Opinion
Docket No. 12319.
1949-03-25
TRUMAN BOWEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Blaine B. Shimmel, Esq., Louis McClennen, Esq., and James A. Smith, C.P.A., for the petitioner. E. A. Tonjes, Esq., and H. A. Melville, Esq., for the respondent.
A partnership furnished equipment to the Government during 1941 for use at construction work to which the Government took title during 1942. The value of each item of equipment was agreed upon. Monthly payments called rent were made. The monthly payments were treated as equity of the Government under the agreements. Title was to pass to the Government when the monthly payments equaled value plus charges for interest at the rate of 1 per cent of value per month plus freight. The Government could take title upon completion of work by a further payment which, added to monthly payments, would equal value plus 1 per cent plus freight. Held, that the monthly payments accrued in 1941 did not constitute rent under section 22(a) of the code; and that the partnership was not obligated to report part of the payments as profit in 1941 under I.T. 3533, C.B. 1942-1, p. 87. Blaine B. Shimmel, Esq., Louis McClennen, Esq., and James A. Smith, C.P.A., for the petitioner. E. A. Tonjes, Esq., and H. A. Melville, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax liability for the year 1941 in the amount of $26,779.90. The parties have disposed of one issue under a stipulation which will be given effect under Rule 50. Petitioner has waived one claim for depreciation deductions on certain property.
Petitioner is a member of a copartnership which carries on business under the name of ‘Truman Bowen Company and J. L. McLaughlin.‘ Respondent has determined that the income of the copartnership for the year 1941 was greater than was reported; and upon the basis of that determination he has increased the amount of petitioner's share of the partnership income and determined a deficiency in petitioner's income tax for 1941. The question raised by the pleadings relates to several contracts which were made by the partnership.
The chief question is whether payments which the partnership received during 1941 under several contracts were rents within section 22(a) of the Internal Revenue Code, as respondent has determined, or were payments for property giving rise to profits, as petitioner contends.
Respondent has made claim for increase in the deficiency to $57,700.31, under section 272(e) of the code.
Petitioner filed his return for 1941 with the collector for the district of Indiana, but he is now a resident of Phoenix, Arizona.
This proceeding was submitted originally under Rule 30(a), under stipulation of the facts, but it was set for trial subsequently, when additional evidence was adduced and further facts were stipulated. The record consists of testimony, exhibits, and stipulations of certain facts.
FINDINGS OF FACT.
The facts which have been stipulated by the parties are found as facts. The stipulations are incorporated herein by this reference.
Truman Bowen & Co. & J. L. McLaughlin, a copartnership, was and still is engaged in the general contracting business throughout the United States. Petitioner is a member and one-half owner of the partnership. Since the question presented relates to the partnership, it is referred to hereinafter as the partnership.
In the spring of 1941 and thereafter the United States Government, through the War Department, made prime contracts with various contractors for the construction of ordnance works and other plants at various places. In connection with the construction work under the prime contracts, subcontracts were made to obtain equipment, which were called ‘equipment rental agreements.‘ The parties to the subcontracts were prime contractors and the Government, on the one hand, and owners of equipment, on the other hand; and the subcontract was subject to the prime contract. The subcontracts were let out after receipt of bids by the War Department. The form of the subcontract was a Government form, the terms thereof being required by the Government. The form of subcontract which is involved in this proceeding is Form 40-2111. In some instances it was described as a ‘rental purchase agreement.‘ Since the prime contracts were cost plus fixed fee contracts, the prime contractors were reimbursed by the Government for all payments which they made under the equipment agreements.
On March 6, 1941, the partnership entered into a so-called equipment rental agreement with the Government and Winston Bros., prime contractors, who were constructing the Hoosier Ordnance Plant at Charlestown, Indiana. Since the equipment agreement was made subject to the prime contract, it had to be and was executed by the same contracting officer of the Government, or his authorized representative, who had executed the prime contract. Attached to the agreement was a schedule, another Government form, which was designated schedule A. The schedule was stated to be, on its face, ‘an addendum to‘ the agreement, ‘of which it forms an integral part.‘ There were set forth in the schedule a description of each piece of equipment delivered under the schedule, the value of the item, per agreement, the amount of the monthly ‘rental,‘ and the hourly rate.
During the year 1941, 62 pieces of equipment were delivered to the receiving point at the Hoosier Ordnance Plant under the agreement. All of these items were not delivered at one time; rather, certain items were delivered in each month from March to December. Upon each delivery of equipment one of the forms called schedule A was made up and made part of the agreement, so that several schedules ultimately were made part of the agreement.
The number of pieces of equipment which were delivered in each month was as follows:
+---------+ ¦Mar ¦1 ¦ +------+--¦ ¦Apr ¦4 ¦ +------+--¦ ¦May ¦5 ¦ +------+--¦ ¦June ¦10¦ +------+--¦ ¦July ¦11¦ +------+--¦ ¦Aug ¦1 ¦ +------+--¦ ¦Sept ¦18¦ +------+--¦ ¦Oct ¦5 ¦ +------+--¦ ¦Nov ¦6 ¦ +------+--¦ ¦Dec ¦1 ¦ +------+--¦ ¦ ¦ ¦ +------+--¦ ¦Total ¦62¦ +---------+
The equipment was for use in excavating, moving dirt, and general work. It consisted of cranes and draglines, air compressors, shovels, various kinds of trucks, and like equipment.
