Syracuse Washing Machine Corp. v. Commissioner

SYRACUSE WASHING MACHINE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Syracuse Washing Machine Corp. v. Commissioner Docket Nos. 26851, 41474. United States Board of Tax Appeals 17 B.T.A. 11; 1929 BTA LEXIS 2375; July 26, 1929, Promulgated *2375 On January 2, 1920, the petitioner paid to a trustee the total sum of $338,000 for the benefit of and to secure contracts for the services of the two employees for a period of five years, at the end of which time the funds were to be paid by the trustee to the employees, provided the employees had carried out the terms of their employment contracts. The contracts were duly carried out and the funds paid to the employees. Held that the amount of the petitioner's expenditure should be spread ratably over the life of the contracts, and an aliquot portion deducted from gross income for each year. Edmund H. Lewis, Esq., and John J. Heberle, Esq., for the petitioner. J. E. Marshall, Esq., and C. L. Lavendar, Esq., for the respondent. TRAMMELL *11 These proceedings, duly consolidated by the Board for hearing and decision, are for the redetermination of deficiencies in income tax for the period July 29 to December 31, 1922, in the amount of $155.43, and for the calendar years 1925 and 1926 in the amounts of $2,494.23 and $423.56, respectively. The only error assigned by the petitioner relates to the action of the respondent in disallowing*2376 as deductions from gross income for the respective taxable years aliquot portions of the sum of $338,000 paid by the petitioner in 1920 to a trustee for the benefit of and to secure the services of two employees over a term of years. *12 FINDINGS OF FACT. The petitioner is a Delaware corporation, with its principal place of business at Syracuse, N.Y. During the taxable years it kept its books and made its tax returns upon an accrual basis. On January 2, 1920, the petitioner duly executed under seal a tripartite contract or trust agreement with the Syracuse Trust Co. and one John N. Derschug, which, omitting signatures and acknowledgments, reads as follows: AGREEMENT, made this second day of January, A.D. 1920, by and between SYRACUSE WASHING MACHINE CORPORATION, a corporation duly organized and existing under and pursuant to the laws of the State of Delaware, hereinafter called "the Company", THE SYRACUSE TRUST COMPANY, a corporation duly organized and existing under and pursuant to the laws of the State of New York, hereinafter called "the Trustee", and JOHN N. DERSCHUG, of the City of Syracuse, N.Y., hereinafter sometimes called "the Beneficiary". A contract*2377 is this day entered into between the Company and John N. Derschug providing for his employment as chief executive and general manager for a period of five years from January 1, 1920, for considerations to be fixed by the Board of Directors. As one of the inducements to the execution of said contract, the Company has deposited with the Trustee, and hereby assigns and transfers to the Trustee the sum of Two Hundred Seventy Thousand Dollars ($270,000) in cash, to be held upon the trusts and subject to the powers, conditions, reservations and limitations hereinafter set forth. In consideration of the premises it is covenanted and agreed between the parties hereto that the trusts upon which said fund is to be held and the covenants, conditions and stipulations in respect thereto and the rights and obligations of the respective parties in connection therewith, are as follows: FIRST: The Trustee shall invest, and from time to time reinvest said fund in such securities or property as may be jointly approved by the Trustee and the Beneficiary, free from any restriction or limitation provided by law. In case of their failure to agree in regard to the investment of said trust fund, investments*2378 shall be made by the Trustee in any securities authorized by the laws of New York for the Investment of trust funds, or at the option of the Beneficiary the amount for investment shall be deposited on interest with such bank or trust company as may be designated by the Beneficiary. SECOND: The Trustee shall pay the entire net income of said fund quarterly to the Beneficiary, until the termination of said agreement for his employment by the Company. THIRD: Upon the termination of said agreement, including its termination by the death of the said John N. Derschug in case said John N. Derschug shall have faithfully performed, or duly and properly tendered performance up to that time all the duties and obligations imposed upon him by said contract of employment, the Trustee shall pay over the principal of said trust fund to the Beneficiary, or to his estate in case of his death free and clear of all charges and commissions; provided, however, that the Company may at its own expense carry insurance upon the life of the Beneficiary in the sum of Two Hundred Seventy Thousand Dollars ($270,000), such insurance to be payable to the estate of the Beneficiary, and in case of his death and*2379 upon payment of such insurance to the estate of the Beneficiary the principal of said trust shall *13 revert to and become the property of the Company, with however the distinct understanding that said trust does not become the property of the Company until the Beneficiary or his estate has received from said insurance or the Company, or both, the amount of Two Hundred Seventy Thousand Dollars ($270,000) free and clear of all charges and commissions. FOURTH: In case the principal of the trust created hereby shall become payable or accrue to the Beneficiary or to his estate in accordance with the provisions hereof, the Company will pay and save him or his estate harmless from any income tax or taxes which he or his estate may be required to pay under any laws of any State or States or of the United States by reason of the receipt or accrual of said principal sum or any part thereof. FIFTH: If upon the termination of said agreement the principal sum is claimed by the Company notice of such claim and of the grounds thereof shall be given in writing to the Trustee within thirty (30) days after the termination of said agreement. In the absence of such notice the