Mitten Management, Inc. v. Commissioner

MITTEN MANAGEMENT, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Mitten Management, Inc. v. Commissioner Docket Nos. 42494, 53990, 61861. United States Board of Tax Appeals 29 B.T.A. 569; 1933 BTA LEXIS 917; December 15, 1933, Promulgated *917 1. BUSINESS EXPENSE. - In 1926 the Producers & Consumers Bank of Philadelphia, a labor bank, failed and its assets were taken over by a newly organized bank which agreed to make immediate payment of 60 percent of all deposit liabilities and to pay the remaining 40 percent to all depositors who agreed to leave their deposits with the new bank. Also the new bank agreed to make good the losses to stockholders of the old bank who took an equivalent amount of stock in the new bank, such payments to be made in both cases out of the first profits earned by the new bank. Petitioner, a corporation, was closely allied with the new bank and, in order to create good will for the new bank and for itself, voluntarily agreed to pay and did pay in the taxable year the remaining 40 percent to the depositors and made good the losses of the stockholders of the old bank who took an equivalent amount of stock in the new bank. Held, such payments were voluntarily made by petitioner and are not deductible as ordinary and necessary business expenses incurred in its trade or business. Welch v. Helvering,290 U.S. 111. 2. Id. - Where taxpayer claims deduction for $100,000*918 for promoting an airplane service and no evidence is offered attempting to give any itemization as to how and in what amounts the $100,000 was expended, held, its rejection was proper. 3. Id. - COMMISSIONS. - Where petitioner was engaged in the management of a street car company and assisting in the sale of its securities, and at the same time promoting and selling the stock of a securities company, commissions paid employees for the sale of the stock of the latter company are deductible where petitioner made a profit from the use of the money deposited with it, which profit was included in its return and tax paid thereon. William R. Spofford, Esq., for the petitioner. Mason B. Leming, Esq., for the respondent. BLACK *569 The taxes in controversy are corporation income taxes in which deficiencies were determined as follows: Docket No. Year Deficiency 42494 [1926] $43,521.51 52990 [1927] 13,220.28 61861 [1928] 29,441.93 *570 The cases were consolidated for hearing and at the hearing certain of the issues were disposed of by stipulation of counsel and some were abandoned by the petitioner with permission*919 of the Board. The remaining issues relate to whether certain expenditures are deductible as ordinary and necessary expenses incurred in carrying on petitioner's business under section 234(a)(1) of the Revenue Act of 1926 and section 23(a) of the Revenue Act of 1928. These will be stated and discussed in the opinion. The expenditures claimed by petitioner as deductions in the respective taxable years come under three separate heads. FINDINGS OF FACT. Our findings will be grouped under three separate headings to correspond with petitioner's assignments of error discussed later in the opinion. 1. Payments to depositors and stockholders of Producers & Consumers Bank, a defunct banking corporation. - The petitioner is a corporation, organized March 11, 1921, under the laws of Delaware for the purpose of engaging in the business of the management of corporations, firms, individuals, etc., with particular reference to the business of passenger transportation in municipalities and other kindred activities. Among other things it was authorized to carry on any business commonly carried on by capitalists, managers, promoters, contractors, merchants, brokers, and agents, and*920 in the course of such business to deal in negotiable paper, stocks, and bonds. It has the right to act as consulting, industrial, and contracting engineers in all branches; to acquire and own lands or any interest therein; and to build, erect, promote, construct, acquire, operate, manage, and control practically any kind of public utility, including electric railways, street railways, interurban railways, and other means of transportation. The articles of incorporation were introduced in evidence and are incorporated herein by reference. Petitioner was organized for the purpose of carrying on the business organized and developed by the late Thomas E. Mitten, who was its president from organization until his death in 1929. During the years involved in these appeals, 1926, 1927, and 1928, the capital stock of petitioner was owned mainly by T. E. Mitten and his son, Arthur A. Mitten, who each owned 30 shares. Of the remaining 40 shares, 10 each were held by J. A. Queeney, C. J. Joyce, A. L. Mitten, and W. K. Myers. The latter 40 shares were qualifying shares and were not owned by the holders. The shares were of $100 par valuation. T. E. Mitten entered to transportation business*921 in the early 1880's. As the result of his extensive experience with organized and *571 unorganized labor he conceived the Mitten plan of cooperation between the men operating the property and the management of the property. The plan was divided into two parts, one having to do with wages and working conditions and the other with cooperative benefits. Details of the Mitten plan were offered in evidence, but we do not feel that any issue we have to decide in this proceeding requires that we make findings of fact as to the details of the plan. The companies managed by petitioner during the years 1926, 1927, and 1928 were the International Railway Co. of Buffalo, Philadelphia Rapid Transit