Opinion
Docket Nos. 11534 12517.
1948-06-7
CAMLOC FASTENER COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.J. MILLS SUMMERS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Bernard J. Long, Esq., for the petitioners. William F. Evans, Esq., for the respondent.
1. Held, that a certain sum paid by petitioner corporation in compromise and settlement of a lawsuit for damages for termination of a sales contract was an ordinary and necessary expense of petitioner's business.
2. Held, that the sum paid in compromise and settlement of lawsuit did not constitute income to the president of the corporation, who negotiated the settlement. Bernard J. Long, Esq., for the petitioners. William F. Evans, Esq., for the respondent.
The respondent determined deficiencies for the year 1941, as follows:
+-----------------------------------------------------------+ ¦ ¦Docket No. ¦Docket No.¦ +---------------------------------+--------------+----------¦ ¦Tax ¦11534 (Camloc)¦12517 ¦ +---------------------------------+--------------+----------¦ ¦ ¦(Camloc) ¦(Summers) ¦ +---------------------------------+--------------+----------¦ ¦Income tax ¦$18,544.54 ¦$54,484.79¦ +---------------------------------+--------------+----------¦ ¦Declared value excess profits tax¦7,640.50 ¦ ¦ +---------------------------------+--------------+----------¦ ¦Excess profits tax ¦42,659.87 ¦ ¦ +---------------------------------+--------------+----------¦ ¦Penalty, excess profits tax ¦10,664.97 ¦ ¦ +-----------------------------------------------------------+
The questions are: (1) Is Camloc Fastener Co. entitled to deduct in 1941 from gross income the sum of $84,748.33
FINDINGS OF FACT.
The petitioner, Camloc Fastener Co., hereinafter referred to as the corporation or as Camloc, was organized July 3, 1939, under the laws of the State of New York. Thereafter, and during the taxable year 1941, it was engaged in the manufacture and sale of fastening devices, known as ‘Camlocs,‘ for the aircraft industry. Its Federal income and excess profits tax returns were filed with the collector of internal revenue for the third district of New York. Its books of account and records were dept on the accrual basis of accounting and its returns were prepared on the same basis. The corporation was dissolved September 19, 1941, and its business was thereafter carried on in partnership form.
Petitioner Summers is an individual, residing in Englewood, New Jersey. From the date of organization of the corporation, and during the taxable year, he was president, a director, and one of the principal stockholders of the corporation. The other officers and stockholders of the corporation were petitioner's wife and David S. Kane. Summers' individual income tax return for the year 1941 was made on the cash receipts and disbursements basis and filed with the collector of internal revenue for the fifth district of New Jersey.
In the spring of 1937 Summers conceived the idea for a fastening device which thereafter became known commercially as the Camloc Fastener. On July 5, 1938, he was granted Patent No. 2,123,068.
Prior to the organization of the corporation, Summers had been in the market for someone to serve as sales agent for Camloc Fasteners, and in August or September 1937 he was introduced to Lee Skipwith. After a conference it was agreed that Skipwith would be engaged to handle the sale of Camloc Fasteners and Skipwith agreed to and did advance certain funds to defray the expenses of making models and conducting tests incident to obtaining approval of the fastener for use by the United States Army Air Corps.
Shortly after the organization of the corporation, Summers, by letter of July 7, 1939, offered to convey to the corporation all of the goods and assets of the business then operated by him, together with exclusive license in the United States and territories thereof under the above referred to patent then owned by him. The states consideration for this transfer was the issuance of 100 shares of the corporation's capital stock to Summers or his designees; the issuance of the corporation's demand note to Summers in the amount of $6,500, and the payment to Summers of 20 per cent of the net selling price of all fasteners sold by the corporation during its corporate existence. Summers' proposal was accepted by the corporation under date of July 10, 1939.
In the course of negotiations between Summers and Skipwith for an agreement to engage Skipwith as exclusive selling agent of the corporation, Skipwith insisted that the agreement be drawn up between himself and Summers, individually. This matter was brought to the attention of the corporation and Summers was authorized to enter into signing of an agreement with Skipwith either in his own name or the name of the corporation.