The monthly payments were on the basis of one 8-hour shift, with a 50 per cent increase in the rate for each additional shift per day.
The agreement was not for any stated period, but it would end when the prime contract was terminated, if not before. The intent of the parties was that the agreement would last for about 12 or 15 months, depending upon the date when the last piece of equipment was delivered. Since title to a piece of equipment would pass to the Government automatically when monthly payments equaled the agreed value of the item, the agreement ended, with respect to each item, when monthly payments equaled value, plus 1 per cent of value per month, as is shown hereinafter. The amount of the monthly payment was such that this would happen in from 6 to 15 months. The Government had full control over the length of time an item of equipment would be retained at any place. If the Government wanted to have a piece of equipment used at some place other than the first place of use, after it had been used there, it would request a transfer.
When items were transferred to a second project, a new schedule A was made up which set forth, as in the first schedule, a description of the item, its value, the ‘rent‘ per month, and other details. In addition, the second schedule had a space which was designated ‘Equity,‘ in which the total sum of the monthly rentals paid at the first location was entered, so that the monthly payments which had been paid were carried forward. The sum entered represented the Government's equity in the piece of equipment.
Furthermore since prime contractors other than Winston Bros. were doing the construction work at the locations to which items were moved, located in various states, another so-called equipment rental agreement was executed, Form 40-2111, but the second form constituted a supplement to the original contract of March 6, 1941.
The standard form of agreement, Form 49-2111, contained a standard provision governing the transfer of title to items of equipment to the Government. The Government was in need of certain kinds of equipment for moving earth and making concrete in the building of plants, barracks, roads, and air fields, such as tractors, shovels, draglines, trucks, etc. There was an increasing scarcity of such equipment in 1941. After Pearl Harbor, certain supply lines were set up by the Government, some of which went to Europe and others to the Pacific areas. Equipment was sent overseas to be used in construction work of many kinds. Within the country, prime contractors lacked equipment required under their contracts with the Government, and it took steps to acquire needed equipment to provide to prime contractors. The procedure of acquiring equipment was called ‘recapture.‘ In Washington lists were made up of equipment, according to type, model, and make, which were sent into the field with directions to ‘recapture‘ such equipment. Equipment described in other lists was to be ‘recaptured‘ if the Government contracting officer so determined. The standard clause relating to the transfer of title to equipment in Form 40-2111 was intended to provide for the ‘recapture‘ of equipment as set forth above.
The clause referred to above is as follows:
* * * When and if the total rental paid to the Lessor for any piece of equipment shall equal the value thereof, plus freight to the site of the work, plus one per cent per month for each month or fraction thereof such piece of equipment shall have been in use, no further rental shall be paid to the Lessor and title shall vest in the Government. At the completion of the work or upon termination of the principal contract as provided in Article VI of the principal contract, the Government may at its option purchase any piece of such equipment by paying the Lessor the difference between the valuation of such equipment plus freight to the site of the work plus 1% per month for each month or part thereof such piece of equipment shall have been in use and the total rental therefor paid for such piece of equipment.
Under the above clause, title to an item was to pass to the Government automatically when monthly payments equaled the value per contract, plus an additional amount computed on the basis of 1 per cent of value per month. The 1 per cent amount was computed when the Government took title and was called ‘1 per cent Interest per Month‘ in the Government purchase order. Also, in the Government purchase orders the monthly accruals were called ‘rent paid as equity.‘ When the purchase order was made up, the owner of the item was reimbursed for any freight it had paid in the delivery of equipment. Thus, when monthly payments equaled value, plus 1 per cent, plus freight, if any, the Government had a right to receive a bill of sale from the owner. If title to equipment had not passed to the Government automatically, as above, before the time when work was completed or the agreement was terminated, then upon the happening of those events the Government had the right to make a final payment in return for a bill of sale. The final payment was to be in an amount which when added to the monthly payments would equal the total of value per contract, 1 per cent per month, and freight, if any. The way the final payment was computed is shown hereinafter.
The parties have stipulated as follows: The total price paid by the Government for an item of equipment was the sum of the contract value of the item, the 1 per cent increment, and freight. When the Government acquired title to the equipment in 1942, the monthly accruals were applied on the total price.
In the equipment agreement the parties were designated ‘lessor‘ and ‘lessee,‘ and the monthly payments were called ‘rent.‘ In the schedule attached to continuations of an original agreement, the monthly payments which had been made which were carried forward, were called ‘rent paid as equity.‘
The following schedule shows the number of the agreed monthly payments, without additions for overtime, the sum of which would equal value per contract. The following schedule, relating to 27 items, is typical of the agreement, as it covered the entire 62 items.
