucita Investment Co.

(7) The respondent refused to allow any sum as invested capital on account of a lease on the Hotel Savannah acquired by the J. E. Pound Hotel Co. in exchange for $25,000 of its capital stock.

(8) No allowance was made for the amortization of the lease on the Hotel Savannah.

(9) The respondent refused to allow as invested capital the sum of $40,000 representing the excess value of a lease on the Watterson Hotel over the $60,000 in the capital stock of the Watterson Hotel Co. paid by it for the said lease.

(10) No allowance was made covering the annual depreciation or amortization of the above leasehold on a basis exceeding $60,000.

(11) The respondent refused to allow the Watterson Hotel Co. as deductions from its income for 1918 and 1919 the sum of $910 expended by it in securing good roads in the vicinity of Louisville and also the sum of $2,200 expended by it in 1918 for the purpose of obtaining the location of Camp Taylor near Louisville.

(12) The respondent reduced the petitioners' invested capital by the amount of income and profits taxes shown to be due on the returns filed for 1918 and 1919 and also by the amount of additional income and profits taxes found by him to be due.

FINDINGS OF FACT.

On January 21, 1924, the respondent notified the petitioners that an additional tax for 1918 was due from them in the amount of $57,248.51, with the usual provision allowing protest thereof within 30 days. Of February 28, 1924, the petitioners protested against the action of the respondent and requested a hearing. The hearing was granted and the date thereof fixed as April 22, 1924, but later, at the petitioners' request, was postponed until May 6, 1924. In March, 1924, the taxes were assessed. On May 21, 1924, the petitioners received from the collector of internal revenue a notice and demand for the payment of the tax, and on May 27, 1924, filed a claim for abatement of the entire tax. By a certificate of overassessment bearing the date June 27, 1925, the petitioners were notified that the respondent had allowed $14,236.28 of the claim, leaving a balance of $43,012.23 as the correct tax liability. No part of the said balance was paid prior to June 3, 1924. The appeal to the Board was filed July 25, 1925, and was pending on February 26, 1926.

The Hotel Patten Co. is a corporation organized under the laws of Tennessee and operated the Hotel Patten in Chattanooga, Tenn.

The Ucita Investment Co. is a corporation organized under the laws of Florida and operated the Hotel Seminole in Jacksonville, Fla.

The J. B. Pound Hotel Co. is a corporation organized under the laws of Georgia and operated the Hotel Savannah in Savannah, Ga.

The Watterson Hotel Co. is a corporation organized under the laws of Tennessee and operated the Watterson Hotel in Louisville, Ky.

J. B. Pound owned more than a controlling interest in all the above corporations.

In 1906 the Stone Fort Land Co. erected the Hotel Patten in Chattanooga, Tenn., and leased it to the Chattanooga Hotel Co., the owner of the furniture and fixtures of the hotel. In 1910 the Chattanooga Hotel Co. assigned the lease on the Hotel Patten building to J. B. Pound and also executed a lease covering the furniture and fixtures owned by it. Pound organized the Patten Hotel Co. (not petitioner herein) and assigned the lease to that corporation in exchange for $50,000 of its capital stock, of which, however, only a portion was actually issued. The unexpired term opf the lease at that time was about 18 years.

The petitioner, the Hotel Patten Co., was organized about January 1, 1918, and on that date acquired all the assets of the Patten Hotel Co. and the Chattanooga Hotel Co. in exchange for the capital stock issued by the Hotel Patten Co. to the stockholders of the two other corporations. The assets of the Chattanooga Hotel Co., valued at $136,000, were transferred in exchange for $100,000 in the preferred stock of the Hotel Patten Co., while the leases on the hotel building and the furniture and fixtures were assigned by thePatten Hotel Co. in exchange for $100,000 of the common stock of the Hotel Patten.

At the time Pound secured the leases on the Hotel Patten and its furniture and fixtures that hotel was under a contract with one Charles T. Alexander, which provided that the said Alexander should act as its manager for a period of about three and one-half years thereafter. Alexander proved to be an unsatisfactory manager, but refused to terminate his contract as the hotel's manager. To obtain such termination Pound personally paid Alexander $5,000. He also assumed certain obligations incident to the operation of the hotel, including a yearly rental of $8,400 under the lease of the furniture and fixtures and the endorsement of $50,000 of obligations of the Chattanooga Hotel Co.

The Ucita Investment Co. was organized in 1907. In that year it obtained a lease on a lot 105 by 105 feet at the corner of Hogan and Forsythe Streets in the business section of Jacksonville, Fla. This lease prvided for an annual rent of $9,000 during a term of 99 years. It was assigned to the corporation in exchange for $99,000 of its capital stock. Shortly thereafter the company began to erect an office building on the site. Because of the financial situation in Jacksonville the company built as cheaply as possible. The exterior construction, consisting of steel frame, hollow tile and brick covered with concrete, was substantial, but the interior portions were constructed of an inferior grade of material, were of inadequate dimensions, and were fabricated in an unqworkmanlike manner. J. B. Pound purchased the control of the Ucita Investment Co. in 1909 before the building was completed, and the company transformed it into the Hotel Seminole. The type of construction, materials, facilities and equipment, inadequate for an office building, were much more so for hotel purposes. Shortly after the hotel was placed in operation repairs, replacements, and alterations were necessitated almost constantly. The plumbing had to be replaced entirely and expensive repairs made to the elevators. The respondent allowed a total amount of $10,113.78 as depreciation for the years 1918 and 1919.

