Ruspyn Corp.
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Jul 22, 1952
18 T.C. 769 (U.S.T.C. 1952)

Docket No. 31452.

1952-07-22

RUSPYN CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Carter T. Louthan, Esq., for the petitioner. Ellyne E. Strickland, Esq., for the respondent.


Petitioner was incorporated in 1929 to own and operate certain real property. At the time of incorporation petitioner issued its stock and debentures to the owners of the real property in exchange for the property. The real property which was received by petitioner had a fair market value of at least the face value of the stock and debentures which petitioner issued for it. Under the circumstances detailed in the stipulation of facts and uncontradicted oral testimony, amounts accrued during the taxable year 1944 by petitioner as interest on its debentures held deductible as interest within the purview of section 23(b) of the Code. Cleveland Adolph Mayer Realty Corporation, 6 T.C. 732, followed. Carter T. Louthan, Esq., for the petitioner. Ellyne E. Strickland, Esq., for the respondent.

The respondent determined deficiencies in petitioner's income and declared value excess-profits taxes for the calendar year 1944 in the following amounts:

+--------------------------------------------+ ¦Income tax ¦$32,949.39¦ +---------------------------------+----------¦ ¦Declared value excess-profits tax¦12,169.44 ¦ +--------------------------------------------+

The only issue for our determination is whether the respondent erred in disallowing a deduction of $96,400 taken by the petitioner on its tax return as interest accrued on its debentures. The Commissioner is disallowing the deduction stated in his deficiency notice as follows:

(a) The amount of $96,400.00, claimed as a deduction for interest on debenture bonds, is determined not to be deductible in accordance with the provisions of Section 23(b) of the Internal Revenue Code.

FINDINGS OF FACT.

The facts were stipulated in large part and to that extent are found as stipulated.

Petitioner is a New York corporation with its principal place of business in New York City. It keeps its books and files its tax returns on the accrual basis and its taxable year is the calendar year. Petitioner's income and declared value excess-profits tax return for the year 1944 was filed with the collector of internal revenue for the third district of New York.

Petitioner was incorporated under the laws of New York on July 31, 1929. On or about August 29, 1929, petitioner commenced doing business. At that time petitioner acquired two parcels of real property in exchange for its gold debenture bonds in the aggregate amount of $2,100,000 and 6,000 shares of its capital stock (par of $100 per share). Since incorporation petitioner's business has consisted principally in the owning and leasing of these two parcels of real property. During the taxable year one of the parcels, the one having a relatively small value, was condemned and petitioner has returned as capital gain its profit from the disposition of that parcel.

The circumstances leading to the organization of petitioner are hereinafter set forth. Prior to August 1929, a parcel of real property in Riverdale, New York, and a parcel of real property at the northwest corner of Broadway and 49th Street, New York City, known as 1615-23 Broadway, were owned in undivided interests as follows:

+-----------------------------------------------------------------------------+ ¦ ¦Undivided ¦ +-----------------------------------------------------------------+-----------¦ ¦Owner ¦interest ¦ +-----------------------------------------------------------------+-----------¦ ¦1. City Banks Farmers Trust Company, John B. Peabody and Lewis ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Spencer Morris as trustees of four separate trusts for the ¦ ¦ ¦respective benefit of: ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦(a) Ethelberta Pyne Eppley ¦1/12 ¦ +-----------------------------------------------------------------+-----------¦ ¦(b) Helen Rutherford Benson ¦1/12 ¦ +-----------------------------------------------------------------+-----------¦ ¦(c) Constance Rivington Winant ¦1/12 ¦ +-----------------------------------------------------------------+-----------¦ ¦(d) Archibald D. Russell ¦1/12 ¦ +-----------------------------------------------------------------------------+

2. Percy R. Pyne, II, as trustee of two separate trusts for the respective benefit of: (a) Agnes G. Pyne 1/ 12 (b) Agnes L. Pyne 1/ 12 3. Percy R. Pyne, II 1/6 4. Percy R. Pyne 1/3

Prior to August 1929, difficulty had been encountered in managing the property due to the numerous owners thereof, and it was proposed that the owners of all undivided interests in such properties transfer them to a corporation in order to centralize the management of the property and to facilitate negotiations with the tenant of 1615-23 Broadway. Prior to August 16, 1929, all the owners of undivided interests in the properties offered, subject in the case of the trusts to the approval of the New York Supreme Court, to transfer their respective interests therein to Ruspyn Corporation. The court on August 27, 1929, entered its decree authorizing each trust to transfer its undivided interests in the properties to Ruspyn Corporation.