Co., Mitten Management Bank & Trust Co., Mitten Bank Securities Corporation, Philadelphia Rural Transit Co., Yellow Taxicab Co., International Bus Co., Pennsylvania Rapid Transit Co., and Philadelphia Rapid Transit Air Service Corporation. The fee received by the Mitten Management for its operation and management was 4 percent of the gross revenue, one half of which was distributed as a cooperative wage for the benefit of the employees. These fees ran into large figures for each of the*922 taxable years in question. For 1926 the total management service fee received by petitioner was $1,365,632.97, for 1927 it was $2,548,953.66, and for 1928 it was $2,099,808.97. The Mitten plan was harshly criticized by union labor. Following an outlaw strike in 1918 in Philadelphia, labor papers attacked Mitten as hostile to unions and it was alleged that he would not employ union men on properties which his companies managed. The evidence shows however that his companies employed both union and non-union men. The Producers & Consumers Bank of Philadelphia was organized as a labor bank in 1922. The depositors were practically all union members and also their families and friends. The bank failed in 1925. The accounts were mostly small checking or savings accounts. T. E. Mitten reached the conclusion that this bank failure presented an opportunity to show in a practical way that he was not an enemy of organized labor and to bring about a change from hostility to friendship on the part of union labor. On February 1, 1926, an agreement was entered into between the receiver of the Producers & Consumers Bank and Thomas E. Mitten under which a new bank was to be formed by*923 Mitten to take over the assets and assume a certain part of the deposit liabilities of the failed bank. Under the agreement made by T. E. Mitten with the receiver, depositors of the Producers & Consumers Bank were entitled to receive 60 percent of their total deposits in cash forthwith, or, if they permitted the 60 percent to remain on deposit to their cerdit in the new trust company, they became entitled to receive the balance of 40 *572 percent from the first profits of the new trust company. Likewise, stockholders of the Producers & Consumers Bank who subscribed to stock of the new bank became entitled to receive an amount equal to the par value of their stock in the Producers & Consumers Bank from the first profits of the new bank. The agreement with the receiver contemplated payment to the depositors and stockholders from the profits of the new bank if and when earned, but, in order to stress the benefits that the petitioner was conferring upon labor as such, petitioner determined that payment should be made from its own funds, and in order to have it stand out even more prominently it was made at Thanksgiving and Christmas time. On November 22, 1926, petitioner*924 paid $175,612.52 to the Mitten Men & Management Bank & Trust Co., to consummate, as of Thanksgiving Day, payments to depositors of the Producers & Consumers Bank of the difference between the amounts on deposit to their credit with the Producers & Consumers Bank and the amounts which had been credited to them in the new bank under the agreement of February 1, 1926. A list of those benefited by petitioner's expenditure of $175,612.52 was contained in "Service Talks" of Philadelphia Rapid Transit Co. issued November 25, 1926, and widely distributed by petitioner. Local labor unions were well represented among the benefited depositors, both as to number and amounts on deposit. On December 22, 1926, the petitioner paid the further sum of $35,590 to the Mitten Men & Management Bank & Trust Co. for the purpose of having that bank make a distribution to stockholders of the Producers & Consumers Bank who had subscribed to stock of the new bank, which would make them whole. This payment was made at Christmas time so that it would be more conspicuous. "Service Talks" of the Philadelphia Rapid Transit Co. issued December 25, 1926, carried to the public a full account of the payments*925 to the stockholders of the Producers & Consumers Bank who were made whole. Petitioner deducted the amount paid to depositors of the Producers & Consumers Bank, to wit, $175,612.52, as an ordinary and necessary expense in its 1926 income tax return. Petitioner deducted the payment of $35,590 made to stockholders of the Producers & Consumers Bank in its income tax return for 1926. Respondent disallowed both amounts as deductible items. 2. Payment of $100,000 for aerial navigation and development of aerial transportation service. - In 1926 the Sesqui-Centennial exposition was held in Philadelphia. At that time all of the public utilities for passenger transportation in Philadelphia were under the management *573 of petitioner, and T. E. Mitten, its president, felt that petitioner was responsible for a complete exhibit and demonstration of all methods of passenger transportation to visitors during the Centennial. There was no established air service in this country running on regular schedules for passenger service. Mitten conceived and suggested the idea of the establishment of a regular airplane passenger service between Philadelphia and Washington, ultimately*926 to be extended throughout the United States and to be under the management of petitioner under its usual 4 percent management contract. In order to investigate the different types of airplanes, costs and facilities of manufacturing, plans of operation, requirements for airports, and the possibilities of commercial aerial navigation, Mitten determined to go to Europe, where in his opinion the industry was more