+----+ ¦¦¦¦¦¦ +----+
Approximate number of Item Owner's Value per Amount monthly cost contracts per month payments to equal value 1 $895 $1,125 $100 11 2, 3 14,300 17,018 1,350 12 4 12,000 19,000 1,550 12 5 3,575 6,000 700 8 6 6,750 9,800 1,050 9 7 23,500 24,500 2,100 11 8 10,000 14,000 1,350 10 9 10,000 14,750 1,350 10 10 5,500 10,000 1,050 9 11 25,600 32,600 2,100 15 12, 13, 14, 15, 16 4,892 6,385 460 13 17 500 75 6 18 400 650 75 8 19 425 750 110 7 20 750 110 7 21, 22 150 1,000 140 7 23 23,500 27,000 2,100 13 24 11,000 22,000 2,100 10 25, 26 16,830 20,788 1,350 15 60 16,815 19,815 1,700 11
As the work progressed at the Hoosier Plant and certain pieces of equipment were no longer needed there, the Government instructed that items of equipment be moved to other Places from time to time. Before the end of 1941, 50 pieces were moved to other construction jobs, and only 12 remained at Hoosier Ordnance Plant. The pieces were moved at various times, and, in particular, on September 6, November 17, November 23, December 1, 1941, and February 25, 1942. The other jobs were located at Huntsville, Alabama; Plum Brook, Ohio; Wabash River Ordnance Works, Indiana; the Mississippi Ordnance Plant; and the Arkansas Ordnance Plant. At the end of 1941 the original agreement, as supplemented by the agreements which were made when equipment was moved, showed a considerable equity in the Government in most of the 62 items which had been delivered earlier in the year to the Hoosier job.
Monthly payments were made under the agreements in 1942 for equipment with the exception of 18 items for which the last monthly payments were accrued in December 1941. Monthly payments were accrued for 1 item for January and part of February 1942; and for part of January for 5 items.
At various times from January to July 1942 the Government forwarded purchase orders for all of the 62 items and made final payments in return for bills of same. The Government acquired the above mentioned 18 items as of December 31, 1941, but did not make the final payments nor forward the purchase orders until early in March 1942; and the partnership did not receive any notice about the final payments until 1942. In some instances the final payment was less than the agreed amount of a monthly payment.
The construction work at the Hoosier job approached completion in November and December 1941, and it was finished in January and February of 1942.
When Winston Bros. was instructed by the War Department, under its letter of November 3, 1941, to release equipment from the Hoosier Plant and transfer it to Huntsville, Alabama, it notified the partnership in part as follows:
In accordance with instructions issued relative to the transfer of equipment to other projects, we are forwarding to receiving project photostatic copies of your rental agreement Form 40-2111, dated March 6, 1941, together with schedule ‘A‘ and lien sheets in which the valuation and rental of this equipment is set forth. * * *
Further, in accordance with Government instructions set forth in War Department letter QM480E dated November 3, 1941, relative to the transfer of this equipment, we are forwarding to the receiving post the amount of rentals paid up to the date of the Bill of Lading, which amount will be entered into the rental agreement between yourselves and the receiving post.
Winston Bros. stated, inter alia, in a letter to the Constructing Quartermaster at the Hoosier Plant relative to its transfer of equipment to Huntsville, that: ‘This equipment (was) leased by us from Truman Bowen Company— J. L. McLaughlin, on Purchase Order WHMS #1278.‘
Kershaw, Butler Inc., the contractors at Huntsville, notified the partnership, in connection with the equipment rental agreement with Kershaw, in part as follows:
* * * We have inserted the figures as submitted to us from the Hoosier Ordnance Plant, Charlestown, Indiana, relative to the amount of equity on each piece of equipment.
The following, taken from the agreement of November 17, 1941, with Kershaw, illustrates the procedure which was followed in the execution of equipment rental agreements covering equipment which was released and transferred by Winston Bros. to other construction projects:
+----------------------------+ ¦Schedule A. [Exhibit 23-W] ¦ +----------------------------¦ ¦ ¦ ¦ ¦ ¦ +------+------+------+-------¦ ¦ ¦ ¦ ¦ ¦ +----------------------------+
Value per Item contract 1 Equity 2 1 Truck $1,125 $833 5 Crane 6,000 4,769 6 Crane 9,800 6,211 7 Crane 24,500 11,211 8 Crane 14,000 12,003 9 Crane 14,750 6,727 10 Crane 10,000 8,695 11 Shovel 32,600 11,680 12 Air compressor 6,385 2,923 13 Air compressor 6,385 2,241 14 Air compressor 6,385 2,478 15 Air compressor 6,385 2,180 16 Air compressor 6,385 2,733 FN2 Equity represents payments made under original agreements with Winston Bros.
