Horn & Hardart Baking Co. v. Commissioner , 20 B.T.A. 486 ( 1930 )

HORN & HARDART BAKING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Horn & Hardart Baking Co. v. Commissioner

Docket No. 41764.

United States Board of Tax Appeals

20 B.T.A. 486; 1930 BTA LEXIS 2103;

August 6, 1930, Promulgated

---

1. ACCOUNTING - BONUS. - Where petitioner kept its books on basis of a fiscal year ending September 30 and set up on its books during the taxable years certain sums for the payment of a bonus to employees, but the liability and payment thereof was based on their salaries from December 1 to December 1, and dependent on the continuance of the employees in petitioner's service until December 1 of each year, the bonus is not deductible in the year in which so set up on its books, but in year when liability became fixed and payment was made.

2. COMMISSIONS AND FEES paid to agents and attorneys for securing a loan are not deductible in full in the year when paid, but should be spread proportionately over the life of the loan.

3. Loss claimed on furniture, fixtures, and apparatus contained in a building condemned by a city for public purposes and not compensated for in the award of damages should be allowed as a loss for useful value of an asset permanently abandoned.

4. DEPRECIATION. - Respondent's determination of depreciation for the respective taxable years on property used by petitioner in its business approved because it appears to be a reasonable allowance for such purpose.

Andrew L. Wilson, C.P.A., for the petitioner.

W. F. Gibbs, Esq., and O. W. Swecker, Esq., for the respondent.

---

BLACK

Deficiencies in income taxes of $2,957.83 for the fiscal year ending September 30, 1926, and of $6,754.37 for the fiscal year ending September 30, 1927, were determined by respondent. Petitioner alleges that he erred (a) by his failure to allow as a deduction $81,187.90 accrued for the fiscal year ending September 30, 1926, as bonuses to employees instead of $65,404.92 actually paid by petitioner in such fiscal year for such purpose, and the sum of $90,853.33 accrued for the same purpose for the fiscal year 1927 instead of $74,482.33 actually paid; (b) by his failure to allow in its entirety as a deduction for the fiscal year 1927 the legal expenses amounting to $7,500 incurred in connection with a $2,000,000 loan, instead of treating it as a capital expenditure and spreading the deduction over the life of the loan; (c) failure of respondent to allow $5,560.47 loss on furniture, fixtures, and appliances contained in a building condemned by the city of Philadelphia, for the fiscal year 1927; (d) error in method and rates of depreciation for both years amounting to $5.998.68 for 1926 and $7,352.73 for 1927.

At the hearing it was stipulated that the evidence in Docket No. 32383 relative to the claim for bonuses in that case should be considered as applicable to this case, with correct changes as to amounts and years, and in accord therewith and the further evidence offered at the hearing, we make the following findings of fact.

FINDINGS OF FACT.

Petitioner is a New Jersey corporation with its principal office at 208 South Warnock Street, Philadelphia, Pa.

It is engaged in the baking and restaurant business and operates about fifty dining rooms and stores in Philadelphia and its vicinity. In order to encourage its employees and reward those faithful and continuous in service it has for many years had a regular bonus system of extra compensation, paid in December of every year. Originally it was fixed at one week's wages, but in 1922 this was changed to a basis of a percentage of the employee's wages for the entire year, figured on the amount of the employee's wages from December 1 to December 1. This was explained to prospective employees and became part of the contract of employment.

The petitioner kept its accounts on the accrual system and on the basis of a fiscal year ending September 30 of every year. It made its tax returns accordingly. Its method of accruing this bonus charge was to estimate the amount monthly based on the amount paid the previous year. Thus for the fiscal year ending September 30, 1926, the amount accrued was based and estimated on that paid the previous year, and the same system was followed in other years.

For the year ending September 30, 1926, petitioner accrued $81,187.90, but paid only $65,404.92 for such purpose, and for 1927 accrued $90,853.33, but paid only $74,482.33 for such purpose. The books of the petitioner were closed as of September 30, but the correct amounts of the bonuses to individual employees were not figured until in December following the close of the fiscal year, and the liability for and amount of the bonus to each employee was contingent on the employee remaining in service until December 1. In the event any employee left or was discharged from service between September 30, the end of the fiscal year, and December 1, such employee was not entitled to any bonus. There were some cases of this kind.

Respondent allowed the amounts actually paid as deductible expenses in the year when paid and not in the year accrued by petitioner.

During the fiscal year ending September 30, 1927, petitioner borrowed from or through Goldman, Sachs & Co. of New York the sum of $2,000,000. This loan was evidenced by petitioner's unsecured notes falling due as follows: $500,000, April 15, 1930; $600,000, April 15, 1931, and $900,000 in April, 1932. Goldman, Sachs & Co. charged a commission of $20,000 for making or negotiating this loan, which was capitalized and allowed as a deduction spread over the life of the loan. No objection is made to this action of respondent. In order to obtain this loan it was necessary to furnish Goldman, Sachs & Co. certain financial information and the history of petitioner for several previous years. This was done by and under the direction of a law firm in Philadelphia and for which service petitioner paid $7,500 in 1927. Respondent allowed this as a deduction to be spread over the life of the loan, but petitioner contends that it is an ordinary and necessary business expense, deductible in the year in which paid.