advanced than in this country. On April 1, 1926, petitioner advanced and paid to Mitten the sum of $100,000 to go to Europe for these purposes. Accompanied by A. G. Mitten, comptroller of petitioner, and his private secretary, Mitten went to Europe and made extensive investigations, visiting the principal aviation centers - Paris, Berlin, Brussels, Karlsruhe, Amsterdam, and Croydon. Data was gathered and leading manufacturing and aviation experts were interviewed, with the result that it was determined that the Fokker Aviation Co. and Anthony Fokker were the leaders in the manufacturing field. Mitten returned to this country and there was incorporated in April or May 1926, under the laws of the State of Delaware, an aerial navigation company known as the Philadelphia Rapid*927 Air Service, Inc., hereinafter referred to as Air Service, Inc. The company operated a commercial aerial passenger service from Philadelphia, Pennsylvania, to Washington, D.C., which was later extended to Norfolk, Virginia. The capital stock of Air Service, Inc., was owned entirely by the Philadelphia Rapid Transit Co., sometimes hereinafter referred to as P.R.T. The latter company provided the sum of approximately $250,000 for the equipment, maintenance, and operation of air service by its subsidiary. Because of lack of Government assistance and excessive cost of operation, the entire project was abandoned at the end of 1926. No accounts were kept by T. E. Mitten, or any other person, as to the expenditures from the fund of $100,000. Traveling expenses and hotel bills, expensive dinners and entertainment for prominent persons are said to have been paid therefrom, but there is no evidence as to the amounts, details, or time of such payments. No payment was made by petitioner to Thomas E. Mitten to reimburse him for his trip abroad in connection with air service matters other than the $100,000 check. Neither the Philadelphia Rapid Transit Co. nor the Philadelphia Rapid Transit*928 Air Service Corporation made *574 any reimbursement to Thomas E. Mitten for his expenses here and abroad in connection with aerial navigation. Petitioner received as compensation for managing the air service the sum of $2,013.26, which it included in its return for 1926. It took a deduction for the $100,000 advanced to T. E. Mitten, which respondent disallowed. 3. Commissions paid on stock sales of the Mitten Bank Securities Corporation. - In addition to acting as manager of operations of the P.R.T., petitioner assisted in the sale of P.R.T. stock and securities and acted as depositary of funds derived from sales of securities until the funds were needed. While holding these funds petitioner paid the Transit Co. from 2 to 3 percent interest and in turn invested the funds in securities which returned as high as 8 percent. In 1925 and 1926 the Philadelphia Rapid Transit Co. was selling its preferred stock on the market, using the usual methods of advertising in the newspapers and by notices in its cars. Such methods did not prove entirely satisfactory to the Transit Co. Petitioner evolved the idea and plan of incorporating an investment trust, selling its stock, *929 and with the proceeds purchasing the securities of the Philadelphia Rapid Transit Co. and such other securities as were deemed advisable. Such an investment trust was incorporated as the Mitten Bank Securities Corporation, under the laws of Pennsylvania. Its management and the sale of its stock were conducted by petitioner. In order to encourage the sale of Mitten Bank Securities Corporation stock, petitioner agreed to pay the employees of P.R.T. a commission of $1 for the sale of each share of stock. During 1927 petitioner paid $67,732.95 as commissions for sales of stock of the Mitten Bank Securities Corporation pursuant to its agreement and during 1928 the amount so expended for the same purpose was $21,654.64. These payments were made when the obligation to pay was incurred. Petitioner was not reimbursed for any amount so paid as commissions. On January 1, 1927, the Philadelphia Rapid Transit Co. had on deposit with petitioner the sum of $5,500,000 and at the end of that year this had increased to $13,056,050. The sum on deposit at the beginning of the year represented proceeds received from the direct sale of P.R.T. preferred stock and deposited by that company with*930 the petitioner, and later included cash received by the P.R.T. for its preferred stock from the Mitten Bank Securities Corporation, which in turn had secured the funds through the sale of its own stock by petitioner. The accretions or additions to the deposit during 1927 were due to the sale of stock of the Mitten Bank Securities Corporation, in which petitioner always held less than a controlling interest. *575 Petitioner received no compensation for the sale of P.R.T. securities other than its usual management fee. Petitioner deducted commissions paid for the sale of Mitten Bank Securities Corporation stock in the amounts of $67,732.95 and $20,346.20 in its income tax returns for 1927 and 1928, respectively. Respondent disallowed these amounts as deductible items. OPINION. BLACK: At the hearing in these cases a number of issues raised by the pleadings were withdrawn and others were settled by stipulation, leaving for our consideration and determination the following: 1. Whether the petitioner may deduct as an ordinary and necessary business expense in the year 1926 the sums of $175,612.52 and $35,590 paid to depositors and stockholders of the insolvent Producers*931 & Consumers Bank of Philadelphia, under the circumstances narrated in our findings of fact. 2. Whether the amount