Opinion
Docket Nos. 7547 7577 7578.
1946-11-12
LIMERICKS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.G. L. LIMERICK, TRANSFEREE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.B. O. LIMERICK, TRANSFEREE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Howell Ward, Esq., and Fred F. Morgan, C.P.A., for the petitioners. Allen T. Akin, Esq., for the respondent.
Where the Commissioner has disallowed a deduction from income for a portion of payments made by a corporation which were designated rent, this Court may inquire as to what part, if any, of the amount so disallowed was in reality a disbursement of dividends, and it may approve or disapprove the whole or any portion of such disallowance, as a preponderance of the evidence justifies. Where the majority stockholder, with his wife, owned all of the stock of the corporation except qualifying shares, and he also owned real estate which he had purchased for $50,700 and immediately rented to the corporation for $18,000 per year in a community property state, held, that the effect of the community property law may be taken into account in considering the parties in interest in the corporation dividends and the real property rentals; held, further, that $9,600 of said rent was in reality a distribution of dividends to the principal stockholder and his wife. Howell Ward, Esq., and Fred F. Morgan, C.P.A., for the petitioners. Allen T. Akin, Esq., for the respondent.
These are proceedings for redetermination of deficiencies in income, declared value excess profits, and excess profits taxes for the years 1940, 1941, and 1942 and the portion of 1943 from January 1 to September 30, itemized as follows:
+-----------------------------------------------------------------------------+ ¦Year ¦Income tax¦Declared value excess profit ¦Excess profits ¦ ¦ ¦ ¦tax ¦tax ¦ +----------------+----------+-------------------------------+-----------------¦ ¦1940 ¦($5.56) ¦ ¦ ¦ +----------------+----------+-------------------------------+-----------------¦ ¦1941 ¦436.87 ¦$184.64 ¦$1,118.32 ¦ +----------------+----------+-------------------------------+-----------------¦ ¦1942 ¦1,017.50 ¦1,565.85 ¦5,875.33 ¦ +----------------+----------+-------------------------------+-----------------¦ ¦1/1/43 to 9/30/ ¦(149.02) ¦139.53 ¦8,669.40 ¦ ¦43 ¦ ¦ ¦ ¦ +----------------+----------+-------------------------------+-----------------¦ ¦Total ¦1,299.79 ¦1,890.02 ¦15,663.05 ¦ +-----------------------------------------------------------------------------+
Petitioners in Docket Nos. 7577 and 7578 are transferees of the assets of petitioner in Docket No. 7547, and admit their liability as such for any deficiency in Federal taxes found to be owing by petitioner in Docket No. 7547. These cases were consolidated for trial and are to be determined on the facts developed at the hearing without stipulation.
The question involved is whether the amounts of $3,125, $12,000, and $9,000 paid by petitioner Limericks, Inc., in the years 1941, 1942, and the period January 1 to September 30, 1943, to its president and principal stockholder, as a part of rent for a building used by petitioner, constitute a distribution of profits.
FINDINGS OF FACT.
Limericks, Inc., B. O. Limerick, and G. L. Limerick were residents of Corpus Christi, Texas, and filed their respective income tax returns for the years 1941, 1942, and 1943 with the collector of internal revenue for the first district of Texas.
In November 1937 G. L. Limerick engaged in a privately owned furniture business at 425 North Chaparral Street in Corpus Christi, Texas, where he also owned the building in which the furniture business was conducted.
In December 1938 a corporation, known as the B & B Furniture Co., was organized with a capital stock of $6,000, divided into 60 shares owned as follows: B. O. Limerick, 56 shares; R. W. Erwin, 2 shares, and Betty Erwin, 2 shares. B. O. Limerick was the wife, Betty Erwin was the daughter, and R. W. Erwin was the son-in-law of G. L. Limerick. G. L. Limerick transferred to the B & B Furniture Co. his furniture business, but received no stock in the corporation therefor. He rented the store building to the B & B Furniture Co. for $800 per month and entered the employ of the B & B Furniture Co. as store manager.
In October 1940 the rent was raised from $800 per month to $1,000 per month.
