Summary
In Hirsch Improvement Co. v. Commissioner, 143 F.2d 912 (2d Cir. 1944), the taxpayer received rent under a lease that made it somewhat likely, though not certain, that he would later have to refund it; the rent was held to be income in the year received.
Summary of this case from Illinois Power Co. v. C.I.ROpinion
No. 55.
May 19, 1944.
Petition for review of a decision of the Tax Court of the United States.
Petition by the Hirsch Improvement Company to review a decision of the Tax Court of the United States redetermining deficiencies in the petitioner's income and excess profits taxes for the calendar year 1936 imposed by the Commissioner of Internal Revenue.
Affirmed.
The taxpayer was organized in 1922 for the purpose, among other things, as stated in its articles of incorporation, of leasing real estate. Of its four stockholders, Paul and Fannie W. Hirsch owned one-half of the shares and Julius and Isidor Blauner, the other half. Paul Hirsch was the owner of a 99-year lease on certain real property in Cleveland known as the Argyle Block, which he had sublet to the Hirsch Company, operating a ladies' wearing apparel store. The taxpayer's stockholders owned all of the stock of the Hirsch Company. The actual purpose for which the taxpayer was organized was to take this lease from Paul Hirsch.
On March 24, 1924, the taxpayer subleased the premises to McCrory Stores Corporation for a period of 90 years at a rental of $67,500. To consummate the transaction, an agreement was entered into by the Hirsch Company, the four stockholders of the taxpayer, and the Guaranty Trust Company, as trustee, under the terms of the sublease to the Hirsch Company was to be cancelled and that company dissolved. This was done. The Hirsch Company owed the Blauners $200,000, which had been used by it to improve the premises. The Blauners had also paid the Hirsch Company's debts to its general creditors of $204,602.67. The trustee was to collect the rent and, after the payments of the general debts of the Hirsch Company (presumably the $204,602.67 to the Blauners), was to pay one-half of the income from the lease to the Blauners to liquidate their claim of $200,000 and the other half to the Hirsches.
On January 14, 1933, McCrory Stores Corporation filed a petition in bankruptcy. The sublease was disaffirmed by the trustee. Thereafter, the taxpayer settled the claim it had filed in bankruptcy against the McCrory Stores Corporation and entered into a new sublease with it for the period from June 1, 1936, to December 31, 1955. The rental agreed upon was $30,000 per annum for the first seven years of the lease and $32,500 per annum thereafter. The lessee proposed to anticipate the rental to the extent of $25,000 per annum for the first 10 years by the payment of an additional sum of $25,000 (which was made but is not here involved), thereby reducing the rental to be reserved in the lease to $27,500 per annum for the first seven years and $30,000 per annum for the next three years, $32,500 per annum to be paid for the balance of the term.
The lease contained the following provision: "The lessee has, on delivery hereof, paid to the lessor the sum of thirty-five thousand dollars ($35,000), the receipt of which is hereby acknowledged, as security for the payment of rent and the performance of the covenants and conditions of this lease on the part of the lessee to be performed. It is understood and agreed that the lessor shall apply said sum on account of the rent and other payments herein provided to be made for the year ending December 31, 1955, except that in the event of default in the payment of rent or in the performance of the material and important covenants contained in this lease on the lessee's part to be performed, and the termination of this lease pursuant to the terms hereof prior to January 1, 1955, in which event the said security shall be retained by the lessor in payment of or on account of such damages as the lessor may sustain by reason of the termination of the lease because of the default on the part of the lessee. In the event such damages shall be less than the amount paid as such security the surplus, if any, shall be paid to the lessee, by the lessor."
The lease also provided that, in the event the demised premises should be destroyed or seriously damaged by fire or otherwise so as to require rebuilding, and if the taxpayer should be unable or fail to rebuild the premises so as to be ready for occupancy within six months, the lessee might at its option terminate the lease and upon such termination "all rent paid in advance shall be equally apportioned and the unearned portion refunded to Lessee." It was further provided that, if the whole or any part of the premises should be taken by condemnation, the taxpayer would have the right to terminate the lease, in which event "any rent paid in advance shall be prorated and rebated." But, if only a part of the premises were so taken and the taxpayer did not elect to terminate, then "proper adjustment in the rent shall be made based upon the amount of square footage taken in said condemnation as against the amount of square footage hereby demised, and Lessor shall refund to Lessee the proper proportion of any rent of that part of the premises so taken as has been paid in advance * * *."