When the Government exercised its right to take over equipment, the War Department purchase order provided as follows for each item:
+--------------------------------------------------------------------+ ¦Item No. 27. ¦ ¦ ¦ ¦ ¦ +------------------------------------------+-------+---------+-------¦ ¦R-510-1 1/2 Ton Mack Flat Bed Truck * * * ¦ ¦ ¦ ¦ +------------------------------------------+-------+---------+-------¦ ¦Contract Value ¦ ¦ ¦$1,475.00¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦Rent Paid as equity: ¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------------¦ ¦Hoosier Ord. 9/25/41 to 11/22/41 1-28/30 ¦ +--------------------------------------------------------------------¦ ¦Mos. at $175 ¦ ¦$338.33¦ ¦ ¦ +--------------------------------------------------------------------¦ ¦Plum Brook—11/23/41 to 3/17/42 ¦ +--------------------------------------------------------------------¦ ¦3-25/30 Mos. at $113.67 ¦$435.73¦ ¦ ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦Overtime Payments ¦15.15 ¦ ¦ ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦ ¦ ¦450.88 ¦ ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦ ¦ ¦ ¦789.21 ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦Balance to Recapture by Government¦ ¦ ¦685.79 ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦1% Interest per month (6 Months) ¦ ¦ ¦88.50 ¦ ¦ +----------------------------------+-------+-------+---------+-------¦ ¦Total Amount Due to Recapture ¦ ¦ ¦ ¦$774.29¦ +--------------------------------------------------------------------¦ ¦* * * * * * * ¦ +--------------------------------------------------------------------+
+-----------------------------------------------------------------------+ ¦Item No. 8. ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Huntsville Arsenal No. 1529-BM, Old No. BM-30921:¦ ¦ ¦ +-----------------------------------------------------------------------¦ ¦Bay City Dragline, Model 65, Capacity 1 1/4 Yd., Serial No. 2475, Motor¦ +-----------------------------------------------------------------------¦ ¦No. 321946: ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Rental starting date, 5/2/41 ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Recapture date, 12/31/41 ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Original contract value ¦$14,000.00¦ ¦ +-------------------------------------------------+----------+----------¦ ¦8 Mo. interest at 1% per Mo ¦1,120.00 ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Freight from original point of ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦shipment to Hoosier Ordnance ¦ ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Plant ¦263.55 ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦ ¦ ¦$15,383.55¦ +-----------------------------------------------------------------------+
+---------------------------------------------------------------------+ ¦Paid by prime contractors Hoosier Ordnance Plant:¦ ¦ ¦ +-------------------------------------------------+--------+----------¦ ¦May ¦Rental roll D. O. Vou. No. ¦2070 ¦1,262.58¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦May ¦Rental roll D. O. Vou. No. ¦1301 ¦175.24 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦June ¦Rental roll D. O. Vou. No. ¦1691 ¦1,350.00¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦June ¦Rental roll D. O. Vou. No. ¦2223 ¦675.00 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦June ¦Rental roll D. O. Vou. No. ¦2223 ¦255.66 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦July ¦Rental roll D. O. Vou. No. ¦1371 ¦1,350.00¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦July ¦Rental roll D. O. Vou. No. ¦347 ¦675.00 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦July ¦Rental roll D. O. Vou. No. ¦347 ¦300.00 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Aug. ¦Rental roll D. O. Vou. No. ¦2497 ¦1,350.00¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Aug. ¦Rental roll D. O. Vou. No. ¦26 ¦675.00 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Aug. ¦Rental roll D. O. Vou. No. ¦26 ¦290.44 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Sept. ¦Rental roll D. O. Vou. No. ¦2947 ¦1,350.00¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Sept. ¦Rental roll D. O. Vou. No. ¦782 ¦116.44 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Oct. ¦Rental roll D. O. Vou. No. ¦2118 ¦1,350.00¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Nov. ¦Rental roll D. O. Vou. No. ¦2762 ¦900.00 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Nov. ¦Rental roll D. O. Vou. No. ¦2762 ¦7.03 ¦ ¦ +-------------------------------------------------+--------+----------¦ ¦Paid by Kershaw, Butler, Engineers Limited: ¦ ¦ ¦ +-------------------------------------------------+--------+----------¦ ¦Nov. ¦Rental roll D. O. Vou. No. ¦1820 ¦455.62 ¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦Dec. ¦Rental roll D. O. Vou. No. ¦1820 ¦1,600.31¦ ¦ +------+------------------------------------+-----+--------+----------¦ ¦ ¦ ¦ ¦ ¦$14,138.82¦ +------+---------------------------------------------------+----------¦ ¦ ¦Balance to recapture ¦$1,245.23 ¦ +----------------------------------------------------------+----------¦ ¦The monthly payment for item 8 was $1,350. ¦ ¦ ¦ +---------------------------------------------------------------------+
All of the equipment involved in this proceeding was acquired by the partnership at various times in 1941. In every instance the cost to the partnership was less than the value agreed upon under each original equipment agreement. In some instances, the value per agreement was the same as ‘cost new,‘ and in other instances it was less. The schedules attached to the agreements set forth both ‘cost new‘ and value under the agreement. The 62 items cost the partnership the total sum of $315,733.21, and the total values under the agreements were $427,281.76.