In May 1941 the charter of the B & B Furniture Co. was amended, its capital stock increased to $25,000, and its name changed to Limericks, Inc. At that time G. L. Limerick acquired 190 shares of the stock of the new corporation and became its president.
In June 1941 G. L. Limerick delivered possession of his building at 405 North Chaparral Street to Lerners, Inc., a national chain store, and Limericks, Inc., moved to another building, which G. L. Limerick had recently acquired at 205 South Chaparral Street. This building, including the purchase price and necessary repairs, cost G. L. Limerick $50,698.59. He had sold the building at 425 North Chaparral Street for $117,500.
Limericks, Inc., continued to pay G. L. Limerick $1,000 per month rent for the building at 205 South Chaparral Street, just as the B & B Furniture Co. had paid $1,000 per month rent for the building at 425 North Chaparral Street.
Limericks, Inc., advertised extensively through printed media and on the radio that their business had moved ‘out of the high rent, high tax district‘ and that the customers would ‘save the difference.‘
On July 21, 1942, the board of directors of Limericks Inc., adopted the following resolution:
* * * It was agreed that G. L. Limerick should be paid $1,500.00 per month rent on the land and building at 205 South Chaparral Street, Corpus Christi, Texas; such rent to be payable monthly. It was further agreed that rental at the rate of $1,500.00 per month should be made retroactive to January 1, 1942.
and during the year 1942 G. L. Limerick collected from Limericks, Inc., $18,000 as rental. At this rate Limericks, Inc., paid 96 cents per square foot per year, whereas it had been paying only 80 cents per square foot per year at 425 North Chaparral Street. 425 North Chaparral Street was in the heart of the best business district in Corpus Christi. 205 South Chaparral Street was in a district of sparse business buildings, where the general rent level was very much lower than in the 400 block of the North Chaparral Street. The building at 205 South Chaparral Street, however, was ideally constructed for the furniture business. It had abundant display space, large show windows, and a vacant space in the rear of the store, 50 by 154 feet, which was suitable for customer parking.
G. L. Limerick did not collect his rent by the month, but at the end of each tax year he would close out his account with Limericks, Inc., including his salary advancements and rent.
In December 1942 he withdrew from Limericks, Inc., a balance of $7,000.
At no time was there any written lease executed by Limerick with either the B & B Furniture Co. or Limericks, Inc.
205 South Chaparral Street was located on the corner of Chaparral Street and Coopers Alley, on which were located two railway spur tracks, one of which terminated at Chaparral Street and the other crossed the street.
The net sales of B & B Furniture Co. and Limericks, Inc., were as follows:
+---------------------------------+ ¦1940 ¦$160,201.79¦ +---------------------+-----------¦ ¦1941 ¦180,287.91 ¦ +---------------------+-----------¦ ¦1942 ¦164,134.40 ¦ +---------------------+-----------¦ ¦1943 (first 9 months)¦145,300.55 ¦ +---------------------------------+
During the time involved in these proceedings neither the B & B Furniture Co. nor Limericks, Inc., paid any dividends to any of their stockholders. Net profits were transferred to surplus as follows:
+-------------------------------+ ¦1940 ¦$2,931.23¦ +---------------------+---------¦ ¦1941 ¦5,497.05 ¦ +---------------------+---------¦ ¦1942 ¦4,061.34 ¦ +---------------------+---------¦ ¦1943 (first 9 months)¦5,913.05 ¦ +-------------------------------+
The record discloses rents paid and disallowed as follows:
+----------------------------------------------------------------+ ¦ ¦Rent paid to G. L. Limerick¦Rent disallowed by Commissioner¦ +----+---------------------------+-------------------------------¦ ¦1941¦$6,250 ¦$3,125 ¦ +----+---------------------------+-------------------------------¦ ¦1942¦18,000 ¦12,000 ¦ +----+---------------------------+-------------------------------¦ ¦1943¦13,500 ¦9,000 ¦ +----------------------------------------------------------------+
In the deficiency letter the Commissioner commented on this disallowance as follows:
It is held that (of) the deductions claimed as rents paid, the amounts of $3,125.00 in the year 1941. $12,000.00 in the year 1942 and $9,000.00 in the period ending September 30, 1943, were paid to G. L. Limerick as distributions of profits and therefore those amounts are not allowable deductions from your gross income.
