Opinion
Docket Nos. 4255 4256.
1945-08-27
CHARLES J. WILLIAMS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.GRACE MCDONALD WILLIAMS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John S. Breckinridge, Esq., for the petitioners. E. E. Strickland, Esq., for the respondent.
The amount received by petitioner, a general agent for a group of fire insurance companies, in consideration for the cancellation of a contract under which petitioner was to obtain outright a general agency for a state in exchange for specified services to be rendered by him for a period of five and one-half years, of which there was approximately one year left to run, held, ordinary income and not capital gain. John S. Breckinridge, Esq., for the petitioners. E. E. Strickland, Esq., for the respondent.
These consolidated proceedings involve redeterminations of deficiencies in income tax for the taxable year 1941, in the following amounts: Docket No. 4255, $1,782.99, and Docket No. 4256, $2,038.44.
The issue before us is whether the sum of $20,000 received by the petitioners represents ordinary income or whether it constitutes a capital gain. If it is a capital gain, the respondent affirmatively asserts that the sum of $20,000 is the separate income of petitioner Charles J. Williams. Several adjustments made by the respondent are not in controversy.
FINDINGS OF FACT.
The petitioners, Charles J. Williams and Grace McDonald Williams, are husband and wife and reside at Dallas, Texas. They filed separate income tax returns with the collector for the second collection district of Texas. Each reported one-half of the community income and the returns were filed on an accrual basis. Charles J. Williams will hereinafter be referred to as the petitioner.
Petitioner entered into the insurance business in 1920. In about 1927 he became a special agent for the North British & Mercantile Insurance Co., Ltd., the parent corporation of a group of fire insurance companies. He moved to Dallas, Texas, in 1935, as state agent for the North British group. In that capacity he was a salaried employee and the North British group provided him with an office and paid all the expenses. In 1937 he decided to go into business for himself. He had been offered a general agency by another company, which offer he was about to accept.
The group for which he had been working offered him an increased salary if he would remain as their state agent and upon his refusal to accept two members of the group, the Commonwealth Insurance Co. of New York, and the Quaker City Underwriters of the Pennsylvania Fire Insurance Co., offered to sell him their general agency for the State of Texas, which offer he accepted.
Under date of April 16, 1937, the parties executed a contract which stated that the above companies, as sellers, owned the general agency for the respective companies in the State of Texas, and that they would sell:
(a) their right, title and interest in said General Agency, including copies of daily reports, agency lists and all other records in the possession of and owned by the sellers, but not including accounts receivable, furniture and fixtures, office equipment and automobiles;
(b) the good will thereof;
(c) any and all commissions due or to become due on policies or renewals written on or after July 1, 1937; * * *
The petitioner agreed to purchase the same, and a consideration of $1 was paid and received. The sale was to be made upon fulfillment of the following terms and conditions: Petitioner, as purchaser, agreed to continue the general agency for 2 1/2 years from July 1, 1937; to use his best ability to maintain and increase the business received by the sellers during said period and as part of the consideration for the sale, but without any additional compensation, to assume jurisdiction over and supervise business written prior to July 1, 1937, and to use his best ability to collect outstanding balances due from agents and others in connection with business written prior to July 1, 1937; to pay all general agency expenses incurred on or after July 1, 1937; and not to remove, impair, destroy, or dispose of any records, accounts, or other property of said general agency without the written consent of the sellers. The sellers agreed that all commissions on policies or renewals on business written after July 1, 1937, would belong to the petitioner; that the petitioner should have possession of the general agency on July 1, 1937, and that he should not be in default of any of the terms and conditions hereunder or under any general agency contract between the parties. The parties agreed that title should remain in the sellers until such time as the petitioner should have performed and carried out all the terms and conditions of this or any other general agency agreement between the parties during the 2 1/2-year period from July 1, 1937. The contract further provided that if the petitioner, through death, disability, or any other cause whatsoever, failed to carry out the provisions, then the sellers, at their option, could reenter the premises sold, and the petitioner agreed that in such event any increase in the premiums in force on June 30, 1937, should belong to the general agency and the sellers as liquidated damages. The contract provided for arbitration in case of disputes. On February 17, 1939, a new agreement was executed by the parties extending the period for performance to 5 1/2 years from July 1, 1937.
