Opinion
Docket Nos. 14186 14187.
1949-03-31
CATHERINE G. ARMSTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.W. H. ARMSTON CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Warren F. Wattles, Esq., for the petitioners. F. L. Van Haaften, Esq., for the respondent.
Petitioner W. H. Armston Co., a family corporation, owned in 1943 certain heavy equipment then being used in performing its contracts for the construction of air fields for the armed forces. During 1943 petitioner W. H. Armston Co. entered into an arrangement with Catherine G. Armston, its chief stockholder, under which it purported to sell certain of such equipment to her upon the condition it was to be leased back to the corporation at certain rental fixed by OPA. In its tax returns for the years 1943-1945, inclusive, the corporation claimed a deduction of the amounts paid to Catherine G. Armston, under said arrangement, as alleged rentals. The respondent disallowed the claimed deductions. Held:
(1) Such payments did not constitute ordinary and necessary expenses of the business carried on by petitioner corporation so as to constitute proper deductions from gross income under the provisions of section 23(a)(1)(A) of the Internal Revenue Code.
(2) These payments to petitioner Catherine G. Armston were in the nature of a distribution of corporate earnings and, as such, were properly returned by her in the years of their receipt as taxable income. Warren F. Wattles, Esq., for the petitioners. F. L. Van Haaften, Esq., for the respondent.
The respondent determined deficiencies in income, declared value excess profits, and excess profits taxes for the years and in the amounts as follows:
+-------------------------------------------------------------+ ¦Docket No.¦Year ¦Tax ¦Amount ¦ +----------+-----+----------------------------------+---------¦ ¦ ¦ ¦ ¦ ¦ +----------+-----+----------------------------------+---------¦ ¦14186 ¦1943 ¦Income Tax ¦$1,473.26¦ +----------+-----+----------------------------------+---------¦ ¦ ¦(1943¦(Declared value excess profits tax¦6,242.78 ¦ +----------+-----+----------------------------------+---------¦ ¦ ¦( ¦(Excess profits tax ¦40,925.60¦ +----------+-----+----------------------------------+---------¦ ¦14187 ¦(1944¦Excess profits tax ¦20,809.03¦ +----------+-----+----------------------------------+---------¦ ¦ ¦( ¦(Income tax ¦6,027.34 ¦ +----------+-----+----------------------------------+---------¦ ¦ ¦(1945¦(Excess profits tax ¦6,079.95 ¦ +----------+-----+----------------------------------+---------¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------------------------+
The proceedings were consolidated for hearing. The principal issue is the correctness of respondent's action in disallowing to petitioner W. H. Armston Co. certain claimed deductions as rent on equipment alleged to have been sold by it to the petitioner, Catherine G. Armston, its principal stockholder, and rented from her. Other issues, involving the correctness of the action by respondent in failing to allow a claimed operating loss in 1945 as a carry-back to 1943, do not arise for consideration unless the decision herein is against the respondent on the main issue set out above. Another error assigned, upon the failure of respondent to allow additional depreciation for the year 1943, is conceded by respondent if the decision upon the main issue is in his favor. Certain other issues were conceded by the petitioners and the respondent, respectively, and those concessions will be given effect upon redetermination under Rule 50.
FINDINGS OF FACT.
Petitioner W. H. Armston Co. is a Florida corporation, organized September 29, 1930, and is engaged in construction work, chiefly the building of roads, clearing land, and moving dirt. W. H. Armston is president and treasurer of the company. Petitioner Catherine G. Armston is the wife of W. H. Armston and is the company's secretary. Each has held these offices since the corporation was formed. The returns of both of the petitioners for the taxable years here involved were filed with the collector of internal revenue for the district of Florida.
