Levitt & Sons, Inc.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Oct 15, 1945
5 T.C. 913 (U.S.T.C. 1945)

Docket No. 109482.

1945-10-15

LEVITT & SONS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Carol Sherman, Esq., and Louis Goldring, Esq., for petitioner. Francis S. Gettle, Esq., for respondent.


Petitioner was organized in 1938 in a merger of three corporations, one of which was Abraham Levitt & Sons, Inc. It acquired the assets of the predecessor organizations, subject to all liabilities. Among the assets acquired were some land and proceeds formerly owned by the Rockville Corporation, which had been acquired by Abraham Levitt & Sons, Inc., from 1930 to 1933. Abraham Levitt owned stock in Rockville Corporation and in petitioner. In 1938 dissatisfied stockholders of Rockville Corporation sought an accounting of the business of Rockville Corporation, which had been managed by Abraham Levitt, and they made demands upon Abraham Levitt, William Levitt, petitioner's president, and upon petitioner for damages to them as stockholders. The demand was made upon petitioner as an ultimate transferee of property of Rockville. After protracted negotiations, Abraham Levitt and petitioner effected a settlement in December 1939 with the complaining stockholders of Rockville Corporation, as a result of which they gave up their stock in Rockville Corporation, gained control of another corporation, Babylon Harbor, Inc., received lands from Abraham Levitt, and $65,000 cash from petitioner. Upon the facts, held, that the $65,000 did not constitute an ordinary and necessary expense of petitioner in the conduct of its business. The holding is made pursuant to further proceedings under a mandate of the United States Circuit Court of Appeals for the Second Circuit. See Levitt & Sons, Inc. v. Numan, 142 Fed.(2d) 795. Carol Sherman, Esq., and Louis Goldring, Esq., for petitioner. Francis S. Gettle, Esq., for respondent.

Respondent made two adjustments in petitioner's taxable net income for the fiscal year ended June 30, 1940, which resulted in a deficiency in income tax of $14,785.49. Petitioner has conceded that one of the determinations is correct and that there is some deficiency in tax, but it contests the disallowance of a deduction of $65,000, a sum which was paid to stockholders of Rockville Centre Community Corporation. Petitioner claims that it is entitled to deduct the above amount as an ordinary and necessary business expense, and the only question to be decided is whether petitioner is entitled to such deduction. That question is now considered after further hearing of this proceeding pursuant to a mandate of the United States Circuit Court of Appeals for the Second Circuit, at which additional evidence was received. Upon that evidence, and the evidence adduced at the original hearing, new findings of fact are made.

Memorandum findings of fact and opinion were entered on May 19, 1943. Upon the facts it was held that the expenditure in question was not deductible as an ordinary and necessary business expense, nor as a loss. Petitioner appealed to the United States Circuit Court of Appeals for the Second Circuit. The Circuit Court concluded that the expenditure was not deductible as a loss, but did not arrive at a conclusion upon the question of whether it was deductible as a business expense, in the absence of findings of fact by this Court under certain questions. The Circuit Court reversed the order of decision by this Court and remanded the cause to this Court to make findings of fact under the questions set forth below, and stated that under a new order of decision by this Court either party could take a new appeal. See Levitt & Sons, Inc. v. Nunan, 142 Fed.(2d) 795.

The questions upon which we are directed to make findings of fact are:

(1) Was the taxpayer entirely confident that any suit which Edelman might bring could not succeed?

(2) Did it make the payment in question only for the purpose of avoiding the damage to its credit, its reputation, and its business generally which might result from such a suit?

(3) Was any such fear which it may have had so far justified that a reasonable person in its place would have thought a settlement at that figure less than the damage which would follow from such a suit?

FINDINGS OF FACT.

Petitioner keeps its books and makes its returns on the accrual basis. The return for the taxable year involved was filed with the collector for the first district of New York.

Petitioner, a New York corporation, was organized on July 1, 1938; its outstanding stock consists of 1,000 shares; its stock is owned by Abraham Levitt, William J. Levitt, and Alfred S. Levitt, and their wives. William and Alfred are sons of Abraham Levitt. William J. Levitt is president, general manager, and the chief executive officer of petitioner. Petitioner was organized in a merger of three corporations, Strathmore-at-Manhasset, Inc,. Craftsmen's Guild, Inc., and Abraham Levitt & Sons, Inc. The stock of all of those corporations was owned by members of the Levitt family. Abraham Levitt had organized a partnership in 1930, in which he and William J. Levitt were partners, conducting a building business under the name of Abraham Levitt and William J. Levitt. The partnership business was incorporated in 1931 or 1932, and was conducted thereafter by the corporation, Abraham Levitt & Sons, Inc. Petitioner upon its organization acquired all of the assets of the three above named Levitt corporations, subject to all liabilities, and petitioner's stock was issued in exchange for said assets, subject to liabilities.

Petitioner is a distinct entity, separate from the corporations to which its stock was issued.

Included in the assets which were transferred to petitioner in July 1938 were certain parcels of land and the profits and proceeds of certain lands which were formerly owned by Rockville Centre Community Corporation. Petitioner had no dealings with Rockville. It acquired said parcels of land, etc., as set forth above, from Abraham Levitt & Sons, Inc., and/or from William J. Levitt, and/or from Abraham Levitt, and the transactions under which Rockville parted with said property and from which proceeds resulted were made in 1930, 1931, or 1932, under circumstances which will be set forth hereinafter.