At the end of 1941 the monthly payments on 52 items of equipment exceeded the partnership cost, or exceeded 50 per cent of the partnership cost as follows: The monthly payments at the end of 1941 exceeded the cost to the partnership of 17 items; were close to the cost of 3 items; and were in excess of 50 per cent of the cost of 32 items. The monthly payments on 10 items amounted to less than 50 per cent of cost at the end of 1941.
The final payments which the Government made in the cases of 9 items covered only the 1 per cent increment, or the 1 per cent plus all or part of 1 monthly payment; and in 12 instances, it covered the 1 per cent increment plus an amount which was less than 2 monthly payments.
The following schedule shows the operation of the agreements with respect to all of the equipment. The cost of each item to the partnership has been omitted as a matter of convenience. (The total cost is given elsewhere.)
SCHEDULE I
(From Revised Exhibit 2)
+----------------+ ¦¦¦SCHEDULE I ¦¦¦¦ +++-----------+++¦ ¦¦¦ ¦ ¦¦¦¦ +----------------+
[From Revised Exhibit 2] Fair value Price paid Total Total Final Item per by monthly monthly lump sum Partnership contract Government payments payments paid gross profit 1941 1942 1942 1 $1,125.00 $1,203.75 $930.91 $0.00 $272.84 $308.75 2 17,018.18 18,549.81 2,835.00 8,100.00 7,614.81 4,249.81 3 17,018.18 18,379.62 3,040.31 6,750.00 8,589.31 4,079.62 4 19,000.00 20,520.00 2,967.00 8,887.79 8,665.21 8,520.00 5 6,000.00 6,480.00 5,804.74 675.26 2,905.00 6 9,800.00 10,605.50 7,790.27 2,815.23 3,855.50 7 24,500.00 26,508.11 14,186.48 12,321.63 3,008.11 8 14,000.00 15,383.55 14,138.32 1,245.23 5,383.55 9 14,750.00 15,932.50 8,634.09 7,298.41 5,932.50 10 10,000.00 10,845.00 7,863.81 2,981.19 5,345.00 11 32,600.00 36,966.69 14,101.85 8,557.49 14,307.35 11,366.69 12 6,385.00 6,831.95 3,455.85 3,376.10 1,939.95 13 6,385.00 6,768.10 2,806.11 3,961.99 1,876.10 14 6,385.00 6,768.10 2,742.15 4,025.95 1,876.10 15 6,385.00 6,768.10 3,279.17 3,488.93 1,876.10 16 6,385.00 6,768.10 3,044.30 3,723.80 1,876.10 17 500.00 530.00 362.50 167.50 530.00 18 650.00 702.00 471.53 230.47 302.00 19 750.00 802.50 579.34 223.16 377.50 20 750.00 787.50 421.67 365.83 787.50 21 1,000.00 1,090.00 994.00 96.00 940.00 22 1,000.00 1,090.00 993.99 96.01 940.00 23 27,000.00 30,675.76 18,102.12 7,070.00 5,503.64 7,175.76 24 22,000.00 25,842.10 17,690.10 6,511.00 1,641.00 14,842.10 25 20,788.00 22,035.28 675.00 9,480.58 11,879.70 5,205.28 26 20,788.00 22,243.16 675.00 11,167.90 10,400.26 5,413.16 27 1,475.00 1,563.50 482.31 306.90 774.29 597.26 28 1,475.00 1,563.50 483.30 307.54 772.66 597.26 29 1,475.00 1,563.50 518.57 288.86 756.07 597.26 30 1,475.00 1,563.50 409.15 326.48 827.87 597.26 31 1,475.00 1,563.50 483.30 300.44 779.76 597.26 32 1,475.00 1,563.50 518.76 281.02 763.72 608.26 33 1,475.00 1,564.50 518.96 295.34 749.20 608.26 34 1,475.00 1,563.50 486.29 305.66 771.55 597.26 35 1,475.00 1,563.50 525.12 279.15 759.23 608.26 36 1,475.00 1,578.25 608.83 266.96 702.46 623.01 37 1,475.00 1,563.50 539.36 281.00 743.14 608.26 38 1,475.00 1,563.50 447.60 305.86 810.04 608.26 39 1,250.00 1,325.00 454.80 245.65 624.55 524.00 40 1,250.00 1,325.00 456.25 240.66 628.09 524.00 41 1,250.00 1,325.00 459.88 244.95 620.17 524.00 42 1,250.00 1,337.50 647.63 181.19 508.68 536.50 43 1,250.00 1,325.00 449.98 237.42 637.60 524.00 44 1,250.00 1,325.00 455.80 244.02 625.18 524.00 45 1,250.00 1,325.00 459.38 244.24 621.38 524.00 46 1,250.00 1,325.00 388.78 253.10 683.12 516.05 47 2,400.00 2,640.00 1,039.20 1,038.75 562.05 2,035.57 48 2,400.00 2,640.00 779.73 1,236.87 623.40 2,035.57 49 5,100.00 5,763.00 2,842.85 1,747.77 1,172.38 2,634.95 50 5,100.00 5,763.00 2,750.04 1,793.93 1,219.03 2,634.95 51 5,100.00 5,763.00 2,849.52 1,717.93 1,195.55 2,634.95 52 5,100.00 5,763.00 2,715.46 1,820.27 1,227.27 2,634.95 53 5,100.00 5,763.00 2,836.52 1,727.87 1,198.61 2,634.95 54 4,535.00 4,852.45 2,785.43 179.31 1,887.71 1,224.45 55 4,000.00 4,320.00 3,367.37 193.55 759.08 1,092.00 56 4,535.00 4,852.45 3.056.93 129.03 1,666.49 1,224.45 57 1,888.40 2,096.12 1,916.33 58.06 121.73 34.85 58 5,000.00 5,613.00 4,575.39 209.68 827.93 3,299.00 59 970.00 1,067.00 760.00 101.79 205.21 567.00 60 19,815.00 21,400.20 2,266.67 10,200.00 8,933.53 4,585.20 61 17,788.00 19,033.16 2,115.00 6,809.06 10,109.10 4,733.16 62 17,788.00 18,855.28 1,409.06 6,690.94 10,755.28 4,555.28 Total 427,281.76 466,651.09 186,445.16 107,616.01 172,589.92 150,917.88