About three years after the organization of W. H. Armston Co., ceratin road-building equipment was paid in for stock issued to Catherine G. Armston. This equipment had been acquired by W. H. Armston in the liquidation of certain prior construction companies in which he had held an interest. Upon the organization of the company, only five shares of no par value stock were issued, on October 31, 1930, as follows:
+---------------------------+ ¦W. H. Armston ¦3 shares¦ +------------------+--------¦ ¦F. D. Peebles ¦1 share ¦ +------------------+--------¦ ¦Charles K. Miller ¦1 share ¦ +------------------+--------¦ ¦ ¦- ¦ +------------------+--------¦ ¦Total ¦5 shares¦ +---------------------------+
On June 3, 1933, 10 additional shares were issued to Robert M. Brown and on January 6, 1933, 20 shares were issued to Catherine G. Armston. On May 8, 1942, the 1 share standing in the name of Peebles was transferred to K. W. Kerr. On February 1, 1943, there were 35 shares outstanding, of which 20 shares were in the name of Catherine G. Armston. On April 8, 1943, the 1 share standing in the name of Miller was transferred to Catherine G. Armston and the 10 shares in the name of Brown were transferred to W. H. Armston, and a stock dividend was declared of 15 shares of stock, of which 5 4/7 shares were issued to W. H. Armston, 3/7 of a share to K. W. Kerr,
and 9 shares to Catherine G. Armston. On this latter date, the total outstanding stock amounted to 50 shares, of which 30 shares were issued to Catherine G. Armston.
The 1 3/7 shares registered in the name of K. W. Kerr were qualifying shares and were beneficially owned by W. H. Armston.
During the years 1940, 1941, and 1942 W. H. Armston Co. bought certain heavy construction equipment, as follows:
+-----------------+ ¦1940 ¦$37,450.38 ¦ +-----+-----------¦ ¦1941 ¦32,849.73 ¦ +-----+-----------¦ ¦1942 ¦14,054.83 ¦ +-----+-----------¦ ¦Total¦84,354.94 ¦ +-----------------+
W. H. Armston Co. also, during those three years, bought automobiles and trucks at a total cost of $33,373.28. The company had had little business during the depression years, but the Federal rearmament program, beginning late in the year 1939 or early 1940, brought in a large amount of work, mainly in the construction of air fields for the Army engineers.
On January 15, 1943, the corporation borrowed $15,000 from W. H. Armston, and $6,000 more from him on January 27, 1943. The loans were repaid, $6,000 on March 3, 1943, and $15,000 on April 16, 1943. On January 31, 1943, the corporation's cash position was as follows:
+--------------------------------------------------------------+ ¦First National Bank, Kissimmee, on deposit ¦$2,423.01 ¦ +--------------------------------------------------+-----------¦ ¦Bank of Dunedin, overdraft ¦(1,362.32) ¦ +--------------------------------------------------+-----------¦ ¦Bank of Clearwater, overdraft ¦(11,027.95)¦ +--------------------------------------------------+-----------¦ ¦ ¦(9,967.26) ¦ +--------------------------------------------------+-----------¦ ¦Other current assets at this date were as follows:¦ ¦ +--------------------------------------------------+-----------¦ ¦ ¦ ¦ +--------------------------------------------------+-----------¦ ¦Accounts receivable ¦$123,138.60¦ +--------------------------------------------------+-----------¦ ¦Construction in progress ¦37,522.01 ¦ +--------------------------------------------------+-----------¦ ¦Total ¦160,660.61 ¦ +--------------------------------------------------------------+
On this date it had fixed assets in a total of $75,158.71 and other assets of $6,360.34. Its current liabilities, including the overdrafts noted above, were in the sum of $180,055.29. As of December 31, 1942, one month previous to this time, its financial statement rendered to the United States Fidelity & Guaranty Co. showed surplus and undivided profits of $278,371.16.
Prior to 1942 Catherine G. Armston had no income of her own, and in that year all of the income she received was $2,000 as salary from W. H. Armston Co. She was primarily a housewife and performed no duties for W. H. Armston Co., except such formal ones as were required of her as secretary. These consisted solely of the signing of papers, all of which were prepared for her signature by her husband, and whatever she did was on the advice of her husband. She had no authority to sign checks for the corporation.
On February 1, 1943, there was held a special meeting of the board of directors of W. H. Armston Co., the minutes of which read, in part, as follows:
A special meeting of the Board directors of W. H. Armston Company, Inc., was held in the office of the company in Dunedin, Florida, at 2 o'clock, P.M. on February 1, 1943, pursuant to call by the President.
