Elliott Paint & Varnish Co. v. Commissioner

ELLIOTT PAINT & VARNISH COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Elliott Paint & Varnish Co. v. Commissioner Docket No. 103032. United States Board of Tax Appeals 44 B.T.A. 241; 1941 BTA LEXIS 1358; April 23, 1941, Promulgated *1358 1. EVIDENCE - PAROL EVIDENCE TO VARY THE TERMS OF A WRITTEN CONTRACT. - While parol evidence was admissible to show the true agreement of the parties, even though it would tend to vary the terms of their written contract, held, that the actual agreement of the parties was shown by the written contract. 2. INCOME TAX DEDUCTIONS - INTEREST. - Where the parties agreed that the purchase price of a piece of property in the amount of $40,000 should be paid in periodic payments extending over a period of 15 years, held, that no part of the payments was interest. Donald E. Currier, C.P.A., and Roger M. Currier, Esq., for the petitioner. David Altman, Esq., for the respondent. MURDOCK *241 The Commissioner determined a deficiency of $394.43 in the income tax of this petitioner for the fiscal year ended November 30, 1937, and one of $320.83 for the fiscal year ended November 30, 1938. The issues for decision are: (1) Is the petitioner entitled to a deduction for interest on account of amounts paid in each year in connection with the purchase of some real estate? (2) If it is not entitled to deduct the amounts as interest, is it entitled*1359 to deduct equivalent amounts representing proportionate parts of the discount of a note which it gave to secure the purchase price? (3) Was the remaining useful life of the improvements on the property less than the period determined by the Commissioner in computing depreciation? *242 FINDINGS OF FACT. The petitioner is a corporation, and it filed its tax returns for the fiscal years with the collector of internal revenue for the first district of Illinois. It used an accrual method of accounting. The petitioner had been leasing premises adjacent to its plant under a lease providing for a term of 20 years ending about 1941, the rental to be adjusted every 5 years in accordance with an appraisal of the property. The petitioner advised the owner, Mary B. Elliott, in October 1936, that it desired to purchase the property. The letter was in part as follows: Mr. Beardsley's appraisal shows a value of $27,500.00 on the property with a fair rental value of $2,100.00 per year for the next five years, which of course only insures you of an income for five years. I propose to enter into a purchase agreement with you that will guarantee you an income of $2100.00 net per*1360 year for life, with a minimum price for the property to be the present appraised value. This would mean if you should live twenty or twenty-five years, you would receive forty to fifty thousand dollars, and if you should pass away at any time after the contract is signed, the total minimum is to be paid as stated above at the present appraised value. The owner replied that she would come to Chicago and talk the matter over. She met with the president of the petitioner in November 1936 and refused an offer of $27,500 cash for the property, stating that she preferred to receive periodic payments for the property during her life. She was then 67 years of age. A written contract was entered into on December 1, 1936, which was in part as follows: (1) SAID SELLER hereby agrees to sell said premises for the sum of Forty Thousand Dollars ($40,000.00), payable as hereinafter set forth (same to be in addition to all other payments hereinafter provided to be made by said Purchaser); and to convey or cause to be conveyed to said Corporation a good title to said premises by general warranty deed with release of homestead rights or estates; subject to: (1) all unpaid special taxes or assessments*1361 and all unpaid installments thereof, for improvements whether completed or not completed; (2) water taxes; (3) all unpaid general taxes; (4) building lines of record, if any; (5) building or liquor restrictions of record, if any; (6) zoning and building laws or ordinances; (7) party wall rights or agreements, if any. (11) SAID SUM of Forty Thousand Dollars ($40,000.00) shall be paid in the following manner: $250.00 upon the execution hereof as earnest money to be applied on said purchase when consummated, and the balance of said $40,000.00 shall be paid in monthly installments of $250.00 per month, beginning on the First day of January, A.D., 1937, and on the first day of each and every month to and including the First day of November, 1941, and thereafter in monthly installments of $208.33, beginning on the First day of December, 1941, and on the first day of each and every month thereafter, to and including the First day of November, 1951; said deferred payments to be without interest until maturity, but with interest at the rate of seven per cent (7%) per annum after maturity. Upon the consummation of said sale the insurance policies, if any, on said premises shall be assigned*1362 to the Purchaser, and said Purchaser shall pay the premiums therefor for the unexpired term of said policies. (111) *243 SAID PURCHASER agrees to purchase said premises on the terms herein contained, and further agrees that it will on or before the delivery of the deed from said Seller pay or cause to be paid without cost or expense to said