On July 26, 1939, pursuant to authority previously granted by the corporation, Summers entered into a sales agency agreement with Skipwith, the agreement being drawn between Summers and Skipwith, Summers being designated as the inventor and Skipwith as the sales agent. The agreement recited the advance of funds by Skipwith in reliance upon the promise that the sales agent was to have the exclusive sales rights on all products made under the Camloc patent and any supplemental patents. The parties agreed that the sales agent shall have the sole and exclusive right to sell, or offer for sale, all products and devices manufactured under the patents. It was also agreed that the sales agent should, within reason, employ his best efforts, in good faith, to sell the devices covered by the agreement. The agreement fixed the prices at which Camlocs were to be sold under the agreement and the amounts to be sold. It was agreed that the sales agent should receive as ‘compensation under this agreement a commission of twenty-two and one-half per centum (22 1/2%) of the net invoice billing-price on all devices covered by this agreement ‘ for which acceptable orders were procured by him. All actual sales expenses were to be borne by the sales agent. The parties agreed that ‘this agreement and the rights of the sales agent thereunder shall be deemed a lien and encumbrance upon‘ the patents which were the subject of the agreement, and that a copy of the agreement could be recorded in the United States Patent Office or in any foreign patent office.
At a special meeting of the corporation's board of directors held August 10, 1939, the agreement of July 26, 1939, was ratified by the corporation.
Thereafter Skipwith became the selling agent for the corporation and there were accrued and paid to him various sums on account of sales of Camlocs by the corporation.
Various differences developed between Skipwith and the corporation. On October 15, 1940, Summers advised the corporation that the sales progress of Skipwith had not worked out as anticipated and ‘requested authority to deal with the Skipwith situation as he saw fit, and to make such arrangements for selling as in his opinion would best suit the interest of the company.‘ The corporation thereupon granted Summers ‘the authority to deal with Mr. Skipwith in any way he saw fit, including the termination of the sales agreement with Mr. Skipwith, and to make such arrangements for the sale of the company's products as in his opinion, best suited the company's needs.‘
On November 7, 1940, the corporation, through Summers, advised Skipwith by letter of the termination of his employment as exclusive selling agent of the corporation.
Skipwith denied any failure on his part to live up to the terms of his agreement and stated his intention to take legal steps to hold both Summers and the corporation accountable for damages for breach of contract.
On November 25, 1940, Skipwith instituted suit in the State of New York against the corporation, Summers, and the Scoville Manufacturing Co., in which he demanded commissions on fasteners already sold, $500,000 damages for the wrongful breach of contract, a judgment that Skipwith had a lien on the patents and that the right, title, and interest of the defendants in the patents be sold at auction to satisfy Skipwith's lien. Answers were filed by the corporation and the Scoville Manufacturing Co. Summers was not served with summons and complaint in the proceeding and filed no answer.
On January 9, 1941, at a special meeting of the corporation's board of directors, Summers was ‘authorized to carry on the litigation instigated by Mr. Skipwith, either by fighting the same or settling the same as in his opinion and in the opinion of the counsel, was most desirable for the best interests of the corporation, and that he be authorized to make settlement if desirable in his own name or in the name of the corporation,‘ etc.
Negotiations were carried on with Skipwith and his attorneys in an effort to make a settlement of the litigation and an agreement was finally reached to settle the litigation for the sum of $108,000. The corporation had funds available to pay the amount of the sum agreed upon. Skipwith was concerned with the amount of taxes that would accrue if the money were all paid at one time. He and his attorney proposed a plan of settlement as set forth in the agreement of April 16, 1941, together with an escrow plan as contained in such agreement. The agreement provided that ‘skipwith hereby agrees to sell to Summers and Summers agrees to buy from Skipwith all of Skipwith's right, title and interest in said U.S. Letters Patent No. 2,123,058, and all of Skipwith's right, title and interest, if any, in the business of manufacturing and selling Camloc fasteners, or any other device covered by said patent or improvements thereon, for the price of One hundred Eight thousand Dollars ($108,000.), payable as follows:
‘Five thousand Dollars ($5,000.) on the signing of this agreement;
‘One hundred Three thousand Dollars ($103,000.) in ten (10) equal installments of Ten thousand Three hundred Dollars ($10,300.) each, payable April 1 of each year, commencing April 1, 1942.‘
As security for future payments, it was agreed that United States Government bonds of a market value of $103,000 should be deposited with the Chase National Bank of the City of New York as escrow agent.