Directors present were W. H. Armston, Catherine G. Armston and K. W. Kerr, being all of the directors of the company.
W. H. Armston, President, presided, and Catherine G. Armston, Secretary, recorded the minutes of the meeting.
The minutes of the last annual meeting of directors were read and approved.
Mr. W. H. Armston, President, called attention to the fact that although the company had enjoyed a good business year during the year 1942 with respect to earnings, there were other factors facing the corporation which were disturbing and required consideration and prompt action.
Mr. Armston, President, called attention to the fact that:
1. During the year 1942 a Federal tax examiner had examined the books of the corporation for the years 1939 thru 1941.
2. The said tax examiner found that the corporation was due (sic) additional Federal income tax of approximately $10,000.00 for the years 1939 thru 1941, of which amount approximately $3,000.00 had already been paid.
3. The corporation had consented to the payment of a substantial portion of the tax alleged to be due, and that it was likely that the entire balance of about $7,000.00 would have to be paid, and that the corporation was likely to be billed for this tax by the Collector of Internal Revenue at any time.
4. The corporation had at the end of December, 1942, regular accounts payable running something above $40,000.00.
5. The corporation income tax liability for the year 1942 was not known, but that a conservative estimate thereof appeared to be between $40,000.00 and $50,000.00.
6. In view of the large existing current liabilities, and large investments carried in fixed equipment, it was likely that the corporation would be embarrassed for want of ready cash.
7. It was not good business for the corporation to have substantially all of its capital and surplus tied up in fixed equipment, when current funds were needed for the payment of current debts and working capital for supplying payrolls on current and new business.
8. It was considered advisable, and for the best interests of the corporation, that some of its fixed equipment be sold and the cash realized therefrom be used for working capital.
After some discussion, an offer was made by Catherine G. Armston whereby she agreed to buy certain of the company's fixed equipment, the price to be determined by the company's book value as of February 1, 1943, provided the company would agree to rent the said equipment from Catherine G. Armston when the company needed the use of the said equipment in carrying on its general contracting business, and that rental rates would be governed by the rates approved by Office Price Administrator, Leon Henderson, dated April 28, 1942, for the same or similar equipment.
After further discussion, upon motion made, seconded and carried (Catherine G. Armston not voting), it was voted to accept the offer of Catherine G. Armston and to sell certain of the company's fixed equipment in an approximate amount of $30,000.00. Authority was granted to W. H. Armston to work out the details of the sale so that the proceeds of the sale would be received by the company not later than 60 days from February 1, 1943, and it was agreed that when the details of the sale were worked out, such details would be made a part of the corporate minutes.
There being no further business to come before the meeting, the special meeting of the board was adjourned.
(Signed) Catherine G. Armston
CATHERINE G. ARMSTON, Secretary
(Signed) W. H. Armston W. H. ARMSTON, President.
Additions to the minutes of that date read as follows:
Details of sale of fixed equipment to Catherine G. Armston in accordance with authorization granted by Board of Directors this the 1st day of February, 1943.
