Polar Ice Cream & Supply Co. v. Commissioner

POLAR ICE CREAM & SUPPLY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Polar Ice Cream & Supply Co. v. Commissioner Docket Nos. 13805, 25823. United States Board of Tax Appeals 13 B.T.A. 1054; 1928 BTA LEXIS 3117; October 16, 1928, Promulgated *3117 Evidence held insufficient to determine value of leasehold for exhaustion and invested capital purposes. George E. H. Goodner, Esq., for the petitioner. Harry LeRoy Jones, Esq., for the respondent. MORRIS *1054 The proceeding in Docket 13805 is for the redetermination of a deficiency of $959.97 for 1920, and arises from the action of the respondent in disallowing a $2,400 deduction claimed as exhaustion of a leasehold, and in eliminating $10,300, representing the alleged unexhausted value of the leasehold from petitioner's invested capital. The proceeding in Docket 25823 is for the redetermination of a deficiency of $288.42 for 1924, and arises as a result of respondent's action in disallowing a $700 deduction claimed as exhaustion of a leasehold, and in refusing to allow a deduction for an alleged net loss for 1922. The proceedings were consolidated for hearing and decision on motion of petitioner. FINDINGS OF FACT. The petitioner was incorporated February 17, 1919, under the laws of the State of Colorado, with a capital stock of $15,000 nonvoting preferred stock, and $12,000 common stock, the par value of each class of stock being*3118 $1 per share. On January 27, 1919, A. R. Bliesner and the Forbush Fuel & Ice Co., a Colorado corporation, entered into a lease agreement whereby Bliesner, who was in the ice cream business, secured a room, 40 by 17 feet, in the building occupied by the Forbush Company, for the purpose of conducting his business. The instrument provided that the Forbush Company should furnish Bliesner with ice, refrigeration, steam, water, auto storage, heat and electricity and the space aforesaid in consideration of a rental of 9 cents per gallon on all ice cream and ices sold by him. Bliesner covenanted and agreed that he would manufacture all of his ice cream and ices on the premises leased and guaranteed a minimum yearly rental of $1,200. Bliesner's lease was for a 5-year term beginning March 1, 1919, and it provided for two 5-year renewals, and in the event of a sale of the premises the lessor reserved the right to cancel the lease upon giving 6 months' notice and paying $1,500 to the lessee. This lease was subject to the approval of the Atchison, Topeka & Santa Fe Railway Co., from whom the Forbush Company had leased the premises for a period of 4 1/2 years beginning January 1, 1915. *3119 The last mentioned *1055 lease did not contain a provision for renewal. It specifically prohibited the Forbush Company, by the fifth clause thereof, from underleasing or subletting the premises or any part of the same, or assigning the lease, without the written consent and approval of said Railway Company. By an undated indenture containing no provision for renewal, the Railway Company leased the premises to the Forbush Company for another term of 4 1/2 years beginning July 1, 1919. The petitioner sold 11,500 shares of its preferred stock in 1919 for cash, the remaining shares of preferred being unissued. Preferred stock certificates were issued on March 24, 1919, to Otto J. Storm for 3,500 shares, to the Forbush Fuel & Ice Co., for 3,000 shares, and to A. R. Bliesner for 2,000 shares. On June 28, 1919, a preferred stock certificate for 3,000 shares was issued to C. B. Frink. Bliesner assigned the lease which he had acquired from the Forbush Company to the petitioner in exchange for its common stock, which was issued June 28, 1919, on his order as follows: Otto J. Storm, 3,000 shares; C. B. Frink, 3,000 shares; A. R. Bliesner, 3,000 shares; one share of common stock*3120 was issued to A. D. Forbush and 2,999 shares to the Forbush Fuel & Ice Co., on April 19, 1919. Bliesner received no consideration for the transfer of the common stock as above indicated. The lease was set up on the books of the petitioner at a value of $12,000 and written off at the rate of $2,400 per year. Its value was computed by estimating the savings that would result from operations under it, the principal element of which was the saving of $2 to $2.50 per ton in the cost of ice. During the period of the lease the petitioner used 5,831 tons of ice. A delivery charge on ice of $2 to $2.50 per ton was saved by the petitioner by being located in the same building with the ice manufacturing company. In 1921 the petitioner suffered a heavy loss due to a flood, the water around its plant being 12 feet 6 inches deep. The flood occurred during the most profitable season of the year, interfering with the business for about three months, and causing a net loss on the year's operations. The petitioner's records show a net loss of $1,060.20 for the years 1919, 1920, 1921, 1922, and 1923. The capital-stock tax returns of petitioner for the years subsequent to incorporation*3121 show that this tax was computed by valuing the stock issued for the leasehold at par. The taxes shown on such returns were collected by the respondent. For 1920 the petitioner showed a net income on its return of $5,280.83, which the respondent increased by $2,400, the amount of the deduction claimed for exhaustion of the leasehold. For the same year the respondent excluded $10,300 from invested capital, representing the remaining value of the leasehold. For 1924 the petitioner reported net income of $7,326.12, after having deducted *1056 $700 for exhaustion of the leasehold, and $1,607.38 as a net loss for 1922 in excess of 1923 income. At the hearing petitioner amended its petition as to 1924, alleging by the amendment that the net loss for 1922 in excess of 1923 net income should be $3,397.77 instead of $1,607.38 as set forth in petition. The petition was further amended to the effect that the correct net loss for 1921 should be applied against and reduce the corrected income for 1923 and the entire corrected net loss for 1922 should be deducted from the corrected net income for 1924. The respondent disallowed the deduction for exhaustion of the leasehold and for*3122 the net loss for 1922. OPINION. MORRIS: The two questions raised by the petitioner in connection with the leasehold acquired by it depend upon a determination of the actual cash value or fair market value thereof at the date of acquisition. The principal testimony relied upon by the petitioner to establish the $12,000 valuation was that due to the use of the space covered by the lease, which was in a cold storage and ice plant, a saving of from $2 to $2.50 per ton resulted and that during the term of the lease, 5,831 tons of ice were used. It is apparent that this basis of valuation rests, at least in part, upon facts which have come to light subsequent to the date of the acquisition of the lease. At that time this saving, as was testified by one of petitioner's witnesses, was speculative and there was no assurance that it would continue to accrue to the end of the period covered by the lease. A lease has an actual cash value or fair market value only when the value of the rights granted thereunder is in excess of the payments and obligations imposed upon the lessee. The mere fact that a saving to the lessee results by reason of the location of the leased premises does*3123 not of itself establish that the lease had a value in excess of the rental paid. It was testified that a reasonable rental for such space was $75 per month. The petitioner under the terms of the lease was obligated to pay a minimum monthly rental of $100 and we were not advised as to the actual amount paid on the basis of 9 cents per gallon on the ice cream and ices sold by it. The difference of $25 or more per month was undoubtedly to reimburse the lessor for the facilities and service furnished by it; whether a part of that difference represented a charge because of the saving in the cost of ice to the lessee, we do not know. One witness testified that it would cost approximately 3 cents per gallon more to operate without the lease; in other words, that 9 cents when divided properly would not give sufficient payment for the ice to cover the cost of ice and delivery. We do not give any weight, however, to this particular testimony, as the witness was engaged in another business and his knowledge of the petitioner's business was meager. *1057 Considering all the evidence introduced in support of the $12,000 valuation of the lease, we are unable to find that it had any*3124 value at the date of acquisition by the petitioner, and, therefore, sustain the respondent's action in disallowing a deduction for the exhaustion thereof and in eliminating the claimed depreciated value from invested capital. Judgment will be entered under Rule 50.