Lester v. Commissioner , 19 B.T.A. 549 ( 1930 )

GEORGE B. LESTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Lester v. Commissioner

Docket Nos. 24356, 28333.

United States Board of Tax Appeals

19 B.T.A. 549; 1930 BTA LEXIS 2376;

April 11, 1930, Promulgated

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1. An amount received in the taxable year from a corporation does not appear to have been a gift and was, therefore, properly included in gross income.

2. Commissioner's disallowance of a deduction representing the cost of transporting the petitioner's family to England and the maintenance of a residence there where he had gone on business approved.

3. Deductions for losses in operating a farm allowed.

Byrd D. Wise, Esq., for the petitioner.

Byron M. Coon, Esq., for the respondent.

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MURDOCK

The Commissioner determined deficiencies of $11,108.46 and $39,467.74 in the petitioner's income tax for the calendar years 1921 and 1922, respectively. The petitioner alleges that the Commissioner erred (1) in including in his taxable income for 1922, $100,000 which he received during that year from the Fleischmann Co.; (2) in disallowing the deduction of certain expenses incident to a business trip to England paid in the year 1922; (3) in disallowing the deduction of certain losses sustained in the operation of a farm in the years 1921 and 1922.

The cases were consolidated.

FINDINGS OF FACT.

In 1897 the petitioner received an invitation to visit the home of Charles Fleischmann at Peekskill, N.Y. While going to Peekskill on the Fleischmann yacht, he met Julius Fleischmann, son of Charles. Julius and the petitioner were about the same age and at that time they began a friendship and an association which had a most pronounced effect upon the petitioner's later life.

The Fleischmann family had been engaged in the business of manufacturing yeast. Prior to 1890 Charles Fleischmann and his brother Max had carried on this business as partners under the name of Fleischmann & Co. Max died in 1890 and the business was continued without liquidation until the death of Charles in 1897. Thereupon, a suit for an accounting was brought against Julius Fleischmann and other members of his family. The future of the business was precarious. At this point Julius Fleischmann sought the aid of the petitioner, who had recently been admitted to the bar, and retained him as his counsel. The petitioner first succeeded in arranging for the continuation of the business by Julius and avoided the appointment of a receiver. He then advised the employment of other and more experienced counsel for the conduct of the suit. Several of the leading lawyers of the day were selected and secured. The petitioner also hired accountants. He spent a great deal of time studying the business. Finally, in December, 1904, the suit was settled upon payment by Julius Fleischmann and his brother and sister of $2,602,000 in cash; they to own the business.

In order to raise this amount of money, the petitioner formed a corporation, The Fleischmann Company. It was capitalized at $6,000,000, one-half of which represented common stock all retained by Julius Fleischmann and his brother and sister, and the other one-half represented preferred stock which was sold to the public. The new corporation took over the yeast business on April 15, 1905, and has continued that business ever since. One qualifying share was placed in the name of the petitioner and he was made a director of the company and general counsel. He continued his law practice, but gave much of his time to the Fleischmann Co. business. In the summer of 1907, at the request of Julius Fleischmann, the petitioner gave up his law practice and entered the Fleischmann Co. No written contract covering the petitioner's employment was executed at that time.

In the latter part of 1908 the petitioner was elected vice president and appointed general manager, and from then on he acted as president during the frequent absences of Julius Fleischmann. These two men, then close personal friends, were the chief executive officers of the company and the only persons familiar with all the different phases of the business.

During the next ten years the petitioner, with the approval and aid of Julius, made many radical and highly desirable changes in the business of the company. He effected profitable economies; increased efficiency; eliminated practically all competition; extended the territory in which the products of the company were sold until it included all of the United States, Canada, Mexico, and other countries, but not England and the continent of Europe; secured the American rights for many valuable patents covering inventions developed in foreign lands for improvements in the manufacture of yeast; by advertisement and otherwise greatly increased the company's good will; aided in finding new uses for the products and brought to a successful conclusion a suit by the Federal Trade Commission on charges of unfair competitive tactics. When the United States entered the World War, the Fleischmann Co. was a smooth-running organization which had successfully solved its chief problems. The petitioner, with the approval of Julius Fleischmann, then organized its far-reaching forces and agencies to assist the Food Administration. The petitioner's energy, ability, foresight and enthusiastic loyalty to the Fleischmann interests were largely responsible for the accomplishment of these results. During this time, and as the result of the petitioner's efforts, the profits of the company increased enormously.