1. W. H. Armston Company, Inc., agrees to sell and Catherine G. Armston agrees to buy the following fixed equipment:
+-----------------------------------------------------------------------------+ ¦Description ¦Purchase ¦ ¦ ¦Price ¦ +----------------------------------------------------------------+------------¦ ¦ ¦ ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 18 Tractor (#1) TDR948-TDRm1430 ¦$1,946.44 ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 18 Tractor (#2) TDR1130-TDRm1438 ¦1,946.44 ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 18 Tractor (#3) TDR343 5-TDRM3312 ¦3,652.11 ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 14 Tractor (#1) TDF1668 ¦1,952.75 ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 14 Tractor (#2) TDF2166 Eng. 2374 ¦2,228.74 ¦ +----------------------------------------------------------------+------------¦ ¦1 T D 14 Tractor (#3) TDF3209 Eng. TDFM3337 ¦2,838.41 ¦ +----------------------------------------------------------------+------------¦ ¦1 Adams Auto Patrol Model 412 Ser. 1962-H-SN538 ¦3,139.28 ¦ +----------------------------------------------------------------+------------¦ ¦2 Bucyrus Erie Model S-90 Scraper Wagons Model 5-90 Serial 19198¦3,932.55 ¦ ¦& 19200 ¦ ¦ +----------------------------------------------------------------+------------¦ ¦1 Bucyrus Erie Bullgrader Serial 19767 ¦1,318.00 ¦ +----------------------------------------------------------------+------------¦ ¦1 Bucyrus Erie Bullgrader Serial 24063 ¦1,397.73 ¦ +----------------------------------------------------------------+------------¦ ¦1 Bay City Crane (#1) Model 30 Serial UH216421 ¦2,968.71 ¦ +----------------------------------------------------------------+------------¦ ¦1 Bay City Crane (#2) Model 42 Serial S383107 ¦4,101.25 ¦ +----------------------------------------------------------------+------------¦ ¦ ¦$31,422.41 ¦ +-----------------------------------------------------------------------------+
2. Catherine G. Armston agrees to pay W. H. Armston Co. Inc., the total purchase price of $31,422.41 in cash upon demand by W. H. Armston Co. Inc. (after 3 days notice), and if not demanded, not later than sixty days from this the 1st day of February, 1943.
3. It is further agreed that in the event that the final settlement of Income Tax liability of W. H. Armston Co. Inc. involving depreciation on equipment, should change the adjusted cost basis of the assets sold herein, it is agreed that the purchase price of $31,422.41 shall be adjusted either up or down in accordance with such settlement so that the said W. H. Armston Co. Inc. shall suffer no loss in this sale, using the adjusted cost basis as finally determined by the Internal Revenue Department as a cost basis.
4. W. H. Armston Co. Inc. agrees to deliver a bill of sale to Catherine G. Armston covering the equipment described herein when the total purchase price is paid.
5. W. H. Armston Co. Inc., agrees that if any of the said equipment described above is used by the said W. H. Armston Company (and it is agreed that it will be so used when needed) rental shall be paid to Catherine G. Armston by the said W. H. Armston Co. Inc., at the published rates for rental of like or similar equipment, as approved by Office Price Administrator, Leon Henderson, dated April 28, 1942.
6. It is agreed that any rent accruing from the use of equipment as described above shall date from this the 1st day of February, 1943, but no actual payments shall be payable for any rents prior to the payment of the purchase obligation of $31,422.41 but such payments shall be made from February 1, 1943 after the said purchase price has been paid.
7. Catherine G. Armston has this date delivered to the Company properly endorsed, twenty shares of common stock of W. H. Armston Company, Inc. as security for the payment of the obligation until such time as the purchase obligation is satisfied.
(Signed Catherine G. Armston
CATHERINE G. ARMSTON
W. H. ARMSTON COMPANY, INC. BY: (Signed) W. H. Armston Pres. & Treas.
On the date of this meeting the company owned free and clear the equipment involved in the transaction provided for at this meeting and owed very little on its remaining equipment. The alleged selling price of the equipment was later changed from $31,422.41, as set out, to $33,667.36. On this date the equipment alleged to have been transferred was worth substantially more than the ceiling price.
Catherine G. Armston did not have the funds necessary to make the transaction calling for the purchase by her of the machinery, and it was not until about April 2, 1943, that she and her husband went to the Bank of Clearwater and procured a loan to her in the amount of $32,000, secured by more than 50 per cent of the stock of W. H. Armston Co., standing in her name. This loan was repaid as follows: May 5, 1943, $12,000; and, July 12, 1943, $20,000. The $32,000 received from the bank was deposited by her in her personal checking account, and a check was written by her to W. H. Armston Co., and she thereupon received an alleged bill of sale of the equipment.
At the time the aforesaid loan was made, the bank had the balance sheet of W. H. Armston Co., as of December 31, 1942, showing surplus and undivided profits of $278,371.16, and on that date the corporation had approximately $21,000 cash on deposit, $15,000 of which was with the Bank of Clearwater. The bank would not have loaned the money to Catherine G. Armston on the security of the stock if the corporation's credit had been strained.
The equipment involved in the aforesaid transaction would not have been put on the market even if the company could have sold it for more than the ceiling price. It would not have made a sale to an outsider.