As stated previously, the various pieces of equipment were delivered to work projects at various times during 1941, after March 6, 1941. Eight items were delivered after October 27, 1941. The following schedule shows, by item, the percentage of contract value which the 1941 payments represented:
+---------------------------------------------------------------+ ¦ ¦Over ¦ ¦Over ¦ ¦Over ¦ ¦Under ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦Item¦70 percent¦Item¦40 percent¦Item¦25 percent¦Item¦20 percent¦ +----+----------+----+----------+----+----------+----+----------¦ ¦1 ¦83 ¦7 ¦58 ¦27 ¦33 ¦2 ¦17 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦5 ¦97 ¦9 ¦58 ¦28 ¦33 ¦3 ¦18 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦6 ¦79 ¦11 ¦43 ¦29 ¦35 ¦4 ¦16 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦8 ¦101 ¦12 ¦54 ¦30 ¦28 ¦25 ¦3 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦10 ¦79 ¦13 ¦44 ¦31 ¦33 ¦26 ¦3 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦17 ¦72 ¦14 ¦43 ¦32 ¦35 ¦60 ¦11 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦18 ¦72 ¦15 ¦54 ¦33 ¦35 ¦61 ¦12 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦19 ¦77 ¦16 ¦48 ¦34 ¦33 ¦62 ¦8 ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦21 ¦99 ¦20 ¦56 ¦35 ¦36 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦22 ¦99 ¦23 ¦67 ¦37 ¦37 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦24 ¦80 ¦36 ¦41 ¦38 ¦30 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦55 ¦84 ¦42 ¦52 ¦39 ¦36 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦57 ¦101 ¦47 ¦43 ¦40 ¦36 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦58 ¦91 ¦49 ¦56 ¦41 ¦37 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦59 ¦78 ¦50 ¦54 ¦43 ¦36 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦51 ¦56 ¦44 ¦36 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦52 ¦53 ¦45 ¦37 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦53 ¦56 ¦46 ¦31 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦54 ¦61 ¦48 ¦32 ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦56 ¦67 ¦ ¦ ¦ ¦ ¦ +----+----------+----+----------+----+----------+----+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------------------------------------------+
(15) (20) (19) (8)
With respect to the 18 items not used after 1941, which the Government acquired in the early part of 1942, the percentages of the total monthly payments in 1941 to the values of the items were as follows:
+----------------------------------+ ¦Item¦Value per¦1941 ¦Percentage¦ +----+---------+--------+----------¦ ¦ ¦contact ¦payments¦of value ¦ +----+---------+--------+----------¦ ¦1 ¦$1,125 ¦$931 ¦82.7 ¦ +----+---------+--------+----------¦ ¦5 ¦6,000 ¦5,805 ¦96.7 ¦ +----+---------+--------+----------¦ ¦6 ¦9,800 ¦7,790 ¦79.5 ¦ +----+---------+--------+----------¦ ¦7 ¦24,500 ¦14,186 ¦57.9 ¦ +----+---------+--------+----------¦ ¦8 ¦14,000 ¦14,138 ¦101.0 ¦ +----+---------+--------+----------¦ ¦9 ¦14,750 ¦8,634 ¦58.5 ¦ +----+---------+--------+----------¦ ¦10 ¦10,000 ¦7,864 ¦78.6 ¦ +----+---------+--------+----------¦ ¦12 ¦6,385 ¦3,456 ¦54.1 ¦ +----+---------+--------+----------¦ ¦13 ¦6,385 ¦2,806 ¦43.9 ¦ +----+---------+--------+----------¦ ¦14 ¦6,385 ¦2,742 ¦42.9 ¦ +----+---------+--------+----------¦ ¦15 ¦6,385 ¦3,279 ¦51.4 ¦ +----+---------+--------+----------¦ ¦16 ¦6,385 ¦3,044 ¦47.4 ¦ +----+---------+--------+----------¦ ¦17 ¦500 ¦362 ¦72.5 ¦ +----+---------+--------+----------¦ ¦18 ¦650 ¦471 ¦72.5 ¦ +----+---------+--------+----------¦ ¦19 ¦750 ¦579 ¦77.2 ¦ +----+---------+--------+----------¦ ¦20 ¦750 ¦422 ¦56.2 ¦ +----+---------+--------+----------¦ ¦21 ¦1,000 ¦994 ¦99.4 ¦ +----+---------+--------+----------¦ ¦22 ¦1,000 ¦994 ¦99.4 ¦ +----------------------------------+
With respect to the above 18 pieces of equipment, the cost to the partnership, the total value per contract, the total amount paid by the Government, the total ‘rental‘ payments made in 1941, and the total of the sums paid by the Government in 1942 upon execution of the purchase orders were as follows:
+----------------------------------------------------------+ ¦Cost ¦Value per¦Total paid * ¦Rent paid ¦Final payments¦ +-------+---------+--------------+----------+--------------¦ ¦ ¦contract ¦ ¦1941 ¦1942 ¦ +-------+---------+--------------+----------+--------------¦ ¦$85,805¦$116,750 ¦$125,864.76 ¦$78,499.23¦$47,365.53 ¦ +----------------------------------------------------------+ FN* Includes 1 per cent per month, plus freight, if any.