The gold debenture bonds issued by petitioner in the total amount of $2,100,000 were not issued under an indenture; the entire contract between petitioner and the holders thereof is set forth in the debenture. Such debentures were printed on tinted paper with engraved borders and had the usual appearance of a corporate bond. The agreement, as printed on each bond, was as follows:

The RUSPYN CORPORATION, a corporation of the State of New York, hereinafter called ‘the corporation‘ FOR VALUE RECEIVED hereby promises to pay to . . . h . . . executors, administrators, legal representatives or assigns the sum of . . . Dollars in gold coin of the United States of America of or equal to the present standard of weight and fineness on the first day of May, 2019 (unless before that time this bond shall be redeemed) at the principal office of the National City Bank of New York in the Borough of Manhattan City, County and State of New York with interest thereon payable at said bank in like gold coin semiannually on the first days of May and November in each year.

Said interest until May 1st, 1935, to be the ratable distribution among owners of this issue of the corporation's bonds of its entire net income as the same is determined by the Board of Directors of the Corporation in accordance with the Income Tax Law of the United States and the regulations made thereunder, but not in excess of six per centum (6%) per annum. If said income available for interest shall not be sufficient to pay the full rate of interest, so much of said interest as shall remain unearned shall not accumulate. Before paying said interest the corporation may set aside not more than ten per centum (10%) of its net income in any one year as a reserve or surplus fund, but the aggregate amount of such fund reserved from earnings shall not at any time prior to May 1st, 1935, exceed $50,000, and the corporation may, in determining its net income for distribution, as aforesaid, deduct taxes paid by it whether or not such taxes are allowed by the said income tax law and regulations, as well as the interest on these bonds.

Said interest from and after May 1st, 1935, shall be at the rate of six per centum (6%) per annum, irrespective of the income of the corporation.

This bond is one of an authorized issue of bonds limited to the aggregate principal sum of $2,100,000 and issued in the denominations as the Board of Directors may from time to time determine.

The corporation covenants that so long as this bond remains unpaid, it will not, without the consent of a majority of the then owners of the bonds of this issue create or permit any mortgage indebtedness or any funded obligation having priority to this issue.

This bond, together with all the other bonds of this issue, is subject to redemption in whole or in part (and if in part by lot) on any interest date at par and accrued interest on sixty (60) days prior written notice given to the registered owner thereof by mail duly postpaid and addressed to him at his address as the same appears on the records of the corporation. All bonds so redeemed are to be cancelled. Said bonds shall be redeemed on the dated (sic) specified in said notice of redemption upon presentation thereof by the registered owners, his executors, administrators, legal representatives or assigns at said principal office of said The National City Bank of New York. Interest on the bonds called and not presented for redemption shall cease to run on the date designated therefor.

This bond is transferrable by the owner thereof in person, or by attorney, duly authorized, upon the books of the corporation at its principal office in the City, County and State of New York.

In case of default in the payment of interest as herein stipulated for thirty (30) days, or of the filing by the corporation of a voluntary petition in bankruptcy, or its making an assignment for the benefit of its creditors, or in the event that the corporation shall be adjudicated a bankrupt, this bond, together with interest thereon accrued shall forthwith become due and payable.

IN WITNESS WHEREOF, Ruspyn Corporation has caused this bond to be signed by its president, and its corporate seal to be hereto affixed and attested by its secretary this . . . day of . . . 1929.

