Opinion
Docket No. 52927.
1956-02-29
IRVING S. SOKOL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
George B. Lourie, Esq., for the petitioner. Joseph Landis, Esq., for the respondent.
Petitioner operated a wholesale meat business as a sole proprietor. M. and S. Cohen operated the same kind of business as a partnership on property held by the Cohens under a lease expiring on December 31, 1947. Petitioner and the Cohens agreed to pool their businesses and to form a corporation to the capital of which the three individuals were to make equal contributions. Pursuant to this understanding each of the three agreed to contribute the same amount of cash plus certain fixtures. Prior to the organization of the corporation the Cohens raised the point that they were the owners of the lease covering the property which it was intended to be occupied by the new corporation, that this lease was quite valuable and that they would not go ahead with the transaction or agree to the formation of the corporation unless petitioner paid to them $5,000. This petitioner did, the corporation was formed on November 4, 1946, and was permitted by the Cohens to occupy the leased premises. Held, petitioner's payment of $5,000 to the Cohens was, in effect, a contribution of additional capital to the corporation. George B. Lourie, Esq., for the petitioner. Joseph Landis, Esq., for the respondent.
The Commissioner determined a deficiency in petitioner's income tax for 1947 in the amount of $2,886.84. The sole issue presented is whether $5,000 paid by petitioner to the other two stockholders of a corporation so that they would permit the corporation to use a valuable leasehold which they held was an additional capital contribution or the purchase price of an interest in the lease amortizable over the term thereof.
FINDINGS OF FACT.
Petitioner resides in Brookline, Massachusetts. His return for the year 1947 was filed with the collector of internal revenue for the district of Massachusetts.
Prior to November 1946 petitioner was engaged in the wholesale meat business as a sole proprietor under the name of Interstate Beef Company. He operated this business from an office. Morris and Simon Cohen were at that time also engaged in the wholesale meat business as a partnership under the name of State Beef Company. The Cohens conducted their business from a plant on Clinton Street in Boston which they, as individuals, held under a lease expiring December 31, 1947. Petitioner and the Cohens held several conferences prior to November 1, 1946, with respect to pooling their businesses and forming a corporation under the name of Interstate Beef Company. The basic understanding between petitioner and the Cohens with regard to the organization of the corporation was that the contributions of each of the three were to be equal. Pursuant to this understanding each agreed to contribute $30,000 in cash, a total of $90,000, plus certain fixtures. Petitioner's fixtures had an adjusted basis to him of zero.
After the amount of the capital of the corporation, hereinafter referred to as Interstate, and the respective contributions of petitioner and the two Cohens of cash and fixtures had been agreed upon, but prior to the organization of Interstate and as a part of negotiations of petitioner and the Cohens preliminary to its organization, the Cohens brought up the question of the Clinton Street plant the leasehold of which was owned by the Cohens. The parties contemplated that the new corporation would occupy these premises. Petitioner knew that the Cohens' lease thereon was valuable. The Cohens were willing to permit the corporation to occupy the premises at the rent called for by the lease if petitioner would pay to them $5,000. The Cohens would not have joined the petitioner in forming Interstate if he had not agreed to pay them this amount.
On October 21, 1946, petitioner, the Cohens, and Interstate entered into an agreement under which petitioner had the right of first refusal in the event the Cohens wished to sell their stock in Interstate, and also had the right to compel the Cohens to buy his stock if he wished to sell. The Cohens had the right to compel petitioner to sell his stock to them, but he did not have the right to compel them to sell their stock to him. Only if they wished to sell their stock did he have the right of first refusal. The price at which the stock was to be bought and sold under the foregoing provisions was the book value of the shares to be transferred, based upon an inventory to be taken within 24 hours of the receipt of the required notice. In the event the Cohens purchased the petitioner's shares, they were to pay him in addition to the book value of the shares the sum of $357.15 for each month that the then existing sublease by the Cohens of the Clinton Street property to Interstate was unexpired part of a month. The sublease referred to expired on December 31, 1947.
The agreement of October 21, 1946, provided further, in part, as follows:
The good-will of the corporation and the subletting to the corporation shall at no time be figured as assets of the corporation in determining the book value of any shares of stock.
It is further agreed that whereas Simon Cohen and Morris Cohen have sublet the premises now occupied by them at 107-109-111 Clinton Street, Boston, Mass., to Interstate Beef Company for the balance of the term namely December 31, 1947, and any renewal or renewals thereof, or any tenancies at will, in the event of the purchase of and payment for the stock of Irving Sokol by Morris Cohen and Simon Cohen as above provided this subletting, or any other tenancy by which Interstate Beef Company may be occupying the premises, shall come to an end and the remainder of any term or terms shall revert to Simon and Morris Cohen as herein provided. It is further agreed that if a petition for dissolution of the corporation has been brought by anyone or there is litigation between the parties the subletting or any other tenancy by which Interstate Beef Company may be occupying the aforementioned premises shall revert to Simon Cohen and Morris Cohen, however, as long as Interstate Beef Company is in possession of the said premises, it shall be liable for the rent called for in the lease and be bound by all the other terms and conditions of the tenancy during its tenancy. The corporation agrees that it will save Morris Cohen and Simon Cohen harmless of and from all claims by the lessor during the balance of the term of the present lease as long as it is in possession of the premises under said lease, new lease, renewals thereof or as a tenant at will, but if Sokol shall sell his stock as hereinbefore provided the subletting of the original lease or renewals thereof shall not be considered as a liability of the corporation in determining the value of the stock except as to accruals up to the date of giving of notice.