On the same date that the above agreement was entered into, that is, April 16, 1937, the parties executed an agreement appointing petitioner general agent of the two companies for the State of Texas. This agreement provided that, in consideration of specified duties to be performed and obligations to be assumed by him, the petitioner should receive a commission of 10 percent over the amount paid to local agents on all net premiums written through or under the supervision of the general agent, 30 percent commission on reinsurance accepted from other companies, and, in addition, 10 percent of the net profits on the business transacted under the contract each year.
On May 16, 1937, the above agreements were modified to make petitioner the general agent and to permit him to take over, as of that date, the general agency, which was then known as the Dexter Bros. & Coffman agency. He took over the records, bookkeeping statements, typewriters, file cases, etc. He purchased furniture and fixtures and an automobile and hired two employees to handle the office work.
The name under which petitioner conducted the agency was Charles J. Williams. The premium volume of Dexter Bros. & Coffman was approximately $140,000 at the time petitioner took it over. Petitioner paid out no cash for the agency which he took over.
Petitioner operated the general agency and continued to act as the general agent for the companies until December 31, 1941, at which time the parties entered into a new agreement. Under the terms of this latter agreement it was mutually agreed that the contract of sale, dated April 16, 1937, should be canceled as of December 31, 1941. The companies agreed to pay petitioner $20,000 in five equal annual installments of $4,000 each and to employ petitioner to work for the companies under the terms and conditions of an employment contract which was to be entered into coincidently with this contract. Petitioner agreed that all commissions on business after January 1, 1942, should belong to the companies; that he would pay all expenses and charges incurred or accrued before December 31, 1941; that the companies should have access to and possession of the general agency on January 1, 1942, including all records, accounts, and other property of the general agency; and that he would not enter into a general agency business in the State of Texas for a period of five years and for a further period of three years, subject to conditions specified in the employment contract. The employment contract, executed the same day, provided that the companies would employ petitioner and he was to work for a period of five years as manager of the companies' branch office for the State of Texas, beginning January 1, 1942, at an annual salary of $12,000. It further provided that the general agency contract dated April 16, 1937, should be canceled as of December 31, 1941.
Under date of December 22, 1942, the North British Mercantile Insurance Co., Ltd., and the five member companies of the North British group, including the Commonwealth Insurance Co. of New York and the Quaker City Underwriters of the Pennsylvania Fire Insurance Co. and petitioner entered into a new contract of employment. This agreement provided that all of the companies would employ petitioner as the manager of their branch office for the State of Texas for a five-year period beginning January 1, 1942, at an annual salary of $12,000, plus a 3 percent contingent commission on the annual net profits of the business transacted by the branch office for each calendar year. Item fifth of the contract provided:
Fifth: The general agency agreement entered into between THE COMMONWEALTH INSURANCE COMPANY OF NEW YORK and the QUAKER CITY UNDERWRITERS OF THE PENNSYLVANIA FIRE INSURANCE COMPANY and CHARLES J. WILLIAMS, on April 16, 1937, is hereby cancelled as of January 1, 1942. This employment contract supersedes and makes ineffective as of January 1, 1942, an employment contract between such parties, dated December 31, 1941.
The $20,000 was paid to petitioner in accordance with the contract. Petitioner would not have executed the cancellation contract without the employment contract. The premium volume of the general agency at the time the cancellation contract was executed amounted to about $206,000.
In their income tax returns for 1941 petitioner and his wife, Grace McDonald Williams, each reported one-half of the $20,000 as a long term capital gain upon which each of them was taxable to the extent of 50 percent thereof. The respondent treated the profit as ordinary income and restored the sum of $5,000 to the taxable income of each petitioner. The petitioners became husband and wife on October 28, 1939.
