Minneapolis Syndicate v. Commissioner

MINNEAPOLIS SYNDICATE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Minneapolis Syndicate v. Commissioner Docket No. 10163. United States Board of Tax Appeals 13 B.T.A. 1303; 1928 BTA LEXIS 3076; October 30, 1928, Promulgated *3076 INVESTED CAPITAL - LEASE - INCOME. - Petitioner in 1906, by warranty deed, conveyed the title to a certain building. By indenture executed the same date and as part of the same transaction it leased for a term of years to the same interests land upon which the building stood. The lease provided that the building was to be kept in repair, insured for the benefit of the petitioner, and be returned to petitioner as its property at the termination of the lease. Held, that the ultimate beneficial interest surrendered by petitioner and received by the lessees under the transaction was no more than the use and occupancy of the property for the term of the lease and the total consideration paid by the lessees was income to petitioner and its distribution by the latter to its stockholders was not a liquidation of capital. H. A. Mihills, C.P.A., for the petitioner. Harold Allen, Esq., for the respondent. TRUSSELL *1303 This proceeding is for a redetermination of petitioner's income and profits taxes for the calendar year 1917, these having been determined *1304 by respondent under section 210 of the Revenue Act of October 3, 1917, and a*3077 deficiency of $12,084.77 asserted by notice dated October 22, 1925. The only issue presented is whether petitioner's invested capital for the calendar year 1917 can be determined. FINDINGS OF FACT. Petitioner is a corporation and was organized in the year 1882 under the laws of the State of Minnesota, with an authorized capital stock of $600,000, its purposes being to own, operate and deal in real estate and improvements. Its principal place of business is Minneapolis. The specific purpose of petitioner's organization was to purchase the westerly one-half of block 87 in the business section of the City of Minneapolis and erect thereon and operate a large modern building for stores, offices, and an opera house. Upon organization petitioner issued $640,000 par value common stock for which a similar amount of cash was paid in. On March 1, 1885, it issued a stock dividend of $60,000, which was charged in that amount against an earned cash surplus, thus increasing its issued capital stock to $600,000. In the year 1887, by amendment to petitioner's articles of incorporation, the authorized capital stock was increased to $900,000, and a stock dividend issue of $300,000, the*3078 corporation's asset account being increased by this amount as appreciation in value. In the year 1890 the articles of incorporation were again amended to increase the authorized capital stock to $1,000,000. The additional $100,000 of stock was issued for cash in that amount. Upon organization petitioner purchased the lot above referred to for the sum of $74,500 and erected thereon in 1883 and 1884 at a cost of $511,104.43, a large modern building known as the "Syndicate Block" which it rented to various tenants. At various times thereafter it made permanent additions and improvements to this property, as follows: [1886] $8,178.45 [1887] 21,821.55 [1889] 5,849.00 [1890] 19,151.00 Total 55,000.00 The cost of these additions and improvements petitioner charged into its capital account. At various other times between 1883 and 1906 petitioner expended amounts for permanent additions and improvements to this property, which expenditures were charged by it to profit and loss. It is agreed by the parties, and we find accordingly, that the total of these latter expenditures was the sum of $243,909.52, but that this sum included *1305 the amount of $48,284.91*3079 collected by petitioner as insurance for damage to the building and to this extent the expenditure of $243,909.52 represented a restoration, and that the net amount of $195,624.61 constituted capital expenditures charged in error by petitioner to profit and loss. On December 27, 1906, the capital cost to petitioner of the property known as the Syndicate Block, including both land and building, was the sum of $836,22.04, and this cost represented an investment in that amount of the original capital paid in for stock and surplus subsequently earned. In the latter part of the year 1906 negotiations were entered into by certain Boston interests with petitioner to obtain control of its property for a long term of years. Finally, a proposal was submitted to petitioner's board of directors and accepted and the carrying of it into effect authorized. This proposal is set forth in the resolution of the board of directors which authorized its acceptance, as follows: WHEREAS a proposition has been presented to this corporation by Messrs. Bradley & Tyson of Boston, Massachusetts, acting in behalf of certain clients whom they represent, to purchase the building known as the "SYNDICATE*3080 BLOCK" in the City of Minneapolis, Minnesota, situated upon the westerly half of Block 87 of the Town of Minneapolis, according to the recorded plat thereof, for the sum of Two Hundred and Fifty Thousand Dollars ($250.000.00) in cash, and, as a condition of such purchase, to take and receive a lease of the land and premises upon which said "Syndicate Block" is situated, for the period of one hundred and thirty (130) years from the first day of January, 1907, yielding and paying therefor a rental equal to Sixty-one Thousand Dollars ($61,000.00) per year, during each year of said term, in addition to the payment and discharge of all taxes, assessments, rates and charges levied, assessed or voted upon said premises, and every part thereof, during said term: On December 27, 1906, petitioner executed and delivered to Richard M. Bradley, Arthur Lyman and Russell Tyson, trustees, a warranty deed in regular form to the improvements known as the Syndicate Block and situated on the westerly half of block 87 of the City of Minneapolis. This deed evidenced receipt of "one dollar and other good and valuable considerations." One recital of this deed was: This deed is made contemporaneously, *3081 and as a part of one transaction, with the execution