of $100,000 advanced by the petitioner to T. E. Mitten for research and development of an air transport service is deductible either as an ordinary and necessary business expense for 1926 under section 234(a)(1) of the Revenue Act of 1926, or as a loss sustained during the taxable year under section 234(a)(4) of that act. 3. Whether the amounts of $67,732.95 and $21,654.64 expended by the petitioner during the years 1927 and 1928, respectively, for commissions on the sale of stock of the Mitten Bank Securities Corporation may be deducted as ordinary and necessary business expenses under section 234(a)(1) of the Revenue Act of 1926 and section 23(a) of the Revenue Act of 1928. We will discuss these issues in the order of their statement. Issue No. 1. In support of its contention that the amounts paid the depositors and stockholders of the insolvent Producers & Consumers Bank in 1926, represent ordinary and necessary business expenses within the meaning of section 234(a)(1) of the Revenue Act of 1926, petitioner cites, as one of its leading cases, *932 . In that case the taxpayer was the owner of a large department store in Dallas, Texas, and had effected a composition with its creditors by which it was relieved of a large amount of indebtedness. Its credit with banks thereafter was impaired, and in order to reestablish its credit it paid off the balance of the indebtedness voluntarily. *576 In claimed deductions for these payments. The Circuit Court of Appeals for the Fifth Circuit allowed the deductions on the ground that the expenditures were made to rehabilitate the taxpayer's credit and were ordinary and necessary business expenditures within the meaning of the applicable statute. In that case the court, among other things, said: "Each case depends for decision upon its own facts and it would be impossible to formulate a uniform rule to govern all cases." The facts in the ivstant case are altogether different, as we view them, from those in the Harris case, supra. Whether, if the new bank had made the payments here in question out of its first profits as agreed upon in the contract detailed in our findings of fact, the payments would have been deductible*933 as ordinary and necessary business expenses under , and other cases cited by petitioner in brief, we are not called upon to decide. It is sufficient to say that the payments in question were not made by the new bank out of its first profits as the original agreement provided, but were made by the petitioner, Mitten Management, Inc., out of its own earnings. The payments were made in the same year that the new bank was organized. They were voluntarily made by petitioner and we do not think the circumstances of their payment warrant their deduction as ordinary and necessary business expenses. A voluntary agreement to pay the expenses or obligations of some one else does not entitle the taxpayer to a deduction, Such a promise could rise no higher than a voluntary assumption of an obligation of another and such assumption does not come within the revenue act as an ordinary and necessary business expense. ; ; certiorari denied, *934 ; . Petitioner's principal argument in support of its contention, that the expenditures in question should be allowed as ordinary and necessary business expenses, is to the effect that by making the voluntary and generous payments at Thanksgiving and Christmas time it secured widespread and favorable publicity in the Philadelphia newspapers and that as a result of this favorable publicity and also the good feeling which was created among the depositors and the stockholders of the old bank, the feeling of organized labor toward petitioner was changed from one of open hostility to one of pronounced friendship. We think the evidence fully justifies petitioner's contention that valuable good will amongst the ranks of organized labor was created by these payments, not only for the newly organized bank, the Mitten Bank & Trust Co., but for petitioner as well in its management of *577 public utilities. Nevertheless we do not believe the expenditures in question were such as is contemplated by the Revenue Act of 1926, which is section 234(a)(1) allows a taxpayer as deductions "all the ordinary*935 and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." In , the taxpayer, in order to reestablish his credit and to secure customers for his individual business from among those who had been customers of a corporation of which he was an officer, partially reimbursed those who had sustained losses when the corporation was discharged in bankruptcy. On these facts we held that the amounts so paid were not deductible by the taxpayer as ordinary and necessary business expenses. In affirming our decision at , the court, in speaking of the voluntary payments which the taxpayer had made, said: There may be room for argument and difference as to whether payments of this character, under the circumstances here, are "necessary" or not. It would be rather clear that they would be helpful in a business way and that helpfulness might approach or reach necessity. However, we can see no possible basis upon which payments of this character can be treated as "ordinary" expenses of his business (*936 , , and ). In fact they are very extraordinary payments and not expenses of the business at all. They are unlike the payments in , but are voluntary payments similar to those treated in , and . While these payments are highly commendable from an ethical standpoint, we are bound by the law as written. The determination of the Board was correct and the petition for review must be and is dismissed. This case was