Rockville Center Community Corporation and Babylon Harbor, Inc., were active corporations in 1927, and thereafter, and Abraham Levitt owned stock in both corporations. He was the president and manager of Rockville for several years. Both of these corporations had the same stockholders. Rockville owned a large tract of land near Rockville Centre, Nassau County, Long Island, and Babylon owned a large tract of land in Babylon, Suffolk County, Long Island. Rockville was engaged in the business of subdividing land into lots for sale to builders. In 1929 and 1930 the real estate market was inactive and Rockville Centre Community Corporation's sales of lots diminished. Rockville did not carry on any building operations. Abraham Levitt organized the partnership of Abraham Levitt and William J. Levitt in the latter part of 1929 to engage in the business of building houses. Abraham Levitt at the time was the president and manager of Rockville. He entered into an arrangement under which the partnership was to purchase lots from Rockville. The partnership then built houses on the lots and sold the houses and lots. A running account with Rockville was set up on the books of the partnership and later on the books of the corporation, Abraham Levitt & Sons, Inc. The corporation continued the business of the partnership. The partnership and the corporation were successful in the building and sale of houses. During the years 1930 and 1931 these business enterprises purchased 147 1/2 lots from Rockville. Rockville received in consideration for the lots transferred to the Levitt concerns, and/or to Abraham Levitt, and/or to William J. Levitt, some cash plus the purchase money mortgages given by the vendees of the Levitt concerns. The Levitt concerns were able to sell the houses built on the lots acquired from Rockville within about 16 months after completion, so that by 1933 sales had been made of those houses.

Abraham Levitt & Sons, Inc., expanded its business, purchased other land in Rockville Centre apart from the land acquired from Rockville Centre Corporation, and, in general, built up a profitable business.

The issued stock of Rockville Centre Corporation and Babylon Harbor, Inc., amounted to 250 shares and 1,000 shares, respectively. Abraham Levitt owned 62 1/2 shares of the stock of Rockville and 250 shares of the stock of Babylon.

In the latter part of 1938, after petitioner had been organized and had taken over the assets of the Levitt corporations, certain stockholders of Rockville and Babylon, to wit, Isaac Oshlag, Olga Margolin, Benjamin Shapiro, and A. Alexander Edelman, raised questions about the management of the business of Rockville Centre Corporation, the sales of its property, and the proceeds from the property of that corporation. The attorney for the above named stockholders of Rockville Centre Corporation made demands for the Rockville Centre Corporation and the above named stockholders upon petitioner, Levitt & Sons, Inc., and upon Abraham Levitt and William J. Levitt as well. The attorney for the dissatisfied stockholders of Rockville, Isidore Schneider, made a demand upon Abraham Levitt, William J. Levitt, and petitioner corporation for an accounting of the property that Rockville formerly owned, and he asked for an audit of the books of the Rockville and Babylon corporations, which were in the possession of petitioner. When the audit was made of the books of the two corporations, Edelman, Schneider, and the others believed that the audit showed that the moneys of Rockville had been spent for improper purposes. Edelman and the others asserted that property had been transferred out of Rockville into corporations owned by the Levitt, or into individual names, for building purposes, and that the Levitt had taken money out of the Rockville Centre Corporation in salaries and in unreasonable charges to that corporation. A demand was made upon Abraham and William Levitt and the Levitt companies for the return of or compensation for the assets of Rockville. Most of the claims were made with respect to Abraham Levitt's management of Rockville Centre Corporation, and a few claims were made with respect to Babylon Harbor, Inc. Edelman and the others believed that some funds and property of Rockville Centre Corporation had been acquired by the petitioner corporation as an ultimate transferee, but the petitioner corporation was not the only Levitt corporation they had in mind.

The claims of Edelman and the others related to the transactions of the partnership, Abraham and William Levitt, and of the corporation, Abraham Levitt & Sons, Inc., with Rockville Centre Corporation, and to Abraham Levitt's management of Rockville. The petitioner corporation was not organized until July 1938, and it never entered into any transactions with Rockville Centre Corporation.

Petitioner had possession of the books of account of the Rockville Centre and Babylon Harbor corporations, and it permitted the accountants for Edelman and the others to examine those books, but did not permit an audit to be made of petitioner's books. Edelman and his associates were not seeking an accounting of petitioner's own business.

At some time prior to March 23, 1939, Abraham and William Levitt, individually, and the petitioner corporation agreed with Edelman that the claims of Edelman and the others should be settled, and they agreed that $65,000 should be paid to Edelman, who was acting for the group of the dissatisfied stockholders of Rockville. Edelman executed an agreement on March 23, 1939, which was accepted by the two Levitt and the petitioner corporation, which recited that the selling price of all of the stock in Rockville Centre Corporation, except the stock in the name of Abraham or William Levitt or Abraham Levitt & Sons, Inc., was $65,000, which purchase was ‘by the Levitt‘; that, in addition, the ‘buyers‘ of the Rockville stock were to deliver all of their stock, 25 percent, in Babylon Harbor, Inc., and a formal assignment by Rockville Centre Corporation to Edelman of Rockville's claim against Babylon for about $111,000; and that $5,000 had been received from William and Abraham Levitt and Levitt & Sons, Inc., as a deposit on account of the selling price of the stock in Rockville Centre Corporation. The above agreement was subsequently canceled on December 20, 1939, at which time new agreements were executed.

This agreement is respondent's Exhibit C. It is incorporated herein by reference.

The understanding arrived at in March 1939, as set forth above, did not terminate the negotiations, and on November 10, 1939, Isidore Schneider wrote a letter to petitioner stating that he had been retained to commence an action in equity against Levitt & Sons, Inc., petitioner, ‘to account for certain real property or the proceeds thereof received by you in violation of the rights of my said clients, in which action I intend to apply for the appointment of a Receiver of your Company.‘ However, such suit in equity and application for the appointment of a receiver was not instituted against petitioner. Negotiations were continued and in December 1939 the controversy was concluded by the execution of several agreements and releases.