Following the alleged sale to Catherine G. Armston of the items of equipment here involved, the corporation allegedly rented the equipment back from her. The corporation had been renting some equipment from other equipment owners in 1942 and continued renting equipment from other equipment owners during the year 1943 and 1944. All amounts claimed as rental during the taxable years in issue, both those paid to Catherine G. Armston and those paid to other equipment owners, were at OPA ceiling price rates. Catherine G. Armston and other equipment owners were paid at the same rates for like equipment. Amounts paid and accrued to Catherine G. Armston in 1943 by W. H. Armston Co., as claimed rental of equipment, were as follows:
+--------------------------------+ ¦February ¦$6,322.99 ¦ ¦ +---------+-----------+----------¦ ¦February ¦1,350.00 ¦ ¦ +---------+-----------+----------¦ ¦March ¦5,704.05 ¦ ¦ +---------+-----------+----------¦ ¦ ¦ ¦$13,377.04¦ +---------+-----------+----------¦ ¦April ¦$6,784.41 ¦ ¦ +---------+-----------+----------¦ ¦May ¦6,553.00 ¦ ¦ +---------+-----------+----------¦ ¦June ¦6,553.00 ¦ ¦ +---------+-----------+----------¦ ¦ ¦ ¦$33,267.45¦ +---------+-----------+----------¦ ¦July ¦6,553.00 ¦ ¦ +---------+-----------+----------¦ ¦August ¦6,553.00 ¦ ¦ +---------+-----------+----------¦ ¦September¦6,533.00 ¦ ¦ +---------+-----------+----------¦ ¦October ¦6,533.00 ¦ ¦ +---------+-----------+----------¦ ¦November ¦6,533.00 ¦ ¦ +---------+-----------+----------¦ ¦December ¦* 6,533.00¦ ¦ +---------+-----------+----------¦ ¦ ¦ ¦59,128.41 ¦ +---------+-----------+----------¦ ¦Total ¦ ¦72,505.45 ¦ +--------------------------------+ FN* Approximate
The amounts accrued on the books of the corporation for alleged rentals to Catherine G. Armston for the years 1944 and 1945 on the equipment in question were $48,861.75 and $46,763.50, respectively. She allegedly bought additional heavy equipment during 1944 and 1945 at the respective costs of $12,485.72 and $400, which it is claimed that she rented to W. H. Armston Co. None of this equipment is claimed to have been acquired from W. H. Armston Co., and it does not appear that any of the rentals the deduction of which is in dispute were paid on this equipment.
The corporation kept its books and records and reported its income upon the accrual basis, while Catherine G. Armston kept her books and reported her income upon the cash basis. In so doing, she reported all the alleged rentals as income in the year they were paid to her.
About 90 per cent of the work done by W. H. Armston Co., from the time her war started, was on Government contracts. It paid the ordinary costs of operating any equipment which it rented. This included paying for all oil, fuel, grease, and ordinary operating repairs. If major repairs were required, they were made by or charged to the equipment owner. S. A. Davis supervised the making of repairs upon the equipment W. H. Armston allegedly sold to Catherine G. Armston and also supervised its physical care. Davis has been with the W. H. Armston Co. for about 24 years. His salary during the years here involved was at an annual rate of approximately $5,200. There was no difference in his duties with respect to the equipment before and after the alleged transfer. Davis has a close personal feeling for W. H. Armston, and feels more like a sone of the latter than an employee. Catherine G. Armston did not supervise Davis's work, but left him to use his own judgment in the care of the equipment allegedly acquired by her. She paid Davis in December 1943, $1,200; 1944, $645; 1945, $700. She also paid small amounts each year, except in 1943, to Marjorie James and Lucille Smith, also employees of W. H. Armston Co., who kept a small set of books for Catherine G. Armston. They kept her books whenever it was convenient. She did not supervise their work. The depreciation allowances on machinery shown on the books were figured by someone else and handed to the girls for posting. One took care of the cash and deposits and made out checks for Catherine G. Armston; the other did the posting. Catherine G. Armston did not pay either girl in 1943, but paid each girl $150 in 1944 and $200 in 1945. Among other things, the girls made up monthly rental statements for her rendered to W. H. Armston Co., and Lucille Smith kept Catherine G. Armston's household accounts and made out checks to pay some of them.