The total monthly payments on the 62 items in 1941 were 43.6 per cent of the total value per contract of the items.
With respect to the equipment which the Government purchased in 1942, on which rental payments were made in 1942 as well as in 1941, the following schedule shows the total paid under the agreements, ‘rent‘ paid in 1941 and in 1942, and the total of payments made upon ‘recapture‘ in 1942:
+-----------------------------------------------------------+ ¦Total paid * ¦Rent paid 1941¦Rent paid 1942¦Final payments¦ +--------------+--------------+--------------+--------------¦ ¦ ¦ ¦ ¦1942 ¦ +--------------+--------------+--------------+--------------¦ ¦ ¦ ¦ ¦ ¦ +--------------+--------------+--------------+--------------¦ ¦$340,786.33 ¦$107,945.93 ¦$107,616.01 ¦$125,224.39 ¦ +--------------+--------------+--------------+--------------¦ ¦ ¦ ¦ ¦ ¦ +--------------+--------------+--------------+--------------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------+ FN* Includes 1 per cent per month, plus freight, if any.
The following schedule sets forth the total amounts, for the entire 62 items of equipment, of the value per contract; of freight paid by the partnership in certain instances; of 1 per cent per month of value up to the time of execution of bills of sale; of rental payments in 1941 and 1942; and of the final payments in 1942:
+------------------------------------------------------------------+ ¦ ¦Total 1 per cent¦ ¦Total paid under¦ +------------------+----------------+-------------+----------------¦ ¦Value per contract¦of value ¦Total freight¦agreements ¦ +------------------+----------------+-------------+----------------¦ ¦ ¦ ¦ ¦ ¦ +------------------+----------------+-------------+----------------¦ ¦$427,281.76 ¦$35,922.62 ¦$3,446.71 ¦$466,651.09 ¦ +------------------+----------------+-------------+----------------¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------------+
Final payments Total received by Rent paid 1941 Rent paid 1942 1942 partnership $186,445.16 $107,616.01 $172,589.92 $466,651.09
The final payments in 1942, exclusive of 1 per cent interest per month and freight were about 31 per cent of the total contract value of the 62 items of equipment.
All of the equipment covered by the agreements was used by the partnership in its business.
Under all of the agreements, the value of each item of equipment represented the amount which was required for transferring title, to which was to be added 1 per cent per month plus freight.
The partnership kept its books on the accrual basis. The partnership did not return for tax purposes for 1941 any of the amounts which it had received or accrued in 1941 as rental payments under the agreements. The partnership did not return for tax purposes for 1941 any profit from the agreements as income from installment sales.
The rental payments which were received or accrued in 1941 were credited to a suspense account. When the Government acquired title to the equipment in 1942, these amounts were cleared from the suspense account and credited to the partnership's asset account. Profits on these transactions were reported in the partnership's income tax return for 1942 as capital gains under section 117(j) of the Internal Revenue Code, and petitioner reported his share of these profits in his 1942 income tax return.
During 1941 the partnership paid freight on moving equipment to Government jobs in the total amount of $3,446.71. That amount was charged in 1941 to the partnership's freight expense account, and was closed to profit and loss at the end of the year. It was reflected in the cost of labor, supplies, etc., in line 2(c) of the 1941 partnership income tax return, Form 1065.
The partnership did not take any deductions for depreciation of any of the 62 items of equipment in its income tax return for 1941.
Prior to ‘recapture‘ of items of equipment by the Government, the partnership paid all property taxes assessed against the equipment, and carried insurance thereon against loss and public liability, which items were charged to expense and were deducted as such in the partnership's income tax returns.
The partnership and petitioner were given extensions of time within which to file income tax returns for the year 1941, and these returns were filed on April 15, 1942.