The money used to purchase the real estate owned by G. L. Limerick was acquired after marriage from the joint efforts of Limerick and his wife, and the real estate is community property. The stock owned by Mrs. Limerick in the B & B Furniture Co. and Limericks, Inc., was also community property.
Limericks, Inc., was dissolved on September 30, 1943, when B. O. Limerick and G. L. Limerick acquired the stock of R. W. Erwin and Betty Erwin, took over the assets of Limericks, Inc., and continued to operate the furniture business individually. They concede transferee liability for any tax due from Limericks, Inc.
OPINION.
HARLAN, Judge:
The most fundamental consideration in the determination of the nature of the payments made by Limericks, Inc., to G. L. Limerick is the relationship of G. L. Limerick to the corporation, as it is obvious that payments made on contracts negotiated at arm's length may have an entirely different character than payments made between a corporation and its sole stock owner.
In this case G. L. Limerick owned a building and a furniture business located therein in the year 1937. In 1938 the furniture business was acquired by a corporation the stockholders of which consisted of Limerick's wife, daughter, and son-in-law, yet there is no evidence that Limerick himself received any consideration therefor, and he certainly did not receive any stock in the corporation. All that he had after the corporation was formed was the same position as manager which he had held as a matter of course while he was operating the business. When the B & B Furniture Co. then increased its capital stock from 60 shares to 250 shares, Limerick acquired, by a transaction he designates as a ‘purchase,‘ 190 shares of stock in the enlarged corporation and became president thereof. What consideration, if any, he paid for his 190 shares is not disclosed in the record. Prior to acquiring this stock Limerick says that he entered into an oral contract with the ‘shareholders‘ of the B & B Furniture Co. whereby the rent was to be increased from $12,000 a year to $18,000 a year, beginning January 1, 1942. However, Limerick was completely indefinite as to when or where this agreement was consummated with the stockholders and there was no reference to such agreement in the minutes of the stockholders' meeting, nor was there any written memorandum of the lease made. Limerick rented property to the corporation at 425 North Chaparral Street from 1938 until October 1940 for $800 per month and from then to June 1941 at $1,000 a month. This property had a market value of $117,500. He then rented the property at 205 South Chaparral Street, which he had acquired at a cost of $50,698, for $18,000 a year. This agreement was evidenced by a resolution of the directors of the corporation at a regular meeting held in July of 1942 and was made ‘retroactive‘ to January 1, 1942.
One might well be dubious of the existence of the alleged oral contract or lease which Limerick says he made in the spring of 1941, but for which there was no corroborative memorandum made at that time and to which no reference was made when the directors passed their resolution in July 1942. Certainly if there had actually been a contract entered into in the spring of 1941, there would be no reason for making the rental agreement ‘retroactive‘ in July 1942.
Furthermore, there could be no serious question but that the real estate and the corporate stock owned by Limerick and the corporate stock owned by Mrs. Limerick were all community property. Limerick testified that the money used to purchase the property at 425 North Chaparral Street, the sale of which supplied the funds to purchase the property at 205 South Chaparral Street, was the joint funds of Mrs. Limerick and himself. ‘Mrs. Limerick and myself had been in business together in all of our business ventures since we were married * * * . Our business is owned together.‘ There was no testimony introduced into the record overcoming the presumption also that Mrs. Limerick's stock in Limericks, Inc., was also community property. The presumption that such property is community property is well established in the law of Texas.
Therefore, we not only have a corporation leasing property from the owner of 76 per cent of its capital stock, but we also have a situation where a husband and wife own all the stock in the corporation except qualifying shares and not only are the dividends received on the stock equally divided between the two shareholders without regard to the number of shares owned by each, but the profits obtained from the lease are also equally divided between these two stockholders without regard to the number of shares they hold in the corporation.
