Sheppard v. Commissioner

CHESTER A. SHEPPARD, TRUSTEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Sheppard v. Commissioner Docket No. 87430. United States Board of Tax Appeals 37 B.T.A. 279; 1938 BTA LEXIS 1058; February 4, 1938, Promulgated *1058 1. The petitioner, acting under a bondholders' agreement, bid in the security behind the bonds at a judicial sale under foreclosure proceedings. Pending incorporation and transfer of the assets so acquired to a new corporation, petitioner operated the property under the bondholders' agreement. In determining taxable income for the period he operated the property, petitioner accrued interest in an amount equal to the interest on the old mortgage and claimed a deduction therefor in his return. The amount so accrued was not paid by the petitioner. Held, that the agreement placed no obligation on the petitioner and the amount accrued does not meet the statutory requirement of interest on indebtedness. 2. Respondent's allowance of depreciation sustained for lack of evidence to show error. C. D. Phillips, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent. ARUNDELL *279 This proceeding involves a deficiency of $1,881.79 for the fiscal year ended October 31, 1934. Two issues are presented, namely, whether petitioner is entitled to deduct $13,685.72 alleged to represent interest accrued on mortgage trust certificates for the*1059 period from November 8, 1933, to March 31, 1934, and whether petitioner is entitled to an additional depreciation deduction on the properties held by him as trustee in the sum of $2,418.24. FINDINGS OF FACT. On November 8, 1933, petitioner, as trustee, acquired a gasoline absorption and compression plant in Texas under circumstances hereinafter set forth, and operated the plant until March 31, 1934. The plant had formerly been the property of the Forrest E. Gilmore Co. of Texas, hereinafter called Texas Gilmore. A mortgage had been placed on the property by Texas Gilmore with the Security Savings & Trust Co. of Portland, Oregon, as trustee, against which mortgage the Trust Co. had issued trust certificates in the amount of $482,000, bearing 7 percent interest. The capital stock of Texas Gilmore was owned by the Forrest E. Gilmore Co. of Delaware, hereinafter called Delaware Gilmore. Certain creditors of Delaware Gilmore brought proceedings against that company and made Texas Gilmore a party thereto. The Trust Co. intervened in the proceedings in order to protect the mortgage held by it. In January 1932 the holders of the trust certificates issued by the Trust Co. *1060 and secured by the mortgage of Texas Gilmore, entered *280 into an agreement which had for its immediate objects the acquisition of the properties of Texas Gilmore under foreclosure, the formation of a new corporation, and the execution by the new corporation of bonds secured by the properties in place of the trust certificates they then held. The agreement conferred upon designated trustees, of whom the petitioner was one, the necessary authority to act for the subscribers and gave in considerable detail the steps to be taken. As far as material here the agreement provided that the certificate holders would "accept, severally, either first mortgage bonds against the newly acquired property * * * and/or trust certificates for the amount of their respective claims plus accrued interest, and plus such costs as may be incurred by them in the acquisition of said property * * *." Other provisions were to the effect that any value in the property in excess of the amount necessary to secure the contemplated mortgage should be made available to security holders of Delaware Gilmore after the subscribers were fully protected, including provision for "interest which may hereafter accrue. *1061 " Interest was paid on the old trust certificates by Texas Gilmore to June 1, 1932. Thereafter that company paid no further interest on the certificates. On November 8, 1933, the petitioner, acting under the terms of the agreement of the certificate holders, bid in the property of Texas Gilmore for $50,000. None of the trust certificates were turned in to the court or to Texas Gilmore. From November 8, 1933, the petitioner operated the property as trustee for the certificate holders. On or about March 31, 1934, he conveyed all of said property, plus any and all profits received from his operation thereof, to the Portland Gasoline Co., a Delaware corporation. The Portland Gasoline Co. was organized in or about March 1934, pursuant to the terms of the aforesaid agreement. Thereafter it executed and delivered to the Title & Trust Co. of Portland, Oregon, its indenture of mortgage, to secure the payment of the sum of $482,000 aggregate principal amount of first mortgage sinking fund bonds due June 1, 1944, bearing interest at the rate of 7 percent per annum. This trust indenture and the bonds were dated as of June 1, 1934, and had attached thereto interest coupons representing*1062 the interest from June 1, 1934, to the time of maturity. In addition to those coupons, there was also attached the following form of coupon: (For interest June 1, 1932, to June 1, 1934) No. . THIS IS TO CERTIFY That interest on this bond at the rate of seven per centum (7%) per annum from June 1, 1932, shall become due and payable on December 1, 1932, at the office of Title and Trust Company, in the City *281 of Portland, Oregon, if so declared in the absolute discretion of the Board of Directors of the Portland Gasoline Company, and not otherwise. Until interest is declared by the Board of Directors, this coupon shall not be payable. , Treasurer. The mortgage and the bonds of the new Portland Gasoline Co. were in the same aggregate principal amount, $482,000, as