and delivery by the party of the first part to the parties of the second part of a ground-lease of the lands above described for a term of one hundred and thirty (130) years, from the first day of January, 1907, to and including the 31st day of December, 2036. On the same date petitioner, as lessor, and these three trustees mentioned, as lessees, executed an indenture whereby the use of the westerly one-half of block 87, referred to above, was demised to the lessees for a period of 130 years from that date, in return for considerations stated to be (a) the purchase of the building by the lessees under the deed referred to, (b) an agreement to pay a yearly *1306 rental of $61,000 during the term of the lease, and (c) various covenants binding the lessees to pay all taxes and public charges; to keep the property free of liens; to keep the building fully insured for the benefit of the lessor, the proceeds in case of destruction to be used for replacing it; to keep the premises in repair, and if demolished by lessee, then to replace with a building of a value of not less than $500,000; and, finally, to return the premises at*3082 the conclusion of the lease term with improvements maintained, or reconstructed as agreed upon, and with a then value of not less than $500,000, these improvements to be the absolute property of the lessor. This lease bears witness by its terms as follows: The lessor is the owner in fee simple of the tracts, lots and parcels of land hereinafter described, and hereby demised, and the lessees are the owners, (under and by virtue of a conveyance thereof, executed and delivered by the lessor contemporaneously herewith, and as part of one transaction with this lease), * * *. (Italics ours.) Upon execution and delivery of these two instruments petitioner was paid the sum of $250,000 in cash and on January 26, 1907, distributed this amount as a special cash dividend to its stockholders. On December 11, 1909, by amendment to its articles of incorporation, petitioner's purposes and powers were limited to the holding of title under the lease for 130 years above set out and the collecting and distributing to its stockholders of the rents received thereunder. OPINION. TRUSSELL: Upon audit of petitioner's tax return for the year 1917 invested capital as shown by its books in*3083 the sum of $1,009,156.93 was reduced by the revenue agent to $451,100.23, resulting in the determination by respondent of $3,216.18 additional income and profits taxes. To this petitioner objected, claiming invested capital in addition to that determined. Upon consideration of this question respondent held that it was impossible to compute petitioner's correct invested capital and accordingly determined its tax liability under section 210 of the Revenue Act of October 3, 1917. This action resulted in the increase of the deficiency from $3,205.78 to $12,084.77. Upon organization in 1882 petitioner had paid in for stock $540,000 in cash. Later the additional sum of $100,000 in cash was paid in for stock. In 1885 a stock dividend of $60,000 was issued, which was charged against a cash surplus. In addition it is admitted that petitioner's books show a net amount of $195,624.61 in capital expenditures by way of permanent additions and improvements to its building which were erroneously charged to profit and loss. It necessarily follows that petitioner is entitled to adjust by addition of *1307 these amounts the book costs of its building and improvements, these adjustment*3084 to be made as of the dates of the several expenditures. ; ; . We now come to the transaction effected by the deed and lease of December 27, 1906, and the cash distribution of $250,000 to stockholders by petitioner on January 26, 1907. A determination of petitioner's invested capital is a simple matter of computation when the extent to which it was depleted in these transactions is ascertained. The theory of respondent, as announced by his counsel at the hearing, is that the sale of the building and lease of the land were transactions separate and distinct; that petitioner sold the building, which on its books represented a cost of $640,000, for $250,000 cash and thereby sustained a loss of $390,000, and its invested capital was accordingly reduced in this amount, and the subsequent distribution of the $250,000 in cash to its stockholders further reduced it by that amount, leaving only that portion represented by the cost of the lot, or $74,500. However, on examination of the deed and lease executed on December 27, 1906, and*3085 consideration of all the circumstances of the transaction carried into effect thereby, we are convinced that these can not be considered as two transactions with a separate and individual loss or gain in each as the case may be. We are unable to accept respondent's theory of a loss incurred when the transaction shows a result entirely inconsistent with such conclusion. A theory assuming a fact, or by which a conclusion is reached, which is shown to be manifestly incorrect can not be accepted, no matter how sound in general principle or how plausibly the several steps leading up to the conclusion may be sustained. Petitioner's tax liability is determined by the facts as they actually exist. On this question the court in said: Taxes are not laid and collected on theory, but on a situation actually existing, as the facts may show that situation to be. They is applied in the absence of such facts. The question of taxation is one of fact, and cannot turn on theories or fiction. In the transaction in question this petitioner received $250,000 in cash, a fixed net income of $61,000 per year for*3086 a term of 130 years, and a reversion of the property at the end of that time, and the total cost to petitioner of the property involved was $836,229.04. The value alone of the net income contracted for, capitalized at 6 per cent, was in excess of $1,000,000, and yet we are asked to conclude that a loss of $390,000 was sustained. Petitioner insists that the deed and lease executed on December 27, 1906, were merely incidents of one transaction in which it disposed *1308 of the use of its property for the term of 130 years for a cash payment of $250,000 