Holeproof Hosiery Co. v. Commissioner

HOLEPROOF HOSIERY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Holeproof Hosiery Co. v. Commissioner Docket No. 7535. United States Board of Tax Appeals 11 B.T.A. 547; 1928 BTA LEXIS 3769; April 13, 1928, Promulgated *3769 1. Disallowance of a deduction for an alleged loss approved. 2. An amount paid in connection with an increase in the capital stock of the petitioner to the State of Wisconsin in accordance with the law of that State held deductible as a tax under section 234(a)(3) of the Revenue Act of 1921. 3. Attorneys' fees paid in the same connection were not ordinary and necessary expenses within the meaning of section 234(a)(1) of the Revenue Act of 1921. 4. An amount paid as rental on machines in which the petitioner with each payment acquired an equity was not deductible under section 234(a)(1) of the Revenue Act of 1921. 5. The Commissioner was in error in adding to income a discount deducted consistently from inventories. W. L. Harrison, C.P.A., and J. B. Grice, C.P.A., for the petitioner. T. M. Wilkins, Esq., for the respondent. MURDOCK *547 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar year 1921, in the amount of $15,699.24. The petitioner contends that the Commissioner erred (1) in disallowing a deduction of $1,000 as a loss on stock in a steamship company held*3770 by it as an investment; (2) in disallowing a *548 deduction of $2,660, $900 of which represented legal expenses, and $1,760 of which represented an amount paid to the State of Wisconsin, on an increase in its authorized capital stock; (c) in disallowing a deduction of $13,060, representing rent paid for the use of machinery leased by the petitioner; and (d) in denying the right of the petitioner to reduce its closing inventory for 1921, in the amount of $12,924.78. FINDINGS OF FACT. The petitioner is a Wisconsin corporation with its principal office at Milwaukee. Its books were kept on an accrual basis. In 1919, the petitioner purchased 10 shares of stock in the Milwaukee, Chicago & Michigan City Line for $1,000, as an investment. This line operated boats. In May, 1921, the petitioner received the information from some undisclosed source that the Milwaukee, Chicago & Michigan City Line had current liabilities of $113,000 and a possible additional liability of $30,000 or $40,000 for claims for shortages and missing freight, and that the only assets owned by the company consisted of two old steamboats and an old hull which were not in proper condition for operation. *3771 Thereafter the petitioner regarded the stock as worthless and charged it off its books. It never received anything from the stock after this charge-off. The petitioner was organized in 1904. Its stock has always been held by the Freschl family and L. Heilbronner. From time to time the amount of capital stock outstanding has been increased by stock dividends and by applying the proceeds of cash dividends to stock purchases. No outside capital was ever brought in. In 1910 the capital stock was increased to $500,000. In 1917 it was increased to $1,000,000. In 1920 it was increased to $2,000,000 and in December, 1921, an application was made to the proper officer of the State of Wisconsin for authority to increase the capital stock to $3,750,000. The request was granted. All expenses incident to the various increases in the capital stock were charged to expense. In 1921 the following expenditures were incurred, paid and charged to expense in connection with the increase in the amount of its authorized capital stock: Attorneys' fees $900 State fee for filing an amendment to charter [10] State fee of $1 per thousand for increase in authorized capital 1,750 Total 2,660 *3772 The petitioner claimed this amount as a deduction on its income-tax return. The Commissioner disallowed it. In December, 1921, there was in force in the State of Wisconsin, a statute which included chapter 86, entitled "Organization, Powers *549 and Dissolution of Corporations." Section 1772 under this chapter, entitled "Articles to contain what; fees." provided in paragraph (9): (a) * * * Fees for filings are required to be paid to the secretary of state as follows: (c) By every other corporation, except as is otherwise provided in these statutes, twenty-five dollars for the articles and ten dollars for each subsequent amendment thereof, together with a further fee of one dollar for each one thousand dollars of its authorized capital stock in excess of twenty-five thousand dollars. The Secretary of State of the State of Wisconsin made a biennial report of the State Department covering the fiscal years ended June 30, 1921, and June 30, 1922, in compliance with the statutes describing his duties. This report showed the