Farming Corp. v. Commissioner

FARMING CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Farming Corp. v. Commissioner Docket No. 1387. United States Board of Tax Appeals 11 B.T.A. 1413; 1928 BTA LEXIS 3624; May 16, 1928, Promulgated *3624 1. A certain contract of employment between a corporation and its manager covered a term of three years, the entire remuneration was paid, and 80 per cent of the services were rendered in the first year. Held, that the Commissioner was not in error in deducting an aliquot part of such remuneration from the petitioner's income for the taxable year. 2. The evidence does not sustain the claim that certain second mortgages on real estate had no actual cash value at date of their receipt by the petitioner. William Ritchie, Jr., Esq., for the petitioner. Philip M. Clark, Esq., for the respondent. LANSDON *1414 The respondent has asserted a deficiency in income and profits tax for the year 1919 in the amount of $5,669.14. The petitioner contends that respondent erred (1) in prorating a certain salary paid by it to its manager over a period of three years instead of allocating 80 per cent of such salary as a deduction from income as an operating expense in the taxable year, and (2) in adding to its income for the taxable year the sum of three notes secured by second mortgages on lands sold by it in such year and avers that such second mortgages*3625 were not salable when received except at substantial discounts from their par value. FINDINGS OF FACT. During the taxable year the petitioner was a Nebraska corporation, with its principal office at Omaha. It was engaged in the acquisition, improvement and sale of irrigated farm lands in the western part of the State of Nebraska. Shortly after its incorporation, or on or about March 1, 1919, the petitioner entered into a contract of employment with one William Ritchie, Jr., to act as its agent or manager in the transaction of its business and the conduct of its operation for a period of three years. As full compensation for all services to be rendered during the term of such contract it issued and paid to said Ritchie at some date within the taxable year its common capital stock of the par value of $5,000. Pursuant to the conditions of the contract of employment, Ritchie took charge of the organization and operations of the petitioner and continued to render the services for which he was employed for a period of three years from March 1, 1919. In the year 1919 the petitioner acquired 32 irrigated or irrigable farms in western Nebraska. Ritchie selected the lands in*3626 question, subdivided such lands into farms, arranged for irrigation by having lateral ditches constructed and by grading and leveling the lands, had the several farms fenced and otherwise improved and prepared for occupation and cultivation, and secured tenants or purchasers for such farms. Not less than 80 per cent of the services required of Ritchie under the terms of the contract of employment were rendered in the taxable year. In the taxable year the petitioner sold three farms for which it received cash payments and first mortgages in amounts not disclosed by the record or material here and several second mortgages in the total face value of $12,550. Such second mortgages were not marketable through the regular or usual agencies for the sale of such securities except at a substantial discount. In the taxable year or the first year subsequent thereto the petitioner transferred such second mortgages *1415 to the corporation from which it had purchased its lands and received credit therefor in the amount of the face value thereof. In its income and profits-tax return for the taxable year the petitioner deducted from its gross income the amount of $5,000, representing*3627 the stock which it had issued to Ritchie, as an ordinary and necessary business expense incurred and paid within the year and did not include in its gross income for such year the amount of $12,550, representing the face value of the three second mortgages above described. Upon audit of such return the Commissioner prorated the remuneration paid to Ritchie over the three-year term of employment, allowed $1,250 as ordinary and necessary expense for the taxable year, and added the remainder to gross income for such year together with the face value of the three second mortgages and determined the deficiency here in controversy. OPINION. LANSDON: The petitioner asserts and the respondent admits that on or about March 1, 1919, it paid the amount of $5,000 to one William Ritchie, Jr., as consideration for a three-year contract of employment beginning at such date. During the entire term of the contract Ritchie acted as operating manager of the petitioner and rendered services as set forth in our findings of fact. The petitioner contends that such payment was for services as rendered and that as 80 per cent of the work under the contract was done within the taxable year it was entitled*3628 to deduct 80 per cent of the payment or $4,000 from its income in its income and profits-tax return for such year as an ordinary and necessary business expense. Upon audit of the petitioner's return for 1919 the Commissioner disallowed the deduction of $4,000 claimed as above stated, prorated the entire amount paid to Ritchie ratably over the life of the contract and allowed a deduction from the petitioner's gross income for the year 1919 in the amount of $1,250 on the basis of the time elapsed between March 1 and December 31 of such year. In his answer to the petition of the taxpayer, the respondent says that "such allocation has been made on the statement of the taxpayer that the $5,000 paid to Mr. Ritchie in advance was compensation for services to be performed over a period of three years." There is no dispute over the facts involved in this controversy. The parties agree that the payment made was in the amount of $5,000 and therefore the value of the stock at date of payment is not at issue. We are asked to decide only as to the proper method of allocating and distributing the payment for services over the term of the contract of employment. We believe this point is controlled*3629 by the case of , and by our own *1416 opinion in , and therefore approve the action of the Commissioner in refusing to allow a deduction of more than $1,250 from the income of the petitioner for the taxable year as an ordinary and necessary business expense incurred and paid within such year. The only evidence adduced by the petitioner in support of its second contention is the testimony of Ritchie that there was no market for the second mortgages except at a discount of at least 25 per cent from face value. Against this is the fact that in the taxable year or the first year subsequent thereto the petitioner applied such second mortgages, without discount, to a part payment of the balance of the purchase money that it owed on the lands involved in the transactions. We conclude, therefore, that these mortgages were worth their face value to the petitioner when received and approve the determination of the respondent on this point. Reviewed by the Board. Judgment will be entered for the respondent. STERNHAGEN: Ritchie, who signed the*3630 petition as president, organized this corporation in 1919, and for this and further services in the conduct of its business for three years, he was to receive $5,000 par value of its stock. The remaining issued or outstanding stock does not appear. I can not agree that the corporation either paid or incurred an ordinary and necessary expense in any amount by issuing its stock. It paid out nothing and incurred to obligation to pay. It created a new interest in its assets and business, and this did not affect its income any more than the possibility of dividends or liquidating distributions ever do. LITTLETON, SMITH, TRAMMELL, ARUNDELL, and MURDOCK concur in the above.