Opinion
Docket No. 18748.
1950-03-1
ASSOCIATED THEATRES CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Robert C. Coplan, Esq., for the petitioner. William R. Bagby, Esq., for the respondent.
Petitioner owns and operates a motion picture theatre in Toledo, Ohio. Its three principal stockholders were its officers and directors. In the first year of its operation none of its officers and directors were paid any salaries or compensation for their services, except $50 per week which was paid to its president and treasurer for his special services in buying and booking moving pictures films for showing in the theatre. In the second year of its operation, which was its fiscal year ended October 31, 1943, on July 12 petitioner entered into an agreement with Colony Management Co., a partnership composed of petitioner's three officers and directors, to pay them a management fee of $400 a week for their various services in management, and made this agreement retroactive to the beginning of the fiscal year. The Commissioner has allowed the weekly payments from the date of the management agreement to the end of the fiscal year as ordinary and necessary business expenses, but has disallowed the payments in so far as they were retroactive to November 1, 1942. Held, such weekly payments, including those which were retroactive to November 1, 1942, represented reasonable compensation for services actually performed and were deductible as ‘ordinary and necessary business expenses.‘ Lucas v. Ox Fibre Brush Co., 281 U.S. 115. Robert C. Coplan, Esq., for the petitioner. William R. Bagby, Esq., for the respondent.
For its fiscal year ended October 31, 1943, the Commissioner has determined a deficiency in petitioner's income tax of $568.48, a deficiency in petitioner's declared value excess profits tax of $585.79, and a deficiency in petitioner's excess profits tax of $13,280.02. The deficiencies result mainly from the disallowance by the Commissioner of $12,880 of a deduction claimed by petitioner on its return for the period in question, which is explained in the deficiency notice as follows:
(a) Under Item 29 of your tax return, Form 1120, for the fiscal year ended October 31, 1943, you deducted a total of $21,697.50 for administration and office expenses. It is held that the deduction of $617.50 for bookkeeping fees paid for the 36-week period beginning November 1, 1942 to July 11, 1943, is an allowable deduction. It is further held that the amount of $50.00 per week paid to M. S. Fine for the 36-week period from November 1, 1942 to July 11, 1943, and managing fees of $400.00 a week paid to the Colony Management Company, a partnership created on July 12, 1943, to October 31, 1943, are allowable deductions. The excess of $12,880.00 claimed by you has been disallowed on the ground that the amount thereof is not an ordinary and necessary expense within the provisions of Section 23(a) of the Internal Revenue Code.
By an appropriate assignment of error petitioner contests the correctness of the Commissioner in making the disallowance above referred to.
FINDINGS OF FACT.
Petitioner is an Ohio corporation, with its principal place of business in Cleveland, Ohio, and it was organized October 31, 1940, to engage in the motion picture theatre business in Toledo, Ohio. Petitioner's Federal income and excess profits tax returns covering its fiscal year ended October 31, 1943, were filed with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland, Ohio.
During its taxable fiscal year 1943, petitioner owned and operated the Colony Theatre in Toledo, Ohio, having leased the Colony Theatre building for a 25-year period from June 1, 1941, to May 31, 1966, and opened the theatre on or about October 31, 1941. Petitioner's officers and stockholders and their respective interests remained unchanged from the time of its incorporation through the fiscal year 1943 and were as follows:
+----------------------------------------------------------------------------+ ¦Officers ¦Stockholders and their interests¦ +-------------------------------------------+--------------------------------¦ ¦ ¦ ¦ ¦ +-------------------------------------------+------------------------+-------¦ ¦M.S. Fine, president and treasurer. ¦M.S. Fine and his family¦42 1/2%¦ +-------------------------------------------+------------------------+-------¦ ¦S.H. Stecker, vice president and secretary.¦S.H. Stecker and ¦ ¦ +-------------------------------------------+------------------------+-------¦ ¦ ¦his family ¦42 1/2%¦ +-------------------------------------------+------------------------+-------¦ ¦ ¦Louis Berman ¦15% ¦ +----------------------------------------------------------------------------+
Fine, Stecker, and Berman constituted the board of directors and Stecker and Fine were the only officers of the petitioner. After the organization of the corporation, Stecker, Fine, and Berman cooperated in the task of getting this neighborhood motion picture theatre of 1,800 seats ready for its opening in October, 1941. The board of directors of the petitioner had many informal meetings prior to the opening of the Colony Theatre and held a formal board of directors' meeting on October 14, 1941. At this meeting the following resolution was adopted:
Whereupon, on motion of S. H. Stecker, and seconded by Louis Berman, the following resolution was adopted (M. S. Fine not voting):
THAT M. S. FINE is hereby designated to be in full charge of the operation of the Colony Theatre, owned and operated by this company, and that the said M. S. Fine shall have the responsibility for the buying of all film required to be used in the operation of said theatre and the booking thereof, and, in consideration thereof, the said M. S. Fine shall receive a salary of Fifty Dollars ($50.00) per week, commencing with the opening of said theatre, for his special service of buying and booking of film for said theatre.
