Docket No. 24648.
Richard S. Doyle, Seq., and Jules G. Korner, III, Esq., for the petitioner. Edward Pesin, Esq., for the respondent.
1. Petitioner, accounting on the accrual basis, executed and delivered to an exempt pension trust its demand negotiable promissory note on the last day of its taxable year. It thereafter made a partial payment and substituted its demand negotiable promissory note for the balance due on the original note, within 60 days after the close of its taxable year, but did not discharge either note by actual payment within that period. Held, delivery of such notes was not payment within 60 days after the close of the taxable year of the amount accrued in that year, as required by section 23(p)(1)(E) of the Internal Revenue Code, and therefore deduction may not be taken except to the extent of the actual payment made within the 60-day period already allowed by the respondent.
2. On the record it is held that expenditures by petitioner for purchase and improvement of a property conveyed to its foremen's association for the use of its employees for recreation purposes constituted reasonable and necessary expense in carrying on business, deductible for the years in which made. Richard S. Doyle, Seq., and Jules G. Korner, III, Esq., for the petitioner. Edward Pesin, Esq., for the respondent.
The respondent determined deficiencies in petitioner's excess profits taxes as follows:
+----------------+ ¦1943¦$40,273.30 ¦ +----+-----------¦ ¦1944¦17,715.13 ¦ +----+-----------¦ ¦1945¦24,055.83 ¦ +----------------+
Petitioner does not contest all of the adjustments contained in the statutory notice and the parties have stipulated the facts with respect to the deductibility of certain items as to which decision will be entered under Rule 50. The questions left for decision are: (1) whether delivery of petitioner's demand negotiable promissory note to the trustee of its employees' pension fund on December 31, 1943, constituted a deductible payment under section 23(p) of the Internal Revenue Code; and (2) whether amounts expended by petitioner during 1944 and 1945 for the purchase, renovation, and improvement of a recreation lodge which it conveyed to trustees of its foremen's association were deductible as ordinary and necessary expenses under section 23(a) of the Code.
FINDINGS OF FACT.
Most of the facts were stipulated and are found accordingly.
The petitioner is a Pennsylvania corporation located at Lancaster, Pennsylvania. It kept its books and records on the accrual basis and filed its income and excess profits tax returns for the calendar years 1943, 1944, and 1945 with the collector of internal revenue at Philadelphia, Pennsylvania. On September 28, 1943, petitioner adopted an employees' pension plan and authorized the appointment of a pension board. On October 6, 1943, it approved the pension trust indenture submitted by the pension board and the appointment of John M. Kendig, treasurer of petitioner corporation, as trustee under the pension trust indenture, and authorized and directed the treasurer to assign and transfer as the corporation's irrevocable donation to the pension fund for the year ending December 31, 1943, a sum of not exceeding $55,000 pending determination of the exact amount according to the actuarial computations.
Information concerning the pension trust was filed with the Commissioner of Internal Revenue on November 19, 1943, together with copies of the by-laws, Formula of Benefits, and the Trust Agreement, and actuarial computations showing the amount necessary to cover the current year's service and one-tenth of the discounted past service reserve for the employees included in the plan, aggregating $54,326.30. By ruling dated January 11, 1944, the Commissioner held that the pension plan met the requirements of section 165(a) of the Internal Revenue Code, as amended, and that the trust was entitled to exemption from income tax thereunder.
On December 31, 1943, petitioner executed and delivered to the trustee of the pension fund its demand negotiable promissory note in the amount of $54,326.30, payable to the Slaymaker Lock Company Employees' Pension Fund. The ledger accounts of petitioner and the pension board reflect the giving and receiving of such note as of December 31, 1943.
At a meeting held January 4, 1944, the pension board authorized the trustee to purchase two United States 2 per cent Treasury Bonds, then owned by the corporation, at par plus accrued interest, and further authorized the trustee to make loans to the corporation conditioned that the same would be paid, upon demand, at such time as the opportunity to invest such funds on a more permanent basis might present itself.
On January 5, 1944, petitioner made a payment to the trustee of the pension fund in the amount of $10,500 on account of said $54,326.30 note, and $10,062.22 thereof was utilized by the trustee in the purchase of the two above-mentioned Treasury Bonds. The respondent has allowed that $10,500 as a deduction from gross income for the year 1943 under the provisions of section 23(p), Internal Revenue Code.
