Walling v. Commissioner

Estate of Ritner K. Walling, Deceased, Margaret C. Walling, Ritner E. Walling and J. Wesley McWilliams, Executors, and Margaret C. Walling, Surviving Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent Walling v. Commissioner Docket No. 4274-62 United States Tax Court 45 T.C. 111; 1965 U.S. Tax Ct. LEXIS 22; October 25, 1965, Filed *22 Decision will be entered for the respondent. The owners of two vessels agreed to transfer them to the X corporation. As required by the agreement and as an incident to the transfer the owners made expenditures for needed repairs to the vessels. Held, such expenditures were capital in nature and were not deductible as ordinary and necessary expenses. David P. Brown, Jr., and George Chimples, for the petitioners. Stephen P. Cadden, for the respondent. Raum, Judge. RAUM *111 The Commissioner determined a deficiency in income tax in the amount of $ 46,514.10 for the year 1957. The sole issue is whether amounts, totaling $ 57,567, paid by the Oliver Transportation Co., *23 a partnership, during the year 1957 represented ordinary and necessary business expenses or capital expenditures. FINDINGS OF FACT Some of the facts have been stipulated, and, as stipulated, are incorporated herein by reference. Ritner K. Walling and Margaret C. Walling, husband and wife, filed a joint Federal income tax return for the year 1957 with the district director of internal revenue at Philadelphia, Pa. Ritner K. Walling died on October 17, 1958. Margaret C. Walling, Ritner E. Walling, and J. Wesley McWilliams are the duly qualified and acting executors of his will. During the year 1957 Ritner K. Walling and Margaret C. Walling were the two members of a partnership carrying on a waterborne commerce business under the name of the Oliver Transportation Co. (hereinafter referred to as the company), with principal offices at 842 Fidelity-Philadelphia Trust Building, Philadelphia, Pa. The share of each partner in the partnership during 1957 was as follows: Ritner K. Walling 37.62 percent Margaret C. Walling 62.38 percent *112 The 1957 partnership was created by an agreement dated January 1, 1957. It provided, in part, that a "Limited Partnership Agreement between*24 the parties dated April 15, 1937, as amended from time to time, be and the same hereby is cancelled as of December 31, 1956." The company filed a partnership return of income for the year 1957 with the district director of internal revenue, Philadelphia, Pa. In their joint return for that year the two partners reported the following net income from the partnership: Ritner K. Walling $ 49,519.95 Margaret C. Walling 82,112.04 131,631.99 The waterborne commerce business of the company was the carriage of cargo, principally coal, by means of barges which it owned and operated. These vessels were used in river, harbor, and deepwater transportation. They required the services of tugs and their crews, which were hired from third parties by the company. As of January 1, 1957, the company owned and operated 13 steel barges and 4 wooden barges in river or harbor trade in the port of Philadelphia. It also owned and operated two steel barges, the Darien and Mamei, which were used in the coastwise or deepwater trade. The Darien and Mamei had been purchased on April 1, 1932, at a cost of $ 42,000 each, and, prior to January 1, 1957, they had been completely depreciated*25 on the books of the company. They were sister ships, each having a length of 335.8 feet; a beam of 52.1 feet; a depth of 29.4 feet; a gross tonnage of 3,916.32 tons, and a net tonnage of 3,584 tons. On May 1, 1957, the Oliver Transportation Corp. was organized under the laws of the State of New Jersey, with an authorized capital stock consisting of 7,500 shares of common stock having a par value of $ 100 per share, for the purpose of carrying on waterborne commerce in the form of deepwater barge transportation theretofore carried on by the company. The first meeting of the board of directors of the corporation was held on May 29, 1957. At that meeting resolutions were adopted that the corporation accept an offer of Ritner K. Walling and Margaret C. Walling to transfer to it the barges Darien and Mamei and authorizing its president and secretary to enter into an agreement to purchase these barges in behalf of the corporation. On May 29, 1957, the following agreement was entered into between the company and the Oliver Transportation Corp.: *113 THE OLIVER TRANSPORTATION CORPORATION AGREEMENT FOR THE ACQUISITION OF PROPERTY An Agreement made this 29th day of May, 1957, *26 by Ritner K. Walling and Margaret C. Walling, co-partners trading as THE OLIVER TRANSPORTATION COMPANY (hereinafter called the "transferors") of the first part, and THE OLIVER TRANSPORTATION CORPORATION, a corporation organized under the laws of New Jersey (hereinafter called the "Corporation") of the second part. Whereas the transferors are the owners of the property and rights hereinafter described; and Whereas the Corporation has been duly organized with an authorized capital stock of $ 750,000.00; and Whereas the Board of Directors of the Corporation have ascertained, adjudged and declared that the said property and rights are of a fair value of at least $ 600,000.00 when required repairs have been made to the barges included in the sale, and that the acquisition thereof is necessary for the business of the Corporation and to carry out its contemplated objects: Now, Therefore, This agreement witnesseth: I. That the transferors have assigned, transferred and set over, and do hereby assign, transfer, and set over unto the Corporation, and its successors and assigns, all right, title and interest in and to the following described property, to wit: Two ocean going steel barges, namely: *27 the Mamei the Darien free and clear of any encumbrances, and in a seagoing and operational condition with current Coast Guard certificates and American Bureau of Shipping Load Line certificates, and those two certain contracts dated February 6, 1957, with, respectively Winslow-Knickerbocker Coal Company New Jersey and Barrows & Company, Incorporated, involving the operation of said barges, In Exchange For 6,000 shares of the capital stock of this Corporation of the par value of One Hundred Dollars ($ 100.00) each. II. The Corporation hereby agrees, in consideration of said transfer and upon the delivery of said property to it, to issue to the transferors and their nominees as hereinafter provided, certificates of stock of the Corporation to the aggregate amount of 6,000 shares, and said shares shall be deemed to be and are hereby declared to be full paid shares and not liable to any further call, and the holders of such stock shall not be liable to any further payment thereon.III. Said stock shall be issued as follows: To Shares Ritner K. Walling [2255] Margaret C. Walling [3743] Donald W. Fuller [1] J. Wesley McWilliams [1] IV. The delivery of the certificates for*28 said shares to the above named parties and their respective receipts for the same shall be a full discharge of each of the parties hereto to the extent thereof. V. The transferors hereby covenant and agree with the Corporation, upon the request and at the cost of the Corporation, to execute and do all such further assurances and things as shall reasonably be required by the Corporation for vesting in it the property and rights agreed to be hereby transferred, and giving to it the full benefit of this agreement. *114 Witness the hands and seals of the transferors and the corporate seal of the Corporation, attested by the signatures of its officers thereunto duly authorized, the day and year first above written. (S) Ritner K. Walling [L.S.] (S) Margaret C. Walling [L.S.] co-partners trading as The Oliver Transportation Company In presence of: (S) Anne M. Brown The Oliver Transportation Corporation [Corporate Seal] By (S) Margaret C. Walling President. Attest: (S) Mary C. Harlan Secretary. The following journal entry was made on the books of the Oliver Transportation Corp. May 29, 1957 Fixed assets $ 600,000 Capital stock issued $ 600,000 To record*29 the acquisition of the barges "Mamei" and "Darien" thru the issuance of 6,000 shares of capital Stock, Par Value $ 100. The 6,000 shares of its stock were issued under date of May 29, 1957, as follows: Number of Percentage shares Ritner K. Walling 2,255 37.60 Margaret C. Walling 3,743 62.36 Donald W. Fuller [1] .02 J. Wesley McWilliams [1] .02 During the year 1957 these four individuals and Ritner E. Walling were the members of the board of directors of the Oliver Transportation Corp. The contracts of coal carriage between the company and the Winslow-Knickerbocker Coal Co. and Barrows & Co., dated February 6, 1957, mentioned in the May 29, 1957, agreement, were assigned by the company to the Oliver Transportation Corp. on July 11, 1957. Vessels operating in the type of deepwater and coastwise transportation engaged in by the Darien and the Mamei are subject to periodic inspection and survey of and certification of structural efficiency by duly authorized officers of the U.S. Coast Guard, in accordance with 46 U.S.C.A. sec. 395(b). 1 A temporary certificate may be *115 issued to a vessel. 46 U.S.C.A. sec. 399.*30 Interim inspection by the duly authorized officers of the U.S. Coast Guard may be had when deemed necessary. 