Watkins Salt Co. v. Commissioner

The Watkins Salt Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Watkins Salt Co. v. Commissioner Docket No. 107012 United States Tax Court 1 T.C. 125; 1942 U.S. Tax Ct. LEXIS 31; November 24, 1942, Promulgated *31 Decision will be entered under Rule 50. A payment made in 1938 as a lump sum settlement in compromise of a claim, presented in 1938, for a share of income received in years since 1921 under a 1921 agreement the terms of which were not clear, held deductible in 1938. William Flannery, Esq., and Charles L. Brayton, Esq., for the petitioner. Z. N. Diamond, Esq., for the respondent. Sternhagen, Judge. STERNHAGEN *125 A deficiency of $ 2,923.10 was determined in petitioner's income tax for 1938. Of several items of adjustment, petitioner assails the disallowance of deductions taken as ordinary and necessary business expenses. FINDINGS OF FACT. Petitioner, a Delaware corporation with principal office at Watkins Glen, New York, filed its income tax return for 1938 with the collector for the twenty-first district of New York. On June 22, 1921, petitioner acquired by conveyance from the directors and trustees of the Rock Salt Corporation a salt mine with plant and equipment at Lansing, New York. This property had been struck off for a $ 50,000 bid at a public auction on May 28, 1921, to Warren W. Clute, who assigned his purchase rights to petitioner. The auction*32 sale was held pursuant to a court order in the course of proceedings for the voluntary dissolution of Rock Salt. Two of its shareholders, Howard Cobb and Fordyce A. Cobb, had demurred to the complaint praying the sale and, after the demurrer was overruled, had filed an appeal. On February 28, 1921, they agreed to withdraw the appeal and to: give to Warren W. Clute and the Watkins Salt Company full power and authority to sell, manage, lease, handle and make such disposition of the said Rock Salt property as to them in their judgment seems best and wise. In consideration of which Warren W. Clute and the Watkins Salt Company agree to and with the said Fordyce A. Cobb and Howard Cobb to use their best endeavors to handle said property for the best business interests of themselves and said Cobbs. They also agree to treat the original holdings in the Rock Salt Corporation of the said Fordyce A. Cobb and Howard Cobb with the same fairness as they do their holdings and those of the John A. Clute Estate, and when any moneys or property is distributed to them and the John A. Clute Estate, a like proportionate amount thereof will be so distributed to the said Fordyce A. Cobb and Howard*33 Cobb. *126 On June 23, 1921, petitioner leased the property to the Cayuga Rock Salt Co., for 20 years. The stipulated rental was $ 5,000 for the first year; $ 15,000 for the second, and $ 42,000 for each of the remaining years; and in addition, the lessee was to bear taxes and insurance premiums and to pay petitioner one-half of the net operating profits of the mine. During the years 1921-1937 petitioner received rents of about $ 346,000, which it reported as income. It paid no part of these to the Cobbs. After Clute's death in April 1938, a law firm which represented his estate and the petitioner received a letter dated June 10, 1938, from Howard Cobb, saying that Fordyce A. Cobb had died and that something should be done about the contract of 1921. Conferences followed at which Cobb claimed that he and Fordyce A. Cobb were entitled to 5 percent of amounts received by petitioner as the lessee's proceeds of operation, and other matters relating to the claim, its validity, and the amount thereof were discussed. Negotiations continued until a settlement was reached on September 15, 1938, between Howard Cobb, Herbert L. Cobb as administrator of Fordyce A. Cobb, the petitioner, *34 and the executors of Clute. The settlement was approved by petitioner's board of directors. By this settlement, Howard Cobb and Herbert L. Cobb, administrator of Fordyce A. Cobb, released and discharged petitioner and Clute's executors from all claims, debts, and causes of action arising out of or related to the contract of 1921 to the extent of claims for moneys due prior to January 1, 1938, and petitioner on September 28, 1938, paid $ 12,500 to the Cobbs. On August 15, 1939, petitioner paid the Cobbs $ 1,268.62, representing 5 percent of the rents received in 1938 under the lease. It reported as income in its 1938 return the full amount of rents received by it in 1938. Of each amount, petitioner paid one-half to Howard Cobb and one-half to Herbert L. Cobb as administrator of Fordyce A. Cobb. OPINION. The Commissioner held