On December 20, 1939, Abraham Levitt executed an agreement, as an individual and as the president of Rockville corporation, with the four dissatisfied stockholders of Rockville, and with Babylon corporation, under which he agreed to forgive Babylon its indebtedness to him in the sum of $8,007.44 and to cause to be conveyed to Edelman certain lots and parcels of land in a tract known as Venetian Shores at Babylon, and to induce Levitt & Sons, Inc., ‘to settle its dispute with A. Alexander Edelman.‘ The agreement provided that the transfers of land by Abraham Levitt were to be in consideration for the transfer to and the retirement by Rockville of all of its capital stock, except the stock in the name of Abraham Levitt, to wit, the stock owned by Edelman and his associates, and in consideration for the release from all damage claims by Edelman and the others against Abraham Levitt.

Also, on December 20, 1939, Abraham Levitt executed a memorandum of sale, his signature being duly acknowledged, by which he purportedly sold his 250 shares of stock in Babylon to Edelman for $500.

Also, on December 20, 1939, Edelman, Oshlag, and Margolin, as the owners of 187 1/2 shares of stock in Rockville, executed an assignment of said stock to Rockville corporation, their signatures to the assignment being duly acknowledged.

On December 20, 1939, and on other dates at about that time, several other documents were executed by Edelman, Shapiro, Margolin, and Oshlag. Some of the documents are releases, releasing the Levitt, as individuals, and certain Levitt corporations, and the petitioner corporation from all claims by them. Edelman, Margolin, and Oshlag assigned to Abraham Levitt all claims against Rockville which they had or might have. Edelman, as president of Babylon corporation, executed a release by Babylon of the Levitt, of petitioner, of other Levitt corporations, and of Rockville corporation from all claims in consideration for the foregiveness of Abraham Levitt of its debt to him of $8,007.44, and Edelman's forgiveness of its debt of $5,072.39 which petitioner, a creditor of Babylon, had assigned to Edelman, and the acceptance by Rockville of certain property other than money in payment of Babylon's debt to Rockville.

These documents are attached to and made part of a bill of particulars which was filed by Edelman and his associates and his attorneys, as defendants, upon the demand of Abraham and William Levitt, as plaintiffs in the Supreme Court of New York, in Nassau County, on September 10, 1941, which bill of particulars is respondent's Exhibit G in this proceeding. The Levitt instituted a suit against Edelman in the Supreme Court on May 27, 1940.

On December 20, 1939, Abraham Levitt and William J. Levitt executed a document under which they made certain warranties and representations to Edelman, Margolin, Oshlag, and Shapiro. Their signatures to the document were duly acknowledged before a notary public on December 20, 1939. The document recites, in part as follows:

Respondent's Exhibit E in this proceeding is the complaint in the suit of Abraham Levitt and William Levitt v. Edelman and others, instituted in the Supreme Court of New York, Nassau County, on May 27, 1940. The above agreement is Exhibit A attached to said complaint.

WHEREAS, LEVITT AND SONS, INCORPORATED, a domestic corporation, ROCKVILLE CENTRE COMMUNITY CORPORATION, a domestic corporation, BABYLON HARBOR, INC., a domestic corporation, A. ALEXANDER EDELMAN, ABRAHAM LEVITT and certain other persons are entering into certain agreements relating to the settlement of claims and the assignment of certain real property and claims, the transfer and retirement of certain stock, the payment of the sum of SIXTY-FIVE THOUSAND ($65,000) DOLLARS, the delivery of certain general releases and other matters, all of which agreements and matters are incorporated herein by reference; and

WHEREAS, to induce the execution of said documents, certain representations, warranties and indemnification agreements are required;

NOW, THEREFORE, in order to induce OLGA MARGOLIN, ISAAC OSHLAG, A. ALEXANDER EDELMAN and BENJAMIN SHAPIRO to enter into the said agreements and consummate the transactions aforementioned pursuant to and in connection therewith, the undersigned ABRAHAM LEVITT and WILLIAM J. LEVITT hereby jointly and severally represent, warrant and agree with the above-named individuals as follows:

1. That WILLIAM J. LEVITT is the President and Treasurer of LEVITT AND SONS, INCORPORATED and that ABRAHAM LEVITT is the President of ROCKVILLE CENTRE COMMUNITY CORPORATION.

3. That the aforementioned undertakings and transactions on the part of LEVITT AND SONS, INCORPORATED and ROCKVILLE CENTRE COMMUNITY CORPORATION have been duly authorized and approved by all of the stockholders and directors thereof * * *

4. That there are no present obligations, absolute or contingent, matured or unmatured, of BABYLON HARBOR, INC. and/or ROCKVILLE CENTRE COMMUNITY CORPORATION, excepting mortgages of record and taxes or assessments of any kind, other than those appearing upon the books or in the records of said corporations and that those books and records reflect accurately said debts and obligations of the said corporations. That on March 23, 1939 there was unpaid on a certain mortgage recorded on October 22, 1925 in the office of the County Clerk of Suffolk County, in Liber 561, Page 537 of Mortgages, originally in the sum of FIFTY THOUSAND ($50,000) DOLLARS, the principal sum of TWENTY THOUSAND SEVEN HUNDRED TWENTY-FIVE ($20,725) DOLLARS, and that interest thereon has been paid to April 1, 1939.