46 U.S.C.A. sec. 435. Inspections by the U.S. Coast Guard are normally made each time a vessel enters a shipyard for service or repairs. Upon the basis of inspections, or requests by owners for certification, duly authorized officers of the U.S. Coast Guard approve the nature and extent*31 of work done or to be done on barges, or they may prescribe additional work to be done, in order to put ships in an ordinarily efficient operating condition so such vessels may secure effective U.S. Coast Guard certification. A vessel engaged in deepwater and coastwise transportation is also required to have a loadline certificate from officials of the American Bureau of Shipping, which operates under the supervision of certain officers of the U.S. Coast Guard. This certificate is issued by those officials after a survey and after parts or fittings of a vessel, found to be deficient on the survey, are replaced or repaired. The loadline and its certification is designed to protect a vessel and its cargo from overloading beyond the loadline fixed and certified. Although loadline and Coast Guard inspection certificates may be issued for more than 1 year, a vessel is subject to U.S. Coast Guard and American Bureau of Shipping inspection when it enters a shipyard. The only work authorized to be done while a vessel is in drydock is that provided by written contract, referred to as a job order, and such contract must include work prescribed by the U.S. Coast Guard or by the American Bureau*32 of Shipping. In the course of the operation of the barges Darien and Mamei a considerable amount of damage could be normally expected which would necessitate annual repairs. This damage resulted principally from the bituminous coal carried by the barges and from so-called bucket damage. Soft coal gives off sulfuric acid, which is deleterious to the vessels because it is of a corrosive character and causes erosion of the steel frames and bulkheads. The barges were loaded at dockside by a tipple, which is a device that "shoots" the coal into the hold of a vessel. A clamshell bucket was used in unloading them. This bucket weighs 7 tons and could pick up about 5 or 7 tons of coal. When the bucket operator swings the bucket to get it in or out of the hold, he sometimes hits the wood floor of the hold, the bulkheads, and the shell frames, and damages them. When this damage is caused by negligence or improper discharge, the ship line is entitled to reimbursement for such damage. When the company had repairs made for bucket damage, it would take a deduction under the heading of "repairs" in its income tax returns, and if it received reimbursement, the amount of the reimbursement*33 was included in gross income. *116 In order to acquire the "current" Coast Guard and loadline certificates which the company had to "turn over" to the Oliver Transportation Corp. under the terms of the May 29, 1957, agreement, the Darien and Mamei were sent to the shipyard of the Newport News Shipyard & Dry Dock Co. (hereinafter referred to as the N.N.S. & D.D.Co.) in 1957. The Darien was at the shipyard of the N.N.S. & D.D.Co. during the period June 8 to June 17, 1957. When the Darien entered the shipyard this vessel had a U.S. Coast Guard certificate the expiration date of which was October 3, 1957, and a loadline certificate the expiration date of which was July 23, 1957. The Mamei was at the shipyard of the N.N.S. & D.D.Co. at Newport News, Va., during the period July 11 to July 22, 1957. When the Mamei entered the shipyard this vessel had a U.S. Coast Guard certificate the expiration date of which was May 26, 1957, and a loadline certificate the expiration date of which was July 16, 1957. During the periods in 1957 when the Darien and the Mamei were at the N.N.S. & D.D.Co. shipyard certain work was done on these vessels to put them in the*34 operating condition required by the U.S Coast Guard and American Bureau of Shipping as a condition precedent to the issuance of "current" Coast Guard inspection certificates and American Bureau of Shipping loadline certificates. This work was similar to work performed on these vessels on annual visits to shipyards in prior years. It included items such as scaling and painting, and repairing damage to shell frames, brackets, plates, wood decking, bulkheads, tank top ceiling (floor of the hold), etc. The repairs were in the nature of "spot repairs" or "patchwork" and did not involve the complete replacement of the damaged units. The work on each of the vessels was limited to the minimum that could be done in order to obtain Coast Guard and American Bureau of Shipping certificates. The cost of the work done on the Darien in 1957 was $ 30,093 and the company paid this amount to the N.N.S. & D.D.Co. by check dated September 12, 1957. The cost of the work done on the Mamei in 1957 was $ 27,474 and the company paid this amount to the N.N.S. & D.D.Co. by check dated November 13, 1957. After the work on the Darien was completed in 1957 a U.S. Coast Guard certificate of inspection*35 was issued permitting that vessel to be navigated for 1 year from September 23, 1957, on the Atlantic coast between Cape Henry, Va., and Eastport, Me., and a loadline certificate for that vessel