Jack Dempsey's Punch Bowl, Inc. v. Commissioner

Jack Dempsey's Punch Bowl, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent

Jack Dempsey's Punch Bowl, Inc. v. Commissioner

Docket No. 15153

United States Tax Court

11 T.C. 1030; 1948 U.S. Tax Ct. LEXIS 10;

December 15, 1948, Promulgated

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Decision will be entered under Rule 50.

Upon the facts, held, respondent improperly disallowed part of the compensation which petitioner paid to one of its officers during the taxable year 1942.

T. Newman Lawler, Esq., for the petitioner.

Thomas R. Wickersham, Esq., for the respondent.

Hill, Judge.

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HILL

Respondent determined a deficiency in petitioner's excess profits tax for the year ended December 31, 1942, in the amount of $ 12,732.82. Certain adjustments made by respondent are not contested. The only question presented is whether respondent erred in disallowing in part the compensation paid to one of petitioner's officers during 1942.

The tax return for the year involved was filed with the collector of internal revenue for the third district of New York, at New York City.

FINDINGS OF FACT.

The facts as stipulated are so found.

Petitioner is a corporation, organized under the laws of the State of New York on December 28, 1937. It was formed pursuant to an agreement dated November 16, 1937, among William Harrison Dempsey, known as Jack Dempsey, Jacob Amron, and Louis I. Brooks. Its purpose in organizing was to conduct a general restaurant and bar business. The pertinent parts of the agreement are as follows:

First: The parties agree to form a corporation under the laws of the State of New York with an authorized capital stock of three hundred (300) shares, no par value, all of which will be of one class, and for which the parties agree to subscribe in the following proportion:

Amron and Brooks agree to subscribe for two hundred (200) shares, the proportion in which each is to hold said 200 shares to be agreed upon by Amron and Brooks.

Dempsey agrees to subscribe for one hundred (100) shares.

* * * *

Fifth: It is understood and agreed that the total cost of remodeling said bar and grill, including decorations and furniture, including the cost of the decorator selected by Dempsey, shall not exceed Seventy-five Thousand Dollars ($ 75,000) without the mutual consent of all three parties.

* * * *

Seventh: Amron and Brooks agree to loan to the corporation an amount of money necessary to remodel, equip, decorate, furnish and complete the bar and grill, said loans to bear interest at the rate of four per cent (4%) and to be returned to Amron and Brooks out of the first profits of the corporation as hereinafter defined.

* * * *

Fourteenth: Making due allowance for the four per cent (4%) interest to be allowed to Amron and Brooks for each repayment, until one-half of the cost with interest has been recouped by Amron and Brooks, no one of the parties shall draw any salary or other compensation out of said venture.

Fifteenth: As soon as one-half of the cost has been repaid to Amron and Brooks, the parties agree that the corporation shall pay the following amounts as compensation, to wit:

(a) To Dempsey an amount equal to two per cent (2%) of the gross monthly cash receipts of said bar and grill, said sums to be paid monthly on or before the tenth day of the month immediately following the month for which the amount is due.

(b) To Amron and Brooks, the sum of One Thousand Dollars ($ 1,000) per month, to be divided between Amron and Brooks in such percentage as they agree upon mutually.

Sixteenth: After the entire cost of said bar and grill has been repaid to Amron and Brooks, then Dempsey's compensation shall be increased to three per cent (3%) payable in the same manner.

* * * *

Nineteenth: Amron and Brooks agree to secure from the 850 Corporation, and all three parties agree to secure from Jack Dempsey's Corner, Inc., and Dempsey personally agrees to approve such consents, the right to use Jack Dempsey's name in connection with the bar and grill contemplated in this agreement for the full period of this agreement.

Twentieth: Dempsey hereby grants to the corporation the right to use his name in connection with the bar and grill contemplated herein for the full term of the lease and any renewals. It is the intention of the parties that the right to use Jack Dempsey's name in connection with this bar and grill is a personal right granted to the corporation to be formed for the venture and to the individuals named in this agreement, to wit: Amron and Brooks and in the event Amron and Brooks dispose of their interest in the corporation, either by sale or are divested of interest by operation of law, then Dempsey shall have the right to terminate the right to use his name, unless the sale or disposition is with his consent.