W. H. Armston Co. paid no dividends from the date of its organization through the year 1945 except a stock dividend by which the number of shares of its issued capital stock was increased from 35 to 50 on April 8, 1943.
The amount of officers' salaries deducted, net profit or loss reported, with the tax liability, as shown by petitioner W. H. Armston Co.'s Federal tax returns for the years 1930 through 1942, were as follows:
+---+ ¦¦¦¦¦ +---+
Amount of Year officers' Net profit salaries or (loss) Tax deducted reported reported 1930 None None None 1931 None None None 1932 $2,000 ($126.47) None 1933 5,000 785.05) None 1934 12,000 1,574.38 $216.48 1935 5,400 (3,181.46) None 1936 7,500 (3,758.91) None 1937 8,500 1,922.94 277.68 1938 5,000 (318.79) None 1939 8,500 3,466.01 454.66 1940 12,000 12,014.83 2,010.99 1941 12,000 20,603.66 4,877.68 1942 24,000 90,935.11 52,445.80
The amounts reported as salary in each of the above years were to W. H. Armston. In 1942 Catherine G. Armston drew a salary of $2,000, but drew no salary in any other year.
W. H. Armston Co. never used its war contracts as collateral for borrowing money. It financed its operations by borrowing from the Bank of Clearwater and the Bank of Dunedin. At times it occasionally borrowed money from W. H. Armston.
Under state law, the Bank of Clearwater could lend up to 10 per cent of its capital stock of $200,000, or $20,000, on an open account with no security. It could lend on proper collateral up to 25 per cent of its capital, or $50,000. On April 2, 1943, the date the loan was secured by Catherine G. Armston from that bank, as hereinbefore detailed, W. H. Armston Co. had no loans with the Bank of Clearwater, although it had had one of $15,000 in the preceding February and later had two, one of $10,000 and one of $5,000 in August. Subsequently, in the same year, Catherine G. Armston, on December 15, 1943, borrowed $15,000 from the same bank without collateral.
Additional expenses allowed by respondent to W. H. Armston Co., resulting from the disallowance of rental payments, were as follows:
+---+ ¦¦¦¦¦ +---+
1943 1944 1945 Salaries $1,200.00 $900.00 $1,100.00 Interest 400.56 181.58 5.34 Depreciation 14,401.94 14,940.81 4,829.79 Repairs 3,883.88 9,272.57 9,867.26 Total 19,886.38 25,294.96 15,802.39
OPINION.
LEECH, Judge:
The principal issue relates to the propriety of the respondent's action in disallowing petitioner W. H. Armston Co., deductions in the respective taxable periods for the amounts paid or accrued as rentals for the use of certain equipment under an agreement with Catherine G. Armston. Sec. 23(a)(1)(A), I.R.C.
Of course the mere designation of these amounts as rental does not legally characterize them as such. Nor does the fact that as between the company and Mrs. Armston, the parties to the agreement, the obligation to pay may have been enforceable, render the payment deductible as rent or otherwise under section 23(a)(1)(A). Interstate Transit Lines, 44 B.T.A. 957; affd., 130 Fed.(2d) 136; affd., 319 U.S. 590; Deputy v. duPont, 308 U.S. 488.
The question here is whether, in fact, the payments in controversy were deductible as rent or otherwise, under the cited statute. In answering that question, one fundamental inquiry would seem to be whether, in fact, i.e., for tax purposes, petitioner W. H. Armston Co.'s right to use the equipment in controversy during the taxable periods belonged to it as an incident of its admitted original ownership of the equipment, or by reason of the purported lease from Catherine G. Armston. The answer to this inquiry depends, we think, on whether, under the present circumstances, the alleged sale by petitioner W. H. Armston Co. to Catherine G. Armston may be recognized as transferring the unrestricted control and use of the equipment. In our opinion, that ‘sale‘ can not be so recognized.
