Summary
holding that a taxpayer who, as majority shareholder, paid rent obligations on behalf of a corporation, was not carrying on a trade or business and only made the rent payments to enhance his interest in a different, related entity that directly benefited from the success of the corporation; because the payments were made to enhance his interest in the related entity, the expenditures were required to be capitalized
Summary of this case from Simpson v. Comm'r of Internal RevenueOpinion
Docket No. 90048.
1963-09-13
JEAN U. KOREE AND HELEN B. KOREE, PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Richard Henry Pershan, for the petitioners. William F. Chapman, for the respondent.
Richard Henry Pershan, for the petitioners. William F. Chapman, for the respondent.
Held, expenditures made by T in behalf of a Cuban corporation which he was promoting were not deductible as business expenses. Sec. 162, I.R.C. 1954. T was not in the business of promoting corporations, nor were the expenditures related to any trade or business carried on by him. They were made primarily to protect or enhance the value of his stock in the Cuban corporation or to enhance the value of an American corporation under his sole control which stood to profit greatly if the Cuban venture were brought to fruition; such payments were capital in nature as to T.
The Commissioner determined deficiencies in petitioners' 1956 and 1957 income tax in the amounts of $1,665.86 and $1,924.10, respectively. The principal issue is whether they are entitled to deduct as business expenses rentals paid by the male petitioner in respect of property leased to a Cuban corporation which he was promoting. The resolution of a subsidiary issue relating to medical expense deductions for 1957 depends upon the decision with respect to the principal issue.
FINDINGS OF FACT
Some of the facts have been stipulated, and, as stipulated, are incorporated herein by reference.
Petitioners, husband and wife, are residents of New York City. They filed joint income tax returns for the years 1956 and 1957 with the district director of internal revenue, Upper Manhattan, New York. The husband, Jean U. Koree, who will hereinafter be referred to as the petitioner, was born in Roumania. He has resided in the United States since 1919, and became a citizen of this country in 1943.
From 1945 to 1959, petitioner was employed by the Jacques Loewe Research Foundation, hereinafter referred to as the foundation. He was its president, chief executive officer and consultant, and he handled its finances. It performed medical research work for the American Cyanamid Co. and employed six chemists. Petitioner supervised the work of these chemists. The compensation for his services was $1,000 per month in the early years and $1,500 per month in the later years. During the years 1956 and 1957 his compensation amounted to $18,000 per annum and was the only earned income received by him during those years. He devoted about one-half of his time to his services for the foundation. The record does not disclose whether the foundation was a charitable corporation, whether it had any stock outstanding, or who, if anyone, had any equitable or legal interest therein.
Petitioner is neither a physician nor a chemist. He does not appear to have had any formal education in either of these fields. However, he has acquired some knowledge in the chemical field by experimentation, and has obtained some patents. He helped to develop a process for the manufacture of glycerine out of molasses. He organized and has been associated with the Glycerine Corporation of America since about 1940 or 1941, and is its president. It is a holding company for patent rights for the manufacture of glycerine. The American Viscose Corp. had ‘turned over’ to the Glycerine Corporation of America ‘all their patents in the glycerine field.’ Petitioner has never received a salary from the Glycerine Corporation of America. It has never issued any stock, but petitioner is the sole person in control and could cause all the stock to be issued to himself. It is his corporation.
Beginning in about 1954 petitioner went to Cuba from time to time for several years for the purpose of promoting the establishment of a plant in that country capable of producing 20 million pounds of glycerine a year under patents held by the Glycerine Corporation of America. During these visits he conferred with Cuban Government officials concerning the formation of a Cuban corporation to own and operate the plant, the allotment of a molasses quota at less than market price, the acquisition of land for the plant, arrangements for water supply, financing, etc. He estimated that the project would require a total investment of $10 million, $8 million for the erection of the plant and $2 million for working capital. This money was to be raised by having the Cuban Government invest $5 million in bonds or preferred stock of the new Cuban corporation, and by the sale of $5 million of its stock in the United States or elsewhere. The Glycerine Corporation of America was to license patents for the production of glycerine held by it to the new Cuban corporation and receive from the latter a royalty of 2 percent of the sales price of the glycerine sold. Petitioner anticipated that Glycerine Corporation of America would receive a substantial amount of royalties as a result of this project. In 1954 he caused Compania Cubana de Glicerina (Glycerine Corporation of Cuba) to be organized under the laws of Cuba for the foregoing purposes. He also expected to receive from the Cuban corporation a contract of employment as a consultant, engineer, or adviser at a substantial salary.