For many years prior to 1927 the petitioner operated a restaurant at 1302-4 Filbert Street, Philadelphia, on property which it owned. During 1927 the city of Philadelphia condemned the property for public purposes and paid the petitioner $282,335 as the result of the proceedings. The award which was made to petitioner in the condemnation proceedings was for land, buildings, and improvements and did not include payment for furniture and fixtures which petitioner used in its restaurant business at that location. From time to time during the operation of this restaurant petitioner expended $16,505.36 for furniture, fixtures, and appliances used therein, and prior to the condemnation had deducted $10,944.89 for depreciation, leaving $5,560.47 unabsorbed by depreciation. These fixtures and appliances were abandoned by petitioner when it left the property on the ground that they no longer had any useful value, and the amount of $5,560.47 was charged off on its books as a loss and petitioner claimed such loss as a deduction from its 1927 income.

For 1926 petitioner claimed a total depreciation on all the property used in its business, including improvements on its real estate, furniture and fixtures, machinery, etc., amounting to $267,644.70. Respondent recomputed the depreciation and allowed $280,173.67. For 1927, petitioner claimed $388,677.28 and respondent allowed $381,314.55. The rates of depreciation which respondent used in making the computation were 2 per cent on buildings, 10 per cent on machinery and equipment, 10 per cent on bakery furniture, fixtures and apparatus, 20 per cent on motor vehicles, 7 1/2 per cent on dining room furniture, fixtures and apparatus, 10 per cent on patterns, 10 per cent on office furniture and fixtures. Such rates were just and reasonable.

OPINION.

BLACK: The question of the allowance of the bonus to employees as accrued by the petitioner, instead of an allowance of the amount actually paid in each fiscal year, was considered by the Board in Docket No. 32383, Horn & Hardart Baking Co.,19 B.T.A. 704">19 B.T.A. 704, and on the authority of that case the issue is decided adversely to the petitioner. The action of the respondent in allowing petitioner deductions of the amounts actually paid to employees as bonuses in each of the taxable years is approved.

The disallowance of the deduction of the item of $7,500 representing law fees paid in connection with the loan of $2,000,000, except on the basis of prorating the deduction over the life of the loan, is approved. This was a necessary part of the expense in obtaining the loan, just as the commission paid the bankers was, and should be treated in the same way and spread as a deduction over the life of the loan, which was done by the respondent. This was correct. Julia Stow Lovejoy,18 B.T.A. 1179">18 B.T.A. 1179; Horn & Hardart Baking Co.,19 B.T.A. 704">19 B.T.A. 704.

The third error complained of by petitioner was the failure of rospondent to allow $5,560.47 loss on furniture, fixtures, and appliances contained in a building condemned by the city of Philadelphia for public purposes, for the fiscal year 1927. Petitioner claims the right to deduct such loss under section 234(a)(4), which permits the deduction of losses sustained during the year and not compensated for by insurance or otherwise. Article 143, Regulations 69, reads:

ART. 143. Loss of useful value. - When, through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in such business, he may claim as a loss for the year in which he takes such action the difference between the basis (see article 141) and the salvage value of the property. In determining the amount of the loss, adjustment must be made, however, for improvements and for depreciation. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as, for example, where an increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Any loss to be deductible under this exception must be charged off on the books and fully explained in returns of income.

The award which was made to petitioner by the city of Philadelphia in the condemnation proceedings included damages for the taking of land, building and improvements, but did not include furniture and fixtures. On this point the manager of petitioner's business testified at the hearing as follows:

Q. This award for damages, just what did that cover, what did the City of Philadelphia pay you for?

A. It was for the land, buildings and improvements erected thereon.

Q. Now when you say "improvements erected thereon," are you differentiating between your furniture, fixtures and apparatus as an improvement, or do you mean assets were actually attached to the land?

A. That is considering the building and what they mean by the building and improvements such as elevators and boilers for heating purposes and those things.

Q. Let me put it another way - Did you receive anything in this award covering your furniture, fixtures and apparatus?

A. No, not what we class as furniture, fixtures and apparatus.

Q. Now, before actually vacating that building, you had some furniture, fixtures and apparatus in there which could be moved - what became of that?

A. It was practically all left right there, because in equipping our restaurants our counters and so forth are built to fit the space in that particular floor and to tear them out and refinish them and rebuild them to fit in with our line-up of equipment in other restaurants is more expensive than to line-up new stuff and the facts are that very seldom can anything be used, consequently it was just left as junk.

* * *

Q. And what was the amount you charged off?

A. $5,560.47. That represents the undepreciated cost of our furniture and fixture account.

Under these circumstances, we think respondent erred in refusing to allow petitioner to deduct from its 1927 income the item of $5,560.47. This item was deductible under section 234(a)(4) and article 143, Regulations 69, Revenue Act of 1926. See A.R.R. 469, C.B. 4, p. 164.

Petitioner's last assignment of error is to the effect that respondent erred in methods and rates of depreciation for both taxable years, resulting in insufficient depreciation allowances to petitioner of $5,998.68 for 1926 and $7,352.73 for 1927. As we have pointed out in our findings of fact, respondent allowed petitioner $12,528.97 more depreciation for 1926 than it claimed on its return and $7,352.73 less than it claimed in its return for 1927. The treatment by respondent of these depreciation items for the respective taxable years was consistent. The rates at which depreciation was allowed were just and reasonable and petitioner has offered no evidence which would be adequate cause for us setting aside respondent's determination of the depreciation items. Respondent's action in this respect is therefore approved.

Judgment will be entered under Rule 50.