At the date of the transfer to Ruspyn Corporation of the property known as 1615-23 Broadway, it was subject to a lease to three brothers, hereinafter referred to as Brill Brothers, under an agreement dated September 28, 1909. The lease was for a term ending April 30, 1931, and provided that the lessee should pay all taxes and assessments with respect to the property and a money rent of $32,000 per annum. The lease also provided that upon the expiration of the original term, Brill Brothers should have the option to renew for a further term of 21 years upon the payment of all taxes and assessments with respect to the property and an annual money rent equal to 4 1/2 per cent of the value of the land, considered as vacant and unencumbered as of the beginning of such renewal term, except that the rent should not be less than that payable during the preceding term. Further options were given Brill Brothers to renew such lease for an indefinite number of successive 21-year terms upon the same conditions. This lease was not assignable.

For some time prior to 1929, 1615-23 Broadway was improved with a two-story building of the type commonly known as a ‘tax-payer.‘ A. E. Lefcourt, a New York real estate operator and builder, had been negotiating with Brill Brothers for a sublease of the premises with the intention of demolishing the existing building on the premises and erecting a new building. Accordingly, Brill Brothers desired a modification of their lease so that it would be assignable and entered into negotiations with the owners of the property to accomplish that end.

After petitioner acquired title to the real properties, the negotiations with Brill Brothers culminated in the cancelation of the old lease with Brill Brothers and the execution under date of August 29, 1929, of a new lease for a term ending April 30, 2015, which would be assignable by the tenant and which provided, among other things, for the payment of all taxes and assessments by the tenant during the term of the lease plus a money rent of $32,000 per annum for the portion of the term ending April 30, 1931, and an annual money rent during each successive 21-year portion of the term equal to 5 1/2 per cent of the value of the land considered as vacant and unencumbered at the beginning of each such 21-year portion of the term, except that such money rent could not be less than that payable during the preceding portion of the term. The new lease also provided that on or before February 1, 1932, the tenant would erect a new building upon the property which would cost at least $400,000.

The negotiations between Brill Brothers and A. E. Lefcourt culminated in the execution of a lease under date of August 29, 1929, between Brill Brothers and 1619 Broadway, Inc., a corporation organized by A. E. Lefcourt, for a term commencing March 1, 1930, and ending April 29, 2015. The lease provided that on or before November 1, 1931, 1619 Broadway, Inc., would erect on the property a new building of at least six stories which would cost not less than $400,000. A larger building was in fact contemplated by the parties and the building erected on the property by 1619 Broadway, Inc., was 10 stories in height.

At the time the property in Riverdale, New York, was transferred to petitioner the property was leased for an annual gross rental of $4,000 which produced an annual net profit of approximately $2,000. On the date of transfer, some time between August 16, 1929, and August 29, 1929, the parcel of property in Riverdale had a fair market value of not less than $50,000 and the property known as 1615-23 Broadway had a fair market value of not less than $2,650,000.

The trustees of the trusts established under the will of Archibald D. Russell employed a competent real estate appraiser to appraise the property known as 1615-23 Broadway. On February 7, 1929, the appraiser valued the property considered as vacant and unemcumbered at $2,550,000 and a copy of his appraisal was introduced in evidence in the court proceeding brought by the trustees for authority to transfer their interests in the two parcels of property to petitioner.

In March 1929, it was the opinion of the officers of the City Bank Farmers Trust Company, who were responsible as trustees for the management of the properties, that 1615-23 Broadway would be appraised as of May 1, 1931, at $3,000,000 for the purpose of fixing the rent payable pursuant to the terms of the proposed lease for 21 years net succeeding such date. This opinion as to value was communicated to the attorneys who were attending to the organization of petitioner. The value of the property at 1615-23 Broadway as of May 1, 1931, as finally determined for the purpose of computing the rent payable by Brill Brothers to Ruspyn Corporation for the 21-year portion of the term beginning on that date was $1,800,000 so that the annual money rent called for by the lease during the period May 1, 1931, to April 30, 1952, was $99,000. Between the date of petitioner's organization in 1929 and its acquiring 1615-23 Broadway and the date of the appraisement which was made May 31, 1931, there had been a very substantial decline in New York City real estate values due to the widespread depression which began the latter part of 1929.