The purported sale of the equipment to Mrs. Armston and the leasing back of the property to the corporation were not isolated transactions. They were, as planned, integral steps in a single transaction and must be so considered here. Cf. Commissioner v. Ashland Oil & Refining Co., 99 Fed.(2d) 588; certiorari denied, 306 U.S. 661; Diescher v. Commissioner, 110 Fed.(2d) 90; certiorari denied, 310 U.S. 650; Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179; Heller v. Commissioner, 147 Fed.(2d) 376; certiorari denied, 325 U.S. 868; Koppers Coal Co., 6 T.C. 1209. So considered, we find it to be nothing more than a mere assigning of corporate income to her. The record, we think, amply supports such premise.
W. H. Armston Co. was engaged in construction work, chiefly road building, cleaning land, and removing dirt, and, during the rearmament program incident to World War II, in the construction of air fields. It owned a considerable amount of heavy equipment suitable to the work in which it was engaged. Of its outstanding capital stock, 60 per cent was then owned by Catherine G. Armston and 40 per cent by her husband, W. H. Armston. As of December 31, 1942, the corporation's financial statement showed surplus and undivided profits of $278,371.16. Due, however, to the purchase of a considerable amount of heavy equipment, its working capital had been reduced. The situation was discussed between Armston and his wife, with the result that a plan was adopted in substance as follows: Mrs. Armston agreed to purchase specified heavy equipment then owned by the corporation, with the understanding that the corporation would lease it from her at the ceiling rental rate fixed by the Office of Price Administration.
Mrs. Armston had no substantial funds with which to make the purchase of the equipment which the corporation purported to sell. The funds which Mrs. Armston borrowed from the bank for the alleged purchase were actually repaid from moneys earned by the use of the equipment under contracts which the corporation was then performing. At the time the arrangement was entered into, both Mrs. Armston and her husband well understood that the current earnings from the use of such equipment would enable the loan to be repaid in the course of the next two or three months. The agreement became effective on April 1, 1943, and by July 1, 1943, the alleged rentals paid to Mrs. Armston aggregated $33,267.45, whereas the agreed purchase price was $33,667.36. On April 1, 1943, when the transaction became effective, the corporation had already set aside $13,377.04 in earnings, which were ultimately paid to Mrs. Armston as alleged rentals. Very shortly after Mrs. Armston paid over the proceeds of the loan to the corporation, it repaid a loan of $15,000 to Armston. Also in the month of April, the corporation paid to Mrs. Armston the additional sum of $6,784.41 as alleged rentals. These amounts aggregate $35,161.45, which is considerably in excess of the consideration for the purported sale.
Thus the corporation, instead of receiving the alleged needed working capital, in effect, as was intended from the inception of the transaction, furnished the funds with which Mrs. Armston is said to have purchased the equipment from petitioner W. H. Armston Co. And the contention that this petitioner was benefited by receiving needed working capital is obviously contrary to the fact.
We conclude that there was no presently recognizable sale or transfer of the right to the use of the equipment to Mrs. Armston, that petitioner corporation never in fact parted with that right, and that thus no valid obligation on the part of the corporation to pay rentals to Mrs. Armston existed. In such situation, the payment of so-called rentals did not constitute ordinary and necessary expenses of carrying on the business of petitioner corporation within the purview of section 23(a)(1)(A) of the Internal Revenue Code. These alleged rental payments were in effect distributions of corporate earnings in the nature of cash dividends.
