Hudson-Duncan & Co. v. Commissioner

HUDSON-DUNCAN & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Hudson-Duncan & Co. v. Commissioner Docket No. 85220. United States Board of Tax Appeals 36 B.T.A. 554; 1937 BTA LEXIS 692; September 24, 1937, Promulgated *692 1. DEDUCTION; INTEREST. - Contract for sale of realty named a "purchase price (including interest)." The evidence establishes that in the sale negotiations the parties carefully worked out separately the sale price and the interest; that the seller intended to charge and the buyer intended to pay interest; that the amount named as purchase price including interest is the aggregate of the price agreed upon for the property and the interest calculated by the parties. Held, that a portion of the monthly payments made by the purchaser represents interest and deduction therefor is allowable. 2. DEPRECIATION; BASIS. - The amount of the specified purchase price of property that is determined to be interest should not be included in the basis of depreciable property in computing deductions for depreciation. Albert W. Gentner, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent. ARUNDELL *554 In this proceeding the respondent determined a deficiency in income tax in the amount of $1,323.66 and an overassessment of excess profits tax in the amount of $289.22, for the fiscal year ended January 31, 1934. The deficiency results from*693 the partial disallowance *555 of a claimed deduction for depreciation. That disallowance is not disputed by the petitioner. The petitioner's claim here is that it is entitled to a deduction for interest accrued and paid in the amount of $9,771.33. FINDINGS OF FACT. Petitioner is an Oregon corporation. In June 1932 it was in possession of a warehouse under a lease from the Standard Box & Lumber Co., hereinafter called the Standard Co. On June 17, 1932, the petitioner entered into a contract for the purchase of the leased premises from the Standard Co. The contract, as far as material here, provided: No. 3. CONSIDERATION. NOW THEREFORE, For and in consideration of the stipulations hereinafter contained and the payments to be made, as hereinafter specified, the Vendor agrees to sell and the Purchaser agrees to purchase the above described real property for the total purchase price (including interest) of Two hundred and forty-seven thousand six hundred and sixty-six dollars and sixty-six cents ($247,666.66) payable as follows: $4,738.66 upon the signing of this agreement, the receipt whereof is hereby acknowledged, and the balance of $242,928.00 to be paid in one*694 hundred and forty-four (144) monthly installments of $1,687.00 each. The first monthly installment of $1,687.00 payable on or before the 5th day of July, 1932, and a like monthly installment payable on the 5th day of each following month until the total purchase price has been paid in full. No. 4. INTEREST. It is understood and agreed that the total purchase price includes interest. That there shall be no interest charged on this contract in addition to that included in the purchase price except and in the event that the Purchaser becomes delinquent, under the terms of this agreement, in which event it shall pay interest at the rate of six per cent (6%) per annum on all delinquent payments until such delinquent payments have been made. * * * No. 18. DELINQUENCY. Should, however, the Purchaser fail to make the payments as aforesaid, or any of them, punctually and upon the strict terms and at the times above specified (time of payment being declared to be the essence of this agreement), or should the Purchaser fail to comply with any of the terms and conditions of this agreement, then the Vendor shall have the right to the following remedies: * * * Second.The Vendor*695 may elect to enforce payment of any delinquent installments and delinquent interest under the terms of this contract from time to time as such delinquency accrues. Should, however, the Vendor enforce payment of any delinquent installments and delinquent interest under the terms of this contract, and subsequent thereto, the Purchaser become delinquent, such election to enforce payment of previous delinquent installments shall not preclude the Vendor from electing to take advantage of either remedy set forth under subdivision No. 18 of this contract. No. 19. DISCOUNT. It is agreed and understood that the Purchaser may, at any time after July 1st, 1938, pay to the Vendor the balance of the purchase price then remaining unpaid on this contract, and in the event that the Purchaser *556 so elects to make full payment after July 1st, 1938, the Vendor agrees to allow a discount on said balance figured as follows: First. There shall be ascertained that portion of the remaining unpaid balance which consists of interest figured on a basis of six per cent per annum on the principal sum. Second. When said amount of interest is ascertained then thirty per cent of said interest*696 then remaining unpaid shall be the amount of discount to be allowed. The contract was negotiated by the presidents of the companies. The president of the Standard Co. wanted interest on the deferred payments and the president of the petitioner was willing to pay interest. They both felt that it would be desirable that the deferred payments should be in equal amounts rather than to have decreasing amounts each month. Accordingly, they worked out a method in which they started with the building. The construction cost of the building in 1930 was $107,255.01. Its sale price was set down at $107,000. To that was added $41,730 as interest, which is the amount the parties figured would result at a 6 percent rate over 12 years. They set down the land at $71,200 and added to that $27,768 as interest over the 12-year period. These several amounts aggregate $247,698. Petitioner made a cash payment of $4,738.66, leaving a balance of $242,959.34. This balance was reduced by agreement of the negotiators to $242,928 in order to avoid odd cents in the monthly payments. In addition to the amounts