Opinion
Docket No. 35469.
1952-12-3
A. RHETT DU PONT AND GERTRUDE DU PONT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William S. Gaud, Jr., Esq., and John N. Stull, Esq., for the petitioners. Robert R. Blasi, Esq., for the respondent.
William S. Gaud, Jr., Esq., and John N. Stull, Esq., for the petitioners. Robert R. Blasi, Esq., for the respondent.
The agreement by which the partnership du Pont took over a stock brokerage branch office in Elmira, New York, constituted a sale of a going business. Held, therefore, that the payments pursuant to the sale were a capital expenditure and not deductible expenses under section 23(a)(1)(A), I.R.C.
Respondent has determined a deficiency in petitioners' income tax for the calendar year 1948 in the amount of $3,680.38. The only adjustment which is contested is explained by respondent as follows:
(1) It is held that the payment of $12,423.37, a portion of its profits, by the partnership of Francis I. du Pont & Company to Paine, Webber, Jackson & Curtis, does not constitute an ordinary and necessary expense of carrying on a trade or business. Hence, the deduction claimed by the partnership is disallowed and your distributive share of its profits increased accordingly.
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Petitioners are husband and wife who filed a joint return for the period in question with the collector for the second district of New York.
At all times pertinent herein the petitioner A. Rhett du Pont was a general partner with a 30 per cent interest in the firm of Francis I. du Pont & Co. (hereinafter called ‘du Pont‘), a partnership under the laws of the State of New York. du Pont was and still is a member firm of the New York Stock Exchange (hereinafter called the ‘Stock Exchange‘) and carries on a business as brokers and dealers in securities and commodities. du Point carries on its business through its main office located a 1 Wall Street, New York 5, New York, and through a number of branch offices located throughout the United States.
Petitioners included the distributive share of 30 per cent of the income and expenses of the partnership du Pont in their 1948 income tax return. At all times pertinent herein petitioners kept their records and reported their income for Federal income tax purposes on the cash method of accounting, while du Pont kept its books and reported its income for Federal income tax purposes on the accrual method of accounting. At all times pertinent herein the taxable year of both petitioners and of du Pont was the calendar year.
Prior to February 1, 1948, du Pont had no office in Elmira, New York, but Paine, Webber, Jackson & Curtis, hereinafter called ‘Paine Webber,‘ also a member firm of the Stock Exchange, had a branch office there. The brokerage firm of Paine Webber was formed by the merger of two firms, Paine, Webber and Jackson and Curtis, in 1942. The Elmira office which was a well established branch office of Jackson and Curtis, having been in existence with different firms since 1926, was taken over by the new company in the 1942 merger.
The business of the Elmira, New York, branch office of Paine Webber was conducted by a manager and several registered representatives with the aid of a small force of clerical assistants.
Throughout the period between 1942, when Paine Webber was formed, and 1948, that firm had two representatives (hereinafter referred to as ‘outside representatives‘) soliciting business in the Elmira area. While these outside representatives were primarily brokerage business, they solicited customers of Paine Webber's Elmira office, and the employees of that office did not participate in any of the commissions earned by these outside representatives. The activities of these outside representatives were a source of irritation to the Elmira office. In the latter part of 1947, Paine Webber put into effect a new schedule of commissions which resulted in decreasing the compensation of the men in the Elmira office. On behalf of the office, the manager had protested the activities of the outside representatives and revised commissions, but got nowhere. The manager and registered representatives considered leaving Paine Webber and discussed the possibility of an Elmira office with other stock exchange firms, including du Pont. The desire on the part of the manager and certain of the registered representatives of the Elmira office to enter the employ of du Pont was made known to Paine Webber. The manager and two of the registered representatives of the Elmira office resigned from the employ of Paine Webber on January 17, 1948. The resignation preceded and was independent of the negotiations for the sale of the Elmira office by Paine Webber to du Pont.