Dempsey's grant of the right to use his name is made with the consent of the 850 Corporation, and shall not be construed by either party in derogation of any rights which 850 Corporation, Jack Dempsey's Corner, Inc., Amron or Brooks may have in and to the use of Jack Dempsey's name, pursuant to preexisting agreements.

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Twenty-second: In the event Jack Dempsey's Corner, Inc. shall cease to operate the restaurant and bar at 850 Eighth Avenue, New York City, and as a result of such cessation of operation Dempsey's compensation from that source shall be cut off, then it is agreed that Dempsey's minimum compensation, to be computed at the rate of three per cent (3%) of the gross receipts, shall be a guaranteed monthly minimum of Fifteen Hundred Dollars ($ 1,500). Any additional amounts paid to Dempsey to make up his guarantee shall be charged against the business of the corporation as an operating expense and before any dividends are declared.

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Twenty-fourth: Amron and Brooks agree to follow Dempsey's directions regarding the manner of service, food, liquors and any other suggestions which he may have regarding the manner of operation of said bar and grill.

Twenty-fifth: The parties agree that under no consideration will Dempsey be liable for any of the obligations or debts of said bar and grill, or for the construction or equipment of same, or for any other obligation that may be incurred in connection with the venture.

(a) It is understood and agreed by the parties that after the bar and grill is fully completed that no capital expenditures in excess of $ 5,000 per annum shall be made in any year of the first two years of actual operation without the consent of all three of the parties unless such expenditures are requested as the result of any governmental order.

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Twenty-seventh: Dempsey agrees to devote as much time and attention as he possibly can and be present at the bar whenever possible, except when he is engaged in other business matters in this city or elsewhere, it being the intention of the parties that whenever he is in the City of New York that he shall personally appear at the bar and grill and supervise the business of operating the same, it being further understood that his failure to appear at any given time at the bar and grill shall not be construed as a breach on Dempsey's part.

All parties recognize the fact that Dempsey's presence will materially increase the revenue of said bar, and that he will, as far as he is able without interfering with his other commitments, be present at the bar and supervise its operation.

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By resolution passed at the meeting of petitioner's incorporators held on December 29, 1937, the following shares were issued as consideration for the assignment by Dempsey, Amron, and Brooks to petitioner of a lease on premises known as the Trans-Lux Theatre, located at 1695 Broadway, New York, New York:

Jack Dempsey	100 shares
Jacob Amron	170 shares
Louis I. Brooks	30 shares

During 1938 petitioner found that it needed additional capital. Dempsey advanced petitioner $ 23,000, for which Amron transferred to him 70 shares of the 170 shares of stock of petitioner which he owned at that time. In 1942 Dempsey transferred 35 of these shares to his manager, Max Waxman. On May 21, 1942, the stockholders of petitioner were as follows:

Jack Dempsey	135 shares
Jacob Amron	100 shares
Max Waxman	35 shares
Louis I. Brooks	30 shares

Petitioner's officers from 1938 through 1942 were as follows:

	1937-1940	1940-1941	1942-1943
President	Jack Dempsey	Jack Dempsey	Jack Dempsey
Vice president	Herman Amron	Jacob Amron	Jacob Amron
Treasurer	Jacob Amron	Jacob Amron	Jacob Amron
Secretary	Louis I. Brooks	Louis I. Brooks	Louis I. Brooks
Asst. secretary			Joseph Dempsey
Asst. treasurer			Max Waxman.

Amron, petitioner's vice president and treasurer, was general manager of the restaurant and bar. His actions were subject to Dempsey's veto. Amron, before his association with petitioner corporation, had many years of experience in the restaurant and bar business.

Brooks, petitioner's secretary, was in charge of construction, changes, and any repairs which had to be made to petitioner's properties.

Dempsey, petitioner's president, served as its host. He signed autographs, talked with customers, and as many times as possible put in his appearance in the bar and restaurant.