On February 29, 1944, petitioner executed and delivered to the trustee of the pension fund its demand negotiable promissory note in the amount of $43,826.30 made payable to the Slaymaker Lock Company Employees' Pension Fund, and the trustee canceled and returned to petitioner the note dated December 31, 1943, in the amount of $54,326.30. Neither note required the payment of interest and both were without security. The principal amount due on the note of February 29, 1944, was paid by petitioner as follows:
+-------------------------+ ¦Oct. 20, 1944 ¦$10,000.00¦ +--------------+----------¦ ¦Nov. 28, 1944 ¦25,000.00 ¦ +--------------+----------¦ ¦Nov. 28, 1944 ¦7,500.00 ¦ +--------------+----------¦ ¦Nov. 28, 1944 ¦1,326.30 ¦ +--------------+----------¦ ¦Total ¦$43,826.30¦ +-------------------------+
Petitioner also paid the following sums as interest on the two
+-------------------------+ ¦Sept. 30, 1944 ¦$997.75 ¦ +---------------+---------¦ ¦Dec. 16, 1944 ¦185.48 ¦ +---------------+---------¦ ¦Total ¦$1,183.23¦ +-------------------------+
Neither the note of December 31, 1943, in the amount of $54,326.30 nor the note of February 29, 1944, in the amount of $43,826.30, constituted payment within the meaning of section 23(p) of the Internal Revenue Code so as to entitle petitioner to deduction of the amount thereof from its gross income for the year 1943.
In September 1944, petitioner purchased 5 1/2 acres of farm land near the city of Lancaster, Pennsylvania, on which an old stone house was located, for a total cost of $1,802.61. Thereafter petitioner expended $9,606.59 in the year 1944 and $26,694.47 in the year 1945 in improving said property, including the installation of a power line for which application was approved by the War Production Board on December 7, 1944. By fee simple deed dated December 30, 1944, petitioner conveyed said property to certain trustees selected by The Foremen's Association of the Slaymaker Lock Company, an organization comprised of certain supervisory employees and officers of the company previously in existence. On the same date, December 30, 1944, the petitioner and the foremen's association entered into a trust agreement with said trustees for the operation and maintenance of said property for the exclusive use and enjoyment of all employees of the Slaymaker Lock Company under rules and regulations to be prescribed by the association.
During World War II petitioner entered into a number of contracts connected with the war effort. Its volume of business increased from an average of $452,000 per year in 1938 and 1939 to an average of $2,025,000 in 1944 and 1945, and its working force increased from an average of 207 employees in 1943 to a peak of 407 in 1944 and an average employment of 374 in 1945. In increasing its working force petitioner was compelled to compete with other industries in the area likewise engaged in increased activities due to the war effort, some of which were larger and had higher wage bases. Payroll costs for 1944 and 1945 aggregated $1,436,533.95.
Petitioner deducted from gross income in its income and excess profits tax returns for the years 1944 and 1945, respectively, as ordinary and necessary expenses, the cost of said property ($1,802.61 in 1944) and the amounts expended in renovation and improvements ($9,606.59 in 1944 and $26,694.47 in 1945). Respondent disallowed those items as deductions from gross income.
The contributions consisting of the cost of the foremen's lodge and the improvements thereto, constituted ordinary and necessary expenses clearly connected with the operation of its business, so as to entitle petitioner to deductions therefor from its gross income for the years indicated, within the meaning of section 23(a) of the Internal Revenue Code.
The first question for decision is whether or not the delivery of petitioner's demand negotiable promissory note to the trustee of its employees' pension fund, in and of itself, constituted a deductible payment under section 23(p) of the Internal Revenue Code. There is no question but that the payment of $10,500 made by petitioner to the trustee on January 5, 1944, on account of said note, coming within the 60-day period allowed by section 23(p)(1)(E), was deductible, and the Commissioner so held.
Deductions are granted to taxpayers by the legislative grace of Congress, and in order to secure deductions taxpayers must clearly show that they are within the terms of the statute as written. New Colonial Ice Co. v. Helvering, 293 U.S. 435; Lake v. Commissioner, 148 F.2d 898, certiorari denied 326 U.S. 732.
Section 23(p) allows the deduction of contributions of an employer to an employees' trust in the year when ‘paid.‘ Section 23(p)(1)(E) provides that a taxpayer on the accrual basis shall be deemed to have made a payment on the last day of the year of accrual if the payment is made within 60 days after the close of the taxable year of accrual. In Logan Engineering Co., 12 T.C. 860, 868, we held that ‘ * * * section 23(p), like sections 23(o) and 23(q), had the effect of placing cash and accrual taxpayers upon an equal footing (subject to the exception spelled out in section 23(p)(1)(E),‘ and that ‘an actual payment of the contribution to an employees' trust in the taxable year is a prerequisite to the allowance of a deduction on account thereof, and that the issuance and delivery of a promissory note does not constitute such actual payment.‘
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(p) CONTRIBUTIONS OF AN EMPLOYEE TO AN EMPLOYEES' TRUST OR ANNUITY PLAN AND COMPENSATION UNDER A DEFERRED-PAYMENT PLAN.—(1) GENERAL RULE.— If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under subsection (a) but shall be deductible, if deductible under subsection (a) without regard to this subsection, under this subsection but only to the following extent:(E) For the purposes of subparagraphs (A), (B), and (C), a taxpayer on the accrual basis shall be deemed to have made a payment on the last day of the year of accrual if the payment is on account of such taxable year and is made within sixty days after the close of the taxable year of accrual.
