Foer Wall Paper Co. v. Commissioner

FOER WALL PAPER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Foer Wall Paper Co. v. Commissioner Docket No. 10103. United States Board of Tax Appeals 9 B.T.A. 377; 1927 BTA LEXIS 2601; November 28, 1927, Promulgated *2601 1. Capital expenditures distinguished from ordinary and necessary repairs. 2. Deduction of $6,710.11 claimed either as a bad debt or additional compensation disallowed. Lawrence Koenigsberger, Esq., for the petitioner. W. H. Lawder, Esq., for the respondent. MORRIS *377 This proceeding is for the redetermination of a deficiency of $2,250.35 in income and profits taxes for the year 1920. The petitioner alleged that respondent erred in determining that certain expenditures were for capital items and not for ordinary and necessary repairs; and that respondent erred in disallowing a deduction of $6,710.11 which is alleged to be either a bad debt or additional compensation. FINDINGS OF FACT. The petitioner is a Virginia corporation with its principal office in Washington, D.C., and is engaged in the wall paper business. For 1920 petitioner deducted $1,904.90 from its taxable income because of alleged ordinary and necessary repairs. Such repairs *378 consisted in part of the following items: cost of cementing cellar, $400; mending leaks in roof, $150; plastering work, $200; altering store front and putting in new plate glass, *2602 $1,100. The basement was cemented because a spring near one said of the building kept the cellar filled with water. The roof was of slag and tar and the portions where leaks had developed were removed and the leaks repaired. The plastering was for the ceiling on the first floor and a side of the wall on the second floor. The store front was altered and improved by removing the old time show windows and substituting new ones therefor. On its income-tax return for 1920 petitioner deducted $7,719.76 as bad debts, $6,710.11 of which was carried on its books as an account receivable from its president, and was disallowed as a deduction by the respondent. The balance, amounting to $1,009.65, represented the aggregate of some 33 accounts. These accounts were charged off of petitioner's books for various reasons. Some were disputed by customers, some were allowances on accounts, and some were considered uncollectible. Prior to 1914 Frank A. Foer conducted a wall-paper business as an individual, but having become very heavily involved, he had to take some action to secure his various creditors. He had purchased some 25 or 30 parcels of real estate, had heavily mortgaged them, *2603 and was unable to renew his mortgages; his business had become heavily involved for various wall-paper bills; and he had contracted a great many personal obligations. In order to straighten out both his personal and business affairs Foer transferred all his real property to Rudolph B. Behrend in trust for the payment of the debts against the property, a debt of $14,000 to Behrend, and for the payment of expenses incident to carrying the property. The trustee was given authority to handle and dispose of the properties as he saw fit. The trust was to continue for 10 years, at the expiration of which the trustee was to reconvey all the assets then in his hands to Foer, who was to pay to him 50 per cent of the value of said assets. It was further decided to incorporate the business, which was done, and Foer was made president. By a certain indenture dated March 8, 1914, Foer deposited 138 shares of the petitioner's capital stock with the Security Savings & Commercial Bank of Washington, D.C., as collateral for "certain loans, discounts, and other financial accommodations heretofore given or that may hereafter be given." By this contract Foer secured a loan of $8,000 from the bank, *2604 which was used to pay up the business debts incurred by Foer as an individual. The stock was returned in 1922 or 1923 when the obligations were paid. Foer was to receive from the petitioner a salary of $50 per week and was allowed to withdraw from the corporation from time to time *379 certain amounts which he was to use for the purpose of satisfying his personal creditors. During the years subsequent to incorporation he withdrew from time to time various amounts which were charged against his personal account. Foer used such amounts to satisfy personal creditors and to meet his current personal expenses. From time to time he received certain rents or profits from sales under his trust agreement with Behrend, which amounts he turned over to and was credited for on his personal account by the petitioner. The receipts from Behrend stopped during 1919 or 1920. Foer's personal account as shown by the petitioner's books indicate the following totals and the action of the corporation as to the debit balance during some of the years: Year Debits Credits Debit balance Charged to profit and loss — 1914 — $8,144.94 $2,778.30 $5,366.64 $5,366.64 — 1915 — 4,938.92 1,098.27 3,840.65 3,840.65 — 1916 — 4,019.00 2,403.24 1,615.76 1,615.76 — 1917 — 3,124.88 552.06 No records. No records. — 1918 — No records. No records. No records. No records. — 1919 — 4,497.86 195.00 4,302.86 — 1920 — 13,923.57 3,828.02 10,095.55 6,710.11 *2605 The petitioner's records of Foer's personal account were incomplete for 1917 and 1919 and all the records for 1918 were missing. The last entries in 1917 were on December 22; the first entries in 1919 were in June, but the debit and credit balances for that year were carried forward. For 1920 the debit balance after the charge off of $6,710.11 was carried forward to the year 1921. The debit and credit entries for 1921 ended on November 28, at which time the total debits were $12,830.49 and the total credits were $5,957. OPINION. MORRIS: The first question presented is whether certain expenditures were for capital items or for ordinary and necessary repairs. In , we pointed out the difference between capital items and ordinary and necessary expenses in the following language: In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose*2606 of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, *380 improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. Under the facts in this case the addition of a new concrete cellar, and the alteration and improvement of the store front, and the installation of new plate glass windows constituted capital expenditures and are not deductible. The cost of mending leaks and plastering were repair items which should be deducted from current income. The second error assigned was that respondent erroneously added to income $6,710.11 representing a bad debt owing from the petitioner's president. The deduction is now claimed either as a bad debt or*2607 as additional compensation. Under either claim we are satisfied that petitioner is not entitled to the deduction. For a number of years prior to and during the taxable year in question the petitioner advanced money to its president for the payment of his personal indebtedness. The amounts so advanced were charged to his personal account and carried as an account receivable. During 1920 his account count was debited with $13,923.57 and credited with $3,828.02, making a debit balance at the end of the year of $10,095.55, of which amount $6,710.11, the item in controversy, was charged to profit and loss and the balance was carried forward to the year 1921. The record is silent as to any demand which may have been made on Foer to pay the debt, or as to any efforts on the part of the petitioner to collect the amount charged off. Substantial payments were made on the account during 1920. Only a part of the debit balance was charged off and additional advances and payments were made during 1921. These facts in our opinion are not considered with the petitioner's contention that $6,710.11 was a bad debt ascertained to be worthless. The evidence does not support the alternative proposition*2608 that the amount constituted additional compensation. It was carried as an account receivable. Foer drew an authorized salary of $2,600 per annum and it was testified that those interested in working out the affairs of the business were endeavoring to keep salaries at a minimum. There is no showing of any additional salary authorization or that the services rendered by Foer entitled him to any amount in excess of $2,600. We are therefore of the opinion that the amount of $6,710.11 is not an allowable deduction. Judgment will be entered on 10 days' notice, under Rule 50. Considered by MURDOCK and SIEFKIN.