was issued which was to remain "in force until June 14, 1958." After the work on the Mamei was completed in 1957 a U.S. Coast Guard certificate of inspection was issued permitting that vessel to be *117 navigated on the Atlantic coast between Cape May, N.J., and Cape Henry, Va., until May 23, 1959, and a loadline certificate for that vessel was issued which was to remain "in force until July 19, 1959." The amounts expended by the company for work on the Darien and Mamei in 1955 and 1956, which was similar to that performed on those vessels in 1957, was as follows: Year Darien Mamei Total [1955] $ 15,598.10 $ 19,051.84 $ 34,649.94 [1956] 22,710.91 31,381.76 54,092.67 The company claimed deductions for these expenditures as "repairs" in partnership returns of income filed for the years 1955 and 1956. In computing distributable partnership net income of the company for the year 1957, in the partnership return of income filed for that year, a deduction of $ 57,567*36 was claimed as "repairs" on the Darien and the Mamei as follows: Barge Amount involved Darien $ 30,093.00 Mamei 27,474.00 57,567.00 The total amount claimed as a deduction for repairs in the 1957 partnership return of the company was $ 122,310.20. The Commissioner determined that the claimed deduction of $ 122,310.20 was unallowable in part and increased distributable partnership net income of the company and the petitioners' net income by the amount of $ 57,567 for 1957. The following explanation was given for this adjustment: 1. The deduction for repairs in the amount of $ 122,310.20 has been disallowed to the extent of $ 57,567.00, which sum was not incurred as an ordinary and necessary expense of the partnership but rather for the benefit of a corporation known as The Oliver Transportation Corporation, and furthermore, the said sum constitutes a capital expenditure so that in either event it is not deductible (Sections 162 and 263 of the Internal Revenue Code of 1954). OPINION The sole question for decision is whether the amounts totaling $ 57,567, expended by the Oliver Transportation Co. during the year 1957 represented deductible ordinary and necessary*37 business expenses or nondeductible capital expenditures. Section 162 of the Internal Revenue Code of 1954 provides, in pertinent part, that "There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Petitioners contend that the expenditures involved qualify for deduction under this section. They *118 argue that the work done on the Darien and Mamei in 1957 was typical of the items of repair required at least annually to maintain them in seagoing condition and to obtain new Coast Guard and loadline certificates; that the purpose of the repairs was only to restore the wear and tear on the vessels which had occurred since their last annual visit to the shipyard; that the repairs consisted of "patching-up" work which did not lengthen the lives of the vessels; that amounts expended for such repairs are normally considered to be ordinary and necessary business expenses deductible from gross income under section 162; and that their deduction should not be denied merely because the repairs were incidental to the transfer of the vessels to the Oliver Transportation Corp. We agree*38 with petitioners that expenditures for work similar to that done on the Darien and Mamei in 1957 would normally be considered to be ordinary and necessary business expenses if incidental to the operation and maintenance of those vessels for business purposes. However, the 1957 expenditures do not fall in that category. These vessels were not used nor were they intended to be used by the taxpayers after the repairs "in carrying on any trade or business." The repairs were made in June and July of 1957, but the Wallings on May 29, 1957, had already transferred the Mamei and the Darien to the Oliver Transportation Corp., and the expenditures in question were made in order to fulfill one of the conditions of the contract of sale or transfer. They were thus incidental to that transfer and were therefore capital in nature. In the contract of sale bearing that date the Wallings assigned and transferred to the corporation all of their right, title, and interest in the Darien and Mamei free and clear of any encumbrances "and in a seagoing and operational condition with current Coast Guard and American Bureau of Shipping Load Line certificates" in exchange for 6,000*39 shares of the capital stock of the corporation. Before "current" Coast Guard and American Bureau of Shipping certificates would be issued certain work had to be done on the vessels. This work consisted principally of painting, checking the ship bottoms and sea valves, and repairing damage that had occurred to the vessels since their last visit to the shipyard. When it was completed current certificates were issued indicating that the vessels were in a seagoing and operational condition satisfactory to the Coast Guard and American Bureau of Shipping. The company was then able to comply with the terms of the May 29, 1957, contract providing for the transfer of the vessels to the corporation in a seagoing and operational condition with "current" Coast Guard and loadline certificates in exchange for 6,000 shares of the corporation's stock. The expenditures made by it to put the vessels in that condition clearly represented part of the cost of acquiring the stock. In the circumstances *119 the respondent's determination that they were capital expenditures, and not deductible as ordinary and necessary business expenses, must be, and is, approved. 