As a result of depression conditions, 1619 Broadway, Inc., defaulted in the performance of its sublease with Brill Brothers and was dispossessed. During the depression period varying rent reductions were requested by Brill Brothers and were granted by Ruspyn Corporation. During the period from the issuance of the documents denominated gold debenture bonds to and including the taxable year 1944, the money rents received by Ruspyn Corporation from the properties owned by it and the amount paid by it on account of what its directors considered as the interest accruing during such year on the documents denominated gold debenture bonds were as follows:

+-------------------------------------------------+ ¦ ¦ ¦ ¦Amount paid as ¦ +-----+-------------+-----------+-----------------¦ ¦ ¦ ¦ ¦the interest ¦ +-----+-------------+-----------+-----------------¦ ¦ ¦Gross rents ¦Gross rents¦called for by the¦ +-----+-------------+-----------+-----------------¦ ¦ ¦from ¦from ¦documents ¦ +-----+-------------+-----------+-----------------¦ ¦Year ¦Broadway ¦Riverdale ¦entitled gold ¦ +-----+-------------+-----------+-----------------¦ ¦ ¦property ¦property ¦debenture bonds ¦ +-----+-------------+-----------+-----------------¦ ¦1929 ¦$10,666.64 ¦$1,000 ¦$0 ¦ +-----+-------------+-----------+-----------------¦ ¦1930 ¦31,999.92 ¦4,000 ¦6,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1931 ¦76,666.64 ¦4,000 ¦78,750 ¦ +-----+-------------+-----------+-----------------¦ ¦1932 ¦71,083.30 ¦3,800 ¦73,500 ¦ +-----+-------------+-----------+-----------------¦ ¦1933 ¦49,916.62 ¦3,600 ¦45,750 ¦ +-----+-------------+-----------+-----------------¦ ¦1934 ¦75,000.00 ¦3,600 ¦75,000 ¦ +-----+-------------+-----------+-----------------¦ ¦1935 ¦79,166.65 ¦3,240 ¦78,000 ¦ +-----+-------------+-----------+-----------------¦ ¦1936 ¦90,833.31 ¦750 ¦88,050 ¦ +-----+-------------+-----------+-----------------¦ ¦1937 ¦99,000.00 ¦1,125 ¦97,500 ¦ +-----+-------------+-----------+-----------------¦ ¦1938 ¦90,750.00 ¦0 ¦95,400 ¦ +-----+-------------+-----------+-----------------¦ ¦1939 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1940 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1941 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1942 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1943 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦1944 ¦99,000.00 ¦0 ¦93,300 ¦ +-----+-------------+-----------+-----------------¦ ¦Total¦$1,269,083.08¦$25,115 ¦$1,198,050 ¦ +-------------------------------------------------+

At no time in its corporate existence, including the taxable year, did petitioner pay any dividends on its capital stock. The only real properties ever owned by petitioner were the Riverdale property and the property known as 1615-23 Broadway.

The income and deductions of petitioner as reported on its tax return for the year 1944 were as follows:

+-----------------------------------------------------------------------------+ ¦Rents ¦$99,000.00¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Gross income ¦ ¦$99,000.00¦ +-------------------------------------------------------+----------+----------¦ ¦Interest ¦$96,400.00¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Real estate and franchise taxes ¦6,444.99 ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Net operating loss deduction ¦74.11 ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Director's fees ¦300.00 ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Insurance ¦12.25 ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Accounting ¦50.00 ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Total deductions ¦ ¦103,281.35¦ +-------------------------------------------------------+----------+----------¦ ¦Net income for declared value excess-profits tax ¦ ¦(4,281.35)¦ ¦computation ¦ ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Excess of net long term capital gain over short term ¦ ¦15,795.15 ¦ ¦capital loss ¦ ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Net income ¦ ¦$11,513.80¦ +-----------------------------------------------------------------------------+

The balance sheets of petitioner as reported on its tax return for the year 1944 are, in summary, as follows:

+----------------------------------------------------+ ¦ ¦ ¦12/31/44 ¦12/31/45 ¦ +------------------+-----+-------------+-------------¦ ¦Cash ¦ ¦$4,259.45 ¦$10,489.08 ¦ +------------------+-----+-------------+-------------¦ ¦Investments ¦ ¦ ¦74,000.00 ¦ +------------------+-----+-------------+-------------¦ ¦Land ¦ ¦2,712,549.50 ¦2,650,000.00 ¦ +------------------+-----+-------------+-------------¦ ¦Other assets ¦ ¦15,837.85 ¦15,871.52 ¦ +------------------+-----+-------------+-------------¦ ¦Total ¦[sic]¦$2,735,672.69¦$2,750,360.00¦ +------------------+-----+-------------+-------------¦ ¦Debentures payable¦ ¦$2,100,000.00¦$2,100,000.00¦ +------------------+-----+-------------+-------------¦ ¦Accrued interest ¦ ¦27,326.30 ¦30,426.30 ¦ +------------------+-----+-------------+-------------¦ ¦Common stock ¦ ¦600,000.00 ¦600,000.00 ¦ +------------------+-----+-------------+-------------¦ ¦Earned Surplus ¦ ¦8,346.39 ¦19,934.30 ¦ +------------------+-----+-------------+-------------¦ ¦Total ¦ ¦$2,735,672.69¦$2,750,360.60¦ +----------------------------------------------------+

From the date of organization of the petitioner to and including December 31, 1943, it accrued on its books as unpaid interest on debenture bonds the sum of $27,326.30. During the taxable year petitioner accrued the sum of $96,400 as interest on debenture bonds and paid $93,300, thereby increasing to $30,426.30 the accrued but unpaid interest on debenture bonds at the close of the taxable year.

The capital gain of $15,795.15 reported on the petitioner's income tax return for 1944 represents the gain realized upon the condemnation of the Riverdale property.

At all times during the taxable year 1944 the shares of capital stock of petitioner and its gold debenture bonds were owned as follows:

+-----------------------------------------------------------------------------------------------+ ¦Owner ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦H. ¦ ¦ ¦ ¦Rivington ¦ ¦ ¦ ¦Pyne and ¦ ¦ ¦ ¦Mary P. ¦ ¦ ¦ ¦Filley as ¦ ¦ ¦ ¦trustees ¦ ¦ ¦ ¦of three ¦ ¦ ¦ ¦separate ¦ ¦ ¦ ¦trusts ¦ ¦ ¦ ¦under the ¦ ¦ ¦ ¦will of ¦ ¦ ¦ ¦Percy R. ¦No. of shares of stock ¦Face amount of documents denominated gold debenture bonds ¦ ¦Pyne to ¦ ¦ ¦ ¦pay the ¦ ¦ ¦ ¦income ¦ ¦ ¦ ¦thereof to¦ ¦ ¦ ¦the ¦ ¦ ¦ ¦persons ¦ ¦ ¦ ¦set forth ¦ ¦ ¦ ¦below ¦ ¦ ¦ ¦during ¦ ¦ ¦ ¦their ¦ ¦ ¦ ¦respective¦ ¦ ¦ ¦lives: ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦Maud H. ¦1,000 ¦$350,000 ¦ ¦Pyne ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦H. ¦ ¦ ¦ ¦Rivington ¦250 ¦87,500 ¦ ¦Pyne ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦Mary P. ¦250 ¦87,500 ¦ ¦Filley ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦Maud H. ¦500 ¦175,000 ¦ ¦Pyne ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦H. ¦ ¦ ¦ ¦Rivington ¦84 ¦29,400 ¦ ¦Pyne ¦ ¦ ¦ +----------+------------------------+-----------------------------------------------------------¦ ¦Mary P. ¦83 ¦29,050 ¦ ¦Filley ¦ ¦ ¦ +-----------------------------------------------------------------------------------------------+

William Dexter and Richard C. Curtis as joint tenants, as nominees for the persons designated below and as nominees for five separate trusts created by such persons, the income of which is payable to such persons during their respective lives: Alison Pyne 66.6 23,310 Grafton H. Pyne, Jr 66.6 23,310 Eben W. Pyne 66.6 23,310 John W. Pyne 66.6 23,310 Percy R. Pyne, II 66.6 23,210