At all times pertinent herein, Rule 439 of the Rules of the Board of Governors of the Stock Exchange provided as follows:
Except as may otherwise be permitted by the Exchange, a member firm establishing any office other than a main office shall not employ within six months thereafter any person who is, or who during the three months preceding such proposed employment has been, in the employ of another member or member firm in an office in the same vicinity, without the consent of the former employer, unless such person has been released voluntarily by such former employer.
At a conference held on January 19, 1948, attended by petitioner A. Rhett du Pont and Charles Moran, Jr., partners of du Pont, and Lloyd W. Mason, a partner of Paine Webber, the projected sale of the Elmira office by Paine Webber to du Pont was discussed for the first time. The terms of sale were worked out at that meeting. It was agreed that the furniture and fixtures would be bought for the appraised fair market value. It was also agreed that du Pont would pay to Paine Webber 10 per cent of the gross earnings of the Elmira office for the first year and 5 per cent the second year. The entire office staff and facilities were taken over by du Pont when it acquired the Elmira office from Paine Webber. The terms of sale were reduced to writing in a letter dated January 20, 1948, from Paine Webber to du Pont, which included the following provisions:
In accordance with our conference Monday morning, January 19, attended by yourself and your partner, Mr. Charles Moran, Jr., and your subsequent telephone call on the same day, it seems best that we reduce to writing our understanding of the arrangement between Francis I. du Pont & Co. and Paine, Webber, Jackson & Curtis with reference to your taking over our Elmira office as of February 1, 1948.
Assuming the transfer is consummated by February 1, 1948, you agree to pay us 10% of the gross income of the office from all sources for one year ending January 31, 1949, and 5% of such income for the second year ending January 31, 1950, plus a reasonable amount for furniture, fixtures and equipment, this amount to be negotiated between ourselves when we have had an opportunity to appraise its value. We would like to effect periodical settlements with your firm as of June 30 and December 31 in each year, the month of January 1950 to constitute final settlement.
We wish to assure you of our complete cooperation in effecting the transfer of the office and also that in this transaction the goodwill existing between your good firm and ours has suffered no deterioration.
Such letter is the only written instrument evidencing the terms of sale agreed upon by the purchaser and seller. It was also tacitly understood that Paine Webber would not open a competitive office in Elmira, New York, during the term of the agreement.
After the above agreement had been entered into, the Stock Exchange was advised by Paine Webber that it had no objection to du Pont's employing certain of its Elmira employees as of February 1, 1948. Thereafter the Stock Exchange advised du Pont that it had no objection to du Pont's doing so.
At the time of the proposed sale of the brokerage business, there were 287 open customers' accounts, in addition to cash accounts, on the books of Paine Webber's Elmira branch office. In the open accounts there were debit balances of $230,272.87, free credit balances of approximately $82,000 and secured credit balances of approximately $2,000. The debit and credit balances on the accounts which transferred to du Pont were settled by the exchange of the long and short securities belonging to the individual customers. The debit balances were paid to Paine Webber by du Pont and, in turn, Paine Webber paid the credit balances to du Pont. Brokerage accounts are the property of the brokerage firm dealing with the customer and not the property of the registered representatives that service them.
du Pont and Paine Webber agreed that the then value of the furniture and fixtures in the latter's Elmira office was $2,500. du Pont paid Paine Webber this sum and on February 1, 1948, took over the furniture and fixtures for use in its new office. The lease covering the premises occupied by Paine Webber in Elmira expired on or before December 31, 1947. Thereafter, Paine Webber's occupancy of those premises was on a month-to-month basis. du Pont entered into a 3-year lease covering those premises for a term commencing February 1, 1948, and took possession on or about that date. The Elmira month-to-month employees of Paine Webber who continued with du Pont were employed on a similar basis.
On February 1, 1948, Paine Webber closed its Elmira office and du Pont opened its Elmira office. The respective closing and opening of these offices was announced in the Stock Exchange weekly bulletin of January 30, 1948. du Pont announced the opening of its Elmira office by local newspaper advertisements and cards. On the opening of the office, letters signed by du Pont's Elmira employees were sent to former customers of Paine Webber, including those who had debit or credit balances with that firm or for whose securities Paine Webber had acted as custodian. Paine Webber sent the following letter to its Elmira customers:
TO OUR CUSTOMERS:
We have just concluded negotiations for the transfer of our Elmira office to the firm of Francis I. du Pont & Co., Members of the New York Stock Exchange and other Principal Stock and Commodity Exchanges.