The sum of $5,000 paid to Skipwith on the signing of the agreement was paid by check dated April 15, 1941, of Hortense G. Summers, one of the officers of the corporation and the wife of petitioner Summers, which sum was later repaid to her by the corporation. The corporation during the taxable year 1941, purchased United States Government taxable 2 1/2 per cent bonds at a total cost of $103,000, which were deposited with the Chase National Bank pursuant to the agreement of settlement. On April 25, 1941, counsel for Skipwith and for the corporation entered into a stipulation of discontinuance of the Skipwith suit. The stipulation recited that the action had been duly instituted except as to J. Mills Summers, who had never been served in the suit; that the suit had been theretofore discontinued as to the Scovill Manufacturing Co., and that a settlement had been effected between the plaintiff and defendants Summers and Camloc Fastener Co.
The first installment payment pursuant to this settlement agreement was made to Skipwith by the corporation on April 1, 1942, and the Chase National Bank released to the corporation, pursuant to the escrow agreement, $8,700 par value of bonds. Subsequent payments have been made by the bank directly to Skipwith, after selling bonds in each instance of the approximate amount of $10,300.
There were accrued on the books of the corporation to Skipwith at the date of settlement on April 16, 1941, commissions in the amount of $23,251.67. At the end of 1941 there were also accrued on the books of the corporation royalties to Summers in the amount of $67,232.49 and the sum of $7,500 to Summers as salary; said items due to Summers were deducted by the corporation, but were disallowed by respondent because not paid within 2 1/2 months after the close of the year. The corporation does not contest this disallowance.
Petitioner Summers, during the taxable year 1941, received from the corporation salary in the amount of $10,500, net royalties in the sum of $36,832.80, and as profits from the partnership for the year 1941, the sum of $15,039.46. The above amounts were included in Summers' individual income tax return for the year 1941.
We make the following ultimate conclusions of fact:
The sum of $108,000 ($23,251.67, plus $84,748.33) paid by the corporation in 1941 in settlement of the Skipwith lawsuit was an ordinary and necessary expense incurred in carrying on the business of petitioner corporation.
The sum of $84,748.33 paid as above stated did not constitute income to Summers in the taxable year 1941.
OPINION.
VAN FOSSAN, Judge:
A single issue is presented by each of the two cases here before us. Both are questions of facts. In the corporation case the question is, was the amount of $84,748.33 paid by petitioner corporation consequent on a compromise settlement with Skipwith of a suit for damages an ordinary and necessary expense of the corporation business and deductible as such, or was it a capital expenditure made in the purchase of a capital asset, therefore not deductible? Respondent confesses error as to part of the above amount originally determined, viz., $23,251.67, being that part of the compromise payment attributable to commissions due. In the Summers case, the question is, did petitioner Summers receive income in an aggregate sum of $84,748.33, said sum being the same payment actually paid to Skipwith but contended by respondent to represent a clearing of the patent owned by Summers from claims and liens? The answer to both questions is to be found in the proper characterization of the compromise payment.
Respondent contends that the compromise settlement of the lawsuit for damages was, in fact, the purchase of a capital asset. After a careful study of the record, we have concluded and found as a fact that respondent erred and that the payment did not represent the purchase of a capital asset. The contract with Skipwith made him the exclusive sales agent for the corporation, and no more. It did not purport to, nor did it, in fact, give Skipwith any interest in the ownership of the Camloc patent nor did Skipwith acquire any such interest in any other way. The simple fact is that Skipwith had no actual or direct interest in the patent at any time, and, despite the all comprehensive legal lingo of the settlement agreement, he sold nothing and had nothing to sell. It is not unusual for legal draftsmen to employ extravagant or inartful or inappropriate phases in characterizing a relatively simple transaction. Thurlow E. McFall, 34 B.T.A. 108; Inaja Land Co., Ltd., 9 T.C. 727. Thus, albeit the contract, which was drawn by Skipwith's attorney, speaks in terms of a sae of ‘Skipwith's title, right and interest in said U.S. letters patent,‘ etc., the preceding ‘Whereas‘ sets out the limit of Skipwith's interest, i.e., that ‘Skipwith claims a lien upon such patent pursuant to a contract dated July 26, 1939.‘ When the 1939 contract is examined, it reveals no granting to Skipwith of any interest in the patent. It merely gave him a ‘lien and encumbrance‘ on the patent to secure payment of unpaid obligations under the agreement. It was not a granting of property or of ownership rights in property. It gave Skipwith a right to resort to equity to enforce payments due. It follows that by the compromise agreement nothing was sold. Therefore, respondent's contention that the deal was the purchase of a capital asset by the petitioner corporation or by Summers must fail.