OPINION.
ARUNDELL, Judge:
The sole issue is whether the sum of $20,000 represents ordinary income, as has been determined by the respondent, or whether it resulted in a gain on a sale or exchange of a capital asset, as is contended by the petitioners.
We think it clear the sum in question is taxable to the petitioners in its entirety as ordinary income, irrespective of whether the ‘general agency‘ which the petitioner contracted to purchase be characterized as a capital asset.
Under the terms of the contract of sale petitioner, as buyer, agreed to continue the agency for 2 1/2 years, later extended to 5 1/2 years, and to exercise his best ability to maintain and increase the business received by the sellers. It was further provided that ‘as part of the consideration for this sale and without any additional or other compensation,‘ the petitioner ‘would assume jurisdiction over and supervise the business written prior to July 1, 1937,‘ and would ‘use and exercise his best ability to collect the outstanding balances or accounts due from assureds, agents or others in connection with business written prior to July 1, 1937.‘ The sellers agreed that the petitioner should have possession of the agency after July 1, 1937, and the right to conduct and operate the same so long as he should not be in default of any of the terms or conditions of the agreement. The contract expressly provided that the ownership and title of the agency should be and remain in the seller until such time as the petitioner should have performed and carried out all of the terms and conditions in the agreement. The contract further provided that if the petitioner, for any reason, failed or declined to carry out the agreement the sellers, at their option could reenter the premises and recover possession of the property. Petitioner agreed that in such event any increase in premiums in force over and above the premium volume of June 30, 1937, should belong to the general agency and to the sellers as liquidated damages.
The petitioner paid out no money or other property and it is apparent that no gift was intended. The ownership of the general agency was to pass to petitioner in return for services he was to perform. Hence, irrespective of whether the property be in the nature of a capital item, its fair market value at the time of its receipt would constitute ordinary income to the petitioners.
See William T. Bivin, 21 B.T.A. 1051; Hitner v. Lederer, 63 Fed.(2d) 877; Mason v. Commissioner 125 Fed.(2d) 540; Hawaiian-Philippine Co., 35 B.T.A. 173.
SEC. 19.22(a)-3 (Regulations 103). Compensation paid other than in cash.— If services are paid for with something other than money, the fair market value of the thing taken in payment is the amount to be included as income. * * *
Petitioner, though having possession and use of the general agency, never came into its ownership, since the contract was canceled at a time when there was approximately one year of the performance period left to run. Thus, he could not have sold or exchanged a capital asset even if it be conceded that the general agency is in that category. At most, the petitioner received the sum of $20,000, or some part thereof, in lieu of his contractual rights. That cash payment measured his reward for the services he rendered. Cf. George K. Gann, 41 B.T.A. 388; Fritz Worm, 22 B.T.A. 36; affd., 61 Fed.(2d) 868. In Elliott B. Smoak, 43 B.T.A. 907, which is the case upon which petitioner most strongly relies, the taxpayer had owned for a period of more than two years the agency which was the subject of the sale.
Petitioners have not claimed or attempted to evaluate for the purposes of this proceeding an equity in the enhanced value of the general agency.
Moreover, we think it is clear that under the terms of the cancellation contract some part of the $20,000 was paid in consideration of petitioner's agreement not to enter into a general agency business in the State of Texas for a period of five years and for his agreement to give up his commission basis appointment as a general agent in exchange for an employment contract which was to be executed by the parties. Compensation for such considerations clearly falls in the realm of ordinary income. There is no basis in the record upon which the apportionment of that part of the payment relating to these considerations could be made.
In view of all the circumstances, we must conclude that the payment is taxable in its entirety. The parties have agreed that if the $20,000 represents ordinary income, one-half thereof is taxable to each of the petitioners herein. It is so ordered.
Decisions will be entered under Rule 50.