Before the theatre was opened for operation, it was agreed by Stecker, Fine, and Berman that the three of them would participate in the management and operation of the theatre. Their respective duties were outlined and they agreed that they would at some time in the future form a management partnership composed of the three of them and that this management partnership would manage the theatre and would be paid a fee in lieu of the payment of salaries to themselves for their services. No salaries were provided for the officers and directors as such. During the first year of operation Fine drew a salary of $50 per week for buying and booking films. Neither Stecker nor Berman drew any compensation for certain services which they performed in the operation and management of the theatre during its first year, and Fine drew nothing for his services in the management and operation of the theatre in the first year, except his weekly salary for buying and booking films.
Along toward the end of petitioner's first fiscal year of operation, which ended October 31, 1942, Fine, Stecker, and Berman discussed the terms of a partnership agreement under which they would enter into a partnership agreement under which they would enter into a partnership for the purpose of managing petitioner. The amount that petitioner would pay such partnership per week as management fee and how it should be divided among the respective partners was discussed, but not definitely agreed upon. Neither the management agreement between the petitioner and the partnership nor the articles of partnership were reduced to writing pending the outcome of decision by the Commissioner of Internal Revenue in regard to management charges by other theatre corporations which employed management partnerships.
On December 20, 1942, at a meeting of the board of directors, the following resolution was adopted:
That whereas it is highly advantageous to this company to assure the continued employment of M. S. Fine to buy and book the motion pictures exhibited at the Colony Theatre for the period of the lease that this corporation has on said theatre which lease expires on the 31st day of May, 1966.
BE IT THEREFORE RESOLVED, that S. H. Stecker, the Vice-President and Secretary of this corporation, is hereby authorized and empowered on behalf of this corporation to enter into a written contract of employment between this corporation as employer and M. S. Fine as employee for a period commencing January 1, 1943 and ending May 31, 1966 by the terms of which the said M. S. Fine will be employed by this corporation to buy and book all film exhibited at the Colony Theatre, Toledo, Ohio at a weekly compensation of $50 for the special services of M. S. Fine, and that this compensation for the buying and booking of film shall be in addition to any other amounts which the said M. S. Fine may be voted as salary as an officer of this corporation.
On July 12, 1943, Fine, Stecker, and Berman entered into a written partnership agreement, the partnership to be known as ‘Colony Management Company.‘ This agreement contains the following pertinent paragraphs:
I.
The partnership shall be known as ‘COLONY MANAGEMENT COMPANY‘, the members of the partnership being, subject to Article IV hereof, M. S. Fine and S. H. Stecker of Cleveland, Ohio, and Louis Berman of Toledo, Ohio.
II.
The business of the partnership shall consist of the rendition of booking and management advice and service to the owners of moving picture theatres and entering into and performing management agreements with such owners of moving picture theatres.
III.
The term of the partnership, effective as of November 1, 1942, shall be at the will of the partners, subject to the provisions of Article IV hereof.
VI.
All profits and losses resulting from the operations of the partnership shall be shared by the partners in the following proportions, namely: M. S. Fine, fifty per cent (50%) thereof, S. H. Stecker, thirty-seven per cent (37%) thereof and Louis Berman, thirteen per cent (13%) thereof.
VII.