condition of all state funds, together with detailed statements of receipts and disbursements for the period. For the fiscal year ended June 30, 1922, the*3773 report showed in regard to the general fund, which fund embraced all state revenues applicable to the payment of ordinary governmental expenses, total book receipts of $33,626,072.77, including receipts from the Department of State in the amount of $4,313,233.45, and total book disbursements in the amount of $30,758,898.25, which included disbursements in the State Department of $233,653.20. The receipts of the State Department included motor vehicle license fees in the total amount of $4,088,570, and the following: Domestic corporations $79,000.75 Foreign corporations 28,658.50 Miscellaneous corporation fees 36,428.30 Amendments 72,275.75 Notaries Public 6,198.00 Miscellaneous 1,802.15 E. R. Mihills, refund of salary 300.00 Total 224,663.45 The disbursements in the State Department from the general fund in the amount of $233,653.20 were itemized in the report and were then recapitulated as follows: Disbursements by appropriations: General administration $51,921.58 Automobile registration (including refunds) 181,731.62 233,653.20 The biennial report of the Treasurer of the State of Wisconsin for the fiscal years ending June 30, 1921, and*3774 June 30, 1922, shows total book receipts of $51,957,421.07 and total book disbursements of $48,455,361.27 for the year ending June 30, 1922. For this year the total book receipts included $33,626,072.77 from the general fund and the total book disbursements included $30,758,898.25 from the general *550 fund. The report stated that the general fund embraced all the revenues of the State applicable to the payment of the ordinary expenses of the state government and included in the receipts of this fund $11,530,666.75 as departmental receipts, made up of the following from the State Department: Fees and income $224,363.20 Motor vehicles 4,088,570.25 Legislature 158.00 The report showed that general fund disbursements included those of the State Department, which amounted to $233,653.20, itemized as follows: Salaries $88,630.46 Traveling and field expense 5,852.82 Stationery and office supplies 1,238.89 Postage 30,679.70 Telephone and telegraph 286.67 Express, freight and drayage 363.84 Printing and binding 36,933.27 Publishing delinquent corporations 224.70 Auto plates 60,899.75 Miscellaneous 8,543.10 Refund 233,653.20 *3775 On July 27, 1921, the petitioner, as lessee, entered into four lease agreements with the Textile Machine Works of Wyomissing, Pa., as lessor, each of which provided in part as follows: That the lessor doth hereby lease and hire unto the Lessee certain machines and property manufactured and owned by the Lessor and described as follows: 3 - Standard 18 Section 39 Gauge Full-fashioned Leggers (here follows a description of the machine) Price per machine complete, as specified above $6,600.00 1 - Standard 20 Section 39 Gauge Full-fashioned Footers (here follows a description of the machine) Price per machine complete, as specified above 6,850.00 In consideration of the execution of this agreement by the Holeproof Hosiery Company, the Textile Machine Works, guarantees that the machinery to be delivered by them hereunder will be new, well designed and well made of proper materials and properly erected by them for its purpose, namely, the knitting of Full-fashioned Hosiery, and that any imperfections on account of wrongful materials or imperfect workmanship or adjustments becoming manifest during the term of the lease herein contemplated, shall be promptly rectified*3776 by the Textile Machine Works, without loss or expense to the Holeproof Hosiery Company each machine being valued as specified above, and all of them being valued at Twenty-six Thousand Six Hundred Fifty ($26,650.00) Dollars, with the privilege of using the same at Hole Proof Hosiery Co., 4th & Fowler Street, Milwaukee, Wis., or at any other place or places to which, with the written consent of the said Lessor, said machines and property may be removed by the Lessee, for the term of Thirty Months, from the date hereof, *551 at a rental of Two Hundred ($200.00) Dollars, per machine per month plus any sums that may be paid by the Lessor as premium for the insurance of said demised property against loss by fire; said rental to be payable as follows, viz: the sum of Two Hundred ($200.00) Dollars, per machine in cash upon delivery of each machine and the balance of said rentals (exclusive of the insurance premiums and taxes, charges and assessments hereinafter mentioned) in monthly installments as follows, viz: during the continuance of this lease the sum of Two Hundred ($200.00) Dollars, per machine, this amount to