Newman & Carey Subway Constr. Co. v. Commissioner

NEWMAN & CAREY SUBWAY CONSTRUCTION COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ESTATE OF HENRY ROTH, AS ALLEGED TRANSFEREE OF THE ASSETS OF NEWMAN & CAREY SUBWAY CONSTRUCTION COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Newman & Carey Subway Constr. Co. v. Commissioner Docket Nos. 88775, 88776. United States Board of Tax Appeals 37 B.T.A. 1163; 1938 BTA LEXIS 932; June 30, 1938, Promulgated *932 1. A corporation recovering a judgment against the city of New York for damages, being indebted to another (B) for advances, causes, pursuant to an earlier agreement, the amount of the judgment to be cleared through a third person, thereby discharging its indebtedness to B. Held that the earlier agreement did not operate as an assignment of the damage award to B, and the amount thereof is taxable income of the corporation. 2. An amount recovered by a corporation in 1935 in recoupment of a loss suffered on a construction contract, completed in 1921, and covered by a return for that year on the completed contract basis, is income to the corporation in 1935. 3. A creditor who received payment from a corporation for advances made to it in prior years is not liable as a transferee of assets for the corporation's unaccrued income taxes for the year of payment, notwithstanding that such creditor is a minority shareholder, no distribution to shareholders having been made. L. L. Hamby, Esq., for the petitioners. Lloyd W. Creason, Esq., for the respondent. STERNHAGEN *1164 In Docket No. 88775 the Commissioner determined a deficiency of*933 $135,646.83 in income taxes of the petitioner construction company for 1935, (a) by including in income the amount of a judgment paid to it by the city of New York as damages for interference with the completion of a subway construction contract with the city, and (b) by disallowing the deduction of litigation expenses connected with the subway, found to have accrued and been deducted in prior years. The corporation contends that the proceeds of the judgment had been equitably assigned by it to the estate of Henry Roth, and, in the alternative, that its loss on the contract should offset the proceeds of the judgment; it denies that the expenses were accrued or deducted in prior years. In Docket No. 88776, the estate of Henry Roth assails the Commissioner's determination that it is liable as transferee for payment of the deficiency determined against the corporation. FINDINGS OF FACT. The Newman & Carey Subway Construction Co. is a New York corporation, with principal office at Brooklyn, New York. Benjamin Roth and Jerome Roth are executors of the estate of Henry Roth, who died a resident of New York on July 15, 1918. Decedent was the owner of 30 percent of the corporation's*934 shares. In 1915, the corporation made a contract with the city of New York for the construction of a section of subway on Nostrand Avenue, Brooklyn. Decedent advanced $250,000 to it, and agreed to advance more, as needed. He also guaranteed payment of the corporation's notes, and after his death his estate made further advances and was required to pay the notes. In 1921 the corporation completed construction under the contract, and in respect thereof made its income tax return on the completed contract basis. The costs and expenses of performance exceeded the proceeds by $671,130.98. The corporation has retained its charter and franchise, but has not engaged in any active business enterprise since, and its liabilities have at all times exceeded its assets. The advances and payments on endorsed notes, with interest, made by decedent and his estate on the corporation's behalf aggregated *1165 $798,411.10. Demand was made by the estate upon the holders of the other 70 percent of the shares for reimbursement of 70 percent of these payments, of $558,887.77. They questioned the amount of their liability, and to settle the dispute and avoid litigation, an agreement was*935 executed on July 30, 1924, whereby the corporation acknowledged its indebtedness to the estate for $798,411.10 advanced, and the other shareholders agreed: * * * that in settlement of the dispute with the Estate as to the amount for which they are obligated, they acknowledge their total indebtedness to the Estate to be seventy-one-hundredths (70/100) or seventy (70%) per cent. of the said total indebtedness of the Company to the Estate * * *. and they agreed to pay their respective portions thereof without interest by having the Necaro Co. pay to the estate 25 percent of all dividends or liquidating distributions upon shares of its stock owned by them, and to deposit the shares as security for performance. It was further agreed that any amounts of "retained percentages" under the contract, collected by the corporation from the city of New York or the Interborough Rapid Transit Co. should be paid over to the estate and credited against the corporation's indebtedness to it after deduction of claims due other creditors, legal fees, and expenses. * * * In the same manner, any damages which may be collected in a suit about to be