that the amounts of $ 12,500 and $ 1,268.62 paid to the Cobbs were "not allowable deductions as ordinary and necessary business expenses as provided in section 23 (a) of the Revenue Act of 1938." There is no denial that the payments were made. The controversy is as to whether they are deductible expenses; the respondent holding the petitioner to its burden*35 of an affirmative showing that they were such in view of some possible doubt as to what the payments really were. The evidence indicates, in our opinion, that the payments were ordinary and necessary expenses of the petitioner in carrying on its trade or business, and are therefore proper deductions in 1938. *127 The payment of $ 12,500 was expressly made in settlement of the claims of the two Cobbs based by them on the agreement of February 28, 1921, whereby, in consideration of their withdrawal of their appeal from an adverse decision of a trial court, petitioner and Clute, recognizing the Cobbs' holdings in the old Rock Salt corporation, agreed to a parity of treatment of their holdings and a distribution to them of moneys received proportionately with those to the other shareholders. Although the 1921 agreement is not drawn with precision, and the letter of June 10, 1938, is even more uncertain in its terms of claim, nevertheless the evidence is sufficient to give a fairly clear idea of the circumstances and character of the agreement, claim, settlement, and payment. The Cobbs had been original holders of an interest, direct or indirect, in the Rock Salt mining property*36 acquired by petitioner and leased by it at a rental. The Cobbs had become involved in litigation with the trustees of that corporation, and, to settle the litigation, made the agreement of February 28, 1921. The Watkins Salt Co. acquired the Rock Salt properties. No payments were made by petitioner pursuant to the agreement, and the claim of the Cobbs was therefore submitted in the letter of June 10, 1938. After negotiation, the claim was compromised, and in September 1938 the $ 12,500 was paid by petitioner in settlement of all liability to the Cobbs for the period ending December 31, 1937. 1 *37 Taking the case here as arising from a settlement payment made by this petitioner in 1938 in compromise of a disputed claim against it for a contract share of the rents which it had received during the period ending December 31, 1937, we think the payment may properly be regarded as an ordinary and necessary business expense. The claim was not sufficiently definite in either substantive liability or terms to require a determination that the amount paid had been serially accruing in the years from 1921 to 1938, for so far as appears the claim was in those years neither known nor accounted for. Petitioner first knew of it when the letter was received in 1938. The language of the 1921 agreement may have been intended to cover such a definite liability, but it can not be said, after seventeen years of silence and inaction under the contract, that liabilities under it definitely accrued each year so that they were deductible as accrued expenses. Cf. ; certiorari denied, . Nor is it fair to say that the liability was not that of petitioner but that of *38 individual parties to the agreement; for the rents against *128 which the former shareholders of the old Rock Salt company claimed a share were the rents which had been received by the Watkins Salt Co., and it would be unwarranted to treat the compromise payment by that company as if it were gratuitously made. The further payment of $ 1,268.62 was the proportionate amount of the rents received in 1938. It was paid according to the 1921 agreement. Even though, as has been held in respect of the $ 12,500, the payment is an ordinary and necessary expense, it was not made until 1939. Nothing in the evidence shows that the petitioner's method of accounting was an accrual method, and the payment of 1939 may not, therefore, be taken as a deduction of 1938. The disallowance is to this extent sustained. In respect of the deduction of $ 12,500, the determination is reversed. Decision will be entered under Rule 50. Footnotes 1. A similar claim was filed by another person named Welty, who had had an interest in the old Rock Salt company, and this claim was sued upon in the United States District Court and judgment was given for the plaintiff on May 26, 1942. The opinion of the District Judge throws some additional light upon the circumstances of the Cobb claim, although that opinion and its statement of facts are not in evidence in this proceeding, and we do not, therefore, go to that opinion for any of the facts here.↩