Warren Steam Pump Co. v. Commissioner

WARREN STEAM PUMP CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Warren Steam Pump Co. v. Commissioner

Docket Nos. 14813, 22389.

United States Board of Tax Appeals

13 B.T.A. 721; 1928 BTA LEXIS 3195;

October 2, 1928, Promulgated

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Petitioner entered into a 5-year agreement to make certain payments to one of its stockholders or to his heirs or assigns as salary for his services as manager and in consideration of such stockholder placing his stock in trust. Said stockholder died in the second year in which the agreement was in effect and the petitioner thereafter, and in the taxable years, made the payments in question. Held, that in the circumstances herein, such payments may not be deducted from income in the determination of the petitioner's tax liability for any of the several taxable years involved, either as ordinary and necessary expenses or as losses.

Merrill S. June, Esq., and George Avery White, Esq., for the petitioner.

Paul L. Peyton, Esq., and Hugh Brewster, Esq., for the respondent.

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LANSDON.

The respondent has asserted deficiencies in income taxes for the years 1921, 1922, and 1923, in the respective amounts of $8,784.75, $3,127.01, and $2,556.73. The only issue involved is whether certain payments made by the petitioner in the taxable years are deductible from gross income in each of such years as ordinary and necessary business expenses or, an alternative, as losses sustained in such years. By agreement of the parties the two proceedings have been consolidated for hearing and decision.

FINDINGS OF FACT.

At all times in the taxable years the petitioner was a Massachusetts corporation, with its principal place of business at Warren. It was successfully engaged in the manufacture of steam pumps. Prior to and during the taxable years it earned large profits.

Frank F. Phinney entered the service of the petitioner in 1912, and later became its president, treasurer and general manager. In 1919 he owned in his own name 1,300 shares and other members of his family owned 369 shares of the petitioner's stock then outstanding.

In 1919 the petitioner and Phinney entered into the following agreement:

AGREEMENT BETWEEN THE WARREN STEAM PUMP COMPANY AND FRANK F. PHINNEY.

WHEREAS The Warren Steam Pump Company of Warren, Massachusetts, believes that the growth and present success of the Corporation has been due to the management of Frank F. Phinney and the stock control exercised by him and that his continued management and a unified stock control will contribute to the further success of the Corporation therefore the Corporation believes it to be for the interest of the Corporation and its stockholders that the block of stock now standing in the name of Frank F. Phinney, of Warren, Mass., amounting to 1,300 shares be kept intact as long as possible and also that as long as possible the services of the said Frank F. Phinney as Treasurer and General Manager of the Corporation be retained. Therefore in order to accomplish these purposes this agreement witnesseth;

The said Frank F. Phinney hereby agrees to assign, set over and transfer to the three persons named as Trustees in the Agreement of Trust copy of which is annexed hereto the shares of stock now standing in his name upon the books of the said Corporation and any other shares therein that he may acquire to have, manage and dispose of under the terms of said Agreement of Trust and to execute and deliver to the persons named therein, the said Agreement of Trust, copy of which is hereto annexed and made part hereof.

That the said Corporation will employ the said Frank F. Phinney as Treasurer and General Manager of the said Company for the term of five years from and after the date of its next Annual Meeting paying annually the same annual salary heretofore received by him, whether as President, Treasurer or General Manager, plus an increase of twenty (20) per cent. And the said Frank F. Phinney agrees to serve as Treasurer and General Manager for the said period of five years at the said annual compensation and will at the expiration of said term of five years if elected Treasurer and General Manager and able to act in these capacities serve as Treasurer and General Manager at said annual compensation.

That in consideration of the said assignment of said shares, of the execution and delivery by said Frank F. Phinney of the Agreement of Trust as aforesaid said and of the aforesaid Agreement to serve as Treasurer and General Manager, and any of them the said Company hereby agrees that if and when the said Frank F. Phinney shall cease to act as Treasurer and General Manager for any reason whether this shall occur during or after the five year period aforesaid the said Company will pay to him or in case of his death to his executors, administrators or assigns annually in regular monthly installments the same sum hereinbefore specified to be paid to him as Treasurer and General Manager aforesaid provided, however, that the said payment shall cease if and when the said Agreement of Trust shall terminate and upon such contingency this Agreement shall become null and void.

IN WITNESS WHEREOF the Warren Steam Pump Company has caused these presents to be signed in its name and behalf and its corporate seal to be hereto affixed by Louis A. Gendron its Director and Acting President, and the said Frank F. Phinney has signed and affixed his seal to these presents this eleventh day of January 1919.

(SEAL)

WARREN STEAM PUMP COMPANY,

WARREN STEAM PUMP COMPANY,

By LOUIS A. GENDRON

Director and Acting President.

FRANK F. PHINNEY (SEAL)

In pursuance with the conditions of the above agreement Phinney, at the same time, executed the following trust instrument:

AGREEMENT OF TRUST

I, Frank F. Phinney, of Warren, Massachusetts hereby assign, transfer and set over 1,300 shares of the Warren Steam Pump Company, being the shares now standing in my name upon the books of said Company, to

Herbert K. Hallett of Boston 53 State St.

Mary Wells Phinney of Warren

Frank F. Phinney of Warren

and their successors in this Trust to hold, manage and dispose of upon the following terms and conditions and with the following powers and immunities:

To receive and hold upon the same trusts any additional shares of the stock of the said Corporation that may be transferred to them by said Phinney his executors, administrators or assigns.

To receive and hold upon the same trusts any new or additional stock that may be issued to them by the said Corporation.