8. The undersigned jointly and severally further warrant and represent that the agreements and undertakings entered into by LEVITT AND SONS, INCORPORATED, delivered simultaneously herewith, and the instruments delivered by it pursuant thereto and in connection therewith are not ultra vires that corporation and that the compliance by the parties herewith indemnified and BABYLON HARBOR, INC. with the terms and conditions of their agreements of settlement, assignment and release, delivered simultaneously herewith, shall and do constitute, good, valid and sufficient consideration to said corporation for its undertaking to pay said A. ALEXANDER EDELMAN the sum of SIXTY-FIVE THOUSAND ($65,000) DOLLARS and for the other undertakings and agreements on its part entered into as part of said settlement, and the undersigned jointly and severally agree that the said corporation will at no time urge, raise or plead the defense (partial or complete) of ultra vires and/or want of good, valid or sufficient consideration to or against the said claim or demand against it for the payment in full of the said sum of SIXTY-FIVE THOUSAND ($65,000) DOLLARS, upon which there is now unpaid the sum of THIRTY-SEVEN THOUSAND ($37,000) DOLLARS, or to or against any claim or demand upon any of the aforementioned agreements and undertakings on its part, provided the parties herewith indemnified and BABYLON HARBOR, INC. have complied with the terms and conditions on their part to be performed under the said agreements of settlement.

On December 20, 1939, the petitioner corporation received a refund of the $5,000 which was paid under the agreement of March 23, 1939, and that agreement was canceled. On the same day the petitioner corporation, Babylon Harbor, Inc., Rockville Centre Community Corporation, Abraham Levitt and William J. Levitt, as individuals, and Edelman, Oshlag, Margolin, and Shapiro executed an agreement in nine counterparts, by the terms of which the ‘claim against Levitt & Sons, Inc., and all other claims of any kind and nature against any of the persons or corporations to be released under paragraph 1 ‘ (and paragraph 2), was settled. The agreement recites that Rockville and Babylon are New York corporations, with stock issued in the respective amounts of 250 and 1,000 shares; and that Margolin, Oshlag, and Edelman own, in varying amounts, 187 1/2 shares of stock in Rockville, and 750 shares of stock in Babylon. The agreement recites further, in part, as follows:

This agreement is respondent's Exhibit B in this proceeding. It is incorporated herein by reference.

WHEREAS, certain real estate belonging to Rockville was heretofore transferred under circumstances which certain of the parties to this agreement claim made those transfers improper and said parties claim that the transferees of said property and of the proceeds realized upon the development and sale of said property are subject to suit by them; and

WHEREAS, the transfers chiefly involved in said claim are described in Schedule ‘A‘ attached hereto and made a part hereof; and

WHEREAS, it is claimed that among the ultimate and/or intermediate transferees liable for said reasons is a certain New York corporation known as LEVITT AND SONS, INCORPORATED; and

WHEREAS, the validity of the said claim is disputed by said transferees, but the aforesaid parties have threatened to commence a suit in equity in which LEVITT AND SONS, INCORPORATED would be a defendant; and

Attached to the agreement as ‘Schedule A‘ is the description by map and lot numbers of lots deeded from Rockville Centre Corporation to William J. Levitt (215-1/2 lots, by number), and to Abraham Levitt & Sons, Inc. (3 lots by number).

By the terms of this agreement it was agreed that Margolin, Oshlag, Edelman, Shapiro, and Babylon Harbor, Inc., would and had executed a general release, made part of the agreement, releasing and discharging the petitioner corporation ‘and others‘ from all claims, as set forth in the release, and releasing Rockville Centre Corporation from all claims against it, subject to the prior assignment of the claims to Abraham Levitt and the forgiveness by him of said claims. It was agreed, further, that petitioner, Levitt & Sons, Inc., ‘and others‘ would and had executed a general release, made part of the agreement, releasing and discharging Margolin, Oshlag, Edelman, Shapiro, and Babylon Harbor, Inc., from all claims as set forth in the release.

The agreement provided that, in consideration of the delivery of the release and the settlement of all of the claims against petitioner and the persons and corporations named in the release, the petitioner corporation agreed to pay $65,000 to Edelman, and to assign to him its claim against Babylon for a debt owing by Babylon in the amount of $5,972.39; and that Rockville Centre Corporation agreed to release the petitioner corporation and others from all claims against them.

Levitt & Sons, Inc., paid Edelman $28,000 when it executed the above agreement, and agreed to pay the balance of $37,000 in installments.

The settlement which was made in December 1939 related solely to Rockville corporation and its stockholders, and to the management of Rockville during years prior to 1938. For reasons which have not been disclosed, Abraham Levitt agreed to compromise the claims of the other stockholders of Rockville. The plan of the settlement appears to have been to eliminate intercompany debts owing by Babylon to Rockville, petitioner, and Abraham Levitt; to transfer lands and cash to Edelman, who was to retransfer such new assets to Babylon or to a new corporation; and to completely separate Edelman and his group from any association with the Levitt enterprises. Edelman acquired Abraham Levitt's stock in Babylon for $500, thus eliminating Levitt from that corporation. Edelman and others surrendered their stock in Rockville. The financial condition of Babylon was improved, and Edelman and his associates, the dissatisfied stockholders of Rockville, gained complete control of Babylon.