In view of the fact that all of the partners are engaged in other business ventures, no one of the partners shall be bound to devote all of his business time to the affairs of the partnership, but each partner shall devote so much of his time thereto as may be necessary to the proper and efficient conduct of the business of the partnership.
On the same day that the written articles of partnership were signed by Fine, Stecker, and Berman, a management agreement was entered into by petitioner and the partnership. Pertinent paragraphs of this agreement are as follows:
THIS MANAGEMENT AGREEMENT made at Cleveland, Ohio, effective as of the 1st day of November, 1942, between ASSOCIATED THEATRES CORPORATION, hereinafter referred to as ‘ASSOCIATED‘ and COLONY MANAGEMENT COMPANY, a partnership, hereinafter referred to as ‘MANAGEMENT‘,
WITNESSETH, THAT
WHEREAS, ASSOCIATED is Lessee under an Indenture of Lease dated November 7, 1940, of a certain motion picture theatre known as the Colony Theatre in the City of Toledo, Ohio, and requires skilled and experienced advice and service for the purpose of successful management; and
WHEREAS, the members of Management are experienced and skilled in the various aspects of management of moving picture theatres; and
WHEREAS, one of the members of Management has heretofore rendered advisory service to Associated upon a basis of nominal compensation with the understanding that a management contract would be entered into retroactive to November 1st, 1942.
NOW, THEREFORE, it is hereby mutually agreed between Associated and Management as follows:
I.
This Agreement shall be effective as the first day of November, 1942, and shall continue in force until terminated by written notice of termination delivered by one of the parties to the other not less than sixty (60) days before the date of termination fixed in such notice.
III.
Associated hereby employs Management to perform and Management agrees to perform for Associated the following services:
(a) To furnish advice concerning the policies and generally concerning all aspects of management of said moving picture theatre:
(b) To make recommendations as to the selection, and if necessary as to the discharge, of all personnel employed by Associated:
(c) To attend to the purchasing and booking of all film for said moving picture theatre:
(d) To adjust and settle for Associated and in its name any and all claims or demands of any kind or character for or against Associated arising in connection with the business of Associated, and, if necessary, in the opinion of Management, to prosecute or defend in the name of Associated, any and all actions at law or in equity arising out of said business and generally to advise Associated in regard to any and all such matters.
(e) To maintain books and records of all receipts and disbursements of Associated which, together with any and all contracts, commitments, or engagements, entered into by Management in behalf of Associated, shall at all reasonable times be open to inspection and audit by Associated acting by any of its officers or by auditors, accountants, attorneys, or other persons employed by Associated for such purpose.
(f) To maintain an office in Cleveland, Ohio, at the sole expense of Management at which all requisite books and records of Associated shall be kept and maintained. Management shall pay all expenses incident to the maintenance of said office including salaries of auditors, bookkeepers and other clerical help located therein. Said office shall be available to Associated at all reasonable times for the holding of stockholders, directors, and other business meetings.
V.
For the services herein required to be rendered by Management, Associated agrees to pay to Management and Management agrees to receive and accept in full payment thereof from Associated the sum of Four Hundred Dollars ($400.00) per week so long as this Agreement shall remain in effect.
On July 28, 1943, the petitioner paid to the management partnership the sum of $15,200 for the services of the partnership form the beginning of the fiscal year November 1, 1942, to the date of the signing of the check. This check included $14,400 in payment for 36 weeks at $400 a week retroactive from July 12, 1943, to November 1, 1942. After the execution of the written agreement between the management partnership and the petitioner, petitioner paid to that partnership $400 a week for the remainder of that fiscal year, and these sums were allowed by the respondent as a deduction for the fiscal year.
The management partnership, Colony Management Co., reported in its partnership information income tax return the receipt by it of $20,800 gross income for the fiscal year November 1, 1942, to October 31, 1943, and divided it in the respective percentages that were provided in the partnership agreement.
From November 1, 1942, to July 12, 1943, Fine was paid $50 a week for buying and booking films for the theatre during that period, but the total of these drawings, to wit, $1,700 was paid back to the partnership by Fine and the partnership in turn repaid the $1,700 to the petitioner in accordance with a prior oral agreement entered into between Fine and the other interested parties.