2 Cf. Bloomfield Steamship Co., 33 T.C. 75,*40 affirmed 285 F. 2d 431 (C.A. 5). *41 Chickasha Cotton Oil Co., 18 B.T.A. 1144, relied upon by petitioners, does not require a contrary result. Apart from the fact that the meager findings of fact and opinion as they relate to this issue make it difficult to determine precisely what was decided in that case, it appears that there was involved at most the question whether the cost of replacements incurred by the taxpayer under an apparent warranty in connection with certain cotton gins which it had previously sold had already been reflected in the computation of its taxable income. And it was held at most in that case that the taxpayer had not already had the benefit of the resulting loss in the determination of its taxable income. No question appears to have been raised there as to whether the expenditures constituted ordinary and necessary expenses or as to whether the concededly allowable loss stemming from those expenditures was to be treated as an ordinary or as a capital loss. 3 In the present case the expenditures at issue were made in connection with an exchange in which petitioners acquired stock for the two vessels; those expenditures in the circumstances herein represented*42 part of the cost of acquiring that stock and became part of its basis for gain or loss on any subsequent sale or other taxable disposition of that stock. It is only at such time that tax benefit may be obtained in respect of these capital expenditures. Chickasha Cotton Oil is in no way in conflict with this result. Decision will be entered for the respondent. Footnotes 1. (b) The head of the department in which the Coast Guard is operating also shall require the Coast Guard to inspect, before the same shall be put into service and at least once in every two years thereafter, the hull and equipment of every seagoing barge of one hundred gross tons or over, not carrying passengers; and to determine to its satisfaction that such barge is of a structure suitable for the service in which she is to be employed, has suitable accommodations for the crew, if manned, and is in a condition to warrant the belief that she may be used in navigation with safety to life.↩ 2. This conclusion is confirmed by the practical consequences resulting therefrom. Suppose a taxpayer had property requiring $ 100,000 repairs which he could sell for $ 900,000 "as is." If he should contract to sell it, agreeing to make the repairs himself prior to transferring title, one would expect that in the normal course the parties would negotiate a sales price of $ 1 million. The $ 100,000 paid out by the owner for such repairs would be treated as capital expenditures and would be reflected in the computation of his gain or loss upon the sale. His actual gain or loss would thus remain the same, and he would obtain appropriate tax benefit for such expenditures made in connection with that capital transaction. But if he were allowed to deduct those expenditures from ordinary income as business expenses, there would be a distortion that Congress plainly could not have intended, for the $ 100,000 increase in sales price would be accorded the favorable capital gains treatment whereas the $ 100,000 deduction from ordinary income would result in a net unintended tax benefit growing out of the transaction as a whole. We note, of course, that the gain on the transfer of the two vessels herein was treated as nonrecognizable, but petitioners have not made any argument based upon this consideration. The point in this respect is that the expenditures represent an addition to basis that will ultimately be reflected upon any subsequent sale or other taxable disposition.↩ 3. Indeed, in view of the fact that the taxpayer was a corporation, nothing turned upon whether the loss was a capital loss, since under the applicable statute at that time capital gains and losses of corporations were treated in the same manner as ordinary gains and losses. And even as to individual taxpayers, limitation upon deductions of capital losses did not appear in the law until the Revenue Act of 1924, after the years involved in the Chickasha↩ case.