Before petitioner completed its payments to Edelman under the agreement of December 20, 1939, Edelman and his associates complained to the Levitt that the unpaid balance due from Babylon Harbor, Inc., on the mortgage on its properties was $28,225 instead of $20,725, as was stated in the warranty agreement executed by the Levitt on December 20, 1939. They made a demand upon the Levitt in the spring of 1940 for a further payment of $7,500, being the difference, whereupon Abraham and William J. Levitt filed a ‘Summons and Complaint‘ against Edelman, Oshlag, Margolin, Shapiro, Isidore Schneider, Sydney Newman, Leonard Bisco, and others, on May 27, 1940, in Nassau County, in the Supreme Court of New York, asking that the warranty agreement executed by the Levitt on December 20, 1939 (Exhibit A attached to respondent's Exhibit E) be reformed by the court to substitute the figure ‘$28,225‘ for ‘$20,725,‘ upon the allegation that Edelman knew, but concealed such knowledge from the Levitt, the true balance due on the mortgage on December 20, 1939, or at about that time. The Levitt filed, on June 14, 1941, a demand for a verified bill of particulars from the defendants. Among the items requested of the defendants were copies of all of the written agreements which constituted the settlement which was concluded in December 1939. The defendants filed a bill of particulars on September 10, 1941, to which they attached copies of agreements and releases and other documents which constituted the settlement in December 1939. On October 17, 1941, the parties settled this suit by stipulation. The parties stipulated that the plaintiffs would pay the defendants $3,900 as a compromise, and that Levitt & Sons, Inc., would pay $3,000, the balance due under the agreement of December 20, 1939.

Petitioner's business since its incorporation in 1938 has been the building of houses in areas where it bought tracts of land and developed residential sections. In 1938 its business amounted to $2,000,000 a year. In 1939 petitioner's business operations were extensive. It had a development of residential property at Village of North Hills, Manhasset, and at Great Neck, on Long Island, and at Yonkers, New York. Petitioner built 200 houses at Manhasset in 1938, which were sold for an average price of $10,000 each. At North Hills petitioner had purchased a tract of land which had been the Vanderbilt estate, and it planned a community development there which would center about a community clubhouse, swimming pool, and shopping center. The swimming pool had been built at a cost of $100,000. Negotiations were pending with New York department stores to lease locations to them for stores. Petitioner was negotiating with the town council at Village of North Hills for their approval of the community clubhouse. Petitioner advertised its developments at great cost, as high as $100,000 a year. Petitioner had established a very satisfactory credit line with the Bank of Manhattan, and with vendors of building materials, including Johns-Manville and General Electric.

Petitioner's attorney believed that the suit in equity which Edelman threatened to institute against petitioner would not be successful, but he advised petitioner's president, William Levitt, to consider the matter carefully because he, the attorney, knew of instances where such suits involved risks. Petitioner's accountant, David A. Berlin, advised that petitioner should compromise and settle the claim for business reasons. He believed that the publicity which would result from such contest in court would affect the petitioner's reputation, good will, credit, and sales, and would nullify the benefits to be derived from the large expenditures for advertising which petitioner was making. William Levitt agreed with Berlin's advice. He believed there was always a chance of losing in any litigation and that petitioner should work out a settlement.

The controversy which was settled in December 1939 was among the stockholders of Rockville and Babylon corporations. The claim made was for the return of or compensation for property which Rockville had owned, and the claim which was made against petitioner, in particular, was made upon the belief that petitioner was a transferee or an ultimate transferee of some of Rockville's property. Petitioner's agreement to pay Edelman $65,000 was part of a broad plan of settlement among the stockholders of Babylon and Rockville, and petitioner's payments of cash were not the only consideration received by Edelman in the settlement of his claims. The claims and the dispute originated out of transactions between Rockville and business entities other than petitioner which took place before petitioner came into existence. The transaction, the claims, and the settlement did not develop from any business dealings of petitioner.

The warranties made by Abraham and William Levitt under the document dated December 20, 1939, which is Exhibit A attached to respondent's Exhibit E, and the agreement among petitioner, Edelman, and others bearing the same date, which is respondent's Exhibit B, were part of the settlement under which petitioner paid the $65,000.

Petitioner was obligated to pay the liabilities of Abraham Levitt & Sons, Inc.

Petitioner was not entirely confident that any suit which Edelman might bring could not succeed.

Petitioner did not make the payment in question only for the purpose of avoiding the damage to its credit, its reputation, and its business generally which might result from such a suit.

The amount of $65,000 was arrived at by all of the parties to the entire settlement in connection with the arrangements whereby Babylon corporation was freed from obligations to pay debts which on the books of account were about $125,000, and Abraham Levitt agreed to deed a substantial number of lots at Venetian Shores to Edelman, and Edelman and others agreed to surrender their stock in Rockville, and Abraham Levitt agreed to transfer his stock in Babylon to Edelman. There is no evidence relating to the fair market value of the lots which Levitt agreed to transfer to Edelman, or the value of the total consideration received by Edelman in the entire settlement. Edelman had made a claim for about $200,000. Edelman regarded the $65,000 as part of the consideration for the surrender of the Rockville stock by himself and others.

Petitioner's decision to pay $65,000, and the agreement by all the parties concerned that the sum of $65,000 from petitioner would be sufficient, had some relation to Abraham Levitt's agreements and to the entire consideration received by Edelman in the settlement. Petitioner's considerations with respect to whether it would agree to pay the amount of $65,000 or some other amount, more or less, were not founded solely upon comparative estimates of the costs of defending a lawsuit in which it would be the only defendant, or one of several defendants. Petitioner received releases from all claims of Edelman in consideration for the payment of $65,000 and his agreement not to institute a lawsuit in which petitioner would be named a defendant.

The above finding is made with reference to question three propounded by the Circuit Court.

The sum of $65,000 was not paid or incurred by petitioner in the conduct of its own business, and it was not an ordinary expense.

OPINION.

HARRON, Judge:

Having heard further evidence in this proceeding and having before us a record which contains evidence which was lacking in the original record, it is necessary to make entirely new findings of fact, and with new findings of fact it is necessary to reconsider the question. The only question to be decided is whether petitioner is entitled to deduct $65,000 as an ordinary and necessary business expense incurred in carrying on its business within the provisions of section 23(a)(1) of the Internal Revenue Code. Petitioner has the burden of proving that the expense comes within the statutory provision. There must be proof that the expense was incurred in the conduct of petitioner's business, and that it was both ordinary and necessary. Welch v. Helvering, 290 U.S. 111.