become due every thirty days after date of shipment of each respective*3777 machine for the period of Thirty Months, mentioned above, making in all a total rental of Twenty-four Thousand ($24,000.00) Dollars * * * The Lessee hereby further agrees to use said leased property in a careful and prudent manner, to keep the same and every part thereof in good repair, order and condition at all times, to preserve intact the marks of ownership that are placed on said machines by the Lessor, that no alterations shall be made to said machines and property and no attachments shall be placed thereon or added thereto without the written consent of the Lessor, to keep possession and control of said leased property in the factory of Holeproof Hosiery Co., 4th & Fowler Streets, Milwaukee, Wis., and not to sell or remove or attempt to remove or permit the same or any part thereof to be removed therefrom without the consent of the Lessor endorsed in writing hereon, and not to assign this lease or sublet or in any way dispose of the said leased property or any part thereof to anyone during the continuance of this lease without the written consent of the Lessor; and that upon the expiration of this lease the leased property and every part thereof shall be surrendered and*3778 delivered up to the Lessor in as good condition as when received by the Lessee, ordinary and reasonable wear and tear excepted, and without excuse for non-delivery because of unavoidable accidents, unless purchased by the Lessee from the Lessor within the time and in the manner hereinafter specified. * * * After the Lessee shall have faithfully performed all the stipulations of this contract and paid all the installments of rent aforesaid in manner and form as herein provided, without default, then it is agreed that the Lessee may, at his option, at any time within ten days after the time of maturity as above stipulated, of the last instalment of rent, purchase the said leased machines and property at the price of Thirteen Hundred Forty-Three & 90/100 ($1,343.90) Dollars per Legger and Sixteen Hundred Forty-Five & 56/100 ($1,645.56) Dollars per Footer, and upon payment of said sum to it within ten days' time limited as aforesaid, the Lessor shall thereupon, by bill of sale, convey said leased machines and property to the Lessee. It is also agreed that immediately upon the expiration of Twenty-four Months from the date of this agreement, provided and upon condition that the*3779 Lessee shall have faithfully performed all the stipulations of this contract and shall have paid all the installments due and payable, including also the Twenty-fourth instalment of rental of Two Hundred ($200.00) Dollars, together aggregating Nineteen Thousand Two Hundred ($19,200.00) Dollars, without default, the Lessee may, at his option, at any time within five days after the expiration of said Twenty-four-month period from the date of this agreement as above stipulated, purchase the leased machines and property at the price of Twenty-four Hundred Ninety-nine & 92/100 ($2,499.92) Dollars per Legger and Twenty-seven Hundred Ninety-one & 58/100 ($2,791.58) Dollars per Footer, and upon payment of said sum to it within the five days' time limit as *552 aforesaid, the Lessor shall thereupon, by bill of sale, convey said leased machines and property to Lessee. This agreement and the provisions hereof shall be construed in accordance with the law of the State of Pennsylvania. Each lease also provided that the value of the machines was $26,650, and if they were lost or destroyed prior to actual redelivery to the lessor, the value, with interest from the date of the agreement, *3780 less the rent previously paid for the use of the machines, should become immediately due and payable by the lessee to the lessor. In case any machine was returned in a damaged condition, the lessee was to pay the amount of the damage. The lessor was to have the right of inspection. The lessee was to insure the machines in the name of the lessor and pay all taxes assessed or levied against the leased property. These leases were never modified and were still in effect on December 31, 1921. The machines mentioned in the leases were delivered to the petitioner and installed several months after July 27, 1921. They were still in use in January, 1927. After the petitioner acquired title to the machines it entered an amount representing their cost in a capital account. The petitioner claimed as a deduction for rent on these machines for the year 1921, the amount of $13,060, which amount the Commissioner disallowed as a deduction on the ground that it represented a capital expenditure. The petitioner always took an inventory at the end of each year on the basis of cost or market whichever