The above holding is practically an end of necessary discussion of the corporation case. The payment was not the purchase of a capital asset. Respondent concedes that, so far as the sum of $108,000 originally disallowed represents commissions earned, it is deductible as an ordinary and necessary expense of petitioner's business. Such commissions amounted to $23,251.67. The remainder, or $84,748.33, was in compromise of the suit for damages brought by Skipwith because of the termination of the exclusive sales contract—clearly an ordinary and necessary expense of the corporation business. International Shoe Co., 38 B.T.A. 81. There was no element of illegality or of conspiracy such as has been held a barrier to deductions in some cases. See National Outdoor Advertising Bureau, Inc. v. Helverying, 89 Fed.(2d) 878; Burroughs Building Material Co. v. Commissioner, 47 Fed.(2d) 178. There is no doubt that this compromise payment grew directly out of petitioner's business. The deduction by the corporation of the sum of $84,748.33 attributable to damages, together with the sum of $23,251.67 now conceded by respondent to be deductible, is therefore approved.
The determination of the deficiency against Summers was apparently in the nature of an anchor to windward. The sum of $84,748.33 is the identical sum disallowed by respondent as a deduction and added back to the corporate income in the above discussed case of the corporation. As to the item, the statement attached to the notice of deficiency states:
It has been determined that a certain payment designated on the records as pertaining to the matter of litigation with one Lee Skipwith, in the amount of $84,748.33, made on or about April 16, 1941 by the Camloc Fastener Company, Inc., 420 Lexington Avenue, New York, New York, did constitute the receipt by you of taxable income.
In his brief, respondent explains his position thus:
It is the contention of respondent that Summers in the transaction became indebted to the corporation in the amount of $84,748.33 advanced in his behalf, and that to the extent of the accrued liabilities due him by the corporation for royalties in the amount of $67,232.49, and unpaid salary in the amount of $7500.00, Summers received payment at least by equitable set-off. The corporation was dissolved during the taxable year, and, it appears so far as settlement of the debt to the corporation is concerned, nothing else was done. Under such conditions equity would apply the amounts due Summers on the books of the corporation to the discharge pro tanto of the debt due by him for the advancement to Skipwith.
Respondent says very little in amplification or support of the above determination. In the next paragraph of his brief following the above quoted matter, he states, ‘Summers otherwise never received payment for the royalties due or the salary unpaid. Had he in any other manner been paid or the indebtedness otherwise discharged, he would have said so when examined as a witness.‘ Speaking frankly, we confess it to be difficult to grasp respondent's theory of how the compromise payment to Skipwith made by the corporation in settlement of damages for termination by the corporation of the agency contract became income to Summers. Although the agency contract was in the name of Summers, it was so drawn only for convenience, the real party in interest being the corporation which authorized it, ratified it, and performed under it. The corporation paid Skipwith the commissions as they were earned. It produced and finished the manufactured products. In all practical aspects it assumed and performed the contract. Summers acted only as an agent for the corporation. When it came to enforcing his right, Skipwith sued both the corporation and Summers, but no service of process was made on Summers. The three parties joined in the settlement agreement, Summers acting for the corporation pursuant to prior blanket authorization. The real debtor was the corporation.
Analyzing respondent's statement of contentions above quoted, the fact is that Summers did not become indebted to the corporation in any amount. The payment by the corporation was made on its own behalf and in settlement of its own liability. Summers had acted throughout pursuant to prior authorization from the corporation and as its agent. We see n‘ basis for invoking the doctrine of equitable set-off. Similarly as to the concluding statement, the corporation did not advance the money for or on behalf of Summers, but in its own interest. As to respondent's animadversions as to Summers' testimony, we can not conjecture what Summers would have said had the facts been otherwise than they were.
The only advantage personally derived by Summers from the compromise agreement was the intangible advantage of ridding the patent of the contingent liability to respond for default of the corporation— an element not measurable in dollars. Assuming that, by some legerdemain, it be held that Summers received income in the amount of $84,748.33 when that sum was paid to Skipwith by Summers as president and agent of the corporation, which amount we have held to be deductible, the question arises, is the same amount to be again deducted from the corporation income? In short, we are unable to follow respondent's argument to any logical conclusion. We hold that he erred in his determination.
Decisions will be entered under Rule 50.