+------------------------------------------------------------------------------------------------+ ¦Owner ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦City Bank ¦ ¦ ¦ ¦Farmers ¦ ¦ ¦ ¦Trust ¦ ¦ ¦ ¦Company, ¦ ¦ ¦ ¦John D. ¦ ¦ ¦ ¦Peabody and¦ ¦ ¦ ¦Lewis ¦ ¦ ¦ ¦Spencer ¦ ¦ ¦ ¦Morris as ¦ ¦ ¦ ¦trustees of¦ ¦ ¦ ¦four ¦ ¦ ¦ ¦separate ¦ ¦ ¦ ¦trusts ¦ ¦ ¦ ¦established¦No. of shares of stock ¦Face amount of documents denominated gold debenture bonds ¦ ¦under the ¦ ¦ ¦ ¦will of ¦ ¦ ¦ ¦Archibald ¦ ¦ ¦ ¦D. Russell ¦ ¦ ¦ ¦to pay the ¦ ¦ ¦ ¦income ¦ ¦ ¦ ¦thereof to ¦ ¦ ¦ ¦the persons¦ ¦ ¦ ¦set forth ¦ ¦ ¦ ¦below ¦ ¦ ¦ ¦during ¦ ¦ ¦ ¦their ¦ ¦ ¦ ¦respective ¦ ¦ ¦ ¦lives: ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦Ethelberta ¦625 ¦$218,750 ¦ ¦Pyne Eppley¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦Helen ¦ ¦ ¦ ¦Rutherford ¦625 ¦218,750 ¦ ¦Benson ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦Constance ¦ ¦ ¦ ¦Rivington ¦625 ¦218,750 ¦ ¦Winant ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦Archibald ¦625 ¦218,750 ¦ ¦D. Russell ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦City Bank ¦ ¦ ¦ ¦Farmers ¦ ¦ ¦ ¦Trust ¦ ¦ ¦ ¦Company, as¦ ¦ ¦ ¦trustee of ¦ ¦ ¦ ¦a trust ¦ ¦ ¦ ¦created ¦ ¦ ¦ ¦under the ¦ ¦ ¦ ¦will of ¦500 ¦175,000 ¦ ¦Moses ¦ ¦ ¦ ¦Taylor ¦ ¦ ¦ ¦Pyne, Jr., ¦ ¦ ¦ ¦to pay the ¦ ¦ ¦ ¦income ¦ ¦ ¦ ¦thereof to ¦ ¦ ¦ ¦Agnes G. ¦ ¦ ¦ ¦Pyne ¦ ¦ ¦ +-----------+------------------------+-----------------------------------------------------------¦ ¦Agnes L. ¦ ¦ ¦ ¦Pyne Hudson¦500 ¦175,000 ¦ ¦(now Coke) ¦ ¦ ¦ +------------------------------------------------------------------------------------------------+

The gold debenture bonds issued by the petitioner in August 1929, were evidence of indebtedness of the petitioner.

OPINION

Black, Judge:

The issue which we have to decide in the instant case is whether the amount accrued upon petitioner's books as interest on its debenture bonds was interest upon indebtedness so as to be deductible under the provisions of section 23(b) of the Internal Revenue Code. The applicable regulation is printed in the margin. It is well settled under the decisions of the courts that the determination of whether a particular instrument represents an indebtedness within the meaning of section 23(b) or is preferred stock must be determined after consideration of all relevant facts. See our discussion in Cleveland Adolph Mayer Realty Corporation, 6 T.C. 732 (reversed on another point, 160 F.2d 1012) where we said:

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(b) INTEREST.— All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this chapter.