In December 1954, the Cuban Government enacted ‘Law-Decree No. 1882’ which provided, in part, as follows:
ARTICLE 1. Of the final or blackstrap molasses with a 52% or higher sugar content produced during the coming crop and thereafter in future crops, there shall be segregated, to be delivered in the manner and at the times required by the industrial concerns producing glycerine from molasses, up to 20,000,000 gallons of 52% final molasses, or its equivalent, every year.
ARTICLE 6. The Cuban State through the ‘Fund for Economic and Social Development‘ and for the account of the same, may grant loans with first mortgage security to be used exclusively for the development of the glycerine production industry and of other byproducts of blackstrap molasses, up to the sum of $5,000,000.00, provided the natural or juridical persons who apply for the same show to the satisfaction of the ‘Banco Nacional de Cuba’ that they are financially solvent and, as an essential condition, that they have at their disposal, irrevocably, an amount of money at least equal to that which they are applying for as the State contribution. Said mortgage loan may not be granted for a period greater than fifteen years nor shall it bear interest higher than 4% per annum.
The Cuban State may also, at the election of the ‘Banco Nacional de Cuba‘, render said financial assistance with a view to the development of said industry through the purchase of its fixed dividend preferred stock to the extent of up to 50% of the subscribed and paid up capital of the industry established under the terms of this Law-Decree. In this case the Cuban State or the ‘Fund for Economic and Social Development’ may not sell the said preferred stock until three years after the industry has been operating and, before disposing thereof, shall offer it to its original issuer, who shall be allowed a period of six months to acquire the stock prior to any other person or concern.
Petitioner purchased 10 shares of stock of Compania Cubana de Glicerina and paid $1,000 therefor. Eight of these shares were issued to petitioner, one to his attorney, and one to the secretary of the corporation, as incorporators. The $1,000 was used for organizational expenses. None of the corporation's stock was ever purchased by the Cuban Government or by any persons, other than petitioner, in the United States or elsewhere, and it never acquired any funds to engage in business.
In May 1955, petitioner arranged for a lease of 37 acres of land, bordering on the Bay of Matanzas, to Compania Cubana de Glicerina for a term of 50 years. The least provided that the Cuban corporation pay a rental of $500 per month within the first 10 days of each month and that in the event the rental was not paid within that period the lessor could proceed to dispossess the lessee. No plant of any kind was ever built on the leased property.
Compania Cubana de Glicerina did not have any funds and could not pay the $500 per month rental. Petitioner did not want the corporation to lose the right to use the land because it was an ideal site for a glycerine plant, and, during the years 1956 and 1957, he paid the rent each month from his funds. Those payments, including the cost of transmitting them to Cuba, amounted to $6,019.80 in each of the years 1956 and 1957. There was never any agreement providing for the reimbursement to petitioner of the amounts so expended or for the issuance of any stock to him in return therefor.
Petitioner discontinued the rental payments when the Castro regime took over in Cuba and the Cuban corporation lost the right to use the leased land. He never recovered the amounts which he expended for rental of the land leased by the corporation or received any other consideration therefor.
In his income tax returns for both 1956 and 1957 petitioner deducted the amount of $6,019.80 as ‘Expenses of maintaining rights for income project.’ Respondent disallowed the claimed deduction.
OPINION
RAUM, Judge:
We cannot agree that the rent paid by petitioner in respect of The cuban corporation's obligations under the lease constituted expenses incurred by him ‘in carrying on’ his ‘trade or business' within section 162, I.R.C. 1954, as urged by him. He relies on no other statutory provision.
Although petitioner described his occupation on his income tax returns as an ‘Industrial Engineer and Consultant,‘ these words are misleading. He had a continuous position as president of the foundation at a fixed salary. During the years before us he did not receive any fees or salaries from any other source, nor does it appear that he held himself out as a consultant or otherwise or that he offered his services to potential clients or to anyone else for a fee or other compensation. He has not shown that he was engaged in any business or occupation other than as a salaried officer or employee of the foundation. And the expenditures in question certainly did not relate to that salaried employment. Nor is there any suggestion that petitioner was in the business of promoting corporate enterprises so as to furnish a basis for the deduction of promoter's expenses in carrying on such business. Cf. Whipple v. Commissioner, 373 U.S. 193, 202-203. The business of the Cuban corporation was not his business within the meaning of the statute. Cf. Deputy v. du Pont, 308 U.S. 488; Dalton v. Bowers, 287 U.S. 404.
