Docket No. 29191.
R. M. O'Hara, Esq., for the petitioner. Byron M. Coon, Esq., for the respondent.
R. M. O'Hara, Esq., for the petitioner.
Byron M. Coon, Esq., for the respondent.
The respondent has asserted deficiencies in the income tax of the petitioner for 1921, 1922 and 1923, in the respective amounts of $78,052.26, $29,639.45 and $20,950.73, all of which is in dispute. Three of the six specifications of error, set out in the amended petition as filed, were verbally withdrawn by the petitioner's attorney at the hearing of this case and issues joined upon the following allegations of error, to wit:
(1) That the respondent erred in adding to the petitioner's taxable income for these years certain proceeds derived by him from the operation of five hotels which were involved in litigation;
(2) That in computing the tax upon the income in controversy the respondent erred in not allowing deductions on account of depreciation on said hotel properties; and
(3) That the respondent further erred, in respect to the years 1921 and 1922, in not allowing deductions from the disputed income for those years of $21,567.25 and $15,366.14, respectively, on account of interest paid.
FINDINGS OF FACT.
The petitioner is an individual residing at Omaha, Nebraska. For many years prior to and during all of the time involved, he was engaged in the hotel business. Early in 1921 he acquired possession of five hotels, located in different parts of the State of Nebraska, which belonged to a corporation known as "The Nebraska Hotel Company" and which he operated during the taxable years under the circumstances hereinafter set forth.
The Nebraska Hotel Company was a corporation engaged in the operation of hotels in the State of Nebraska. Early in 1921 its affairs became involved and on January 7 of that year, upon application made by some of its stockholders, the District Court of Lancaster County, Nebraska, issued an order appointing a receiver for all of its properties. Two days later several of the creditors of this corporation filed a petition in the Federal court seeking to have it adjudicated a bankrupt. While these proceedings were pending, the petitioner went into possession of the five hotel properties in dispute, under a contract of sale made to him by the receiver appointed by the State court. This contract was entered into April 7, 1921, but made retroactive as of February 1 of that year. Under its terms the petitioner agreed to pay the sum of $1,000,000 as purchase price for the five hotels and other assets, upon terms, and further agreed that if the transaction should be held illegal by the Supreme Court of the State of Nebraska, or invalidated by the bankruptcy proceedings in the Federal court, the sale should be canceled and held for naught; and that the parties should be restored to their previous status. During the following three years the petitioner operated these hotels and made payments of principal and interest on his contract in the amount of $321,934.49. Of this amount the receiver returned $43,809.06 to the petitioner in October, 1922.
On June 22, 1922, the Supreme Court of Nebraska, to which tribunal the dissenting stockholders had appealed the receivership case, rendered its decision and vacated that entire proceeding, including the appointment of the receiver, and the sale to the petitioner, in an opinion which held that the District Court, in such premises, was without any jurisdiction whatsoever; and directed that the sheriff of Lancaster County be made temporary receiver of all of the assets of the Nebraska Hotel Company. The petitioner refused to deliver the hotel properties to the new receiver, upon the theory that his payments of $321,934.49 made to the former receiver under the circumstances gave him an equitable lien upon them to secure repayment of that and other expenditures. Following this refusal, the Nebraska Hotel Company filed suit in the State court against the petitioner to obtain possession of its properties, and for an equitable accounting of the income from their operation; also for damages on account of such unlawful withholding.
On the day following the filing of this last mentioned suit, the United States District Court issued its order adjudicating the Nebraska Hotel Company a bankrupt, which resulted in the appointment of a Federal receiver with directions to take over the disputed assets. The petitioner, reasserting his alleged lien, appealed from the order issued by the Federal District Court, which directed him to deliver the hotel properties to its receiver, to the United States Circuit Court of Appeals, and, pending further hearing, was permitted to hold possession of the disputed property upon the giving of a supersedeas bond. Petitioner's appeal was decided by the United States Circuit Court of Appeals for the Eighth Circuit, December 22, 1923, in an opinion which denied in toto all of his contentions and held him to be "without any colorable rights" in the property or to its possession.
During and concurrent with these legal controversies, the petitioner had been engaged with the receiver and creditors of the corporation in negotiations to settle all matters in dispute between them, and these negotiations finally resulted in a new sale, on December 22, 1923, of the corporations' properties, including these hotels and all of the stock of a subsidiary corporation, being made to the petitioner by the receiver appointed by the United States Court. Under the terms of this last mentioned sale the petitioner was given credit upon the purchase price of $278,125.43, representing the unreturned balance of the amount paid upon the vacated contract of sale, and less certain other minor credits for interest paid and mortgages assumed. Petitioner also agreed to assume other liabilities connected with the pending litigation and all claims and counter claims made by the parties against each other growing out of the controversies over the former sale or possession and use of the hotel properties were mutually compromised, settled and released.
Included in the payments made by the petitioner under his first contract were the respective sums of $21,567.85 and $15,366.55 made in 1921 and 1922, as interest on deferred payments under its terms. For these payments credits were allowed by the Federal receiver in the final settlement which resulted in his purchase of the properties. It is conceded that the respondent has correctly determined the proceeds derived from the operation of the five hotels during the periods involved, and that the petitioner received and retained the same under the circumstances shown.