REGULATIONS 111.SEC. 29.23(b)-1. INTEREST.— Interest paid or accrued within the year on indebtedness may be deducted from gross income, except that interest on indebtedness incurred or continued to purchase or carry obligations, * * * the interest upon which is wholly exempt from tax, is not deductible. * * ** * * So-called interest on preferred stock, which is in reality a dividend thereon, cannot be deducted in computing net income. * * *

Whether a debenture issued by a corporation constitutes an indebtedness or whether it is a share of capital stock must be resolved upon the facts of the particular case. If the debenture holder has the rights merely of a stockholder, the issuance of the debentures does not create a debtor-creditor relationship. There is a vital distinction between a creditor relationship and a stockholder relationship. The debenture holder is entitled to look to the obligor for payment of his debt at some definite date or at some date which will become definite upon the happening of some event. A stockholder has a proprietary interest in the corporation. In no real sense is he a creditor. The property which he has paid into the corporation in return for his stock is at the risk of the business. He is not entitled to receive any return upon his investment in the absence of earnings and those earnings will be distributed to the stockholders upon vote of the board of directors. A creditor, on the other hand, has no proprietary interest. He has no voice in the management. He is entitled to receive interest upon his debt according to the terms of his debt obligation and the payment of principal of the debt at maturity.

The facts which have been considered material in determining that securities represent an indebtedness in other cases which have been before the Tax Court may be summarized thus: that there was a good business reason for the issuance of debt securities, that the securities have a fixed maturity date at which time the principal becomes payable in all events, that reasonable interest is payable in all events without regard to earnings, that the holders of the securities may enforce payment in the event of default, that the securities have no voting rights, that the security is called a bond and is reflected on the books and financial statements as an indebtedness, that there is a substantial investment in stock, and that the ratio of the debt securities to stock is reasonable.

The facts in the instant case, we think, show that the gold debenture bonds issued by petitioner represent an indebtedness under the foregoing tests so that the interest which petitioner accrued on its books and claimed as a deduction on its return for the taxable year 1944 is allowable.

What were the business reasons which prompted the organization of petitioner July 31, 1929, and its acquiring in August 1929, two parcels of real estate in New York City and the issuance in payment thereof of 6,000 shares of stock of the par value of $100 a share and $2,100,000 gold debenture bonds? The business reasons as shown in our Findings of Fact may be stated thus: Some time prior to 1929, a parcel of real property known as 1615-23 Broadway, New York City, and a parcel of real property in Riverdale, New York, had been owned in undivided interests by six trusts and two individuals. Due to this division in the ownership of the properties difficulty had been encountered in managing them, particularly in view of the fact that negotiations were then being carried on with the tenants of 1615-23 Broadway for a modification of the lease covering such property. It was decided that it would be desirable for all owners of undivided interests in such properties to transfer them to a corporation so as to achieve unity of title and ease of management. The trusts instituted a proceeding in the New York Supreme Court pursuant to the provisions of section 116 of the New York Real Property Law for the purpose of securing a decree which would authorize them to transfer their undivided interests in the properties to a corporation. The New York Supreme Court thereafter duly entered its decree authorizing the trusts to transfer their undivided interests in the properties to petitioner in exchange for the issuance by it of a proportionate share of its stock and debenture bonds to the trusts.

The two properties transferred to petitioner had a fair market value of at least $2,700,000 at the date of transfer. Petitioner, in exchange for the transfer to it of such properties, issued $2,100,000 face amount of debenture bonds and 6,000 shares of capital stock each of the par value of $100. Accordingly, full value was paid in to petitioner for the debentures and the stock. Such an equity investment of $600,000 in petitioner clearly was substantial and represented the proprietary interest in the corporation. The ratio of debt to equity investment was only 3 1/2 to 1, whether taken on the basis of face and par value or on the basis of actual value. In view of the substantial equity investment in petitioner and a ratio of debt to equity investment of only 3 1/2 to 1, the situation is as favorable to petitioner as that involved in Kelly v. Commissioner, 326 U.S. 521, where the ratio of debt to stock was 4 to 1. There the Court said at page 526, ‘as material amounts of capital were invested in stock we need not consider the effect of extreme situations such as nominal stock investments and an obviously excessive debt structure.‘

