Docket No. 20238.
Joseph A. Rafferty, Esq., for the petitioner. E. J. Woolf, Esq., for the respondent.
1. Income from Government construction contract awarded to petitioner and assigned by it to its president, held, on facts taxable to petitioner as income earned by it.
2. Payment to petitioner's president by architect employed to work on contract held not taxable to petitioner. Joseph A. Rafferty, Esq., for the petitioner. E. J. Woolf, Esq., for the respondent.
This proceeding was brought for a redetermination of deficiencies in tax as follows:
+----+ ¦¦¦¦¦¦ +----+
Declared Excess Year Income tax value excess profits Penalty profits tax tax 1943 $1,250.00 $9,978.00 $56,240.30 $14,060.07 1944 356.32 216.75
The issues are whether petitioner's portion of the profits, for the years in question, on a contract awarded to petitioner and others by the Federal Government is taxable to petitioner or to its assignees; whether part of an amount paid to an architect working on the contract is taxable to petitioner; and whether respondent erred in disallowing $1,184.21 as a net operating loss deduction for 1944.
FINDINGS OF FACT.
Petitioner, a Delaware corporation, is inactive at the present time. Its address for mailing purposes is 2005 Bladensburg Road NE., Washington, D.C. The Federal income tax returns for the periods in question were filed with the collector of internal revenue for the district of Maryland. No excess profits tax return was filed for the year 1943.
During the years 1943 and 1944, and for some years prior thereto, petitioner was engaged in the construction business. All of petitioner's capital stock was owned by Frank B. Essex, Sr., and his two sons, Frank, Jr., and Richard. Of 1,000 shares issued, Frank B. Essex, Sr., president of petitioner, held 10 shares, Frank B. Essex, Jr., 985 shares, and Richard B. Essex, 5 shares. The two sons paid nothing for the shares of stock issued in their name, never worked for petitioner, and took no active part in its business. Petitioner had three regular employees. It was managed and operated by Frank B. Essex, Sr., until his death, October 23, 1947.
Prior to May 27, 1942, petitioner was awarded a contract, hereinafter called the ‘primary contract,‘ by the Federal Public Housing Authority for the construction of 2,000 dwelling units in Norfolk, Virginia. Petitioner was unable to satisfy the Government's bond requirements, and in order to comply joined with George T. McLean and Nicholas C. Wright of Norfolk, Virginia, who were able to satisfy the bond requirements. Petitioner, McLean, and Wright collectively entered into a contract as ‘Contractor‘ with the Federal Government on May 27, 1942, for the construction of the 2,000 dwelling units at Norfolk for a total consideration of $2,282,832.80.
Under the ‘General Conditions‘ of the contract, paragraph 3 provided as follows:
Except as provided in the Assignment of Claims Act of 1940 (Public No. 811, 76th Congress, approved October 9, 1940), neither the Contract nor any part thereof nor any claim arising therefrom shall be assigned by the Contractor to any person, firm or corporation. This provision shall not preclude the Contractor from sub-letting parts of the work in accordance with section 7, hereof.