and an annual rental of $61,000 per year. It is an unquestioned rule of construction that two instruments executed in carrying out the same transaction must be read and construed together in determining the intent of the parties, and that such intent will be given effect irrespective of the particular names given the individual instruments by the parties or the particular form in which they are drawn. ; *3087 ; ; ; ; ; ; ; ; ; . In , the grantor sued upon his deed to recover the stated consideration, which had not been paid, the deed having been delivered together with a draft for acceptance, in accordance with a contract obligating the grantee to accept the draft upon delivery of a deed conveying a merchantable title. The court, in holding that the obligations of the parties were not limited to those set out in the deed alone, said: The contract, draft and lease were part of one transaction. In the eye of the law they are one instrument. They will be read and construed together, as if they were one in form as they are in substance. *3088 In ; , in which one of the issues was the sufficiency of the consideration for a deed to land, the grantor as plaintiff insisting that it was limited to the one stated in the instrument and the defendants contending that it included the obligation placed upon them by a separate contract, executed at the same time, whereby, for a small stated consideration, they agreed to furnish plaintiff maintenance and support for life, the court said: The deed and the contract were executed at the same time and formed one transaction. The latter was a part of the consideration for the deed, and in legal contemplation had the same effect as if it had been incorporated in the deed, instead of being taken and considered separate from the deed and destructive of it. In the case before us it can not be questioned that these two instruments were executed as parts of one single transaction. Both instruments by express recital bear witness to this fact. The execution of the deed and the payment of $250,000 cash is expressly stated by the lease to be one of the considerations for its execution. We must, under the*3089 rule of construction laid down, construe these instruments as if they were one, and the ultimate interest received by the grantees *1309 under both, so construed, must be considered as represented by the total of the considerations received under each by petitioner. What is the ultimate interest received by the grantees under this deed? It purports to convey to them an unrestricted, fee simple title to the building, but the conditions of the lease of the land, which by the rule of construction noted are considered as embodied in it, impose definite and specific restrictions in respect to the building which are inconsistent with the ownership of a fee simple estate, by obligating them to keep the building insured for its full insurable value, to keep it in repair, to give bond to petitioner before making structural changes or repairs which necessitate the demolition of a portion of the building, and finally requiring them to return the lot at the end of the lease period with these improvements as maintained, or similar ones of a value of not less than $500,000. These restrictions reserve to the grantor a reversionary interest in the building itself in addition to the land*3090 and it can not be said, in our opinion, that the effect of the transaction was to divest petitioner of all interest in the building and leave it with $250,000 representing that interest. The form of the conveyance of the building is that of a warranty deed, but the reservations noted result in the grantees taking no greater beneficial interest in that property than they would had the instrument been a lease for 130 years. The form of the conveyance does not determine the interest taken. This is illustrated in the case of , where the owner of a lot and building sold it by warranty deed in which he expressly reserved title to two rooms in the building. The court held that although the wording of the deed reserved the legal title, the effect was merely a lease of that portion of the building to the grantor, without rent, for so long as the building existed. We are dealing here with a question of invested capital as an incident of tax liability. Our concern is with the ultimate beneficial interest surrendered by petitioner and the consideration received therefor, and not with the delicate questions of conveyancing*3091 and the technical estates created in law by the particular method used. These questions may be important in determining the particular rights and remedies of the parties in proceedings for re-entry on breach of covenants of the agreement, but we have no such questions here. Our question is whether the transaction has resulted in petitioner disposing definitely and finally of certain of its capital assets and under the record we must conclude that it has not done so. By this transaction petitioner has, in fact, only surrendered the use and occupancy of its property for a term of 130 years, at the *1310 end of which time it will stand possessed of it again. The total consideration to it for this transaction was $250,000 cash and a yearly rental of $61,000. The identical result in so far as benefits and ultimate interest received are concerned, would have been effected by the execution of a lease to land and buildings, with the same privileges and restrictions stated, for a cash bonus of $250,000 and a yearly rental of $61,000, and, as the court says in *3092 , "Taxes are not laid and collected on theory, but on a situation actually existing, as the facts may show that situation to be." Our conclusion is that the transaction was in fact, in so far as petitioner's tax liability is concerned, a lease of the property for a cash bonus of $250,000 and a yearly rental of $61,000. The $250,000 in cash does not represent the sale price of a capital asset. ; ; . Its distribution by petitioner to its stockholders was a distribution of income and not a liquidation of capital. The deficiency will be recomputed in accord with the foregoing findings of fact and opinion. Reviewed by the Board. Judgment will be entered under Rule 50.