The present case is to be sharply distinguished from Lou Levy, 30 T.C. 1315, 1329, relied upon by petitioners, where the expenditures in question were directly related to the business carried on by the taxpayer. Charles J. Dinardo, 22 T.C. 430, and Cubbedge Snow, 31 T.C. 585,
also relied upon, are similarly distinguishable.
The Cubbedge Snow and Dinardo cases must in any event be read in the light of the later decisions in S. M. Howard, 39 T.C. 833, and Charles Oran Mensik, 37 T.C. 703, 749-750.
There is, however, an even more fundamental ground for the disallowance of the deduction, namely, that the expenditures were predominantly capital in nature.
Without doubt petitioner intended to profit in some fashion from the glycerine venture and it was for that reason that he paid the rentals in question. But those payments represented, as to him, capital expenditures. In the first place it was he who had purchased all of the then outstanding stock of the Cuban corporation, and he owned all of that stock during the tax years except two qualifying shares. Plainly, an outlay by a stockholder in behalf of his corporation, absent any fixed obligation for repayment,
is generally regarded as a contribution to capital which should be added to the basis of his stock. Cf. Menihan v. Commissioner, 79 F.2d 304 (C.A. 2).
The parties have stipulated that there was no ‘agreement‘ for reimbursement, and also that there was no ‘agreement‘ providing for the issuance of stock in return for the expenditures in question. As to the latter, many a capital contribution does not involve the issuance of any stock. Petitioner already was the sole beneficial stockholder at the time of the expenditures. Moreover, even though there was no ‘agreement‘ for the issuance of any stock in respect of the rentals paid by him, it was far from clear, in view of his dominant position, that additional stock might not in fact be issued to him to reflect such payments at a later time when stock might be offered for sale to outsiders generally. There is no assurance whatever on this record that the advances in question would not ultimately be reflected in shares of stock owned or to be owned by petitioner.
In the second place, it must be remembered that petitioner was the sole owner of the Glycerine Corporation of America which controlled the patents that were to be used by the Cuban corporation in the proposed venture, and the plan called for royalties to be paid to the Glycerine Corporation of America on the Cuban corporation's entire production of up to 20 million pounds of glycerine a year. Here, then, were payments by petitioner in furtherance of a venture calculated to enrich the Glycerine Corporation of America and thus to enhance his interest therein. For this reason alone the payments may not be regarded as ordinary expenses but must be treated as capital in nature. We deem it of no moment that stock had not yet been issued by the Glycerine Corporation of America. Petitioner was its organizer and president; he was in complete control; and could cause its stock to be issued to himself at will. It was his corporation, his asset, and any enhancement of its value meant a corresponding enhancement of his proprietary interest therein.
The blunt realities of the situation before us disclose that the success of the Cuban venture was directly related to capital assets of the petitioner, whether they be regarded as stock in the Cuban corporation or ownership of Glycerine Corporation of America or both. And the payments in respect thereof were capital outlays as to him rather than ordinary business expenses.
To be sure, there was testimony that petitioner made the expenditures in order to obtain a contract of employment from the Cuban corporation as a consultant or adviser, and indeed we have made a finding that he expected to receive such contract of employment. However, apart from the doubt whether such purpose might justify the deduction,
we must take that testimony with at least a grain of salt. We observed petitioner and listened to the testimony, but we were not convinced that the expectation of a contract of employment did in fact motivate his making the advances. We do not doubt that petitioner contemplated the possibility of serving the corporation at some future time, and that such service would be well compensated. But, as we view the evidence, the possibilities of very great enhancement of his proprietary interests loom too large to be ignored as the dominant reasons for the expenditures. We think that the possibility of being retained as a consultant or in some other capacity was at best merely of secondary concern to him and that he did not pay the rent of the Cuban corporation for that reason. His testimony to the contrary did not ring true. We hold that his payment of the rentals constituted nondeductible capital expenditures and that the claimed deductions were not properly allowable on this ground as well as on the ground that petitioner failed to show that they were related to a trade or business carried on by him.
Cf. S. M. Howard, 39 T.C. 833; Charles Oran Mensik, 37 T.C. 703, 749-750.
Decision will be entered for the respondent.