In 1908 the petitioner's annual salary was $35,000. During the next ten years it was increased from time to time, although he never requested an increase, until finally he was receiving $100,000 a year. Julius Fleischmann frequently told the petitioner how grateful he and the other members of his family were for all that the petitioner had done for them in the business of the company, and talked with the petitioner about rewarding him in some way for his long, faithful and efficient service.

About June, 1918, the petitioner went on leave from the Fleischmann Co. at half pay and took a commission in the Military Intelligence Service of the United States Government and was assigned to the investigation of German propaganda. In January, 1919, while on duty in Washington, he received a telegram from Julius Fleischmann in California, requesting an immediate meeting with him in New York on a matter of great importance. The petitioner went to New York and met Julius when the latter arrived there. Whereupon, to the petitioner's utter astonishment, he was told that he would have to sever his relations with the Fleischmann Co. Julius was very angry. He explained that his business and personal interests demanded that he and the petitioner separate because certain of the latter's official investigations and acts while in the intelligence work had offended a number of Julius' German-American friends and customers and had injured his business. The petitioner refused to accept $350,000 which Julius then offered him in recognition of his long years of association with the company. The petitioner advised Julius that he was going back to finish his work for the Government and receive his discharge and that he would then return to resign from the Fleischmann Co. if Julius then desired it.

The petitioner, about April, 1919, resigned from his positions in the Fleischmann Co. and its associated companies. Julius again told him that he wished to give him something in recognition of his services, so the petitioner and the Fleischmann Co. on April 25, 1919, entered into a contract for this purpose whereby the petitioner was to receive $60,000 a year for ten years, and if requested, was to give legal and business advice to the company during this same period. The petitioner did no work for the company under this contract.

The petitioner made arrangements to resume the practice of law. He rented an office and sent out announcements, but a week before the date mentioned in his announcement, Julius Fleischmann came to his office and requested him to return to the Fleischmann Co. to continue his former duties. After some discussion, the petitioner agreed to do this, and on October 17, 1919, entered into a contract of employment with the Fleischmann Co. for a period of ten years at a salary of $100,000 a year. This contract canceled he old one then in effect. The petitioner then began to serve the company in much the same way as he had formerly, but without holding office in the company. He continued to receive $100,000 a year from the Fleischmann Co. until May 1, 1925.

In July, 1920, the petitioner went to Germany and there purchased certain improved yeast processes which had been developed during the war. He secured the exclusive right for the use of these processes in the United States and Great Britain. While there he heard of another process and bought similar rights to it. He then went to England and located a former employee of the company who had disappeared. He secured from him patent applications covering certain inventions he had made and the British rights on these inventions. The petitioner, with the approval of Julius Fleischmann, formed the International Yeast Co. in Great Britain, and assigned to it the British rights to all the patents and processes which he had acquired on this trip. He sold 52 per cent of the stock of this company to the United Distilleries, Ltd., of Belfast, Ireland, under an agreement that the latter would supply all of the necessary capital for the development of these processes in Great Britain with the cooperation of the Fleischmann Co. The petitioner then returned to the United States and put in operation the processes, the rights to which he had acquired. Under the new processes the cost of manufacturing yeast was reduced about 40 per cent.

After another trip to Europe, in October, 1921, the petitioner returned to the United States and negotiated for the purchase of the only remaining competitor of the Fleischmann Co. in this country. About this time a disagreement arose between Julius Fleischmann and the petitioner because the petitioner opposed, and Julius favored, continuing the distillation of commercial alcohol by the Fleischmann Co. Julius Fleischmann told the petitioner that if he was to continue with the company he must accede to the business policies which Julius might dictate. The petitioner, at a stormy session between the two, informed Julius that he would continue to oppose the manufacture of commercial alcohol. A few days later, Julius suggested that, as the company had no further competition, and as there was nothing further that the petitioner could do for the company, the petitioner should retire and do anything he wanted, and that his salary under the contract would continue although he should do nothing for the Fleischmann Co. unless requested. He also told the petitioner that he intended to run the business himself. The petitioner asked for the balance due him under the contract, or a substantial part of it, in cash, but Julius said that he would prefer to pay the amount in annual installments. The petitioner ceased to perform his regular duties with the company in December, 1921. In 1922 he received from the Fleischmann Co. the $100,000 above mentioned which he claimed was a gift. The Commissioner included the amount in his income.