The facts in the instant case are indistinguishable in principle from those involved in the case of Ingle Coal Co., 10 T.C. 1199. There a corporation was mining coal under a 20-year lease providing for the payment of a 5-cent royalty to lessor. The stockholders entered into a plan to dissolve the corporation and distribute the mining lease in kind to the stockholders. As a part of the plan, the stockholders were to form a new corporation, to which the mining lease was to be transferred under an agreement to pay its stockholders an overriding royalty of 25 per cent. We held the payment of these alleged overriding royalties was, in fact, a distribution of earnings, and denied the new corporation a claimed deduction of the amount of the overriding royalty as not constituting an ordinary and necessary expense of carrying on its business under section 23(a)(1)(A) of the code. A similar rationale has been applied in many cases involving transactions of like import. The Ingle Coal Co. case, supra, was followed in Gramberg Equipment, Inc., as late as 11 T.C. 704 (Oct. 28, 1948). See also Smith v. Hoey (Dist. Ct. N.Y.), 34 A.F.T.R. 1704, unreported officially; affd., 153 Fed.(2d) 846; Manning v. Gagne, 108 Fed.(2d) 718; Deputy v. duPont, supra; Paul G. Greene, 7 T.C. 142; A. A. Skemp, 8 T.C. 415. We are aware of the decision of the Circuit Court of Appeals for the Seventh Circuit in the Skemp case (168 Fed.(2d) 598) reversing this Court. However, we respectfully refrain from following that court, and adhere to our own decision. See Interstate Transit Lines v. Commissioner, 319 U.S. 590; Deputy v. duPont, supra. On this issue we sustain the respondent's determination.
This conclusion renders moot the further issue respecting the respondent's allowance of a claimed operating loss in 1945 as a carryback to the year 1943, and the further issue respecting his refusal to show a claimed unused excess profits tax credit for 1945 as a carryback to 1943. The concessions of the respective parties as to a certain other issue will be given effect in the recomputation under Rule 50.
In Docket No. 14186, in which Catherine G. Armston is the petitioner, the contention is made that, if the corporate petitioner is denied a deduction of the amounts paid or accrued as rentals, an overpayment be found with respect to her, since she paid the tax upon the amounts paid to her as rentals. We do not agree with this contention. The payments which she received from the corporation were, as we have held, in fact distributions of corporate earnings to her and were made without restriction upon her right to use and enjoy the same. They, therefore, constituted taxable income to her. We therefore sustain the respondent's determination in including such amounts in her income.
Reviewed by the Court.
Decisions will be entered under Rule 50.
BLACK, J., concurring in the result only: I concur in the result reached by the majority opinion, but I do not concur in all that is said in the opinion.
I agree that the transactions between W. H. Armston Co. and Catherine G. Armston relating to equipment allegedly sold by the corporation to Catherine and in turn leased back by her to the corporation seem to fall in principle within the ambit of Ingle Coal Co., 10 T.C. 1199; now on review, C.A., 7th Cir. I think that case was correctly decided and furnishes authority for the result reached by the majority opinion here.
I do not agree that the facts in A. A. Skemp, 8 T.C. 415, cited in the majority opinion, were at all similar to those here. I dissented in the Skemp case and pointed out the reasons upon which I based my dissent. These need not be repeated here. It is sufficient to say that I do not agree that the Seventh Circuit erred in reversing A. A. Skemp, supra. On the contrary, I think its reversal was correct. Therefore, while agreeing that the result here reached is justified under the authority of Ingle Coal Co., supra, I do not agree with the majority opinion wherein it says:
* * * We are aware of the decision of the Circuit Court of Appeals for the Seventh Circuit in the Skemp case (168 Fed.(2d) 598), reversing this Court. However, we respectfully refrain from following that court, and adhere to our own decision. * * *
I do not think there is any occasion for that to be said in the instant case, and I do not wish to be understood as agreeing to it. Therefore, I concur in the result only. ARUNDELL, J., dissenting: It would seem to me that the question posed in this case is whether or not there was a definitive disposition of the machinery by the corporation to Catherine Armston. If, as a result of the transaction, Mrs. Armston became the owner of the property, the rental paid for its use in the business, at OPA prices, would seem to constitute an ordinary and necessary expense. The reason advanced for concluding that the rental may not be deducted is that the sale to Catherine Armston was coupled with an agreement to lease the property back to the corporation, and the net effect of such a transaction is that the seller continues ‘for tax purposes‘ to own the property. It is true that this reasoning finds support in A. A. Skemp, 8 T.C. 415, but that decision was reversed by the Seventh Circuit Court of Appeals in Skemp v. Commissioner, 168 Fed.(2d) 598, and, as in my opinion the reasoning of the higher court is correct, I disagree with the conclusion reached by the majority in this case. The majority opinion recognizes that as between the parties to the transaction the obligation of the company to pay a rental may be enforced.