During the period November 1, 1942, to July 12, 1943, Fine, Stecker and Berman were the only persons rendering managerial services to the petitioner and none of them were paid for these services during that time, except Fine (for buying and booking films). The retroactive payment of $14,400 made on July 28, 1943, was intended as payment for the services of these three to the corporation covering the period November 1, 1942, to July 12, 1943, and was reasonable compensation for services actually performed.
OPINION.
BLACK, Judge:
The petitioner states the issue which is involved in the instant case in the following language in its brief.
This case is concerned with the disallowance by the respondent of $12,880.00 of management expenses claimed as a deduction by the petitioner for the fiscal year November 1, 1942-October 31, 1943. Of this sum, petitioner concedes that $897.50 was properly disallowed but respectfully submits that $11,982.50 should have been allowed as a deduction, and that in respect of this amount, no deficiency in income or excess profits tax is payable by the petitioner.
Respondent in his brief states the issue as follows:
Did the Commissioner properly disallow deductions of $14,400.00 and $280.00 claimed by petitioner in its 1943 return as management and bookkeeping fees, respectively?
Both parties agree that the applicable statute is section 23(a)(1)(A) of the Internal Revenue Code and that the applicable regulations are Regulations 111, section 29.23(a)-1.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) IN GENERAL.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *SEC. 29.23(a)-1. BUSINESS EXPENSES.— Business expenses deductible form gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business, except the classes of items which are deductible under sections 23(b) to 23(z), inclusive, and the regulations thereunder. * * * Among the items included in business expenses are management expenses, commissions (but see section 29.24-2), labor, * * *
Petitioner's officers, as such, drew no salaries. During the first year of operation its president and treasurer, M. S. Fine, drew $50 a week. It is clear from the evidence that this $50 a week was not in payment for his services as chief executive officer of petitioner, but was in payment for his specific services in buying and booking films for showing in petitioner's theatre. On July 12, 1943, a management agreement was entered into by and between petitioner and a partnership, styled ‘Colony Management Company,‘ which was composed of Fine, Berman, and Stecker. Under the terms of this agreement the partnership was to receive $400 a week as a fee for the management of petitioner's theatre. The things which Management was to do for petitioner under the terms of this agreement are set out in our findings of fact and need not be repeated here. The Commissioner has recognized the validity of this management agreement, except its retroactive part, in his determination of the deficiencies. He has allowed petitioner, as a deduction for ordinary and necessary business expenses, the $400 a week which petitioner paid Management from the date of the entering into the contract, July 12, 1943, to the end of petitioner's fiscal year, October 31, 1943. He has, however, disallowed the retroactive payments which were made under the terms of the contract. Therefore, it is these retroactive payments which are in controversy. As shown in our findings of fact the management agreement contained the following retroactive provisions:
This Agreement shall be effective as of the first day of November, 1942, and shall continue in force until terminated by written notice of termination delivered by one of the parties to the other not less than sixty (60) days before the date of termination fixed in such notice.
Under the terms of this retroactive clause of the contract petitioner paid to Management $14,400 covering 36 weeks at $400 a week to November 1, 1942. Petitioner does not claim deduction for the full amount of this $14,400. Fine, who during this period had been paid $50 a week for his services in buying and booking films, repaid to petitioner $1,700. Therefore, petitioner does not claim this latter amount as a deduction, nor does petitioner claim as a deduction bookkeeping fees which it incurred during the fiscal year aggregating $897.50. The net amount which petitioner does claim under the retroactive provisions of the management contract is stated in the first paragraph of this opinion.
As its principal authority for its contention that the retroactive payments are deductible, petitioner relies upon Lucas v. Ox Fibre Brush Co., 281 U.S. 115. In that case the president and the treasurer of the taxpayer corporation were each voted $24,000 ‘as extra compensation for their past services to this company as an officer thereof and in any other capacity.‘ While this extra compensation was paid during the taxable year 1920, the same year in which the extra compensation was voted, the services rendered were all rendered prior to the year 1920. It was the contention of the Commissioner in that case that the deduction of the extra compensation claimed by the corporation should be disallowed. The Supreme Court, in that case, held for the taxpayer on the ground that the payments were made ‘as a reasonable allowance for compensation for personal services actually rendered. The statute does not require that the services should be actually rendered during the taxable year, but that the payments therefor shall be proper expenses paid or incurred during the taxable year.‘ The Court goes on to say that the expenses in that case which were reasonable could not be attributed to any other year than the year 1920, because the corporation had no obligation to pay the money in any other year. The Court sums it up in this manner:
* * * It was deductible in the year 1920, or not at all. Being deductible as a reasonable payment, there was no authority vested in the Commissioner to disregard the actual transaction and to readjust the income on another basis which did not respond to the facts.