Believing that the British methods of manufacturing and distributing yeast were obsolete, the petitioner planned to reorganize the industry along the lines he had followed in developing the Fleischmann Co. in the United States. After discussing this subject with Julius, he interested a group of New York bankers in the project, who formed a syndicate. The petitioner went to England to make an investigation and report to the syndicate. He anticipated that this work would require from 6 to 8 months. Julius Fleischmann knew of these arrangements and agreed that the petitioner should go. He told the petitioner that he did not think much of the International Yeast Co. ; he would sell the Fleischmann interest in it for $500,000; if it could be brought into the scheme of the syndicate and sold, the petitioner would receive a large part of the sale price; in the meantime he would receive the amount called for by the contract of October 17, 1919; and as the petitioner was known in England as a representative of the Fleischmann Co., he should now make it known there that in investigations and negotiations which he might carry on for the syndicate, he was not representing the Fleischmann Co. The petitioner promised not to involve the Fleischmann Co. in any of his negotiations and to keep Julius Fleischmann informed as to any developments in regard to the International Yeast Co.

In January, 1922, the petitioner went to England and began his work for the syndicate. Shortly thereafter, he accidentally learned of a new yeast process which had been developed by the Danes. He went to Denmark, satisfied himself of the value of this process, purchased the British rights to it and cabled Julius Fleischmann, describing the new process and advising him to send a representative to Denmark to purchase the rights to the use of the process in the United States, Canada and Mexico. A representative of the Fleischmann Co. went to Europe and for $400,000 purchased the rights as suggested by the petitioner. The process immediately proved to be very valuable in the Fleischmann factories.

The petitioner transferred the British rights to this Danish process to the International Yeast Co. In July, 1922, the petitioner having completed his preliminary work, returned to the United States and made his report to the syndicate. At this time he saw Julius Fleischmann, who expressed his satisfaction with all that the petitioner had done and told him that he intended to go to Europe to investigate his interests in the International Yeast Co. The petitioner soon returned to England. In October, 1922, Julius Fleischmann also went to England to confer with the officials of the United Distilleries, Ltd., of Belfast and the Distilleries Co. of Edinburgh, which companies had recently merged. The petitioner attended one of the meetings between these men. Julius Fleischmann was not successful in his dealings with the officials of the companies above mentioned; he became disgusted, went to Paris and sent for the petitioner in November, 1922. Julius told him that he could not deal with these people and if the petitioner could get anything out of them for the Fleischmann interest in the International Yeast Co., he might have not less than 25 per cent of the amount received. The petitioner pointed out the strategic position of the International Yeast Co. as owner of the rights to all of the processes which he had acquired and told Julius that the British companies would be forced to use these processes and that the Fleischmann Co. would benefit as a consequence. They also discussed a contemplated recapitalization of the Fleischmann Co. and Julius told the petitioner that if the company was recapitalized, he wanted the petitioner to have a substantial interest in the stock of the company to show his appreciation and the appreciation of his family for what the petitioner had done in the past 25 years for the Fleischmanns, and that when this stock was given to him, it would settle up everything, including payments under the contract of October 17, 1919. Julius Fleischmann then returned to the United States.

About August, 1924, the petitioner came to the United States to make a semifinal report to the syndicate on the status of the yeast situation in England and continental Europe, and also to inform Julius Fleischmann of certain proposals that the merged Irish and Scotch companies had made in regard to the interest of the Fleischmann Co. in the stock of the International Yeast Co. He had a discussion with Julius and his brother Max Fleischmann. They confirmed the arrangement in regard to the annual payment of $100,000 to the petitioner and agreed that he should return to England and try to dispose of the Fleischmann interest in the International Yeast Co. to the best advantage.

In December, 1924, Julius Fleischmann visited the petitioner at his home in England. A meeting with the directors of the British companies was held, but no agreement was reached as to the Fleischmann interest in the International Yeast Co. Julius Fleischmann informed these companies that thereafter the petitioner would deal with them for him. He then told the petitioner that he was going back to the United States to arrange that the petitioner should have a large allotment of stock which he, his brother, and his sister were going to give the petitioner in recognition of what he had done for them, and that this stock would then be in settlement of everything which they owed him, and that the payments which he had been getting would then stop. His parting words were "I am going to settle this up and you will be surprised at what we are going to give you." Julius Fleischmann then returned to the United States and in March, 1925, died suddenly. The petitioner sold the Fleischmann interest in the International Yeast Co. for $2,500,000. He never received any stock of the Fleischmann Co. nor any part of the $2,500,000 received for its interest in the International Yeast Co.