Petitioner's argument that this Court erred in its conclusions in the Logan case, supra, is based upon certain decisions of the Courts of Appeals involving the interpretation of the word ‘paid‘ as used in section 24(c) and legislative history. Similar arguments were considered in the Logan case. Further discussion herein is deemed unnecessary. Our decision in the Logan case is accordingly dispositive of the question here presented unless distinguishable on the facts.
Petitioner points to the following language contained in the trust agreement as a distinguishing feature:
WHEREAS, the Corporation has appropriated, authorized and directed its Treasurer to irrevocably assign to the Trustee on or before December 31, 1943, or within sixty days thereafter, in cash, property or securities, up to the sum of Fifty-Five Thousand Dollars ($55,000.00), the exact amount to be that sum which will provide for the annual service reserve, plus one-tenth of past service reserve for all employees included in the Plan, as shall be determined by accurate actuarial computations, as original corpus for the Trust Fund; * * *
It argues that the demand note herein was such property or security the delivery of which within the taxable year constituted payment, and the Commissioner having approved the trust plan as meeting the requirements of section 165(a) is now estopped from ruling that the giving of the demand note did not constitute a deductible payment.
‘Where the definite word 'paid’ is used in the statute, its ordinary and usual meaning is to liquidate a liability in cash,‘ Logan Engineering Co., supra; Lake v. Commissioner, supra. It is to be assumed that all parties were fully aware of the requirements of the statute and the regulations thereunder (Regs. 111, sec. 29.23(p)-1), and that in approving the trust agreement the Commissioner construed the terms of the agreement to contemplate actual payment, not a mere promise of payment. Any other construction would have been a modification of the statute and without authority. Citation of authority would not seem to be necessary to establish that an estoppel does not operate under such circumstances. Utah Power & Light Co. v. United States, 243 U.S. 389, 408, 409; Federal Crop Insurance Corporation v. United States, 332 U.S. 384.
It is also noted that the resolution of petitioner's board of directors, dated October 6, 1943, (copy of which was also submitted to the Commissioner in connection with the request for his ruling under section 165(a)) authorized and directed the treasurer to assign and transfer ‘a sum or sums not exceeding Fifty-Five Thousand ($55,000) Dollars to the Trustee of said Employees' Trust‘ and makes no mention of property or securities.
Moreover, even if payment were authorized in ‘property or securities‘ the delivery by petitioner of its own demand note does not constitute such payment. In order for there to have been an assignment or transfer of property or securities, the thing assigned or transferred must have been such while in possession of the assignor or transferor. It was neither. A demand note has no legal inception or existence as a negotiable instrument prior to its delivery. 7 Am.Juris.(Bills and Notes, 32), p. 807. ‘A note in the hands of its maker before delivery is not property, nor the subject of ownership, as such.‘ Salley v. Terrill, 95 Me. 553, 50 Atl. 896, 55 L.R.A. 730, 85 Am.St.Rep. 433.
Nor is the fact that the note involved in the instant case was a demand note sufficient to distinguish it from our previous decisions holding that the giving of a promissory note does not constitute payment within the meaning of section 23(p), as contended by petitioner. The delivery of a demand note was not the equivalent of payment by check.
As stated in Estate of Modie J. Spiegel, 12 T.C. 524, 526, ‘It (payment by check) was necessarily placed in a different category from a mere promise to pay; or even from such a promise reduced to formal terms and issued in the form of a negotiable promissory note.‘ A valid check necessarily implies sufficient funds in the bank at the time it is drawn and that it will be honored by the bank when presented. No further affirmative action is required of the drawer. A promissory note payable either on demand or at some future designated time is no more than its name connotes— a promise on the part of the maker to pay— in both instances at some future time, though the one fixes a date prior to which payment may not be required. Further action by the promissor is necessary before payment is consummated. He may or may not have sufficient funds on hand with which to make payment when requested and a line of credit available when the note was given may have been exhausted or be insufficient.