Interstate was incorporated under the laws of Massachusetts on November 4,1946. Its authorized capital stock consisted of 1,000 shares of common stock of $100 par value. Petitioner, Simon Cohen, and Morris Cohen each subscribed for 318 shares of the common stock for which each paid $30,000 in cash, and, in addition, certain fixtures and equipment. Throughout the period involved, the entire issued and outstanding stock of Interstate consisted of 954 shares.
In addition to the foregoing payment made by petitioner to Interstate pursuant to his subscription for its stock, he paid the sum of $5,000 on November 12, 1946, to the Cohens as individuals. The receipt of this amount was reported as income by the Cohens on their income tax returns for 1946. No interest in the lease on the Clinton Street property was assigned to the petitioner.
In 1948 petitioner sold his Interstate stock to the Cohens for $38,000, and in reporting the gain on this sale on his tax return for 1948 he used as his basis $30,000. The Commissioner disallowed a deduction of $5,000 claimed in his 1947 return as ‘forfeiture of deposit on fixtures' but which was intended to be a deduction for the depreciation or amortization of the leasehold.
The stipulation of facts and the exhibits annexed thereto are incorporated herein by this reference.
OPINION.
Kern, Judge:
Petitioner contends that he is entitled to deduct the $5,000 paid by him to the Cohens (or at least twelve-fourteenths thereof, $4,285.70) as amortization of an interest acquired by him in the lease on the Clinton Street plant. He argues that the payment with respect to the lease was a separate bargain, independent of the investment in the stock of Interstate, and comparable to the payment for a covenant not to compete, which has been treated as distinct from the purchase price of the business. See Gazette Telegraph Co., 19 T.C. 692, affd. (C.A. 10, 1954) 209 F.2d 926; Lee Ruwitch, 22 T.C. 1053. The Commissioner has disallowed the deduction on the ground that the payment of the Cohens was either an additional contribution to the capital of Interstate or a payment made to benefit the corporation and thus to increase the value of petitioner's existing investment therein, and hence a capital expenditure under section 24(a)(2) of the Internal Revenue Code of 1939. The Commissioner argues further that even if petitioner acquired an interest in the lease, he is not entitled to deduct any part of the cost because he has failed to show that such acquisition was in connection with any business purpose. Regs. 111, sec. 29.23(a)-10. We agree with the Commissioner that the payment to the Cohens is not deductible by the petitioner.
As we appraise the facts, it is apparent that petitioner and the two Cohens were faced with the following problem: The Cohens owned a valuable leasehold which they were willing to contribute to the corporation but each of them was unwilling to contribute anything more to the corporation than petitioner in view of the basic understanding that the contribution of each of the three was to be the same. The Cohens evidently estimated the value of the unexpired lease to be $15,000. One way by which the problem could have been solved would have been for the Cohens to contribute the leasehold to Interstate and petitioner to contribute an amount of cash to the corporation which would have been equivalent to one-half the value of the leasehold. This would have resulted in petitioner's contribution of $7,500 to Interstate. The parties evidently decided on another way to equalize the contribution incident to the leasehold which was less expensive for petitioner, and that was for the Cohens to permit Interstate to occupy the premises under the lease and for petitioner to pay to the Cohens individually the sum of $5,000. In that way the leasehold would, in effect, be contributed to the corporation and the contribution would be equal from the two Cohens and petitioner.
Simon Cohen testified that no part of the lease was assigned to petitioner. No assignment was introduced into evidence. It does not appear that petitioner was ever to recover his ‘investment’ in the lease through the receipt of some part of the rentals.
Under the agreement of October 21, 1946, if petitioner exercised his right of first refusal in the event the Cohens desired to sell out, it appears that the sublease would not be terminated and that the Cohens would not receive any consideration for the $10,000 premium value of the lease contributed to the corporation. This eventuality did not occur and nothing in the record suggests that it was a serious possibility. On the other hand, if petitioner were bought out by the Cohens (an eventuality which did occur within a short time), he would receive a pro rata refund of his contribution to the premium on the lease. We do not view this situation as implying that an interest in the lease was owned by petitioner rather than by the corporation. Petitioner could not compel the Cohens to sell to him but they could compel him to sell to them, and the situation was, therefore, within the control of the Cohens who had the opportunity of selecting the best course of action for themselves. If the Cohens exercised this right of forcing petitioner to sell out to them his stock interest in the corporation at a book value to be determined without reference to the value of the unexpired lease (which was to revert to the Cohens in this event), and if no provision had been made for some refund to petitioner of a part of the $5,000 payment proportionate to the unexpired period of the lease, then it would eventuate that petitioner's contribution would have been larger than the Cohen's. The fact that the agreement provided that in this eventuality a pro rate refund of his contribution on account of the lease should be made to petitioner is a further indication that petitioner and the Cohens were keenly aware of the fundamental understanding between them that their contributions to the corporation were to be equal.
Any real benefit to petitioner form the $5,000 payment could come from his participation as a stockholder in the corporation which was to enjoy the occupancy of the premises in the conduct of its business. If petitioner ever did acquire an interest in the lease, he appears to have contributed it immediately to the corporation. See I.T.1222, I-1C.B.168 (1922).
The cases involving covenants not to compete cited by the petitioner are not in point. The fact that a separate and independent bargain was made with respect to the lease does not establish that the payment was not an additional investment in Interstate. In the cited cases, this factor merely distinguished the portion of the purchase price allocable to the acquisition of the business itself from the portion attributable to the acquisition of an admittedly wasting asset owned by the taxpayer claiming the deduction. Cf. Lee Ruwitch, supra. We have no evidence herein that petitioner acquired anything other than an increased investment in Interstate, and all the indications are that he did not.
Decision will be entered for the respondent.