At the time of petitioner's organization in July 1929 at a time when real estate values in New York City were high and steadily advancing, it was anticipated by its organizers and stockholders that the earning power of the properties transferred to it would amply cover the interest upon petitioner's debenture bonds and would leave a substantial amount available for expenses, reserves, and dividends. Subsequent events, however, revealed that this anticipation was not well founded. The great depression came on and real estate in New York City, as well as elsewhere, declined greatly in value. Due to the decline in value of its real estate, petitioner was not able to collect the amount of rents which had been anticipated and petitioner had to make adjustments with its lessee to lower rental rates. The stipulated facts show that from 1937 through 1944, the year which we have before us, petitioner collected gross rentals of $99,000 per annum and has actually paid as interest on its debentures $93,300 annually, except 1937 and 1938 when the payments were $97,500 and $95,400, respectively. This latter discrepancy is not explained in the stipulation of facts but so far as we can see it is of no importance to a decision of the issue which we have here to decide.

While it is true that petitioner's expectations which it held in 1929 as to the rentals it would be able to obtain from its properties did not materialize, there can be no question but that the facts show that these expectations were entertained in good faith. We feel perfectly sure from the facts which have been stipulated and from the oral testimony that when petitioner was organized and it issued 6,000 shares of common stock with a par value of $100 per share and $2,100,000 face value of debentures in payment of the real estate which it acquired from the then owners, it fully expected to be able to pay the interest on its debentures and to have have something substantial left over for distribution to its stockholders as dividends on its common stock. Therefore, the fact that events which happened after the widespread depression made it impossible for petitioner to collect the rents which it had anticipated does not throw any shadow on the bona fides of its stock and debenture issues.

The 6,000 shares of capital stock issued by petitioner represented an investment of $600,000, which, based upon the estimates of petitioner's future net rents, would have substantial earning power. The debenture bonds had no voting power but such voting power was vested solely in the stock which thus represented the proprietary interest in petitioner. The absence of voting power is persuasive evidence that the debenture bonds represented indebtedness. Clyde Bacon, Inc., 4 T.C. 1107. Petitioner's debenture bonds were freely transferable without regard to the stock. Petitioner's debenture bonds have a specific maturity date at which time the principal becomes payable in all events unless prior thereto they have been redeemed. A fixed maturity date upon which the principal becomes payable in all events has been considered an important element in determining that a security represents an indebtedness. Commissioner v. O. P. P. Holding Corporation, 76 F.2d 11, affirming 30 B.T.A. 337; Commissioner v. Hood & Sons, 141 F.2d 467. Under the terms of the debenture bonds they mature on May 1, 2019, or in something over 89 years after their issuance and 4 years after the expiration of the lease covering petitioner's principal asset, 1615-23 Broadway. In view of the valuable building which the sublessee agreed to erect and which it did actually erect and the substantial rents which it agreed to pay to petitioner's tenants, the performance by petitioner's tenants of their covenants over the term of the lease seemed well assured. It, therefore, seems logical and not unusual that the debentures should not be payable (except by being called for redemption) prior to the termination of the lease of 1615-23 Broadway.

When all relevant and pertinent facts are considered we think petitioner has borne its burden of proof of showing that its debenture bonds represented bona fide indebtedness and were not, as respondent contends, in effect preferred stock.

The Commissioner in arguing that the $96,400 in question did not represent interest and was, therefore, not deductible relies heavily upon our decision in 1432 Broadway Corporation, 4 T.C. 1158, affd. 160 F.2d 885. We have examined that case carefully and we think it is clearly distinguishable on its facts.

We think the instant case is governed in principle by our decision in Cleveland Adolph Mayer Realty Corporation, supra. In that case we pointed out at page 739 that the Commissioner was principally relying upon 1432 Broadway Corporation, supra, but we gave reasons as to why we though 1432 Broadway Corporation was clearly distinguishable on its facts from those present in Cleveland Adolph Mayer Realty Corporation, supra. After pointing out these distinguishing facts we went on to hold ‘We think it clear from the debentures that they constituted a debt of the petitioner.‘ We make the same holding in the instant case. Substantially the same reasons for distinguishing Cleveland Adolph Mayer Realty Corporation from 1432 Broadway Corporation exist in the instant case. We, therefore, follow Cleveland Adolph Mayer Realty Corporation rather than 1432 Broadway Corporation.

Decision will be entered for the petitioner.