was lower. Except for the inventory taken at the end of the year 1920, it has always*3781 found that the cost of its materials was lower than market at the time of taking the inventory. In taking the inventory at the end of 1920 it found that market was considerably lower than cost and therefore it took the inventory at market. In all of its inventories taken at cost, and particularly in the inventory taken at the end of the year 1921, at the end of the inventory of materials the petitioner deducted 2 per cent from the cost of those materials. It did this for the reason that all of its contracts for purchases called for a 2 per cent discount and it had always taken advantage of this discount. The Commissioner increased the petitioner's taxable income as reported on the tax return by $12,924.78, which was the amount of the discounts deducted from the inventory by the petitioner. OPINION. MURDOCK: The petitioner contends that it sustained a loss of $1,000 during the taxable year in connection with its stock in the Milwaukee, Chicago & Michigan City Line. Satisfactory evidence that this stock was worthless at the end of 1921, has not been offered. An *553 alleged loss of this kind must be supported by facts which show that it was in fact sustained and is*3782 not established by the mere showing that the petitioner heard a rumor that the company was in financial straits. The petitioner claims the right to deduct the amount of $1,760 under section 234(a)(3) of the Revenue Act of 1921, as taxes paid or accrued within the taxable year. The amount was paid to the Secretary of State of the State of Wisconsin in accordance with the law of that State, as set out in our findings of fact, so that the petitioner's authorized capital stock might be increased from $2,000,000 to $3,750,000. The Commissioner disallowed this deduction on the ground that it was a fee and not a tax. In the statute of the State of Wisconsin the amount to be paid to the secretary of state for the increase in the authorized capital stock of this corporation is called a fee, but we do not think that the decision of this case should depend upon this fact. The Supreme Court of the State of Wisconsin has held that certain charges called fees in its statutes were nevertheless taxes. See State v. Chicago & N.W. Ry. Co.,132 Wis. 340; *3783 112 N.W. 515. A fee exacted from a corporation may be a license or a tax, or both. Airway Electric Appliance Corporation v. Archer,279 Fed. 878. Cook on Corporations, 8th ed., vol. 3, sec. 561, gives eleven different methods of taxing corporate interests, including - 9th, Incorporation fees and a tax on any increase of the capital stock. The terms "fees," "licenses," and "taxes" have sometimes been employed as convertible terms, though they are not precisely synonymous. See Parish of East Feliciana v. Levy,40 La.Ann. 332; 4 So. 309. In Words and Phrases, first series, vol. 3, p. 2715, under "Fees" the following appears: The meaning of the word "fees" is the recompense allowed by law to officers for their labor and trouble (2 Bac. Abr. 463); so that where there is no labor or trouble, no necessary services rendered or offered to be rendered, no fees can be allowed. City of Mobile v. Southerland,47 Ala. 511, 517. Thus strictly speaking, the word "fees" signifies compensation for particular acts or services rendered by proper officers in the line of their duties to be paid by the persons*3784 obtaining the benefit of the services or at whose instance they were performed. See State ex rel. Board of Commissioners of Hamilton Co. v. Carey (Ind.) 84 N.E. 761, 762. Various circumstances may lead to the conclusion that a certain charge made by a State is a tax. For example, the purpose for which the charge was made may be determinative. Ward v. Maryland,12 Wall. 418; Glasgow v. Rowse,43 Mo. 479; and Airway Electric Appliance Corporation v. Archer, supra.See also Harvey *554 v. Commonwealthof Virginia,20 Fed. 411. The weight of authority holds that where the charge is made primarily for the purpose of revenue, it is a tax. A license is issued under the police power, But the exaction of a license fee with a view to revenue would be the exercise of the power of taxation. See State v. Bengsch,170 Mo. 81; 70 S.W. 710. In City of St. Louis v. Spiegel,75 Mo. 145, the court said: In this case it is apparent at first blush that the license fee is imposed for the purpose of revenue. That such fee is*3785 also imposed for the purpose of regulation does not deprive it of the salient characteristics of a tax. Many of the so-called license taxes are assessed and collected annually, but there are occasional taxes also which are, nevertheless, taxes, and in deciding whether or not an occasional charge is a tax, we see