In the instant case the payment for personal services was made during the taxable year and was for personal services previously rendered, but rendered for the most part during the taxable year. In Ox Fibre Brush, supra, payment was made for personal services rendered in prior years. We think the Ox Fibre Brush case supports petitioner.
The Commissioner strongly argues that Ox Fibre Brush is distinguishable because in the instant case the Colony Management Co., with which petitioner made the contract, was not in existence prior to July 12, 1943, when the written articles of partnership were entered into and, therefore, there could be no valid retroactive agreement entered into with a partnership which did not have any valid existence prior to July 12, 1943.
Petitioner, on the other hand, contends that late in October, 1942, prior to the beginning of the fiscal year 1943, Fine, Stecker, and Berman agreed that they would form an oral management partnership effective November 1, 1942, that the partnership would manage the theatre during the fiscal year 1943, and that whatever management fee might be agreed upon during the fiscal year would be retroactive to November 1, 1942, the beginning of the fiscal year. Petitioner contends, however, that, even if we should fail to find that there was an oral partnership of the Colony Management Co. prior to July 12, 1943, nevertheless, petitioner is entitled to a deduction of the retroactive payments made to Colony Management Co. because they were made for services actually performed for petitioner by Fine, Stecker, and Berman during the taxable year. These three men were the partners in Colony Management Co. We think this latter contention of petitioner must be sustained. We have not felt justified in making a definite finding that an oral partnership existed under the name of Colony Management Co. from November 1, 1942, to the date of the signing of the written articles of partnership on July 12, 1943. Undoubtedly there was discussion by Fine, Stecker, and Berman concerning the formation of such a partnership and agreement that they would be compensated for their services as officers and directors of the corporation in the way of management fees and that, when and if such management fees were agreed upon during the fiscal year 1943, the agreement would be made retroactive to the beginning of the year 1942. This much seems clear to us from the evidence.
Respondent in his brief lays much stress on the fact that Fine was the one who was rendering most valuable assistance and services to petitioner in a management capacity. The evidence undoubtedly establishes that to be true, but it should be noted that the management partnership agreement provided that Fine should receive 50 per cent of the net profits of the partnership, Stecker should receive 37 per cent, and Berman should receive 13 per cent. The management fees received by these parties during the fiscal year here in question were divided in those proportions. The services rendered by the management partnership after July 12, 1943, were the same as the three officers and directors who composed the partnership had been rendering to the corporation from the beginning of the fiscal year to the date of the signing of the agreement. As we have already stated, these officers and directors of the corporation who were in charge of its business operations received no salaries as such, and it seems to us that, under the doctrine of Ox Fibre Brush Co., supra, the retroactive payments of management fees to the beginning of the fiscal year are deductible, and that this is true even though it be assumed there was no oral partnership existing prior to the signing of the written partnership agreement.
As bearing upon the reasonableness of these management fees, it is in evidence that the return of petitioner shows that after taking the deductions which were claimed on the return, including the ones here in controversy, petitioner showed a net income of $7,169.50 for the second year of its operation. The profits of petitioner have materially increased since then, and for the last fiscal year the profits were about $72,000. The management fee of $400 a week has remained the same.
As we have already stated, we do not understand that the Commissioner is contending that the management fee of $400 a week is excessive compensation to Colony Management Co. for its services in managing petitioner's theatre. He does contend, however, that the retroactive payments to November 1, 1942, do not represent ‘ordinary and necessary business expenses‘ as those terms are used in the applicable statute, and, therefore, should be disallowed as deductions. However, for reasons already stated, we think that the Supreme Court's decision in Lucas v. Ox Fibre Brush Co., supra, supports the deduction and is controlling. Petitioner is, therefore, sustained on this issue.
Decision will be entered under Rule 50.