McCrory Stores Corporation also agreed to pay the taxpayer one-half of all taxes and assessments levied upon the premises of which they formed a part, together with one-fourth of all premiums for fire and lightning insurance.
The taxpayer believed that neither the $25,000 above referred to nor the $35,000 represented income and therefore could not be distributed as dividends. Nevertheless, the taxpayer distributed $55,000 (of the total $60,000) to its stockholders as "advances," and the amounts thus distributed were carried on the balance-sheet as assets. The so-called advances were, however, made without agreement that they should be repaid. No notes were given; the principal was not repaid, and no interest thereon has ever been repaid. In the hearing below, the taxpayer contended that it was entitled to a dividends-paid-credit for these "advances" because there was no intention that the stockholders should repay them; the Tax Court held that this argument was supported by the evidence and it allowed the credit; the Commissioner has not sought review of that finding and ruling.
Since its incorporation, the taxpayer's income has been derived from its leasehold and it has never acquired any other property. Its cash receipts during the period July 1, 1935, to June 30, 1936, consisted of rent and three payments made by the McCrory Stores Corporation aggregating $205,000. Its cash disbursements during the same period aggregated $183,000. Principal among these were approximately $30,000 paid as ground rent, $15,000 for taxes and insurance, $105,000 as dividends and advances to shareholders, $4,000 as commissions, $1,200 for traveling expenses, bookkeeping and sundry other expenses, the greater part of which were incurred in connection with the settlement of McCrory Stores Corporation, and $18,000 for legal expenses connected with the settlement and execution of the leases.
From 1924 to 1933 McCrory Stores Corporation was the sole tenant of the leasehold. Since 1933 (1936) that company has occupied only a portion of the premises and the remainder has been sublet (since 1935) to Robin Redbreast Hosiery Company, Inc., at a rental of a certain percentage of the latter's gross sales, which required the monthly submissions of statements by the tenant to the taxpayer. The later lease is for a period ending June 30, 1945. The taxpayer had conveyed its interest in the property to a trustee in 1924 pursuant to the agreement entered into on March 24, 1924, already referred to. The trust terminated in accordance with its terms in 1933 upon the death of one of the taxpayer's stockholders. The leasehold thereupon reverted to the taxpayer. In the tax year, effective September 1, 1936, the taxpayer employed a bank in Cleveland as its agent in the collection of rentals and the payment of the ground rent and taxes due from the taxpayer. Any balance of income remaining was to be disbursed by the agent on the taxpayer's written instructions.
During the period July 1, 1935, to June 30, 1936, the taxpayer did not supply heat, light, water or janitor service to its two tenants. It made no repairs to the premises. It did not buy, sell, or exchange any assets. During this period considerable time and effort were required in securing the settlement with McCrory Stores Corporation, heretofore referred to. The lease to Robin Redbreast Hosiery Company, Inc., was executed on July 1, 1935. The board of directors held three special meetings between July 1, 1935, and June 30, 1936. These were the only formal directors' meetings that were held. No formal meeting of the stockholders was held during that period. The Robin Redbreast Hosiery Company, Inc., covenanted in its lease to keep and maintain the premises demised to it, including plumbing and electrical fixtures, elevators, etc. in good condition and repair. The taxpayer covenanted to make all necessary repairs to the roof and sidewalk adjoining the premises. McCrory Stores Corporation covenanted in its lease to keep the interior of the premises demised to it in good repair, including the store fronts, show windows and entrance way, and the taxpayer covenanted to keep the exterior of the premises, including sidewalk, in good repair, and to carry insurance against fire and lightning. Similar covenants regarding repairs were contained in the prior lease to McCrory Stores Corporation and in the original lease to the Hirsch Company.
The taxpayer reported an excess profits tax liability of $5,369.23 for the year 1936 which it paid with its income tax in three installments. In its income tax return for the calendar year 1939, it reported the $35,000 in its balance-sheet as "rental securities." On March 15, 1940, it filed claim for refund of the excess profits tax so paid upon the ground that it was not engaged in carrying on business during the period July 1, 1935, to June 30, 1936, and therefore was not liable for capital stock tax or excess profits tax.