the former issue of bonds or trust certificates secured by the mortgage of Texas Gilmore which was foreclosed. The Portland Gasoline Co. has paid all interest upon said indebtedness from June 1, 1932, up to the present time, including the period during which the properties were operated by the petitioner. Funds to complete the last interest payment for the period June 1, 1932, to June 1, 1934, were*1063 deposited with the Title & Trust Co. of Portland by the Portland Gasoline Co. on April 29, 1935. Petitioner claimed a deduction of $13,402.26 on his return as interest at 7 percent on $482,000 for 144 days. The return was made on the accrual basis. The respondent disallowed the deduction. In valuing the properties he operated as trustee, for the purposes of depreciation, the petitioner took the total cost of the plants as shown by the books of the Texas Gilmore Co., reduced this total by the reserve for depreciation, $402,500.37, and arrived at a net book value of $490,763.07 at November 8, 1933. He depreciated the property so valued upon the basis of a 12-year life for a period of 144 days, which amounted to $16,137.92, and claimed that amount on his return as a deduction for depreciation. The respondent allowed $13,719.68. OPINION. ARUNDELL: The first question for consideration is whether the amount of $13,402.26 claimed by petitioner as interest for the 144 days that he operated the Texas Gilmore properties is deductible from gross income. Section 23(b) of the Revenue Act of 1932 allows a deduction for "interest paid or accrued within the taxable year on indebtedness, *1064 " with certain exceptions not here material. Petitioner states the question involved here as being whether or not he had an obligation under the agreement of the certificate holders to pay or cause to be paid the interest on the indebtedness represented by the old trust certificates and says that the answer lies on the construction to be placed on that agreement. It is argued that the agreement contemplated that the indebtedness represented by the trust certificates should be kept alive. The statutory provision allowing deduction for interest on indebtedness means interest on an obligation of the taxpayer claiming it; payments made on obligations of others do not meet the statutory *282 requirement. These fundamentals have often been stated. , affirming ; ; . Turning to the agreement here, it is impossible to find therein any obligation on the part of the petitioner to pay interest on the obligations of the Texas Gilmore Co. The essence of the agreement in so far as it relates*1065 to this question is, as stated in petitioner's reply brief, that if the property was purchased by the trustees, the trustees would cause to be issued through a newly formed corporation new certificates of indebtedness including accrued interest. This, we think, is a complete answer to petitioner's claim. His obligation in this matter was only to cause to be issued by the new corporation certificates evidencing indebtedness taken upon itself and not indebtedness of the trustee. The trustee undertook no obligation of indebtedness or to pay interest. If somehow there can be spelled out of the agreement an obligation of the petitioner for interest while he operated the properties, we would still be forced to the conclusion that no deduction would be allowable. The petitioner, it must be remembered, was operating the properties as trustee for the certificate holders who were the beneficial owners. Under such circumstances, if there was any liability for interest it would be a liability on the part of the certificate holders to pay interest to themselves. The statute clearly does not comprehend any such liability. While we do not have the question of deductions by the new corporation, *1066 it is worthy of note that when the new corporation was brought into being by the certificate holders, they did not place upon it an unconditional liability for interest for the period here involved. Under the coupon set out in the findings of fact, payment for that period was solely in the discretion of the directors of the new corporation. We accordingly hold that the petitioner did not incur liability for interest during the period that he operated the properties and that he is not entitled to the deduction claimed. The record on the depreciation issue is confusing. It appears that the petitioner computed and claimed depreciation in his return on a basis of $490,763.07 and at a rate of 8 1/3 percent. The deficiency notice states the depreciation has been allowed at the same rate, which indicates that the respondent used a lower basis than the petitioner. The assignment of error in the petition attacks only the amount disallowed as a deduction and does not indicate whether the petitioner complains of the basis or the rate used by the respondent. From the facts alleged in the petition, it appears that the petitioner questions *283 the rate and not the basis. The*1067 discussion at the hearing and in the briefs is along the line that the basis is in issue. The evidence is insufficient to establish error in either the rate or the basis. The only evidence directed to the rate is the testimony of the petitioner that in his opinion a fair rate for depreciation is 10 percent. No facts are given upon which we can test the soundness of his statement. The evidence as to the basis is that the petitioner used the figure set up on the books of the Texas Gilmore Co. as depreciated cost. Whether or not that was actual depreciated cost we do not know. In this state of the record it is unnecessary to inquire whether the petitioner's proper basis is cost to him or cost to the former owners. Decision will be entered for the respondent.