It is apparent that there was dissension between a group of stockholders of Rockville Centre Corporation and the Levitt. Petitioner's witnesses testified that Edelman's claim was without merit and was made under such circumstances that it amounted to a ‘holdup‘ directed at petitioner only. On the other hand, respondent has introduced evidence which shows clearly that Edelman's claim was for an accounting of the assets of Rockville and that it was made against others besides petitioner. The evidence strongly indicates that if any suit had been instituted by Edelman it would have been against Abraham Levitt, William J. Levitt, Abraham Levitt & Sons, Inc. (if still in existence), and others, and that petitioner would have been joined in the action only as a transferee of the Levitt, as individuals, and/or of Abraham Levitt & Sons, Inc., with respect to Rockville's former assets.

Petitioner has the burden of proving its contention that the expenditure in question was an ordinary and necessary business expense. Petitioner's evidence is limited. Petitioner offered only testimony of witnesses, and their testimony does not relate to the negotiations preceding the final settlement, or to the broad settlement, which respondent's evidence shows encompassed more than a cash payment by petitioner. Respondent's evidence, consisting of the agreements which were executed in the closing of the dispute, shows that a great deal more was involved in the settlement than petitioner would have us understand from its evidence. Some of respondent's evidence consists of documents which were executed in the settlement. Petitioner, at the trial, did not deny that these agreements and documents were executed and were part of a broad settlement, nor did petitioner cross-examine respondent's witness regarding these documents. Under such circumstances, they must be considered as evidence of what the settlement involved. And they emphasize the narrow area which petitioner's evidence covers.

The evidence presented by petitioner is unsatisfactory in many respects, and part of it is unconvincing. For example: Petitioner's evidence does not show clearly against what persons, corporations, and property the claim of Edelman was directed. The implication of petitioner's evidence is that Edelman, acting for himself and other stockholders of Rockville, directed his claim against petitioner primarily, if not solely, for no reason other than to stage a ‘shakedown‘ at a time when petitioner was prosperous and when its affairs were at such a crucial point that petitioner could do nothing except to pay a ransom. Thus, Abraham Levitt, whose testimony was brief, testified that there was never any demand made upon him by Edelman ‘in any shape, manner or form. ‘ His testimony is understood to mean that no demand was made upon him by any of Rockville's stockholders at any time in 1938 or 1939, during the period when Edelman made the demands which gave rise to the issue here. But when this proceeding came on for further hearing respondent called Edelman's attorney as a witness and introduced evidence relating to the entire settlement made with Edelman, all of which evidence shows clearly that demands were made by Edelman upon Abraham Levitt.

Petitioner's evidence carries the implication that Edelman's claims were satisfied solely by petitioner's payment of $65,000. Petitioner did not offer in evidence the agreement of December 20, 1939, pursuant to which it agreed to pay $65,000, nor the earlier agreement of March 23, 1939, which referred to payment of the same amount. Respondent has introduced those agreements in evidence, as well as about twenty other documents which relate to the settlement. All of this evidence rebuts the inference of petitioner's evidence that Edelman made claims against petitioner only and that the only consideration which he received from petitioner was $65,000, and that the only consideration he received in the entire settlement of his claim was the $65,000.

Petitioner did not attempt to prove that the various agreements, most of which are attached to respondent's Exhibit G, were not in fact executed by Abraham Levitt, William Levitt, and other persons, and by corporations other than petitioner, or that the terms of such agreements were not carried out. Petitioner made a general objection to the receipt of any additional evidence, to all of respondent's evidence, upon the ground that further proceedings pursuant to the Circuit Court's mandate should not involve the receipt of any additional evidence. However, in its supplemental brief petitioner does not challenge the authenticity of the documents attached to Exhibit G, but, preserving the general objection, petitioner states that it is willing ‘to assume, for purposes of argument, that the testimony and exhibits have been properly admitted in evidence.‘

The evidence shows that negotiations among the parties extended over many months in 1939 and that finally several adjustments were made whereby the dissatisfied stockholders of Rockville, who were also stockholders of Babylon, came out of the controversy in complete ownership of Babylon, and that the financial position of Babylon was changed and, apparently, improved. Edelman and his associates stepped out of Rockville by surrendering their stock. The settlement involved, primarily, adjustments of the assets and liabilities of Babylon. The question whether petitioner's contribution of $65,000 in the entire settlement was a business expense of petitioner can not be decided fairly and correctly without giving consideration to the entire settlement, including all of the consideration which Edelman and his associates received. When all of the evidence is carefully considered, petitioner's argument that Edelman was simply conspiring to put petitioner ‘over a barrel‘ and shake the change out of its corporate pockets is not convincing.