recently affirmed by the Supreme Court of the United States. See . Under the authorities above cited, we sustain respondent in his disallowance of the claimed deductions embraced in assignment of error No. 1. Issue No. 2. Petitioner claims the right to deduct $100,000 which it advanced to its president, T. E. Mitten, in 1926 to make investigations with reference to*937 the installation of a commercial aviation service to be operated by a subsidiary of the P.R.T. Such facts as there are with reference to this item have been stated in our findings of fact. We do not believe these facts are sufficient to justify us in allowing the claimed deduction either as an ordinary and necessary business expense or as a loss. Petitioner does not claim it made any investment in the stock of the Philadelphia Rapid Air Service, Inc., or advanced it any money. What it does claim is that prior to the launching of the venture *578 it advanced its president, T. E. Mitten, $100,000 and that he went to Europe in company with his brother, A. G. Mitten, and a secretary and made extensive investigations of aircraft and commercial aviation over there and on his return to the United States continued these investigations. No evidence was introduced showing how much of this $100,000 was spent in Europe and how much of it was spent in the United States. In fact no itemization of any kind as to how this $100,000 was spent was introduced in evidence. Petitioner is a corporation with only a nominal capital stock, but earned very large fees in the taxable years*938 from management services rendered to public utilities. The salaries which it paid its officials, especially its president, were large. For 1926 its president, T. E. Mitten, received $299,272.06 salary, and for each of the years 1927 and 1928 he received $300,000 as salary. Respondent has allowed these salary deductions to petitioner. But to say that a corporation can advance its president $100,000 and then claim it as a deduction for ordinary and necessary business expenses without any sort of itemization is going beyond what we think the law allows. The finding of the respondent in disallowing this item is prima facie correct and we do not think the petitioner has sustained the burden to show its error, or to establish the correct amount to be deducted. We know of no law which authorizes us to hazard a guess at it. We have examined the cases of ; ; ; and , cited by petitioner, and do not consider them decisive of this case. They were cases of individuals claiming deductions*939 for expenses for travel and entertainment under section 214(a), Acts of 1924 and 1926, which expressly provides for such deductions. In those cases the individuals were present at the hearings and testified under oath as to the approximate amounts expended and for what purpose. Neither do we think that petitioner is entitled to take this $100,000 as a deduction for a loss in 1926. As we have already stated, petitioner did not have any investment in the capital stock of the Philadelphia Rapid Air Service, Inc., nor did it advance it any money. It had no capital investment, so far as we can see, in the aircraft enterprise. It did have a management contract with the Philadelphia Rapid Air Service, Inc., from which it collected in 1926 the sum of $2,013.26 which it returned as income. This was not a dividend on a capital investment, but was payment for services rendered. We sustain respondent in his disallowance of this claimed deduction of $100,000. *579 Issue No. 3. This assignment of error relates to commissions paid in 1927 and 1928 to employees of the P.R.T. for sale of stock of the Mitten Bank Securities Corporation, an investment trust. The evidence shows*940 that the sale of the stock in the Mitten Bank Securities Corporation was conducted by petitioner at its own expense. The stock was sold to the public and to employees of Mitten managed properties. Petitioner paid a commission of $1 per share to P.R.T. employees for selling the stock. The petitioner, as we view it, was merely acting as a broker or agent in these transactions, which it had the right to do under its articles of incorporation, and any expense it incurred in making a sale of the stock was a business expense. It seems clear that if petitioner had been receiving a commission for selling the stock of the Mitten Bank Securities Corporation it would have had the right to deduct from its income the selling expenses of such stock. In the instant case the petitioner charged no commission for selling the stock of the Mitten Bank Securities Corporation, but made its profit from the use of the money derived from such sales. On these facts we think petitioner is entitled to deduct the commissions which it paid P.R.T. employees for selling the stock. The transactions occurred in the regular course of the business carried on by petitioner. This is not a case of a corporation*941 selling its own stock. In that case the cost of selling stock is a capital expenditure and is not deductible. On Issue No. 3 we sustain petitioner. It was stipulated that petitioner's income from net management fees should be reduced by $57,461.78 and $92,249.30 for 1926 and 1927, respectively, and should be increased by $58,819.61 for 1928. Due to this stipulated increase in income for the year 1928, the respondent, upon permission granted, filed a claim for increased deficiency for the year 1928. Effect will be given to these stipulations in a redetermination of the deficiencies and if on redetermination it is disclosed that there is an increased deficiency for 1928 it will be allowed. Decision will be entered under Rule 50.