Under article 23 of the contract it was provided that the consideration stated should be the full payment for the work to be performed, and that the several parties (other than the United States) ‘have agreed among themselves as to the proper distribution of the total amount of such consideration and the periodic payments on account thereof; and have duly designated George T. McLean of Portsmouth, Virginia, and Nicholas C. Wright of Norfolk, Virginia, jointly, as agent, for them and for each of them, for the collection and disbursements of all moneys payable by the United States hereunder. Payments to such agent shall be deemed, in so far as the United States is concerned, payments to the Essex Construction Company, Inc., George T. McLean, and Nicholas C. Wright, herein collectively called the principal; * * * ‘
On the same day on which the contract with the Government was executed, i.e., May 27, 1942, pursuant to authority of petitioner's board of directors, petitioner entered into an agreement with McLean, Wright, and Frank B. Essex, Sr., president of petitioner, whereby it was agreed that ‘the furnishing of all materials and the performance of all the work obligatory upon the 'Contractor’ under the terms of said contract with The United States shall be furnished and performed by‘ McLean and Wright, and that petitioner ‘will perform no part of said work, and that all of said work shall be under the exclusive management and control of‘ McLean and Wright, who were to receive the full consideration; that petitioner was to receive no part of the consideration, except that McLean and Wright would pay it 36 per cent of the net profits realized under the contract; that petitioner thereby designated ‘Frank B. Essex, as the Party to whom said Thirty-six percentum (36%) of said net profits shall be paid.‘
On the same date a memorandum of agreement between petitioner (designated as ‘second party‘) and Frank B. Essex, Sr., (designated as ‘first party‘) was executed. It recited:
WHEREAS, said second party has indicated its willingness to assign and transfer all right, title and interest in and to certain Contract of May 27, 1942 for the construction of two thousand dwelling units at Norfolk, Virginia, said Contract being numbered VA-44184, to said first party, provided said first party secure from George T. McLean and Nicholas C. Wright, second parties to said Contract with said Federal Public Housing Authority of the United States, as indemnity that said Contract will be performed by them without the necessity of said second party hereto being required to perform any part thereof and protecting said second party hereto against any financial loss in connection therewith; and said second party hereto against any financial loss in connection therewith; and provided further that said first party hereto by appropriate agreement further indemnify said second party hereto against any loss in connection with said Contract of May 27, 1942 with said Housing Authority aforesaid, and,
WHEREAS, said first party has already secured the consent of said George T. McLean and Nicholas C. Wright for the indemnity protection herein mentioned, and is further himself willing to indemnify said Company additionally against any loss that may be incurred by reason of said Corporation entering into said Contract aforesaid.
NOW, THEREFORE, in consideration of the premises and of One ($1.00) Dollar in hand paid by each of the parties hereto to the other, they have and do hereby agree as follows:
1. The first party hereto has and does hereby agree to protect and indemnify the second party from any loss that it may suffer by reason of becoming a party to the Contract of May 27, 1942 for the construction of said two thousand dwelling units at Norfolk, Virginia, and said first party further agrees that said indemnity hereby provided shall have the legal effect of substituting him in the place and stead of the second party hereto in said Contract so that any loss that might be suffered in connection therewith will be the loss of the individual party hereto.
2. In consideration of the foregoing indemnity, the second party has agreed to execute an appropriate assignment of all of its right, title and interest in and to said Housing Project Contract with said Federal Public Housing Authority of the United States to said party hereto of the first part.
On the same day a document was executed by petitioner by Frank B. Essex, Sr., president, which provided as follows:
In consideration of Indemnity Agreement furnished by Frank B. Essex, Sr. to the undersigned Corporation for its protection against loss in the matter of the Contract of May 27, 1942 for the construction of two thousand dwelling units at Norfolk, Virginia for the Federal Public Housing Authority of the United States known as Project VA-44184, the undersigned Officers of the Essex Construction Company, pursuant to a resolution adopted by the Board of Directors of said Corporation on the 27th day of May, 1942, do hereby assign, transfer and deliver all of its right, title and interest in and to the Contract of May 27, 1942 aforesaid, with the understanding that the said Essex, Sr. shall enjoy for his own use all and any profits that may be derived therefrom.
Under date of July 27, 1942, petitioner, McLean, and Wright, collectively described as ‘Contractor‘ in the Government contract, notified the Federal Public Housing Authority that work had progressed sufficiently to indicate that the profit which would be realized by the ‘Contractor‘ would probably be considerably in excess of the profit anticipated at the time the contract was made, and advised the Government that upon final completion and acceptance of the job petitioner, McLean, and Wright as ‘Contractor‘ would return to the Government all profit realized by ‘Contractor‘ in excess of a net profit equivalent to 10 per cent of the agreed consideration.
On October 25, 1943, an agreement was entered into between the Government and petitioner, McLean, and Wright, ‘collectively called the 'CONTRACTOR,’‘ whereby it was agreed that the contract price for the construction of the 2,000 dwellings at Norfolk for a consideration of $2,282,832.80 should be reduced to $1,943,667.25, and that the ‘Contractor‘ would remit to the Government the sum of $65,481.52, together with any and all claims against the Government.