no reason why the same principles may not govern as are controlling when the same question arises as to annual charges. In Harvey v. Commonwealth of Virginia, supra, there was involved an annual charge for a license and the court said, in part: * * * It is offensive, if not insulting, to the common sense of every candid citizen to pretend that the charge which the state may see fit to impose on merchants for the privilege of carrying on their business is anything else than the commonplace thing which practical men call a tax. The right of residence, of holding property, of conducting a business, may be a natural right, but the enjoyment of it under the protection of law is a privilege granted by the state, and therefore, for short, I have called it a privilege. Nor is there any essential difference between a tax per capita, levied for the privilege*3786 of residence, a tax ad valorem, levied for the privilege of holding property, and a license tax, levied for the privilege of conducting a particular calling. * * * In the case of Airway Electric Appliance Corporation v. Archer, supra, the court said, in connection with a somewhat similar charge made by the State of Ohio: A tax may be laid for the double purpose of regulation and revenue. Adler v. Whitbeck,44 Ohio St. 539, 572, 9 N.E. 672; Fritsch v. Board of Commissioners of Salt Lake City, 15 Utah, 83, 95, 47 Pac. 1026; Parish of E. Feliciana v. Levy,40 La. Ann. 332, 4 South. 309. It may also be exacted for the privilege of exercising corporate franchises in the state and for general revenue (State v. Ferris,53 Ohio St. 314, 329, 41 N.E. 579, 30 L.R.A. 218; Ashley v. Ryan,49 Ohio St. 504, 525, 31 N.E. 721; Gundling v. Chicago,177 U.S. 183, 189, 20 Sup.Ct. 633, 44 L.Ed. 725; * * * The term "fee" and "tax" were, in the legislative mind, convertible and equivalents. *3787 It is immaterial whether the sum charged is characterized as a fee, a tax, or an assessment, if on the whole it is clear that it is a tax. Ashley v. Ryan,49 Ohio St. 525, 31 N.E. 721. In view of the provisions of section 181a, R.S. (now section 270, G.C.), that all money paid into the state treasury, the disposition of which is not otherwise provided by law, shall be credited by the auditor of state to the general revenue fund, it was held, in Ashley v. Ryan,49 Ohio St. 526, 31 N.E. 721, that it is not necessary that the object of a given statute should be stated to be the imposition of a tax for revenue purposes in order to constitute it a statute of that character. The *555 tax or fee charged against a foreign corporation under the statute here considered is expressly required to be paid to the state treasurer (sections 5503, 5504), and section 5491 further provides that all taxes received by the state treasurer under the provisions of the Tax Commission Act shall be credited to the general revenue fund. But any exaction which is made a means of supplying money for the public treasury to defray the expenses of government, and*3788 any sum demanded as a franchise fee or excise tax, which goes into the state treasury and constitutes a part of its general fund, is a tax (Mays v. Cincinnati,1 Ohio St. 268, 273, 274), and the law providing for the same is a revenue law (Peyton v. Bliss, Fed. Cas. No. 11,055). We have already said in interpreting section 234(a)(3) of the Revenue Act of 1918, which is similar to the same section of the Revenue Act of 1921, here involved, that we think Congress used the word "taxes" in this subdivision in a broad sense. Caldwell Milling Co.,3 B.T.A. 1232. Taxes are deductible without regard to their relation to capital or income transactions. United States v. Woodward,256 U.S. 632. In the case just cited, the court in holding that a Federal estate tax might be deducted under section 214(a)(3) of the Revenue Act of 1918, said that if the correct construction should be a matter of doubt, it would follow the rule laid down in Gould v. Gould,245 U.S. 151, and construe the Act most strongly against the Government and in favor of the citizen. *3789 Each party might have presented additional evidence which would have given a better picture of the case than we now have. The respondent offered no evidence but relied upon the wording of the Wisconsin statute. However, the evidence which is before us indicates that the exaction from the petitioner was in substantial excess of any special benefits accruing to it; that it bore little, if any, relation to the cost of any service rendered by the State, or to reasonable compensation for any trouble or expense on the part of the State on account of the increase in the petitioner's authorized capital stock; that the receipts of the office of the secretary of state from this and similar charges greatly