Petitioner claims a deduction for a business expense. It is necessary for petitioner to show as clearly as possible for what it expended the sum in question, or, if that is not possible, why it made the expenditure. It has been stipulated that petitioner had agreed to pay the liabilities and obligations of the corporations which transferred their assets to petitioner in 1938. One of the corporations was Abraham Levitt & Sons, Inc., which we shall refer to as the Abraham Levitt corporation. Edelman was complaining about transfers of property from Rockville to the Abraham Levitt corporation, and, as far as we can observe from the evidence, the chief reason for lodging a claim against petitioner was that petitioner was said to be a transferee of the Abraham Levitt corporation's assets, or of the Levitt, individually. Edelman sought to recover property which had been transferred to the Levitt partnership, the Abraham Levitt corporation, and to any other corporation or persons, or to obtain consideration for such property. It is to be assumed that the Levitt did not admit that there were any improprieties committed in Abraham Levitt's management of Rockville and in the transactions between Rockville and the partnership and the Abraham Levitt corporation, but it appears to be true that Abraham Levitt deeded certain lands to Edelman and gave other considerations in the settlement. Thus, Edelman appears to have succeeded in recovering both property and money, as he set out to do. In this settlement, petitioner did not surrender any of the property which had come to it, which had been owned by Rockville, but petitioner did pay out $65,000. We can not assume that this payment had no relation whatever to two stipulated facts, which are, that petitioner was obligated to pay the liabilities of Abraham Levitt & Sons, Inc., and that it had received property and proceeds from property formerly owned by Rockville. If the payment of $65,000 by petitioner had no relation to those stipulated facts, petitioner should have and could have made the real facts clear.

There was surely a time prior to the closing of the dispute when Abraham Levitt discussed with the president of petitioner, his son, what arrangements he was making with Edelman, how much cash was required in the settlement, and who should pay the cash, and why. There was just as surely a time in the negotiations when Edelman discussed how much or how little cash would be satisfactory to him in the entire settlement, and what other consideration he would require. We do not believe that no reason was declared by Edelman for requiring the payment of some cash, nor that, as between petitioner and Abraham Levitt, there was no reason why petitioner was to contribute cash to the settlement rather than Abraham Levitt, who, apparently, was willing to do other things, and purportedly did. Petitioner has not produced evidence relating to these pertinent questions. Instead, petitioner drew a curtain over the scenes of the negotiations and produced only the testimony of its president and accountant to the effect that they believed it to be to petitioner's best interests to pay $65,000 and thereby avoid litigation.

Respondent's evidence compels us to conclude that petitioner was fully aware of the entire settlement and of the contributions which Abraham Levitt made to the settlement. It would be unreasonable to believe that petitioner made its contribution blindfolded, or that the cash payment by petitioner was separate and apart from the other parts of the settlement. Upon all of the evidence, we find unconvincing petitioner's argument that it paid the sum in question only to avoid the embarrassment and expense of being a party to litigation such as Edelman threatened to institute. Petitioner's argument places an interpretation upon the expenditure and the circumstances attending the agreement to make the payment which is not supported by the evidence.

The testimony given for petitioner in support of its contention that the expenditure was made only to avoid a lawsuit founded upon a claim without any legal merit, and to preserve its credit, good will, and business, can be given little weight in view of the general evidence. The testimony is, in part, prejudiced. Also, it is misleading, in that it does not tell the whole story about the settlement which was made.

Berlin, petitioner's principal witness and accountant, was asked and answered as follows:Q. Did you know the facts on both sides, from the Levitt interest and the Edelman interests?A. Well, I am prejudiced as far as the other interests were concerned, Edelman and his associates, because I felt it was merely a matter of holding somebody up who had plenty.

After careful consideration of all of the evidence, it must be concluded that petitioner paid the $65,000 either in payment of a liability of Abraham Levitt & Sons, Inc., or to discharge obligations of Abraham Levitt. In either event, the payment can not be held to be an ordinary business expense of petitioner. The payment was either a part of the cost of the assets which petitioner acquired from Abraham Levitt & Sons, Inc., and, therefore, a capital expenditure; Athol Mfg. Co. v. Commissioner, 54 Fed.(2d) 230, affirming 22 B.T.A. 105; Caldwell & Co. v. Commissioner, 65 Fed.(2d) 1012, affirming 26 B.T.A. 790; Watab Paper Co., 27 B.T.A. 488; F.S. Stimson Corporation, 38 B.T.A. 303; Brown Fence & Wire Co., 46 B.T.A. 344; or it was a distribution to a stockholder, Abraham levitt. See F.S. Stimson Corporation, supra. We think that the most reasonable view to take of the expenditure, on the entire evidence, is that petitioner made the payment as a transferee of the assets of Abraham Levitt & Sons, Inc., in payment of a liability of that corporation, and that, therefore, the expenditure constitutes part of the cost of petitioner's original assets, and is a capital expenditure.

There is a further reason for holding that the expenditure is not deductible as a business expense. We understand that there is the statutory requirement that an expenditure, to be a business expense, must be paid or incurred in carrying on the taxpayer's business. In Hales-Mullaly, Inc., 46 B.T.A. 25, 34, we said: ‘Moreover, we think it is also material, and incumbent upon petitioner to show, that the suit resulted, at least in part, from some action of the corporation either in, or incidental to, its ordinary business.‘ The evidence shows that the controversy which was settled in December 1939 was between stockholders of Rockville over transactions between Rockville and business entities other than petitioner which were consummated prior to the incorporation of petitioner. The evidence strongly indicates that petitioner was drawn into the controversy only as an alleged transferee of property formerly owned by Rockville, which was transferred to petitioner, presumably, by Abraham Levitt & Sons, Inc. The evidence strongly indicates that the settlement was a settlement made primarily by Abraham Levitt with other stockholders of Babylon and Rockville, and that petitioner was a party to the settlement, again, because it was a transferee of Abraham Levitt & Sons, Inc. Upon all of the evidence, it must be concluded that the controversy did not arise out of any transaction of petitioner in or incidental to its ordinary business. In our opinion, the result to be reached in this case should be the same as in the Hales-Mullaly case, which we consider is controlling here.