Seller, the indebtedness secured by the mortgage or trust deed now existing on said premises, and to obtain the cancellation and release thereof in due form. Said Purchaser further agrees, coincidently with the delivery of said deed to it, to execute and deliver to Seller, its principal promissory installment note in the sum of $40,000.00 payable as aforesaid, and its first mortgage or trust deed to the Chicago Title and Trust Company as Trustee, or to such other Trustee as may be agreed upon, conveying said premises and all buildings and structures now or hereafter placed thereon, said mortgage or trust deed to be in the form ordinarily used by said Chicago Title and Trust Company, insofar as same may be applicable, and with such other provisions as are reasonably necessary or proper to adequately secure the payment of said indebtedness, *1363 and the prompt performance of all the terms and undertakings of said Purchaser herein contained; provided, however, that said mortgage shall contain a provision that in case the said mortgagor shall make default in said monthly payments, and such default shall continue for a period of three (3) months, or in case of a breach of any of the other terms or agreements in said mortgage contained, the whole of said indebtedness shall, at the option of said Seller, without notice, become immediately due and payable. The purchase price of $40,000 was agreed upon after a computation had been made for the seller showing that $27,500, plus interest thereon at 5 percent for 10 years, would equal $41,250. The parties discussed that computation or a somewhat similar one during their negotiations in arriving at the purchase price of $40,000. The contract was approved by the board of directors of the petitioner on January 27, 1937, and at that same meeting a resolution was adopted authorizing execution and delivery of the: * * * installment principal promissory note in the face amount of Forty Thousand Dollars ($40,000.00), payable to the order of bearer in installments as follows: Two*1364 Hundred Fifty Dollars ($250.00) on the First day of December, 1936, and Two Hundred Fifty Dollars ($250.00) on the First day of each and every month beginning on the First day of January A.D. 1937, and on the first day of each and every month to and including the first day of November, 1941, and thereafter in monthly installments of $208.33 beginning on the 1st day of December, 1941 and on the first day of each and every month thereafter to and including the First day of November, 1951; said deferred payments to be without interest until maturity and after maturity at the rate of Seven Per Cent (7%) per annum on each installment until paid. together with a Trust Deed to the Chicago Title and Trust Company, a corporation, conveying the aforementioned real estate as security for the payment of the said note and for the performance of the covenants contained in the aforesaid agreement bearing date of December 1, 1936, and * * *. The petitioner delivered its noninterest-bearing promissory note for $40,000 to the seller, paid her $250 earnest money, and thereafter paid her $250 each month during the taxable years. *244 An accountant, auditing the books of the petitioner*1365 after the fiscal year ended November 30, 1937, discovered that no entry had been made recording the purchase of the property. The following journal entry was entered at his suggestion on the books of the petitioner either in December 1937 or January 1938, together with closing entries: Interest included in Real Estate PurchaseContract (5 1/2%) 12,500.00 Buildings [200] 9,750.00 Land [9] 17,750.00 Real Estate purchase obligation 40,000.00 To record value of land and buildings, per appraisal, purchased under contract dated 12/1/36 payable $250.00 per month thereafter to Nov. 1, 1941 and $208.33 per month thereafter to Nov. 1, 1951. A portion of these payments apply to principal and the remainder to interest computed on a declining principal balance at 5 1/2% per annum, compounded semi-annually. The record does not show in what way the $250 monthly payments were recorded on the books of the petitioner. The seller, upon the advice of the president of the petitioner, reported in her income tax returns for the years 1937 and 1938 as interest, a portion of the payments received by her. There were three brick buildings on the premises purchased*1366 which the petitioner intended to use and did use for storage purposes. One was erected in 1921 at an approximate cost of $5,000. The second was erected in 1917 at a cost not shown by the record. Each of those buildings had a cement floor and asphalt roof. The third, which had wooden floors, was erected in 1924 at an approximate cost of $10,000. The petitioner, at the time of the hearing on December 4, 1940, was still using all three of the buildings but was in the process of vacating one of them because it was unsafe and it had decided to demolish all three of the buildings within two or three years in order to construct larger plant facilities. The petitioner, on its income tax return for the first taxable year, claimed a deduction of $1,492.05 representing interest paid to Mary B. Elliott, and on its return for the second taxable year claimed a similar deduction in the amount of $1,407.97. It claimed deductions for depreciation on the three buildings and a brick connecting