exceeded the portion of the expenses of administration attributable to the performance of any service by the State in connection with the charges; that the receipts were used for general State purposes and considerable revenue was derived in this way; and, in short, that there was a taking under the guise of taxation. See Norwood v. Baker,172 U.S. 269. Under such circumstances we hold that the amount paid was a tax within the meaning of section 234(a)(3) of the Revenue*3790 Act of 1921, and deductible thereunder. The petitioner contends that the amount which it paid as attorneys' fees in order to obtain authority to increase its capital stock was an ordinary and necessary expense of the taxable year in carrying on its business. The Commissioner contends that the payment of this amount was a capital expenditure. *556 Those expenses which are ordinary and necessary in carrying on a business may be deducted from annual income when paid or incurred. Expenditures which are made for the acquisition of capital assets represent the cost of the asset and, if the assets are exhausting, deductions for exhaustion make capital whole in such cases before income is taxed. For example, repairs to a machine due to its use in a business are ordinary and necessary expenses of carrying on that business, whereas the original cost of an expensive machine having a life of several years is not an ordinary expense of carrying on that business. It is not chargeable to the year's business, but should be and may be deducted by way of exhaustion from the income of the years during which it is used. However, all expenditures need not fall into one or the other of*3791 these two classes. Thus, when a payment is made for something intangible with an indefinite life, the expenditure does not seem to fall within either class. The expenditure for attorneys' fees in this case may be such an expenditure. It can be argued, and not without merit, that no capital asset is acquired when attorneys' fees are paid in connection with an increase in capitalization, but it does not follow that the payments are ordinary and necessary expenses of the year when made. It may be that the scheme of the taxing statute fails to provide for their reflection in the computation of the petitioner's tax, but in any event they are not ordinary expenses in carrying on the business during the year 1921, within the meaning of section 234(a)(1) of the Revenue Act of 1921. F. Tinker & Sons Co.,1 B.T.A. 799, 803; First National Bank of St. Louis,3 B.T.A. 807; Emerson Electric Manufacturing Co.,3 B.T.A. 932. The petitioner claimed a deduction of $13,060 as rental for the year 1921 on 16 machines for knitting full-fashioned hosiery. Section 234(a)(1) is the section of the Act governing the question of the deductibility of*3792 rents and it provides for a deduction "including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity." The evidence in this case indicates that at the end of the year 1921 the petitioner had a substantial equity in these machines. We do not know the life of the machines, but we do know that they were still in use five years after the taxable year in question. We do not know at what amount the machines could be rented on the open market but we know that the total amounts to be paid under the lease agreements before the title to the machines was to pass to the petitioner exceeded but slightly the stated value of the machines, and it is inconceivable that the petitioner was not acquiring something of value, that is, a certain equity in the machines, with each *557 payment made in accordance with the agreement. The courts of Pennsylvania have recognized the existence of such an equity under leases similar to these. ,*3793 Schmidt v. Bader,284 Pa. 41; 130 Atl. 259; Packard Motor Car Co. v. Mazer,77 Pa. Super. Ct. 348; Edward's Appeal,105 Pa. 103. The statute does not allow the deduction claimed. The Commissioner was in error when he increased the petitioner's taxable income by $12,924.78. The petitioner had deducted this amount from its inventory as a 2 per cent discount received by it in the purchase of the materials inventoried. It thus arrived at the cost to it of these materials. This method has been used consistently bt the petitioner. In 1920 no discount was actually subtracted from the inventories because of the fact that market at that time happened to be lower than cost and was used in the inventory. We had a somewhat similar situation in the case of Higginbotham-Bailey-Logan Co.,8 B.T.A. 566. We there decided that such a discount could be deducted. This case does not require a different conclusion. Reviewed by the Board. Judgment will be entered in accordance with the foregoing opinion on notice of 20 days, under Rule 50.