Prior to January 15, 1913, S. J. and J. A. Newcomb had acquired a lease on the Hotel Savannah in Savannah, Ga. In June, 1913, they took steps to incorporate their business under the name of the Newcomb Hotel Co. The charter for this company was not granted until about April 1, 1914. During the period from June, 1913, to April, 1914, the Newcomb brothers had expended $120,000 for furniture and fixtures. On April 1, 1914, the incorporators of the Newcomb Hotel Co. met for organization and bought from J. A. and S. J. Newcomb the furniture and fixtures of the Hotel Savannah and the lease under which it was being operated, for the sum of $145,000, $25,000 of which was specified as the value of the lease. Shortly thereafter J. B. Pound purchased the entire stock of the Newcomb Hotel Co. and changed its name to the J. B. Pound Hotel Co. Pound paid $25,000 for the stock of the Newcomb Hotel Co. of the par value of $50,000 and also assumed the obligations of that corporation to the Newcomb brothers in the sum of $95,000. The ill health of J. A. Newcomb and other local reasons were assigned as the reason for the purchase of the stock of the Newcomb brothers at less than its par value. The unexpired term of the Hotel Savannah lease was about 19 years.

In 1912 J. B. Pound secured a 25-year lease (with an additional 25-year option) on theHotelWatterson property located near the corner of Water and Fourth Streets in the heart of the business section of Louisville, Ky. Subsequent thereto the Watterson Hotel Co. was organized and Pound assigned the lease to that corporation in exchange for all its capital stock, of the par value of $60,000, the sum fixed by the respondent as invested capital. The HotelWatterson was advantageously situated and well equipped to produce a substantial return on the investment made in it. At various times prior and subsequent to the opening of the hotel Pound was offered large sums of money for the purchase of the lease.

In 1918 the Watterson Hotel Co. expended the sum of $810 and in 1919 the sum of $100 as contributions to the securing of better roads leading into Louisville. In 1918 the said company also contributed $2,200 to assist in securing the location of Camp Taylor near Louisville. Camp Taylor was a training camp for enlisted men and officers. Persons in and visitors to that camp patronized the Watterson Hotel extensively.

The petitioners' invested capital for 1919 was reduced by the respondent by the amount of income and profits taxes for the year 1918, as set forth in the respondent's deficiency letter dated June 4, 1925.

OPINION.

VAN FOSSAN: Section 283(f) of the Revenue Act of 1926, which became effective on February 26, 1926, provides:

If any deficiency in any income, war-profits, or excess-profits tax imposed by the Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, or the Revenue Act of 1921, or by any such Act as amended, was assessed before June 3, 1924, but was not paid in full before that date, and if the Commissioner after June 2, 1924, but before the enactment of this Act finally determined the amount of the deficiency, and if the person liable for such tax appealed before the enactment of this Act to the Board and the appeal is pending before the Board at the time of the enactment of this Act, the Board shall have jurisdiction of the appeal. In all such cases the powers, duties, rights, and privileges of the Commissioner and of the person who has brought the Appeal, and the jurisdiction of the Board and of the courts, shall be determined, and the computation of the tax shall be made, in the same manner as provided in subdivision (e) of this section, except as provided in subdivision (j) of this section and except that the person liable for the tax shall not be subject to the provisions of subdivision (d) of section 284.

In the proceeding under consideration the deficiency in the income tax, war-profits and excess-profits tax arose under the Revenue Act of 1918 and related to the year 1918. Such taxes were assessed in March, 1924, and were not paid in full before June 3, 1924. On June 27, 1925, the respondent finally determined the amount of the deficiency, setting forth such conclusion in the form of a certificate of overassessment. The petitioners appealed on July 25, 1925, and their appeal was pending before the Board on February 26, 1926, the date of the enactment of the Revenue Act of 1926. Therefore, it is our opinion that this case comes squarely within the said section 283(f) of the Revenue Act of 1926 and that consequently we have jurisdiction of the appeal.

In the computation of invested capital the respondent disallowed the value of the Hotel Patten lease transferred by J. B. Pound to the Patten Hotel Co. in 1910 in exchange for its entire capital stock issue of $50,000, on the theory that Pound had acquired the lease for nothing. This fact in itself is not sufficient to assign no value to the leasehold. ; . Pound and five other competent witnesses fixed the value of the lease at from $100,000 to $200,000 at the time of its transfer to the Patten Hotel Co. All of these witnesses showed themselves to be thoroughly familiar with the hotel business in the South and East and particularly with the situation involved in the leasing and operation of the Hotel Patten, while three of them had had a special reason to ascertain the value of the lease in that they were interested in its purchase before, at or subsequent to the date Pound secured the lease. While the lease originally cost Pound nothing, he expended a considerable amount of money and much effort and lent his credit to the enterprise prior to his assignment of the lease to the corporation. These acts on his part in themselves contributed largely to the real value of the leasehold. We are of the opinion that the claim of the petitioners that the invested capital of the Hotel Patten Co. be increased by $50,000 should be sustained and that a corresponding allowance for computing exhaustion of the said leasehold be made.