Finally petitioner states and there was testimony to the effect that there was an agreement or understanding between its executive committee and the pension board that the corporation's contributions to the pension fund when paid would be loaned back to the corporation in order to enable the pension fund to start earning the actuarially required 3 per cent until such time as the pension board should acquire mortgages or other more favorable forms of investment, and to help the corporation finance its Government contracts. Petitioner asserts that the delivery of its demand negotiable promissory note was thus the consummation of the two transactions consolidated for convenience into one, namely, (1) payment of the sum of $54,326.30 to the trustee of its employees' pension fund, and (2) the loan of such sum by the trustee back to the corporation. While petitioner had a line of credit which would have enabled it to borrow the money from the banks with which to make payment of the contribution to the pension fund at that time, the arrangement as carried out enabled the corporation both to utilize its line of credit with the banks and to have the use of the $54,326.30 due the pension fund, without security or any specified amount of interest. The statute involved, section 23(p), requires actual payment within the taxable year, not an assumed or conditional payment. Such a promissory note is not a corporate security such as contemplated in section 1(b) of article II of the trust indenture, and it is doubtful if such a conditional payment would have been permitted to have been included in the trust indenture in view of section 165(a)(2) prohibiting any part of the corpus or income to be used for or diverted to purposes other than the exclusive benefit of the employees or beneficiaries.
We accordingly conclude that the delivery of petitioner's demand negotiable promissory note to the trustee of the employees' pension fund on December 31, 1943, did not constitute a deductible payment under section 23(p) of the Internal Revenue Code. For similar reasons the delivery of the note of February 29, 1944, did not constitute a deductible payment under section 23(p)(1)(E).
The second question for decision is whether certain amounts expended by petitioner during 1944 and 1945 for the purchase, renovation and improvement of a recreation lodge which it conveyed to its formen's association were deductible or ordinary and necessary expenses under section 23(a), Internal Revenue Code.
The statute provides that a taxpayer may have as a deduction from gross income ‘All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * * .‘
The term ‘necessary‘ as used in section 23(a) does not mean indispensable. In order for expenditures to be ‘necessary‘ in carrying on any trade or business it is sufficient if ‘there are also reasonably evident business ends to be served, and an intention to serve them appears adequately from the record.‘ B. Manischewitz Co., 10 T.C. 1139. Similarly, expenses incurred in carrying on any trade or business are ‘ordinary‘ if within ‘the norm of general and accepted business practice.‘ Cf. Deputy v. DuPont, 308 U.S. 488. As observed by the Supreme Court in the case of Welch v. Helvering, 290 U.S. 111, 113, 114: ‘ * * * what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance.‘
During the war years 1944 and 1945 petitioner's volume of business more than quadrupled what it had been during the prewar years and its working force necessary to enable it to perform its wartime contracts was approximately doubled. In order to increase its working force petitioner had to compete with other industries in the area likewise engaged in war activities. Some of these were large, well known industries with higher wage bases than petitioner was able to meet due to Governmental wage stabilization regulations. Petitioner's officers testified that the farmhouse and grounds were purchased, renovated and conveyed to its foremen's association to be used for recreational purposes by all its employees as a means of holding old employees, to attract new employees and to cut down its labor turnover. The expenses incurred by petitioner in purchasing and improving the lodge property were approximately 2.65 per cent of its payroll cost for 1944 and 1945.
Respondent contends that the expenditures involved were not ordinary and necessary expenses deductible under section 23(a), but that they constituted capital expenditures amortizable over the life of the property. The authorities relied upon by respondent, however, are distinguishable on the facts from the instant case. One important distinguishing feature is the element of control by the taxpayer; another is the relation of the property constructed or improved to other property of the taxpayer. In the cases relied upon by the respondent the expenditures involved did not fall within the norm of general and accepted business practice (Deputy v. DuPont, supra; Roberts Filter Manufacturing Co., 10 T.C. 26, affd. 174 F.2d 79; Oswego Falls Corporation, 46 B.T.A. 801, reversed on other grounds, 137 F.2d 173), were not reasonably necessary to the conduct of the taxpayer's business (Climax Spinning Co., 8 B.T.A. 970), consisted of improvements to property owned and retained by the taxpayer (Woodside Cotton Mills Co., 13 B.T.A. 266, the paving of streets of mill village owned by the company; Athenia Steel Co., 1 B.T.A. 559, brick building erected for use as a club on company property title to which was retained by the company), or they served to enhance the value and use of taxpayer's property (Kauai Terminal, Ltd., 36 B.T.A. 893, involving participation with the Government in the construction of a harbor breakwater; Scovill Manufacturing Co., 25 B.T.A. 265, involving improvement of a dam and reservoir servicing the company's plant). In the instant case the lodge property was located at some distance from the company's plant and had no usefulness in connection with the operation of the plant.
Viewed in the light of the time, place and circumstances, and previous decisions of this Court, it is our conclusion that such expenses were ordinary and necessary expenses paid or incurred by petitioner during the taxable years in carrying on its trade or business. B. Manischewitz Co., supra; Poinsett Mills, 1 B.T.A. 6; Holt-Granite Mills Co., 1 B.T.A. 1246; Elm City Cotton Mills, 5 B.T.A. 309; Superior Pocahontas Coal Co., 7 B.T.A. 380; Franklin Mills, 7 B.T.A. 1290; Weil Clothing Co., 13 T.C. 873.
Decision will be entered under Rule 50.