Trustee shall*2380 be protected in making payment to the Beneficiary after the expiration of said period of thirty days. In case of conflicting claims arising with respect to said trust, whether upon any such notice or otherwise, the Trustee shall not be charged with responsibility for the determination of any disputed question of law or fact, but shall discharge its duties by safely keeping and administering the trust fund and by disposing thereof in accordance with the final judgment in any action or judicial proceeding, to which the Company and the Beneficiary or his estate shall be parties. In case the Trustee shall begin an action of interpleader or other judicial proceeding for the determination of such conflicting claims in a court of competent jurisdiction, the Company and the Beneficiary shall not oppose the Trustee in obtaining such relief, and all proceedings by either of them directly against the Trustee shall be stayed. SIXTH: If said John N. Derschug shall be unable, by reason of illness, or other cause beyond his control, to carry out his part of said contract of employment, the said contract shall not for that reason be terminated; but said contract and the trust hereby created shall*2381 continue for the benefit of the Beneficiary. SEVENTH: In the interpretation of this agreement, the words "Company" and "Trustee" shall be deemed to include their respective successors; and the word "Beneficiary" shall be deemed to include not only the said John N. Derschug, but his heirs, executors, administrators and assigns. EIGHTH: The recitals herein contained are made by the Company and the Beneficiary only. The Trustee shall be held only to reasonable care and diligence in carrying out the provisions hereof. The Trustee shall not be bound to take any action affecting the rights or interest of strangers to this instrument, or to prosecute or defend any suit hereunder unless indemnified to its satisfaction. The Trustee may resign and discharge itself of the trusts hereby created, by notice in writing addressed to the Company and the Beneficiary and personally delivered to them, respectively, or mailed to their last known addresses, and in such case the Beneficiary shall have power to appoint a successor trustee, which shall be a Trust Company or national bank in the State of New York having a capital and surplus of at least one million dollars. NINTH: The Trustee shall*2382 receive and accept as full compensation for the performance of its duties in administering this trust, both as to income and principal, the sum of Four Hundred Eighty Dollars ($480) per year during the period of said trust. The Trustee shall be entitled to the advice of counsel in all matters concerning the trust. The compensation and expenses of the Trustee shall be paid by the Company and the Trustee shall have a lien therefor, *14 as against the Company, on the principal of the trust fund and any accumulations thereof after the termination of said contract of employment. In any suit of interpleader, or of the nature of interpleader, the Trustee may either waive any lien, claim or offset to which it may be entitled as against the Company, without prejudice to its assertion in a separate action, or may prosecute such lien or claim as a separate cause of action in such action of interpleader or of the nature of interpleader; and the Company and the Beneficiary, respectively, covenant and agree with the Trustee not to interpose any objection or defense based upon the joinder of such separate cause of action, or upon the ground that it is not of equitable cognizance. IN*2383 WITNESS WHEREOF, the Company and the Trustee have caused this agreement to be duly executed in their names by their proper officers, and their corporate seals to be hereunto affixed and attested by their secretaries or assistant secretaries, and the Beneficiary has hereunto set his hand and seal, the day and year first above written. The employment contract referred to in the foregoing agreement was executed under seal by John N. Derschug and the petitioner, on January 2, 1920, and, omitting signatures, reads as follows: AGREEMENT made this 2nd day of January, A.D., 1920, by and between SYRACUSE WASHING MACHINE CORPORATION, a corporation duly organized and existing under and pursuant to the laws of the State of Delaware, hereinafter called "the Company", and JOHN N. DERSCHUG, of the City of Syracuse, N.Y., herin called the "Manager". The Company is a manufacturing corporation engaged in the manufacture of washing machines and other domestic appliances, with power to extend its operations to other lines of manufacture. It has a factory at Syracuse, N.Y., with power to establish other factories in the same or other locations. It desires to secure the services of John N. Derschug*2384 as chief executive and general manager for a period of five years from January 1, 1920. In consideration of the mutual promises herein contained, it is agreed as follows: FIRST: The Company hereby employs the said John N. Derschug as its chief executive and general manager for the term of five years beginning January 1, 1920, for considerations fixed and to be fixed by the Board of Directors, including a salary of not less than $36,000 per year. SECOND: The Manager agrees during the term aforesaid to devote his reasonable time and attention to the business of the Company, as directed by the Board of Directors and to manage, supervise, and control such business and to perform such other duties as may be entrusted to him by the By-Laws or by resolution of the Board of Directors. THIRD: The Manager agrees that if he be elected President of the Company to serve during said term or any part thereof, he will accept such office and faithfully perform the duties thereof. FOURTH: The Manager agrees during the term aforesaid not to acquire or hold any interest as stockholder, director, agent, or otherwise in or for any corporation in competition with the Company without the consent*2385 of the Board of Directors, and not to engage in any business competing with that of the Company. FIFTH: The Manager agrees that he will not during the term aforesaid or at any time thereafter, impart to any competitor