Pound testified that the value of the assets transferred by the Chattanooga Hotel Co. to the Hotel Patten Co. in 1918 was approximately $136,000, while the amount of prefered stock received therefor was $100,00. He submitted no basis whatever for what he termed was his "opinion" of the actual cash value of those assets, and his testimony is not convincing. It is our opinion that the petitioners have not brought themselves within the requirements of section 326(a)(2) of the Revenue Act of 1918, which defines invested capital as the -

Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: * * * (Italics ours.)

Petitioners, therefore, on the record, are not entitled to this increase of $36,000 in the invested capital of the Hotel Patten Co. as of January 1, 1918.

The petitioners contend that the lease covering the Hotel Seminole property was worth at least $150,000 at the time it was assigned to the Ucita Investment Co. in exchange for $99,000 of the capital stock of that corporation and introduced the testimony of various real estate dealers and so-called experts to support their claim. However, in 1909 J. B. Pound, then a stranger to the enterprise, purchased at par the entire capital stock of $99,000. The company was in financial difficulties whn Pound purchased its stock. It must be borne in mind also that the Hotel Seminole building itself was not properly adapted to hotel uses and that the success of the venture was by no means assured. We approve the action of the respondent in refusing to allow the sum of $51,000 as paid-in surplus, purporting to represent the excess value of the lease over the amount of capital stock received therefor. Consequently, no increased allowance should be made in computing exhaustion of that lease.

The petitioners assert that the respondent allowed depreciation on the Hotel Seminole property in the amount of $10,113.78 for the years 1918 and 1919, whereas the sum of $12,642.22 should have been allowed for each year. No evidence was submitted to support these figures. Pound described the character of the hotel building, and asserted that it was constantly in need of repairs and stated that in his opinion the yearly depreciation for 1918, 1919, and 1920 was from $12,000 to $15,000. The witness was not certain as to what method was employed by the Ucita Investment Co. in charging repairs, replacements and expenses on its books. On the record petitioners have not proved that they are entitled to an additional allowance for depreciation.

The respondent disallowed an excess value of $25,000, representing a lease on the Hotel Savannah which had been secured originally by S. J. and J. A. Newcomb and assigned by them to the Newcomb Hotel Co. The term of the lease was 21 years and the rental was based on the actual cost of the building and land. No money was expended for promotion or effecting the sale of stock or bonds and the construction bills were paid in cash, thereby resulting in unusual economy. The Hotel Savannah was exceptionally well located and at the time was the only first-class hotel in Savannah. Due to the ill health of J. A. Newcomb and to other purely personal reasons, Pound purchased the capital stock of the corporation, of the par value of $50,000, for the sum of $25,000. The corporation owned the furniture and fixtures and lease. J. A. Newcomb valued the lease at at least $25,000, while Pound testified that it was worth $150,000 at the time he secured control of the Newcomb Hotel Co. We are of the opinion that the petitioners are entitled to a lease value of $25,000 as invested capital, as claimed by them and that a corresponding allowance should be made in computing exhaustion of that lease.

The respondent has allowed as invested capital the sum of $60,000, representing the par value of the capital stock of the Watterson Hotel Co. received by J. B. Pound in exchange for the assignment of his lease on the Watterson Hotel property. The petitioners claim that the said lease had a value of at least $100,000 at the time of its assignment, that the figure of $60,000 was merely nominal because Pound owned all of the stock except qualifying shares and that for purposes of State taxation and for other reasons the full value of the lease was not measured by the amount of capital stock received by Pound himself and other competent witnesses who had made offers for the purchase of this lease prior, near, and subsequent to the time of its acquisition by the corporation, the value therefor was established as at least $100,000. The evidence submitted is convincing and uncontradicted, and we hold that the excess amount of $40,000 claimed by the petitioner as added invested capital of the Watterson Hotel Co. is properly allowable. A corresponding increase should be allowed in computing exhaustion of the leasehold.

The sums expended by the Watterson Hotel Co. to assist in securing better roads for the vicinity of Louisville were for a purpose entirely too remote and unrelated to the direct business needs of the petitioner to permit their allowance as deductions from income. The sum of $2,200 contributed by the Watterson Hotel Co. in 1918 to assist in accomplishing the location of Camp Taylor was for the purpose of, and resulted in a direct and distinct business benefit to the petitioner, and is allowed as a proper deduction from income. ; .

Petitioners contend that their invested capital for 1918 and 1919 should not be reduced by the amount of income taxes appearing due on the face of the returns and by additional taxes found to be due by the respondent for the immediately preceding years. Although no evidence was introduced on this point, this question was ruled adversely to petitioners in .

Judgment will be entered under Rule 50.