Petitioner's gross receipts and profit or loss from 1938 through 1942 were as follows:

Year	Gross receipts	Profit or (loss)
1938	$ 270,170.66	($ 258.91)
1939	396,038.70	30,948.97
1940	423,535.64	27,943.82
1941	516,116.22	36,557.82
1942	819,673.78	110,328.38

The compensation paid to petitioner's officers from 1938 through 1942 was as follows:

	1938	1939	1940	1941	1942
Jack Dempsey, president			$ 12,858.96	$ 18,198.71	$ 36,724.72
Jacob Amron, treasurer			9,000.00	9,000.00	18,999.99
Louis I. Brooks, secretary		$ 3,000	3,000.00	3,000.00	10,400.00
Joseph Dempsey, asst.					3,579.17
treasurer
Total		3,000	24,858.96	30,198.71	69,703.88

Of the total of $ 36,724.72 paid to Dempsey during the year 1942, $ 24,724.72 is 3 per cent of the gross sales for 1942 plus certain other items of income, such as coatroom concessions, but less certain items of sales and certain rebates and allowances to various customers. The difference between the above amount and a straight 3 per cent of gross sales is $ 128.66. The remaining $ 12,000 is money voted to Dempsey by the board of directors during the taxable year 1942.

Beginning in June 1942, Amron and Brooks commenced activities for an increase in their compensation. Both Dempsey and his manager felt that if their compensation was raised, Dempsey's also should be increased. A special meeting of petitioner's board of directors was held on September 11, 1942, for the purpose of acting upon the salary question. The board was composed of Dempsey, Arthur F. Driscoll, Dempsey's attorney, Benjamin Shapiro, Amron's attorney, and Amron and Brooks. There was much disagreement among the members of the board as to what amount each of the officers should receive. It was finally determined by the directors that the payments then being made to petitioner's officers were inadequate and that the matter of compensation should be referred to a resolutions committee composed of Driscoll, Shapiro, Benjamin Blattner, accountant for petitioner, and Amron. The committee then drew up a recommendation and the directors at this same meeting determined, among other things, (1) that the compensation of Brooks be increased by the sum of $ 4,400 for the calendar year 1942, (2) that the compensation of Amron for the same period be increased by $ 10,000, and (3) the compensation of Dempsey be increased during that year in the amount of $ 12,000. The committee on resolutions reported in part as follows:

1. In the opinion of this Committee the compensation paid to the officers of this Corporation should be increased.

2. The compensation to Mr. Dempsey for the use of his name in connection with the said enterprise should be increased by the sum of $ 12,000 for the calendar year 1942.

During 1942 Dempsey, in addition to the compensation of $ 36,724.72 paid to him by petitioner, also received a dividend from it in the amount of $ 13,500.

Dempsey from time to time has received from $ 750 to $ 10,000 a night for refereeing prize fights. He received $ 25,000 for the use of his name in connection with McKesson & Robbins' whiskey. His customary fees for radio appearances are from $ 1,500 to $ 2,000 a night.

From 1938 until June 11, 1942, when he accepted a commission in the Coast Guard, Dempsey's usual hours at petitioner's restaurant were during the lunch period for several hours and from about 6:30 p. m. until, on most occasions, 1 a. m. to 2 a. m. After accepting the commission in the Coast Guard on June 11, 1942, Dempsey no longer appeared at petitioner's restaurant during the lunch period.

During 1942 Dempsey was in New York approximately 300 days. He visited petitioner's restaurant on two-thirds of those days.

During the war years the United States Coast Guard became a part of the United States Navy. In 1942 the Bureau of Naval Personnel Manual, part H, chapter 1, H-1707, provided in part as follows:

Orders to Officers and Men to Active Duty in Time of War

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(3) When so placed on active duty, it is expected that officers and men will devote their whole time to naval duties and shall not engage in private employment, except in such cases as may be specifically authorized by the Bureau of Naval Personnel.

Before Dempsey entered the United States Coast Guard he discussed with his prospective superior officers the fact that he was under obligation to appear at petitioner's restaurant and bar. They told him that he could do so on his off-duty hours. His superior officers accompanied him to the restaurant and bar on several occasions during their off-duty hours.