The petitioner and the Commissioner entered into an agreement, pursuant to section 276(b), to extend the time within which the Commissioner might assess a deficiency for the year 1941 to June 30, 1946, which time was later extended to June 30, 1947. The notice of deficiency was issued on July 23, 1946.
OPINION.
HARRON, Judge:
In his original determination respondent applied the provisions of I.T. 3533, C.B. 1941-1, p. 87; as amended by I.T. 3631, C.B. 1943, p. 197. That is to say, he gave recognition to the fact that the Government took title to all of the equipment in 1942 and determined that a proportionate part of the profit, $66,692.36, was allocable to the year 1941. The ruling set forth in I.T. 3533 is one which permits a taxpayer to allocate the profits from a contract, such as we have before us in this proceeding, among the years during which the contract is in force. However, the partnership did not elect to follow the permissive method of reporting income which is set forth therein. In this proceeding petitioner contends that it is not required to report income from the contract in question under this ruling, and we think petitioner is correct in that view, as will be shown hereinafter.
Under his answer, the respondent made an alternative affirmative allegation. On the basis of this affirmative pleading, the respondent moved for increase in the deficiency of this petitioner from $26,779.90 to $57,700.31 under the provisions of section 272(e) of the Internal Revenue Code. Respondent now contends that the entire amount of the payments received under the contracts in 1941, which aggregated $191,248.49, constituted ordinary rental income to the partnership under section 22(a) of the Internal Revenue Code. The question presented is whether the 1941 payments represented rents. This question is considered first. Whether or not the 1941 payments under the contract constitute rent depends upon the construction of the contract of March 6, 1941, Government Form No. 40-2111.
The determination of the question whether an agreement is a lease or a conditional sales contract is often difficult. Union Stock Yards & Transit Co. v. Matthews, 57 Atl.(2d) 796, 798; 47 Am.Jur.,pp. 24, 25, and 26, secs. 836, 837. In In Re Rainey, 31 Fed.(2d) 197, the court stated the distinction as follows:
The distinction between an ordinary lease and a conditional sale is obvious. A lease contemplates only the use of the property for a limited time and the return of it to the lessor at the expiration of that time; whereas, a conditional sale contemplates the ultimate ownership of the property by the buyer, together with the use of it in the meantime.
See also Vermont Acceptance Corporation v. Wiltshire, 153 Atl. 199, 200; Hamilton v. Highlands, 56 S.E. 929.
The determination of whether an agreement is a lease or a conditional sales contract is controlled neither by the form nor by the use of the terms ‘lease‘ and ‘rent.‘ ‘It is necessary to look through form to substance,‘ In Re Rainey, supra; and the ‘courts will always look to its purpose, rather than to the name given to it by the parties,‘ Hervey v. R. I. Locomotive Works, 93 U.S. 664, 672; Schmidt v. Boder, 130 Atl. 258.
Under the Uniform Conditional Sales Act, par. 1:
A lease is substantially equivalent to a conditional sale when the buyer is bound to pay rent substantially equal to the value of the goods and has the option of becoming or is to become the owner of the goods after all the rent is paid. In such a contract ‘rent‘ means the purchase price, and possession as ‘lessee‘ means the possession of a buyer under an executory contract of sale. That the buyer, in some cases, has the option of becoming the owner and thus a sale is not sure to take place, is of but small importance, for, as a practical matter, the buyer will always be willing to accept ownership when he has paid the value.
See also Eager, The Law of Chattel Mortgages and Conditional Sales and Trust Receipts, 1941, pp. 388-391; Jefferson Gas Coal Co. v. Commissioner, 52 Fed. (2d) 120, 122, affirming 16 B.T.A. 1135; A. B. Watson, 24 B.T.A. 471, affd., 62 Fed.(2d) 35.
VAN FOSSAN, J. dissents.
MURDOCK, J., dissenting: I do not think this case is distinguishable from Estate of Clarence B. Eaton, 10 T.C. 869.
JOHNSON, J., dissenting: In holding that payments received from the Government on account of equipment constituted selling price under a conditional sale agreement and not rent as recited in the contract, the majority imputes to the Government a fixed intention to buy the equipment when the contract was made and relies on decisions in which similar contracts between individuals and corporations have been so construed. In my opinion the motives of financial caution which might influence private parties to incorporate lease terms or ‘recapture‘ clauses in contracts really intended to effect sales can not be rationally imputed to the United States Government. It requires no ‘easy payment plans,‘ no credit extensions, no safeguards against future financial straits. If it had harbored a fixed intention of purchasing the equipment when the contract was made, it would have bought it then for cash. Since it did not do so, the conclusion seems inescapable that it had no fixed intention to buy at that time and mean to rent, as it purported to do. In Estate of Clarence B. Eaton, 10 T.C. 869, this Court treated similar payments as rent under a Government contract that, as the majority here expressly states, ‘contained a provision which is the same as the pertinent one in this proceeding.‘ I perceive no material respect in which the facts here shown differ from those considered there, and the majority's conclusion in this case seems to me in direct conflict with the Court's prior holding.