paid and agreed to be paid under the contract, the petitioner forfeited to the Standard*697 Co. a deposit of $12,418.58 made under the lease and also paid accrued local taxes of $1,782.67. Each month since June 1932 the petitioner has paid to the Standard Co. the installment called for by the sale contract in the amount of $1,687. It did not divide any of the payments on its books into principal and interest and claimed no interest deductions in its income tax returns. In 1936 the Oregon State Tax Commission determined that the Standard Co. had erred in failing to report as interest part of the payments received from the petitioner and asserted an excise tax on such interest for the years 1932 to 1935, inclusive. Total payments made under the contract in the fiscal year amounted to $20,244, of which amount $9,771.33 is properly allocable to interest paid. In its income tax returns the petitioner used the amount of $181,867.93 as the basis for computing depreciation of the building acquired from the Standard Co. The correct basis is $107,000 plus a portion of the forfeited deposit and the accrued taxes paid by the petitioner. *557 OPINION. ARUNDELL: The respondent's view in this case is that the designated "purchase price" in the contract represents*698 principal in its entirety and may not be split up into principal and interest. The evidence is that the amount stated in the contract is not all principal, but is the aggregate of the two items of principal and interest. The seller wanted interest on the deferred payments and the purchaser was willing to pay interest. The president of the seller corporation and the president of the purchasing corporation (the petitioner) acted as negotiators of the deal. Both testified in this proceeding. Their testimony is that in negotiating the deal they started out by fixing the price for the building and the price for the land. They agreed upon the period over which the deferred payments were to be spread. Then they computed interest on the deferred payments at an average rate. They then totaled the several items of principal and interest and that total, with a minor adjustment, they set out in the contract as the "purchase price (including interest)." The testimony of both is that the reason for making the calculation in the way they did was that both parties as a matter of convenience preferred to have the monthly payments in equal sums. Payments separately of principal and interest*699 would of course have required a recomputation each month as the unpaid principal decreased and would result in payment of a different amount each month. The wording of the contract - "including interest" - indicates that the parties calculated interest in arriving at the price specified. The testimony of the negotiators does not vary the terms of the contract but explains them. Prior to the hearing of this proceeding the State Tax Commission of the State of Oregon investigated the matter and arrived at the conclusion that a part of the payments received by the seller represented interest, and asserted a tax on such interest. The petitioner is asking that we treat as interest the same amount taxed as interest by the State Tax Commission. Counsel for the respondent cites a number of cases in which the Board and the courts have refused to permit lump sums to be split up into alleged payments of principal and interest. Among others cited are ; ; *700 ; affd., . We do not pause to refer to more, for all in our opinion are distinguishable from the present case. For example, in the case of Marsh & Marsh, Inc., the findings disclose no mention of interest in the contract of sale, except as a measure of discount on payments made before maturity. We there said that the facts alleged by the taxpayer "were capable of proof, but have not been proven." In *558 the case before us there is satisfactory proof that a part of each payment was in fact interest. In Anderson & Co., the taxpayer claimed as interest an amount equal to 10 percent of the amount due at the beginning of the year. In that case, in disallowing the claim, we pointed out that "the records of the taxpayer make no showing of such interest and the form of contract used by the taxpayer and its customers discloses that the only interest contemplated between the parties is interest on installments not paid when due." In Daniel Brothers Co. there was no provision in the contract for interest on deferred payments. In this case the parties stipulated in their contract that the price*701 named included interest; the men who negotiated the deal testified that it was their intent to and they did include interest; the officials of the State of Oregon found a portion of each payment to be interest and taxed it as interest. In the face of all this we do not see how it can be said that the price specified in the contract represents principal in its entirety and that no part of it is interest. The petitioner has established the portion that represents interest and we hold that that amount should be allowed as a deduction to the extent paid in the taxable year. Counsel for the respondent contends, in the alternative, that he erred in computing depreciation allowances. It appears that the petitioner claimed and was allowed depreciation on the building on a basis of $181,867.93. The evidence in this proceeding shows that that basis is too high. The correct basis is cost, which under the contract of sale is $107,000, to which should be added a portion of the payment forfeited under the lease and a portion of the accrued property taxes paid by the petitioner. The evidence is insufficient to permit us to determine what portion of these two additional sums should be allocated*702 to the building. If the parties are unable to agree on an allocation in their recomputations, they may present further evidence on this one phase of the case. There is no issue as to the depreciation rate and the rate determined by the respondent to be proper will be used on recomputation. Decision will be entered under Rule 50.