We have reviewed many cases where an expenditure made by a taxpayer to settle a lawsuit, or to avoid difficult consequences, or to compromise claims has been held to be a deductible business expense. Among such cases we find the following: Kornhauser v. United States, 276 U.S. 145; First National Bank of Skowhegan, 35 B.T.A. 876; Edward J. Miller, 37 B.T.A. 830; Robert Gaylord, Inc., 41 B.T.A. 1119; Helvering v. Community Bond & Mortgage Corporation, 74 Fed.(2d) 727; International Shoe Co., 38 B.T.A. 81; Dunn & McCarthy v. Commissioner, 139 Fed.(2d) 242. The element which is common to all of the above cases, but which is lacking in this proceeding, is that in each case an expense was paid or incurred in a transaction which grew out of some business transaction of the taxpayer in the conduct of its business, or was made primarily to preserve existing business, reputation, and good will. In our opinion, the question in this proceeding does not come within the ambit of any of the above cases because the expenditure in question was not made in the conduct of petitioner's ordinary business.

It is held that the expense in question was not an ordinary business expense. Petitioner has failed to overcome the prima facie correctness of respondent's determination, and respondent is sustained.

We have made the findings we were directed to make by the Circuit Court under its questions one and two. With respect to question three, a finding of fact has been made which relates to that question. A finding has been made to the effect, in general, that petitioner's payment had some relation to the agreements made by Abraham Levitt, and that the amount of $65,000 had some relation to the total consideration received by Edelman in the entire settlement. This finding is based upon respondent's evidence, which was not seriously questioned or denied by petitioner. We are obliged to express the view that we believe that the testimony of petitioner's witnesses to the effect that the sum in question was paid for no other reason than to obtain releases and a settlement of the threatened litigation is not entirely accurate, and that it does not reveal all of the reasons that entered into petitioner's agreement to contribute $65,000 to the settlement. The testimony for petitioner is that the amount was arrived at by a process of ‘bargaining.‘ We believe that is true, but that the bargaining involved the agreements of Abraham Levitt and the arrangements affecting Babylon Harbor, Inc., as well as the payment of cash by petitioner.

The record in this proceeding does not support a finding of fact that petitioner's officers ‘were not in the least troubled as to the possible success of the suit.‘ Petitioner's president testified under a deposition that he went on ‘the theory that you can lose any kind of a case ‘ (p. 16 of the deposition), and Gustave Simons, petitioner's attorney, testified that he could not guarantee that Edelman would not succeed eventually ‘because there have been similar cases that were very much like that where very competent counsel have been very much surprised on both sides‘ (p. 88 transcript of original hearing). The additional evidence received at the hearing under the mandate shows that petitioner and Abraham and William Levitt had agreed to pay Edelman $65,000 on March 23, 1939. Thereafter, other considerations appear to have reopened the negotiations, and finally on November 10, 1939, Edelman's attorney advised petitioner that he had ‘patiently negotiated the matter‘ and that unless it could be ‘amicably disposed of‘ and the damage claims of his clients satisfied, an action in equity would be commenced. Upon the entire record it has been found that petitioner was not entirely confident that any suit which Edelman might bring could not succeed.

We have endeavored to make some finding of fact under question three which would come closer to the type of answer which the question requires, but that is impossible because of the new evidence which has been received. There is no evidence relating to any estimate in dollars of the costs of defending the threatened litigation or of the costs of the damages which petitioner's officers and directors feared. We believe that the amount which a ‘reasonable person‘ standing in petitioner's position would have thought should be paid in cash in working out the settlement would depend upon the knowledge which the ‘reasonable man‘ had of all of the negotiations and all of the consideration which was to pass in the entire settlement. We have considered the question, and complied with the Circuit Court's direction to us, as far as can be done.

Petitioner objected to the receipt of additional evidence in this case. Petitioner has not cited any authority to support its general objection that it was improper to receive further evidence, and it appears that petitioner has abandoned the general objection.

Further evidence was received for the purpose of enabling this Court to make findings of fact upon certain questions, as we were directed to do by the Circuit Court. It is the statutory duty of this Court to make findings of fact in the proceedings before us. Sec. 907(b), Revenue Act of 1926, as amended by sec. 601. Revenue Act of 1928; Diller v. Commissioner, 91 Fed. (2d) 194, and cases cited. It is our understanding that the admission of additional evidence after a cause is remanded is a matter resting within our discretion, and, also, that after reversal of the decision which has been reviewed by the Circuit Court and the remandment of the cause for further proceedings not inconsistent with the Circuit Court's opinion, our duty to act upon the petition for redetermination of the respondent's determination is not different from what it was before the erroneous decision was rendered. Swenson v. Commissioner, 69 Fed.(2d) 280, 281.

The Circuit Court did not expressly remand this cause to this Court to take further evidence, but, in remanding the cause to us to make further findings of fact, we understand that the Circuit Court has left it to our discretion whether or not additional evidence should be received. Cf. Belridge Oil Co. v. Helvering, 69 Fed.(2d) 432, 433; Kelleher v. Commissioner, 94 Fed. (2d) 294, 296; cf. Peavy-Byrnes Lumber Co. v. Commissioner, 86 Fed.(2d) 234, 235.

The Circuit Court held that the expenditure in question is not deductible as a loss. That decision is now the law of the case. The Circuit Court did not make a decision upon the question whether the expenditure is deductible as a business expense under section 23(a)(1), and so upon that question there is no established law of the case. The Circuit Court expressed the view that payments to protect a business ‘generally‘ are ordinary expenses. We do not understand that the court concluded and held that in this case the particular expenditure was ‘ordinary.‘ The court did not decide that the expenditure was ‘necessary.‘ The expenditure must be both ordinary and necessary. Welch v. Helvering, supra. This question, being left undecided by the Circuit Court on the appeal from our former decision, must be reconsidered and decided by this Court under the remand, and we have reconsidered and decided the question.

Decision will be entered for the respondent.