link. The deduction claimed on the first building for each year amounted to $196.67 and was based upon a cost of $2,950 and an estimated life of 15 years from December 1, 1936. The deduction claimed*1367 on the second building amounted to $350 for each year and was based upon a cost of $3,500 and an estimated life of 10 years from December 1, *245 1936. The deduction claimed on the third building for each year amounted to $183.33 and was based upon a cost of $3,300 and an estimated life of 18 years from December 1, 1936. The deduction claimed on the connecting link for each year amounted to $433.87 and was based upon a cost of $2,061.98 and an estimated life of 3 3/4 years from "1934-35." The Commissioner disallowed the deductions for interest claimed in each year on the ground that the amounts represented "a portion of the cost of property purchased in 1936 at a total price of $40,000 from Mary Borders Elliott." He disallowed $350.11 of the depreciation claimed for each year and allowed the remainder, with the following explanation: Asset Estimated remaining life from acquisition, December 1, 1936 Cost Brick building No. 1 25 years $4,291.22 Brick building No. 2 20 years 5,037.30 Brick building No. 3 28 years 4,761.94 Land 25,909.54 Total $40,000.00 Depreciation deduction claimed on the connecting link building has been reduced*1368 in the amount of $317.70 for the fiscal year ending November 30, 1937 since it has been determined that the remaining life from December 1, 1936 was 17 3/4 years. OPINION. MURDOCK: The petitioner contends that a portion of the total amount paid to Mary B. Elliott during each of the taxable years was interest and not purchase price. This is directly contrary to the provisions of the written contract entered into by the parties, which shows that the payments of $3,000 made in each of the taxable years were entirely a part of the purchase price and were not interest. The petitioner contends that the true agreement of the parties, as shown by parol evidence, was an agreement to pay a purchase price of $27,500 and interest thereon in the amount of $12,500. The question must turn, of course, upon what was the actual agreement of the parties. Was it an agreement to pay so much as purchase price and the balance as interest? This must be determined from all of the evidence, documentary and otherwise. Although no evidence was excluded on the ground that it was parol evidence tending to vary the terms of the written instrument, nevertheless, the evidence as a whole does not establish*1369 that the actual agreement of the parties was different from that which is expressed in their written contract. While the figure $27,500 appears a number of times, the record does not justify a finding that the value of the property at the time of the *246 transaction was $27,500. No opinion evidence of the value of the property was offered. An appraisal was mentioned in a letter from the buyer to the seller, but the appraiser was not called as a witness, his qualifications were not shown, and no basis for his valuation appears. The seller rejected an offer of $27,500 in cash for the property. The parties, in agreeing upon the purchase price of $40,000, as set forth in their written contract, used some kind of a rough calculation in which interest on $27,500, at some rate not shown in the record and for a period of years not shown in the record, was computed and added to $27,500 to arrive at a figure which was approximately, but not exactly, $40,000. The only actual figures contained in the record pertaining to any such computation are on a piece of paper which the seller had in her hands and which had been furnished her by an adviser who was with her at the time the*1370 sale was made. On that paper, interest at 5 percent on $27,500 for 10 years, amounting to $13,750, was added to $27,500 to make $41,250. This total was then divided by 15 to show that 15 annual payments of $2,750 would equal $41,250. The record gives no clue whatsoever as to why the 5 percent rate and the 10-year and 15-year periods were used. Counsel for the petitioner in their briefs twice asked for a finding that the life expectancy of the seller was 15 years at the time of the sale. Although Mary B. Elliott stated that she was 71 years of age at the date of the hearing, there is no evidence in the record to show her life expectancy in December 1936, or to show that the parties had that factor in mind at the time of the deal. The parties did not incorporate any of the computations in their agreement, but, instead, adopted the written agreement of December 1, 1936. The mathematics by which parties arrive at an agreed purchase price does not represent their agreement. . Cf. *1371 ; affd., . The petitioner sets out in its brief an elaborate table dividing the total payments of $40,000 over the 15-year period into semiannual payments, dividing the semiannual payments into payments of principal and payments of interest at 5 1/2 percent on a declining balance of principal which begins with $27,500 and is reduced semiannually by the excess of the total semiannual payments over the portion thereof which is shown as interest. If the parties had actually adopted such a table as a part of their agreement, it might be pretty strong evidence in support of the petitioner's contention. But the first time that any such computation