On February 2, 1948 the entire staff and facilities of our office located in the Keeney Theatre Building will be taken over by them. If you decide to transfer your account to them, we assure you that your investment problems will be serviced promptly and efficiently.
On the other hand, if you wish to continue your account with Paine, Webber, Jackson & Curtis, it will be welcome.
Any instructions with respect to your account or contemplated transactions, subsequent to January 31, 1948, should be addressed to our office at 25 Broad Street, New York 4, N. Y.
As a matter of fact, most of the Elmira customers transferred their accounts to du Pont. The gross income of du Pont's Elmira office for the duration of the agreement was as follows:
+-----------------------------------------+ ¦Period ¦Amount ¦ +-----------------------------+-----------¦ ¦Feb. 1, 1948 to Dec. 31, 1948¦$124,233.70¦ +-----------------------------+-----------¦ ¦Jan. 1, 1949 to Dec. 31, 1949¦113,046.19 ¦ +-----------------------------+-----------¦ ¦Jan. 1, 1950 to Jan. 31, 1950¦13,904.00 ¦ +-----------------------------------------+
The payments made by du Pont to Paine Webber in respect of each of the above periods amounted to $12,423.37, $6,088.88, and $695.20, respectively.
In computing its net income for the taxable year ended December 31, 1948, du Pont deducted as an expense the sum of $12,423.37 representing the entire amount accruing during that taxable year 1948 to Paine Webber, and petitioners received the benefit of this deduction to the extent of a 30 per cent distributive interest.
We hold as an ultimate fact the agreement for the sale of the Elmira, New York, brokerage office between Paine Webber and du Point constituted an agreement for the purchase of a well established and going brokerage business, and the payments in question constituted a capital expenditure.
OPINION.
BLACK, Judge:
The sole question for determination is whether the accrual of payments to be made by du Pont to Paine Webber in 1948, pursuant to the percentage arrangement agreement for the sale of the branch office, constitutes deductible expenses under section 23(a)(a)(A), Internal Revenue Code, or a capital expenditure. The question is essentially a factual one.
We have concluded from all the facts that the payments in question were made essentially to purchase a going brokerage business. Petitioner contends that du Pont made the payments in question only (1) to acquire the immediate services of Paine Webber's former employees in accordance with the Stock Exchange rule, (2) to retain friendly relations with Paine Webber, and (3) the understanding that Paine Webber would not open an office in Elmira during the term of the agreement. We cannot agree that the payments in question were made for such limited purposes. By ‘taking over our (Paine Webber) Elmira office‘ under the sale agreement, du Pont obtained a brokerage office which had been in operation for over 20 years. The sale included the good will of well established customers, a familiar location, a coordinated and working office and organization, tradition, habit, etc. When a going business entity is purchased as a unit, it frequently has an intangible value independent of the value of its separate component parts. That seems to be true in the instant case. The customers accustomed to dealing with the Elmira office might have continued dealing with Paine Webber— but only through the New York City Office— or the two outside representatives who had unsuccessfully competed with the branch office when operated by Paine Webber. The great majority of the accounts of the branch office in fact transferred to the du Pont firm.
The instant case is somewhat similar to Frank L. Newburger, Jr., 13 T.C. 232. In the Newburger case, among other things, we said:
The petitioner and his associates acquired a going business to which they were not theretofore entitled. The evidence does not show error on the part of the Commissioner. Cf. Home Trust Co. v. Commissioner, 65 Fed. (2d) 532; Newark Milk & Cream Co. v. Commissioner, 34 Fed.(2d) 854.
Much the same can be said here as was said above in the Newburger case. We hold, therefore, that the payments in question were capital expenditures and not deductible under section 23(a)(a)(A).
Decision will be entered for the respondent.