The purported assignee supplied no materials and performed no part of the work under the primary contract. Petitioner continued after the assignment to participate and maintain an interest in the contract in entering into supplementary agreements with the Federal Housing Authority, in reducing the original contract price, and in finally securing a release from the Government whereby it accepted the work performed as having complied with all the conditions of the contract. Two of petitioner's employees, the office secretary and the general foreman, performed services in connection with the primary contract and were paid during the performance of such services by funds from the bank account of petitioner.
Petitioner called on Ernest W. Syme to make the quantity survey and prepare the estimates for the primary contract. After the award was made on the primary contract, Syme took charge of the installation of footings at Norfolk, Virginia, under a contract which petitioner had with an Alabama contractor on the construction. Syme rendered a bill for $10,000 to Frank B. Essex for preparing the estimates and the check in payment came from McLean and Wright to the order of Syme. Syme cashed the check and in a personal transaction turned $4,000 over to Frank B. Essex and retained the balance. None of the proceeds were given to petitioner.
Thirty-six per cent of the net profit realized by the ‘Contractor‘ and paid by McLean and Wright under the agreement amounted to $83,344.08, which respondent has determined to be taxable to petitioner in 1943, stating:
Income from joint venture entered into by you and McLean and Wright for construction of 736 buildings at Norfolk, Virginia, for the United States Government is held taxable to you in 1943 in the amount of $83,344.08.
With respect to the payment to Syme the notice of deficiency stated:
Only $7,000.00 was paid to and retained by Mr. Syme and the balance of $3,000.00 is held to represent taxable income to the corporation.
There are two possible views of petitioner's relation to the Government construction contract which it subsequently assigned to its president and the profit on which respondent is seeking to attribute to it. The one approach is to consider that its interest in the future profits was completely earned, as far as petitioner was concerned, from the instant the contracts were executed. The theory of this would be that its function had been to make the preliminary surveys, enter a bid, and receive the award of the contract, all of which it had already performed. Due to the somewhat peculiar arrangements between petitioner and its joint adventures, all of the services contracted for were to be supplied by the other parties, and petitioner had no further obligation. It could merely sit back and wait for the profits to be realized.
The other possible approach is to consider that there remained to be completed certain activities, however formal and insubstantial, which it was the primary obligation of the petitioner under the contract to contribute. This conclusion would be based on the fact that the formulation and execution of supplementary agreements, the renegotiation of the original price, and the tender to and acceptance by the Government and its release from the contractual obligations upon completion were all participated in by petitioner.
It seems to us that on either theory the income in controversy is attributable to petitioner. If the former be adopted, the earnings when received had been earned by and belong to petitioner in the first instance and their transmission to its stockholder pursuant to whatever anticipatory arrangement and however indirect are to be treated as earnings of petitioner, Helvering v. Eubank, 311 U.S. 122; Merton E. Farr, 11 T.C. 552, distributed through it. Commissioner v. First State Bank of Stratford (C.C.A., 5th Cir.), 168 Fed.(2d) 1004; certiorari denied, 335 U.S. 867. That would be so notwithstanding that payments were made direct to the stockholder and that they were never received by nor passed through petitioner. United States v. Joliet & Chicago R. Co., 315 7.S. 44; cf. Lucille H. Rogers, 11 T.C. 435.
Under the latter approach, the earning of the profit was carried out by petitioner and whatever performance was required as to its participation was completed by it. On that theory, no prior assignment of the earnings would prevent their taxation to petitioner. Lucas v. Earl, 281 U.S. 111; National Contracting Co. v. Commissioner (C.C.A., 8th Cir.), 105 Fed.(2d) 488, affirming 37 B.T.A. 689. This performance by petitioner, as distinguished from the assignee, adequately distinguishes the present situation from that in Commissioner v. Montgomery (C.C.A., 5th Cir.), 144 Fed.(2d) 313, and, as pointed out in National Contracting C. V. Commissioner, supra, from Iowa Bridge Co. v. Commissioner (C.C.A., 8th Cir.), 39 Fed.(2d) 777.
A different situation is presented by the second issue. The payment there involved was made by one of petitioner's employees not to petitioner, but to its president. It was a personal transaction. Petitioner did not receive the money. It did not earn it, and was never entitled to it. We view respondent's inclusion of this amount in petitioner's income as error.
The third issue of a net loss carry-over apparently disappears upon our disposition of the first question.
Reviewed by the Court.
Decision will be entered under Rule 50.