was suggested as having any possible application to the contract of December 1, 1936, was when the auditor made the entry in closing the books of the petitioner *247 for the year ended November 30, 1937. That entry was made more than a year after the contract was entered into. It is no more than a remarkable coincidence that the actual payments almost fit into this table. They do not actually fit into the table because the last two semiannual payments*1372 are arbitrarily adjusted by the computator in order to force the figures to come out properly. The record does not show that the parties at the time they entered into the contract gave any consideration to an interest rate of 5 1/2 percent, to the computation of interest semiannually, or to the computation of interest upon declining balances of principal. So far as the record shows, they had no idea that any such table could be devised. The parties adopted the interest figures shown in the table in reporting their income taxes. It does not appear how important this was to the seller but it does appear that she relied entirely in this connection upon the advice of the president of the petitioner, who was her friend. The action of the parties at the time they entered into the contract, including their consideration of the figure $27,500, and their subsequent actions in reporting a part of the payments as interest, are not without probative value. But that evidence is not entirely convincing even by itself, since it does not go far enough to show that they had agreed upon the purchase price of $27,500 with interest thereon at some particular rate of interest for a definite number*1373 of years. Cf. , and . Opposed to that evidence is the written contract, which is, and was intended to be, evidence of the agreement of the parties, entered into by them deliberately after full consideration and drawn at their request and for their benefit by an attorney. The parties have never made any effort to amend or modify that written agreement to provide for the payment of interest. The written contract is clear and the record as a whole does not show that the parties, when they made their bargain, really intended to pay any portion of the $40,000 as interest. This distinguishes the case of . The sale of property for cash is quite different from a sale upon a deferred payment plan. The fact that the deferred payment sale price is greater than the cash sale price does not make interest of the difference. . One justification for the increase in price is to make allowance for the additional risk which the seller must assume. Cf. *1374 The Commissioner did not err in concluding that no part of the periodic payments represented the payment of interest. *248 The alternative contention of the petitioner is also without factual support. The petitioner claims that it gave its note for $40,000 in exchange for property worth only $27,500 and the difference represents discount on the note which ought to be deducted ratably over the life of the note. It is not established as a fact in this record that the property was worth only $27,500 at the date of the sale. This point has been sufficiently discussed already. Furthermore, the transaction was one of purchase of a piece of property. The note was given merely as a part of the security for the unpaid purchase price. The transaction did not represent and was not intended to represent the discount of a note. It is unnecessary to consider this contention further. The Commissioner, in computing depreciation, has used a portion of the $40,000 cost of the properties as basis. This has resulted in a larger basis than was claimed by the petitioner or than would be allowable otherwise. The Commissioner, however, used*1375 a greater estimated remaining life for each building. The final result of his computation was a smaller deduction than the amount claimed by the petitioner. The petitioner had the burden of showing that the probable useful life of each building, as that life might reasonably have been estimated during the taxable years, was less than the period used by the Commissioner. The petitioner has not sustained this burden. Indeed, arguments of its counsel in their briefs indicate a failure to realize that they have this burden. The president of the petitioner testified that, in computing the deductions claimed on the return, an estimate made by Beardsley was used. Beardsley was not called as a witness, his estimates are not a part of the record, the basis of his estimates is not shown, and it is not shown that he was qualified to make estimates of any kind. The petitioner's counsel apparently relies upon the fact that at the time of the hearing the petitioner was vacating one of the buildings and had decided to demolish the other two. But the evidence does not show that any of these events was anticipated during the taxable years. Deductions for depreciation for 1937 and 1938 must*1376 be based upon facts known or anticipated during those years and not upon the hindsight of subsequent years. The record does not enable the Board to make an independent estimate of the probable useful life of any one of the three buildings or the connecting link as of either of the taxable years. Therefore, the determination of the Commissioner on this point can not be disturbed. Decision will be entered for the respondent.