The petitioner concedes that during the periods involved he operated the five hotels which produced the disputed income; also, that he conducted such business as his own, but contends that, inasmuch as the courts subsequently held that the title to such properties was, at all times, in the hands of the Nebraska Hotel Company, it follows, as a matter of law, that all of such proceeds of operation belonged to that corporation. In support of his contentions the petitioner has cited numerous decisions of this Board and of the courts holding that income follows ownership and that it is taxable against the owner of the property which produced it. In this proceeding the property in question produced no income. Here we are dealing with the earnings of a business carried on by the petitioner, in which that property was employed. In such a case the property is merely incidental and its ownership is in no way related to the ownership of the business or the income therefrom. Had the petitioner purchased these hotels as going concerns, with credit, good will and other intangible income-producing incidents, the situation might be different; but as we understand the facts in this case, nothing but bare physical property, consisting of hotel sites, with buildings, furnishings, and some equipment, figured in the transactions we are here concerned with. The petitioner went into possession of such property in good faith, and, although later held to be a trespasser, holding under a void deed, we are of the opinion that the proceeds of the business belonged to him and that he was chargeable to the true owner for no more than reasonable rental upon the property, with rights of subrogation for taxes paid, if any. Crawford v. Galloway, 29 Neb. 261; 45 N. W. 628; Carter v. Brown, 35 Neb. 670; 53 N. W. 580; Taylor v. Roniger, 147 Mich. 99; 110 N. W. 503; and Millard v. Truax, 73 Mich. 381; 41 N. W. 328.
The business which produced the income in this case belonged to the petitioner. He created it and conducted it during all of the time in question as his own, collecting and retaining all of the profits derived therefrom. He was liable, therefore, to pay the tax on this income, over which he was thus exercising ownership and control as and when received, regardless of a possible subsequent liability to answer in damages to the owner of the property. The reasons for this rule are stated by the United States Circuit Court of Appeals for the Sixth Circuit, in its opinion rendered June 30, 1931, sustaining a decision of this Board, in Ford v. Commissioner, 51 Fed. (2d) 206, in the following language:
* * * If taxes regularly assessed could be invalidated, an indefinite number of years later, by a consent judgment purporting to vacate the title of the taxpayer to the fund he had reported as income, the necessary system of tax collection would be much impaired. The true normal criterion to be applied in this class of case is the actual receipt and retention during the year in question of what was then considered to be income, not whether the taxpayer exposed himself to possible personal liability. Italics supplied.
Therefore, consistent with those views, we hold that the respondent correctly determined that the proceeds derived by the petitioner from the operation of the five hotels in question constituted taxable income to him for the years received, and that the petitioner's first assignment of error must be denied. Ford v. Commissioner supra ; Topeka Flour Mills Co., 12 B. T. A. 147; Lucas v. North Texas Lumber Co., 281 U. S. 11; 50 Sup. Ct. 184.
The record fails to show that the petitioner owned any interest in these hotel properties which would form the basis under the statute for a deduction on account of depreciation. Brevoort Hotel Co., 1 B. T. A. 132 and Weiss v. Weiner, 279 U. S. 333. The interest payments were made in 1921 and 1922, on account of the petitioner's first contract with the receiver of the State court, which involved the purchase price of a group of mixed assets of which these hotel properties formed only a part; and which contract was subsequently declared void by the courts. The petitioner contends, however, that, inasmuch as he was bound under his contract with the receiver to make the payments provided for pending the court proceedings referred to, such installments, when due, constituted debts, within section 214 (2) of the 1921 Act, in virtue of which these interest payments were deductible in the years made. It is true that the petitioner made these payments in good faith under the terms of a contract which he believed binding, but since no title passed to him in the transaction, they were without consideration and refundable in law, as well as under the "status quo" provision of such contract and, not being "unconditioned obligations to pay," they were never debts within the provisions of the revenue acts. In re Emil Weitzner, 12 B. T. A. 724; W. S. Gilman, 18 B. T. A. 1277; affd., 53 Fed. (2d) 47. Cf. Inland Products Co., 10 B. T. A. 235; affd., Inland Products Co. v. Blair, 31 Fed. (2d) 867.
The petitioner's sole contention in respect of the amounts of $21,567.85 and $15,366.55 paid in 1921 and 1922 is that they were paid as interest on indebtedness and, therefore, are proper deductions from his taxable income in such years. It might be argued, however, that while not allowable as interest for the reasons which we have set out above, they may be regarded as charges against the income realized from the operation of the hotel business by the petitioner and so included in deductions for ordinary and necessary expense. It is clear that in the circumstances the petitioner was accountable to the bankrupt corporation for a reasonable rental for the use and occupancy of the property to which he had no title, but the amounts paid as interest on the deferred purchase money installments can not be regarded as payments of rentals for the use of the property. Petitioner, himself, recognized that his gross income from the operation of the hotels was subject to reasonable charge for use and possession and in his proposal to purchase, which was finally accepted by the receiver and approved by the court, he fixed and proposed to pay that charge in the amount of $62,500. It may well be that such amount is deductible from operating income ratably over the term of petitioner's operation of the hotel properties as a trespasser, since it was included in arriving at the amount of $957,500 which Eppley finally paid in compromising and settling the whole controversy, but this question is not before the Board and no decision thereon is necessary. In these circumstances, however, we are of the opinion that the amounts paid as interest in 1921 and 1922 can not be included in expenses incurred by the petitioner in operating the hotel properties.
Reviewed by the Board.
Decision will be entered under Rule 50.
MARQUETTE, MURDOCK, and GOODRICH concur in the result.