of the Company, or otherwise *15 use for the purpose of competition with the Company, any confidential information which he may acquire in the performance of his duties aforesaid. SIXTH: It is mutually agreed that if the Manager be prevented by sickness or other cause beyond his control from fully performing the duties aforesaid, this contract shall not terminate, but the Manager shall perform such duties as may be assigned to him by the Board of Directors with such salary and official title as the said Board may determine. IN WITNESS WHEREOF, the Company has caused this agreement to be duly executed in its name by its President and its corporate seal to be hereunto affixed and attested by its Secretary and the Manager has hereunto set his hand and seal the day and year first above written. On January 1, 1920, the petitioner executed under seal a trust agreement with the Syracuse Trust Co. and one Guy C. Wilkinson, and also an employment contract with*2386 Wilkinson, which instruments contained substantially the same provisions as the Derschug agreements, above set out, except that the amount deposited with the trustee was $68,000 instead of $270,000, and the employment contract with Wilkinson provided for his employment by the petitioner in such capacity as its board of directors might determine. Pursuant to the trust agreements above mentioned, the petitioner on January 2, 1920, paid to the trustee the total amount of $338,000. On August 19, 1924, the petitioner and Derschug and the trust company entered into a supplemental agreement to extend the employment contract and the trust agreement in respect to Derschug for an additional period of two years, or until December 31, 1926, and further provided that the salary to be paid to Derschug should be at the rate of not less than $50,000 per year from April 1, 1924. All contracts in question were carried out and fully performed by the respective parties, and the corpus of the trust fund of $68,000 transferred by the petitioner to the trustee on January 2, 1920, was paid to Wilkinson by the trustee in January, 1925. The corpus of the trust fund of $270,000, transferred by the*2387 petitioner to the trustee the trust fund of $270,000, transferred by the petitioner to the trustee 1927. When the petitioner paid over said amounts of $68,000 and $270,000 to the trustee on January 2, 1920, it charged the total disbursements of $338,000 to an asset account styled "Service Contracts." At the end of each year from 1920 to 1924, inclusive, petitioner charged an aliquot portion thereof, or the amount of $67,600, to its surplus account and credited a like amount to a liability account styled "Reserve for Service Contracts." The petitioner filed claims for refund of taxes overpaid by reason of its failure to claim deductions in respect of said $338,000 in each year from 1920 to 1924, inclusive, which claims were eventually rejected by the respondent. *16 OPINION. TRAMMELL: The facts in these proceedings are not in dispute. The sole issue of law is whether or not the petitioner is entitled to deduct from its gross income for each of the taxable years an aliquot portion of the sum of $338,000 paid over by the petitioner on January 2, 1920, to the trustee under the terms and conditions of the trust agreements referred to in our findings of fact. No question*2388 is raised with respect to the right of the petitioner to deductions on account of the salaries paid to Wilkinson and Derschug, nor is any question raised respecting the reasonableness of the compensation or whether it constitutes to any extent a distribution of profits. When the petitioner, on January 2, 1920, paid over to the trustee the trust funds aggregating $338,000, the assets theretofore available for use in its business were reduced by that amount, but in the place of said funds, it acquired the contracts of employment. The petitioner on that date lost possession and control of the funds, subject only to the possibility of recovering them, in the event of a breach of the contracts by the employees. The contingency, in our opinion, is too remote to justify us in the holding that the petitioner did not acquire the contracts for the expenditures made in advance. S. S. White Dental Mfg. Co. v. United States,61 Ct.Cls. 143; affd. 47 Sup.Ct. 598. The facts in this case distinguish it from that class of cases in which the issue involves the right of the taxpayer to accrue and deduct a purely contingent liability. *2389 Becker Bros. v. United States, 7 Fed.(2d) 3; Malleable Iron Range Co. v. United States,65 Ct.Cls. 441. It is our opinion that such contracts as we have here in question represent capital expenditures. Upon payment of the amounts referred to, the petitioner acquired capital assets which were exhausted ratably by the passage of time. Accordingly, it is entitled to deduct and aliquot part thereof from its gross income for each year during the life of the contracts. J. Alland & Bro., Inc.,1 B.T.A. 631; Dallas Athletic Association,8 B.T.A. 1036. It follows from the conclusions reached above that, for the taxable period July 29 to December 31, 1922, the petitioner is entitled to deduct from its gross income an aliquot portion of the total amount of $338,000. However, a different situation is presented with respect to the taxable years 1925 and 1926. At December 31, 1924, the Wilkinson contract expired and the asset represented thereby became fully exhausted. No deduction for said years 1925 and 1926 may be allowed, therefore, on account of the $68,000 paid to Wilkinson. With respect to the $270,000*2390 paid to Derschug, the petitioner was entitled to deduct an aliquot part, or one-fifth thereof, for each year from 1920 to *17 1923, both inclusive, during which period the prospective life of the contract was five years, but on August 19, 1924, this latter contract was extended for an additional period of two years; hence, the unexhausted value of the contract at August 20, 1924, should be spread ratably over the then remaining life of the contract, and a pro rata part thereof deducted from gross income for each of the years 1925 and 1926. Harris-Emery Co.,10 B.T.A. 297. Judgment will be entered under Rule 50.