brought by the Company against the City of New*936 York for damages for delay, increased costs, extra work or amounts due under the contract shall be paid to the Estate and similarly credited against the total indebtedness of the Company to the Estate or to the beneficiaries under the Will of HENRY ROTH, deceased. In the event of such total collection of retained percentages and damages exceeding the sum of Seven hundred and ninety-eight thousand four hundred and eleven and 10/100 ($798,411.10) Dollars or the amount to which it may have been reduced by any credits recovered, then the excess amount of such collection shall be credited to interest on the total principal sum * * *, but the only event in which interest shall be added to said last mentioned sum shall be in the event of collection of claims and/or retained percentages and/or other credits from said The City of New York in an amount in excess of such principal sum, or any amount to which it may have been reduced. It is further provided that the proceeds of any insurance policy on a shareholder's life, paid to the corporation should reduce the indebtedness. The shareholders, the corporation, and the Necaro Co. agreed, by section 23: * * * that they and each of them*937 will, upon the execution of this agreement and/or at any time thereafter when requested so to do by the Estate or by the beneficiaries under said Will, * * * make, execute and deliver any and all other conveyances, assignments, releases, papers, writings, documents and/or other instruments necessary or required to carry out and effectuate the terms, provisions and intent of this agreement. After the execution of this agreement, the corporation instituted suit against the city of New York, and in 1933 recovered a judgment for *1166 $679,751.83 and interest thereon from January 3, 1923, when the claim against the city was filed. This judgment was affirmed by the Appellate Division, and in June 1935 by the Court of Appeals. The amount paid under the judgment, including court costs of $652.76, was $1,246,515.23. Prior to June 1935, the principal of the corporation's indebtedness to decedent's estate had been reduced by $119,305.50 to $679,105.60. On June 28, 1935, the corporation and the estate's executors executed an instrument which recited that the corporation's "indebtedness (with interest)" to decedent's estate exceeded the amount of the judgment with interest, less*938 all contemplated credits, and that the corporation had "* * * by the terms of said agreement of July 30, 1924, transferred to the Estate its interest in said judgment * * *" except the part necessary to satisfy the claims of other creditors. The parties agreed that the full amount of $1,246,515.23 should be collected by a firm which was authorized to disburse it to carry out the purpose of the 1924 agreement. The amount of the judgment was collected, deposited in a special bank account, and during 1935 $259,650.28 was paid out in settlement of fees and expenses connected with the litigation and in satisfaction of an unrelated claim of $3,985.43, and to decedent's estate was paid the remaining $986,864.95, of which $679,105.60 was the balance of principal of its credit and $307,759.35 was interest thereon. On January 1, 1935, the corporation's books showed assets of $115,745.32, consisting of cash $5,919.51; accounts receivable less reserve for bad debts, $6,008.45; supplies, $3,817.36; and contract with the city of New York, $100,000. They showed liabilities: notes payable, $906,968.67; accounts payable, $14,306.73; accrued interest, $716,448.49; and capital stock, $100,000. *939 In fact there were no supplies. Apart from the damage award, the corporation has received no additional assets. OPINION. STERNHAGEN: 1. The Subway Construction Co. assails the Commissioner's determination that the $986,864.95 of the judgment recovered from the city of New York in 1935 was within its gross income, (a) because it was not received by it but by the Roth estate by virtue of the 1924 contract, or (b) because in its nature as damages the principal was not income even though the interest may have been. (a) The judgment was recovered from the city and was paid in 1935. By an authorization given pursuant to the 1924 contract the judgment was collected by a law firm and disbursed by it directly as provided in the contract. Thus the corporation actually received no part of it. The Roth estate received the $986,864.95 as principal and interest of the indebtedness of the corporation to it for advances. There can be no doubt that the indebtedness was the sole occasion *1167 for the amount being turned over directly to the estate instead of to the corporation, for the advances had theretofore been made by the estate, they remained unpaid, and they were recognized*940 by all parties to the 1924 contract. The bona fides is unquestioned. The corporation caused its indebtedness to be satisfied by the short-cut method of deflecting an amount receivable by it directly into the hands of its creditor, and the amount must be regarded as if it had been first received by it. The petitioner