In 1922 the syndicate paid the petitioner $42,000 at the rate of $1,000 per week, from which they had agreed he was to pay his own expenses and those of his family while in England, and to pay for any assistance which he might need in his work. At the time the petitioner first went to England on behalf of the syndicate in January, 1922, his family consisted of his wife and three or four small children. They followed him to England and brought with them two servants. His expenses while in England in 1922 amounted to $44,340.07. The petitioner claimed this latter amount as a deduction in his income-tax return for the year 1922. Of the total amount claimed, the respondent allowed $22,178.58 as a deduction for business expenses. He disallowed the balance of $22,161.49 which included $3,095, the cost of transporting the petitioner's family and servants from New York to England, $9,000 rent for a house and garden in England, $886.60 rent for silver and linen, and the balance represented payments for light, food, and miscellaneous expenses paid by the petitioner for himself and his family while in England. For the year 1922 the petitioner paid $5,000 rent for a house in New York which he had previously occupied but which was vacant for the whole year. He had leased this house for the year 1922. The lease was not assignable and provided against subletting. The petitioner's family thereafter remained in England and he has only returned to this country for short business trips.

In 1921 and 1922 the petitioner owned and operated a farm of about 300 acres situated near Stamford, Conn., on the Mianus River. In 1912 he purchased the first 70 acres of this land. He purchased the remainder prior to 1917. The land was fertile. It had not been cultivated for thirty or forty years. Several dairy farms adjoined the land. The petitioner originally intended to develop a modern dairy farm.

One or two of the buildings on the land were dilapidated and were razed. The remaining five or six small houses were repaired and rented. The petitioner occupied one of them from time to time. It was a story and a half high and had four or five rooms.

Prior to the year 1921 the petitioner had conducted various farming operations on this farm. He had had as many as 24 cows there at one time. He had as many as 140 pigs at one time. In 1916 he built a large barn at a cost of ten or eleven thousand dollars. He raised a great many chickens and sold chickens and eggs from the place. About 70 acres were placed under cultivation and crops of corn, oats and buckwheat were produced. The farm also produced from 60 to 80 tons of hay annually and 600 to 700 bushels of apples, which were sold. The petitioner had an experienced farmer on the land and other helpers were employed. There were approximately 40 acres of timber land on the property from which cord wood was cut and sold. In 1917, due to the sharp advance in the price of labor, the petitioner began to lose considerable money each year on the farm.

When the petitioner resigned from the Fleischmann Co. and its associated companies in the spring of 1919, Julius Fleischmann suggested to him that he retire to this farm. At that time the Fleischmann Co. was conducting extensive experiments for using its byproducts as cattle feed. Shipments of this feed were sent by the company to the petitioner's farm for experimental purposes. The results were rather unsatisfactory.

In 1920 Julius Fleischmann became enthusiastic about the possibility of the use of yeast as a mixture in cattle feed. The company was spending large amounts of money in experimental and research work along this line. Julius Fleischmann suggested that if the petitioner would build on his farm a modern cattle barn fully equipped for use as an experimental station, part or all of the expenses would be assumed by the Fleischmann Co. and the petitioner would be compensated in some way for the use of his farm and his services in connection with the experiments. In June, 1920, the petitioner made arrangements to have the barn built and in the latter part of that same month he was sent to Europe by the Fleischmann Co. When he returned the work had been practically completed, but at a most extravagant cost due to the dishonesty and irresponsibility of certain men left in charge. This building cost almost double the amount which the petitioner intended to spend on it. Meanwhile, Julius Fleischmann had become less enthusiastic about the idea and no further action was taken for some time. In 1921, however, his interest revived, and he again suggested that the petitioner retire to the farm and supervise the experiments, with the Fleischmann Co. supplying all the feed and a great deal of the labor, while the petitioner would be allowed to sell the produce of the farm. An agreement was entered into between the petitioner and the Fleischmann Co. in September, 1921, which recited that the company had advanced $34,000 for the work already done and agreed to advance $125,000 more. It provided that the company should retain $2,500 per month from the "salary or compensation being paid to the petitioner." In October, 1921, the petitioner again went to Europe. When he returned, Julius Fleischmann told him that the whole farm project was canceled. Approximately $82,000 had been advanced by the Fleischmann Co. and spent in developing the property. On December 30, 1922, the contract of September 12, 1921, was canceled, and the amount which had been advanced by the Fleischmann Co. under that contract and charged to the petitioner was written off the company's books as a gift. In addition to the amounts above mentioned, spent in developing the property, the petitioner sustained losses in the operation of this farm which amounted to $20,190.65 in the year 1921 and $8,352.23 in the year 1922. The respondent disallowed the deduction of these amounts on the ground that the operation of the farm was not a transaction entered into for profit.