It is therefore immaterial whether or not there was an oral contract for a lease prior to the time G. L. Limerick became an actual stockholder, as he and his wife, both before and after that event, divided the rental receipts and the dividends between them. It is also immaterial whether the excessive payments made under the guise of rent had any relation to the number of shares of stock held by Limerick, since all the stock, as well as the real estate, was owned as a community interest of Limerick and his wife.
That paragraph of section 23 of the Internal Revenue Code permitting deductions from income of rental payments describes such deductions as follows:
* * * rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.
The Commissioner has determined that all of the rentals paid in 1942 and 1943, except $500 a month thereof, were in reality dividends paid under the guise of rent and were not payments which the corporation was ‘required‘ to pay to procure the occupancy of such building.
The courts have frequently permitted the Commissioner to inquire into and disallow payments which a corporation made in excess of the amount which it should be required to pay for rent, where the individual collecting the rent was the sole or majority stockholder of the corporation. See LeMoyne v. Commissioner, 47 Fed.(2d) 539; Orange & Domestic Laundry Co., 6 B.T.A. 646; McKeever v. Eaton, 6 Fed.Supp. 697.
The case at bar is clearly distinguishable from Stanley Imerman, 7 T.C. 1030. In that case the Commissioner had not determined that the excess rent paid constituted disguised dividends and there was no evidence that any portion of the disallowed rent was in reality a gift to the landlord, nor was there any evidence that the deals between the landlord and the tenant were not at arm's length.
In this case the Commissioner contends that, since G. L. Limerick paid but $50,700 for the rented property, a rental payment to him of $500 per month would return 11 1/2 per cent on his investment and be adequate as rent. He contends, furthermore, that this rental property is worth only half as much as it would be if located in the 400 block on Chaparral Street, where petitioner corporation had been occupying rented premises, first for $8,000 and then for $10,000 per year, in a property which had a market value of $117,500. The Commissioner also argues that the property located on South Chaparral Street, which is in a low rent district, could not reasonably rent at 96 cents per square foot when property in the high rent district, used for the same purpose, was renting for 80 cents per square foot.
Petitioners argue that the nature of the rental district is immaterial in this particular case since the store room was ideally adapted to the corporation's business use because of the increased display space, the larger show windows, and the customers' parking lot in the rear. They call attention to the fact that the business did actually increase in the first full year of occupancy and steadily increased thereafter. They argue that a percentage of this increase should be charged to rent. Petitioners also introduced a so-called expert, who testified that no rent is excessive ‘if it (the rented premises) is suited to the purpose and to the economy of the person renting it.‘
We do not believe that the testimony in this case wholly justifies the contentions of either the respondent or the petitioners. The rented premises unquestionably had a low market value in a low rent district and prior to the occupancy of petitioner corporation they had been used only for dead storage space. They were adjacent to two spur railway tracks and in a part of town where few pedestrians passed the store and there was very little other business in the neighborhood. Under such circumstances, it impresses us as almost absurd for the petitioners to contend that the payment of $18,000 a year, which would repurchase the entire building every thirty-four months, would be an amount that the corporation would be ‘required‘ to pay as rental if it and the landlord were dealing at arm's length. The absurdity is even more apparent when it is noted that during all of the taxable period involved the directors of petitioner corporation had paid out so much for rent that they did not deem it advisable to distribute any of the retained profits as dividends. The rental drained all of the money available for dividends, and such a rental could not well be ‘suited to the economy‘ of the tenant.
After giving consideration to all of the testimony and the evidence in this case, it is our conclusion that all payments in excess of $700 per month made by petitioner corporation to G. L. Limerick, its chief stockholder, under the designation of rent were in truth and in fact distributions of dividends to Limerick and, therefore, are not deductible.
The payment by petitioner corporation of $8,400 per year rental will give at least a color of verity to petitioner's advertisement that it had moved into ‘a low rent‘ district. While it is regrettable from the undisputed evidence in this case that petitioner's customers did not ‘save the difference,‘ the law will permit the Government to ‘tax the difference.‘
Decision will be entered under Rule 50.