The Commissioner included the $35,000 above mentioned in the taxpayer's gross income for the taxable year 1936 as prepaid rental, and as a result of this and other adjustments determined a deficiency in excess profits tax of $7,310.27 and a deficiency in income tax of $17,014.24.
The Tax Court found and held that the $35,000 was paid to the taxpayer as rent. The Tax Court also denied the taxpayer's contention that it was not doing business in the taxable year 1935 and held that it was therefore not to be relieved from the excess profits tax it had paid in accordance with the return it had filed. However, in view of other adjustments made by it, the Tax Court redetermined deficiencies in the taxpayer's income and excess profits taxes for the calendar year 1936 in the amounts of $8,230.33 and $5,939.95, respectively. Taxpayer asks review of that decision.
Pertinent sections of the statutes are quoted in a footnote.
Revenue Act of 1935, c. 829, 49 Stat. 1014:
Sec. 105 [as amended by Sec. 401(a) of the Revenue Act of 1936, c. 690, 49 Stat. 1648].
"Capital Stock Tax. (a) For each year ending June 30, beginning with the year ending June 30, 1936, there is hereby imposed upon every domestic corporation with respect to carrying on or doing business for any part of such year an excise tax of $1 for each $1,000 of the adjusted declared value of its capital stock. * * *
"Sec. 106. Excess-Profits Tax (a) There is hereby imposed upon the net income of every corporation for each income-tax taxable year ending after the close of the first year in respect of which it is taxable under section 105, an excess-profits tax equal to the sum of the following: 6 per centum of such portion of its net income for such income-tax taxable year as is in excess of 10 per centum and not in excess of 15 per centum of the adjusted declared value; 12 per centum of such portion of its net income for such income-tax taxable year as is in excess of 15 per centum of the adjusted declared value." (The 1936 amendment merely reduced the capital stock tax from $1.40 for each thousand of the adjusted declared value of the corporation's capital stock to $1 per thousand.) 26 U.S.C.A. Int.Rev.Acts pages 798, 800.
Revenue Act of 1936, c. 690, 49 Stat. 1648:
"Sec. 22. Gross Income (a) General Definition. `Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *" 26 U.S.C.A. Int.Rev.Acts, page 825.
Elliott A. Daitz, of New York City (Sidney Stark and Herman Zarin, both of New York City, of counsel), for petitioner.
Samuel O. Clark, Jr., Sewall Key, Robert N. Anderson, and Carlton Fox, all of Washington, D.C., for respondent.
Before L. HAND, CHASE, and FRANK, Circuit Judges.
1. The question is whether the payment of the $35,000 was basically rent in the year in which taxpayer received it. That it was rent for a future year would be unimportant. It is also unimportant how taxpayer regarded or treated it. Its character turns on the terms of the lease itself. If the taxpayer had been required to segregate the payment, then it would not have been income for the taxable year. No such obligation here existed. But more than the absence of that obligation is needed to justify the conclusion that it was income in the year of its receipt. How much more is needed is a question not to be answered in a simple categorical manner. Where the line is to be drawn depends in each case on the provisions of the particular lease. The lease here supports the Tax Court's decision. For the sum received was to be repaid, in whole or part, under circumstances which might never occur and of a kind so limited as to be insufficient to require that sum to be categorized as primarily not intended as rent. The facts in Warren Service Corporation v. Commissioner, 2 Cir., 110 F.2d 723 were substantially different. Expressions in Clinton Hotel Realty Corp. v. Commissioner, 5 Cir., 128 F.2d 968, so far as they may appear to be inconsistent with our decision, were qualified by a subsequent case in the same Circuit, Astor Holding Co. v. Commissioner, 5 Cir., 135 F.2d 47, 146 A.L.R. 993, where the Court decided against the taxpayer on facts very similar to those of the instant case.
Until all possible cases have been decided there will seem to exist what Thomas Reed Powell calls "an undulating equator."
For the detailed facts, see the opinion of the Board, 1942, C.C.H., Board of Tax Appeals Service, § 12,599D, at p. 38,816.
2. The Tax Court correctly held that the taxpayer was doing business in the taxable year 1936. Our opinion in New London Northern R. Co. v. Smith, 2 Cir., 141 F.2d 219 amply covers that point.
Affirmed.