In his notice of deficiency, under explanation of adjustments, respondent stated as follows:

(a) It is held that the sum of $ 24,724.72 represents reasonable compensation for services actually rendered by Jack Dempsey during the year 1942 and the amount paid in excess of that sum, $ 12,000.00, is disallowed as a deduction.

A reasonable payment to Jack Dempsey during 1942 for the use of his name and for his services is in the amount of $ 36,724.72.

OPINION.

Respondent contends that $ 12,000 of the $ 36,724.72 paid by petitioner to Dempsey in 1942 was excessive and on that account not deductible by it for tax purposes. Petitioner, on the other hand, argues that the total amount given to Dempsey in 1942 constitutes a reasonable payment for the use of his name and for his services. We agree with petitioner that the payment in question is deductible as an ordinary and necessary business expense under section 23 (a) (1) (A) of the Internal Revenue Code.

As petitioner has pointed out, Dempsey's compensation from petitioner during the year involved, although it was designated as salary, was both for the right to use his name and for the services he performed in putting in his appearance at the restaurant. There can be no question that petitioner would not have enjoyed anywhere near the success it did without the use of his name and his services. The evidence shows that the people who came to New York in 1942, as well as in previous years, sought out petitioner's restaurant in the hope of seeing Jack Dempsey. Harry S. Gerstein, who has been associated with many of Broadway's famous restaurants and night clubs as executive secretary of the Allied Restaurant & Entertainment Industry of New York since 1938, testified as follows:

A. I would like to say from my estimation that Dempsey's is a unique type of operation in so far as Dempsey himself is the drawing card there. Without Dempsey it would be an ordinary restaurant.

On cross-examination he further testified as follows:

* * * After the war started in December of 1941 we had in New York City an influx of uniformed and nonuniformed people gathered here, and the hue and cry up and down Broadway was Dempsey's, Dempsey's, Dempsey's.

As a matter of fact, a lot of the restaurant people complained Dempsey was doing all the business in the early part of the war, 1942.

The payments made to Dempsey by petitioner during 1942 were not disproportionate to compensation he has received from other sources for the use of his name and for his services. He has received from $ 750 to $ 10,000 a night for refereeing prize fights. He received $ 25,000 for the use of his name in connection with McKesson & Robbins' whiskey. He has been paid from $ 1,500 to $ 2,000 for radio appearances. These facts, we believe, lend strong support to petitioner's contention that the $ 36,724.72 which it paid to Dempsey during 1942 for the use of his name and for his services was reasonable.

There can be no doubt that the payment was agreed upon in an arm's length transaction. The facts show that there was a sharp disagreement among the board members as to what the compensation of Amron, Brooks, and Dempsey should be. The question of payments was finally referred to a special resolutions committee for action. Out of this committee came, among other things, the recommendation that payments made to Dempsey should be increased by $ 12,000 in 1942, which recommendation was approved by the board of directors. The above, together with the fact that petitioner in 1942 declared a dividend of $ 100 for each share of stock, is compelling evidence that the payment in question was not a guised distribution of profit.

Respondent points out that Dempsey did not receive permission from the proper authorities in the Navy Department to appear in petitioner's restaurant after receiving his commission from the United States Coast Guard. From this fact he states "a serious question of public policy is presented as to whether the payments should be recognized for tax purposes even if otherwise allowable." He cited no authority for this statement and we have been unable to find any valid reason to support respondent's suggestion. The facts show that Dempsey's appearances at petitioner's restaurant had the approval of his immediate superior officers; indeed, they accompanied him there on several occasions. Respondent, however, says this is not enough, that he should have had the approval of the chief of the Bureau of Naval Personnel. We believe the effect of respondent's argument is an attempt to have this tribunal enforce naval regulations, which function, of course, is not vested in this Court.

In view of all the circumstances of this case, we conclude that the entire amount paid to Dempsey during 1942 as compensation was reasonable in amount for services actually rendered and that such compensation, together with the amounts paid for the use of his name, constituted ordinary and necessary business expenses, and are deductible for tax purposes. It follows that respondent erred in his determination.

Decision will be entered under Rule 50.