OPINION.

MURDOCK: The petitioner contends that $100,000 which he received from the Fleischmann Co. in 1922 was a gift and, therefore, under section 213(b)(3), it should not be included in his gross income. The amount in controversy is the amount which the petitioner was entitled to receive each year under a 10-year contract of employment entered into on October 17, 1919, and not canceled until May 1, 1925. The record does not disclose that any corporate action was ever taken relative to making a gift to the petitioner in the year 1922. Julius spoke of the amount as a "gratuity" but he was not the company. Although after 1921 the petitioner no longer performed the regular duties for the Fleischmann Co. which he had previously performed, it appears that in the year 1922 he rendered valuable services to the Fleischmann Co., was ever watchful of the Fleischmann interests, particularly in connection with the International Yeast Co., and was ready and willing to aid the company in any way in case the company requested his aid. In the past, the petitioner had performed services of great value to Julius Fleischmann and the Fleischmann Co. over a period of approximately 25 years. If his contract with the company had been terminated, a loss to the petitioner would no doubt have resulted. To establish a gift, there must be an intention to make a gift, a change in possession in accordance therewith, and an acceptance by the donee. If there be consideration for the transfer, then there is no gift. See ; ; . Past services may be the consideration for a transfer of the property; likewise, the transfer may be compensation for a loss sustained through a termination of an employment. ;;; . Section 213(a) of the Revenue Act of 1921 defines gross income in very broad terms, and we can not say from the evidence before us that the Commissioner erred in including the amount in controversy in the petitioner's gross income. The evidence does not satisfactorily show an intention on the part of the company to make a gift and it does not appear that consideration was lacking.

The Commissioner's determination in regard to the petitioner's expenses incident to his business in England in 1922 must be approved. If a taxpayer changes his place of business he may not deduct the cost of moving his family to the new location as an ordinary and necessary expense of carrying on his business. ; ; . If he goes away temporarily on business he may not in the ordinary case deduct the expense of taking his family with him. It may be that in some cases a part or all of such expenses would be deductible, but we need not decide the question at this time, for in this case no sufficient business necessity required the petitioner to take his family with him for a temporary stay. He appears to have taken his family with him for personal reasons unrelated to his business. The other items in controversy consist of the usual expenses incident to the upkeep of a suitable residence for the petitioner and his family where all members of the household lodged and had their meals. The total amounts are clearly not deductible. No basis for segregation or allocation of the total amounts was suggested and we can think of none. The entire amount must be disallowed. The rent for the house in New York is not a proper deduction under any provision of the Revenue Act.

At the trial the respondent's counsel made it clear that he had only one reason for questioning the operating losses on the farm, to wit, that the farm project was not entered into and operated for profit. There is nothing in the record to indicate that the petitioner purchased and operated the farm purely for pleasure, but this is not enough; it must appear that he carried on the farming operations for profit. .

From time to time the petitioner's intentions in regard to this farm changed, but at all times he was hopeful of realizing a profit from the operation on this farm. At first, and for several years, he intended to develop it into a model dairy farm. He was not able to give a great deal of his time or attention to the farm although at various times he considered giving a large part of his time to it. Before the taxable years in question, his intentions in regard to the farm had somewhat altered due to the fact that Julius Fleischmann urged him to make certain changes which would be beneficial to the Fleischmann Co., but at all times the question of a profit to the petitioner received first consideration. The deductions should be allowed. ; ; ;; ; .

Judgment will be entered under Rule 50.