To surrender or assign the shares of stock held by them hereunder or any of them in exchange for new or other classes of stock of the said Corporation; any new issue of stock to be held and accounted for by the Trustees as principal and not as income hereunder.

To vote upon the shares of stock held by them from time to time in their discretion unless they shall from time to time be directed as to their vote by the said Frank F. Phinney in writing and in such case to vote as so directed.

To execute and deliver proxies of said stock to be used at any meeting of the Corporation.

To mortgage, pledge or assign as collateral security in their discretion any of the shares held by them hereunder and to borrow monies and give their note as Trustee therefor which may be necessary in their discretion for the purposes of the trust.

To collect and receive dividends that may be from time to time declared upon the stock held by them hereunder and after paying the charges and expenses of the Trust to pay over the balance semi-annually or oftener to the said Frank F. Phinney, his executors, administrators or assigns.

To sell the stock held by them hereunder onlyin block and not in parcels for such prices and upon such terms and conditions as they shall see fit and to turn over the proceeds thereof after paying the charges and expenses of the Trust to Frank F. Phinney, his executors, administrators or assigns free and discharged from all trusts.

The Trustee or Trustees hereunder shall not be required to give bond or security for the performance of their trust or if bond is given shall not be required to give surety thereon.

A Trustee hereunder may resign by written resignation to his co-Trustees.

In case of a vacancy a new Trustee or Trustees shall be appointed by Frank F. Phinney and if not appointed by him shall then be appointed by the remaining Trustee or Trustees. Any new or succeeding Trustee shall have the same discretion, powers and emunities as belong to the original Trustees hereunder.

The Trustees may in all matters act by majority and a Trustee shall not be liable except for his own misconduct or default.

Unless sooner terminated this Trust shall terminate at the expiration of twenty years from the death of the survivor of Frank F. Phinney, Mary W. Phinney or Mary Elizabeth Phinney and the said stock be assigned, set over and transferred to said Frank F. Phinney, his executors, administrators or assigns free and discharged from all trusts.

IN WITNESS WHEREOF I the said Frank F. Phinney hereunto set my hand and seal this - day of January 1919.

FRANK F. PHINNEY (SEAL)

We, the Trustees herein named accept the foregoing Trusts.

HERBERT K. HALLETT

MARY WELLS PHINNEY

FRANK F. PHINNEY

Phinney died in March, 1920. Pursuant to the agreement the petitioner paid the amounts in controversy to his estate and heirs in 1921, 1922, and 1923, and in its income and profits tax returns deducted the amounts so paid from its gross income in the respective years as ordinary and necessary business expenses. Upon audit of such returns the Commissioner added the several amounts so deducted to the petitioner's gross income for each of the taxable years and asserted the deficiencies here in controversy.

OPINION.

LANSDON: The only question here is whether the payments provided for in the agreement above are deductible from the petitioner's gross income in the several years in which such disbursements were made. It is alleged that the payments in question were ordinary and necessary business expenses and so deductible under the authority of section 234(a)(1) of the Revenue Act of 1921, which is as follows:

All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity.

If the payments in question are disallowed as ordinary and necessary business expenses as an alternative contention the petitioner asks that the several amounts thereof shall be deducted from its gross income in the respective taxable years as losses sustained, as provided in section 234(a)(4) of the Revenue Act of 1921, which is as follows:

Losses sustained during the taxable year and not compensated for by insurance or otherwise, unless, in order to clearly reflect the income, the loss should in the opinion of the Commissioner be accounted for as of a different period. * * *

Ordinary and necessary expenses include all regularly recurring disbursements for purposes relating to the earning of income. It is obvious that the payments here in question are not of the kind usually regarded as expenses of operation. So far as the evidence shows, they contributed in no way to the income of the petitioner in any of the years in which deductions on account thereof are claimed.

In several instances the Board and courts have permitted deductions from income, as ordinary and necessary expenses, of certain disbursements not regularly recurring but that were necessarily incurred in connection with the operation of the business. In this category may be included attorney's fees paid for the defense or prosecution of law suits resulting from controversies incident to the regular business activities of the taxpayer or for legal services in the preparation of tax returns or of papers relating to business operations. ; . Whether such expenses are for business purposes are questions of fact to be determined from the evidence. ; .

The agreement between the petitioner and Phinney obviously had two purposes, viz, (1) to secure the services of Phinney for an extended term of years, and (2) to effectuate unified control of a majority of the stock of the corporation. The payments made for these purposes in Phinney's lifetime may have been deductible as ordinary and necessary expenses, since they included Phinney's salary as manager, but, even then, unified stock control was an additional element of consideration. After the death of Phinney the payments were continued in conformity with the agreement, although no service to the petitioner incident to the earning of its income resulted therefrom. From that time it is obvious that the disbursements in question resulted in no other advantage to the petitioner than the assurance of continued control of a majority of the stock. Payments to secure control of the stock of a corporation or to add to or protect the capital assets of a corporation are capital expenditures. Cf. ; ; ; ; . We are of the opinion that the payments here involved were capital expenditures and were not deductible from the income of the petitioner in the several taxable years as ordinary and necessary expenses.

Having held that the payments made by the petitioner under the terms of the agreement set forth above were capital expenditures, and the record failing to show any loss sustained from the disposition of the rights acquired by such payments, we are of the opinion that there is no basis for the deduction of the amounts thereof from the petitioner's income for the several taxable years of such payments as losses.

Reviewed by the Board.

Decision will be entered for the respondent.