contends that there was, by virtue of the 1924 contract, an equitable assignment to the estate of all its rights against the city, and hence that the amount paid by the city in discharge of those rights may not be attributed to it. But there was no such assignment. The 1924 contract contains nothing to support an interpretation of it as such. Rather it was a means of assuring the use of the proceeds of the judgment, if any, to discharge so much of the indebtedness as was not otherwise paid. In fact $119,305.50 was otherwise paid, leaving $679,105.60. Moreover, other claims were recognized as properly to be paid by the collecting firm out of the amount paid by the city. (b) The corporation contends that the amount, even though it be treated as received by it, may not be regarded as taxable income in 1935, except perhaps so much as was interest. *941 It contends that the damages recovered were in recoupment of the loss suffered on its construction contract and such damages are not income. But it chose during its period of operations under the construction contract to make its returns upon the completed contract basis, a basis which is permissible and was recognized while construction operations were going on. The project was completed in 1921 and the return of that year must be assumed to reflect the loss. ; ; . The later recovery is income when received, ; ; ; ; . The Commissioner's treatment of the $986,864.95 as the petitioner corporation's income in 1935 is sustained. *942 2. In the notice of deficiency the Commissioner disallowed a deduction of "Expenses applicable to prior years $10,656.73", and in explanation of the disallowance said "This item represents certain expenses affecting the subway contract litigation which were paid during the current year but were accrued and deducted in prior years." The petitioner assails this, and alleges in its petition that it is unable to identify the items of deductions taken which have been disallowed. *1168 The return is not in evidence and there is no other evidence upon which a finding can be based from which an inference or conclusion can be drawn as to the propriety of the deduction taken or the disallowance made. The petitioner says in its brief: "Before any finding can be made for Respondent regarding this item, it must appear that the Subway Company deducted 'this item' on its 1935 return." This is incorrect. The burden is upon petitioner to demonstrate that the determination is in error, and if there is no evidence to support the attack and nothing to indicate that an error of law has been committed, the determination must stand. That is the situation here. The form of the Commissioner's*943 determination leaves much to be desired as to the nature and identity of the items disallowed, but that is not enough to establish that the disallowance was in error. In the absence of evidence to support findings, the item must be sustained. The Commissioner's determination as to the deficiency of the corporation is sustained. 3. The estate resists the determination of transferee liability against it for the deficiency of the corporation. The burden of proof to establish such liability is upon the Commissioner. He argues that what the estate received from the corporation was a distribution to a shareholder which left the corporation insolvent or with assets insufficient to pay its taxes, thus establishing the estate's liability as a transferee. It is, however, not as a shareholder that the estate received the payment, but as a bona fide creditor upon long standing advances of money, . There was no liquidation distribution among shareholders. Cf. . As a creditor, the estate was fully entitled to be paid without subjecting it to liability for a debt due to another. *944 . The Government had not at that time become a creditor, for the corporation's tax year had not ended. Whatever tax liability might result from the receipt by the corporation of the judgment with interest was unascertained and inchoate. It had not accrued or been assessed, and there was no lien. . Nothing would support a finding that there was an intention or attempt to give an undue preference to one creditor over another or otherwise to fraudulently obstruct the proper collection by the Government of its taxes. . The stipulation that at all times since 1921 the corporation was inactive and its liabilities exceeded its assets is too ambiguous, in the face of the evidence that the chose in action against the city was reflected only by the capitalized value of the contract, to justify a finding that the payment to petitioner left it in a condition *1169 of insolvency; although such a finding would still have less controlling significance to impose*945 a liability in equity upon a creditor than upon a distributee shareholder. There is, therefore, no foundation in this record for any liability of the estate at law or in equity as a transferee of the corporation's assets, and the Commissioner's determination of such liability must be reversed. Judgment will be entered against the corporation for the deficiency and for the estate as an alleged transferee.