Washington v. Commissioner

CHASE, Circuit Judge. The petitioner is the inventor of a process for making desiccated soluble products of coffee and other substances. In 1910, desiring to keep his process secret while manufacturing and selling its product on a commercial scale, he organized a New York corporation called G. Washington Coffee Refining Company, and made an arrangement with it to supply him with the materials which he needed to exploit his process himself and to sell the product he made. Fie was to receive for what he did an agreed amount based upon the quantity of the product with which he provided the corporation and which was sold by it. This was called a royalty. It will be convenient to speak of his income from this arrangement as his royalty. When the corporation was organized, it had common stock of the par value of [830] $500,000 and preferred stock of $100,000 in par value. The petitioner became president of the corporation and owned all of the preferred and $300,000 of the common stock. Capital necessary for operation was obtained for the corporation by selling the remainder of the common stock to the public largely, if not wholly, through the efforts of a friend, Mr. Arkell, who will be mentioned later in connection with one of the questions raised. The business was successful. In 1918 petitioner made a contract with the corporation in terms much like the previous arrangements he had had with it, but providing for monthly payments of royalty to him for furnishing it the product of his process. He had previously been paying Mr. Arkell, in appreciation of his former assistance, an agreed amount per unit of product out of the royalties he received. Arkell had been connected with the corporation, but these payments had not been for his current services. In 1918 Arkell retired, and, instead of paying him as before, it was agreed that petitioner would pay him $2,000 a month so long as Arkell lived. Having so arranged his affairs, the petitioner wrote a letter on December 30, 1918, to his wife and three children, the youngest of whom was then twenty years old, which read as follows: “To my dear wife, Lina, to my dear children, Louise, Irene and George: “Pursuant to our conversations on the subject, in consideration of the devoted care and valuable assistance you have given me, in the past, and other valuable consideration, I, hereby, sell and assign to each of you a one-fifth interest in all my real and personal property, except my shares of the Capital Stock of the G. Washington Coffee Refining Company of New York, but, including the contract I have with said Company by virtue of which they pay me a royalty. However, in view of your inexperience in business matters, I want it distinctly understood that I reserve, for myself, the exclusive right to alter or modify said contract, as well as the amount of royalties payable thereunder, from time to time, as in my judgment may best serve the interests of the business. “Providing, first: That any financial obligations I now have shall be liquidated out of the herewith assigned assets to the extent of one-fifth by each of you; the balance to be used absolutely. “Secondly: That while we live together and as long as we do so, we shall each equally share in the general expense of doing so. “For your convenience, I will inform the company of your interest in my contract and authorize them to pay to each of you, directly, your share of the Royalties upon your request to them to do so. “Realizing that this may not be the best form of an Assignment I will, in the near future, cause a formal document to be prepared and executed. “Lovingly yours, “[Signed] G. Washington.” The corporation was notified of the letter, and on March 3, 1919, the petitioner followed out his intention so expressed by executing four 'formal assignments of “an undivided one-fifth part or share of all my right, title and interest in and to any and all royalties or other sums of money which may at any time hereafter become due and payable to me” from the corporation under his royalty agreement. One of these assignments, none of which covered anything but a one-fifth interest in his royalties to become due, was delivered to his wife and one to each of his children. All of the assignments were made upon the express condition, to which the assignee by acceptance assented, that the petitioner’s royalty contract with the corporation' might be “cancelled, waived, or modified in any respect whatsoever, at any time and from time to time” as he and the corporation might agree. During the years 1925, 1926, and 1927 the petitioner returned only one-fifth of the royalty as his own income, treating the remainder as- that of his wife and children. The deficiencies in controversy were determined by the Commissioner and sustained by the Board upon the ground that it was all taxable to him. In those years the petitioner and his wife and children together owned all of the common stock of the corporation and he owned all of its preferred. The practice from 1918 to 1925 had been to deposit all of his royalty payments in what was called a “trustee account” in a bank of New York. By checks drawn on that account he paid the family living expenses, for the repairs of his town and country houses, the amounts due Mr. Ar [831] kell under the agreement with him, and used it also to pay other expenses as he would from his own personal account, making distributions from it to his wife and children in a manner satisfactory to all concerned. During the three years involved there may have been some change in the method of making withdrawals from the trustee account, but, if so, that was left to mere surmise, with no proof whatever to show what it was. In this respect it was correctly stated in the opinion of the Board that: “Most of the evidence had reference to years prior to 1925, but the situation created and existing before that year was not shown by petitioner, on whom the burden rested, to have been changed at any time before or during the taxable years.” So far as the formal assignments are concerned, it is to be observed that, as they were nothing more than the assignment of the future income of the petitioner as it became due and payable to him under a contract requiring his continuing performance to make them payable, they did not relieve him from liability to pay an income tax upon it, even though the wife and children each became entitled to one-fifth as soon as it was due the petitioner. Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731; Burnet v. Leininger, 285 U.S. 136, 52 S.Ct. 345, 76 L.Ed. 665. But wc shall assume for present purposes that his letter, followed by what was done pursuant to it, did transfer to the wife and children an interest in the royalty contract itself which was enforceable in equity at least. And we will assume arguendo that the property right so created was the producing source of whatever income the wife and children might thereafter be entitled to receive, a proposition essential to such decisions as Hall v. Burnet, 60 App.D.C. 332, 54 F.(2d) 443, 83 A.L.R. 86; Commissioner v. Field (C.C.A.) 42 F.(2d) 820; Nelson v. Ferguson (C.C.A.) 56 F.(2d) 121. Nevertheless the letter contained limitations upon the right of the wife and children which cannot be ignored. Only the one which provided that they should take subject to liability for four-fifths of the petitioner’s then existing financial obligations need now be mentioned, for that is enough to require affirmance. We do not know the extent of those financial obligations. They might still have been in existence during the years involved in such amounts that the petitioner could have required all of the royalty income to be applied to their payment. We know only that he did not in fact insist upon such an application as to all of the income, but the right is alone important; the nonexercise of it having no effect upon the taxability of income he might have used as his own. Corliss v. Bowers, 281 U.S. 376, 50 S.Ct. 336, 74 L.Ed. 916; Mitchel v. Bowers (C.C.A.) 15 F.(2d) 287; Dickey v. Burnet (C.C.A.) 56 F.(2d) 917; Rosenwald v. Commissioner (C.C.A.) 33 F.(2d) 423. The second point relates to the right of the petitioner to deduct the payments made Arkell on the ground that they were the payment of ordinary and necessary business expenses. It seems clear enough that they were but personal expenses the petitioner incurred and paid out of gratitude to Arkell for his previous assistance. The petitioner testified that what he paid Arkell from the first was just the voluntary expression of appreciation, and, when asked if the later modification of that gift to the sum of $24,000 a year was a continuation of that voluntary expression of appreciation, testified that it was. Being nothing more than one of the ways the petitioner chose to spend his own income without closer relationship to the carrying on of any trade or business than that he had a praiseworthy sense of obligation to an old business associate, the payments do not fit into the deduction statute. And so they were properly disallowed. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348. Affirmed.