#### NATIONAL CITY BANK OF SEATTLE v. THE UNITED STATES1

[No. E-228.

Decided November 7, 1927]

*On the Proofs*

*Income tm; deduction»; capital expenditure; ordinary and necessary expense; permanent improvements Try lessee; informal lease; actual occupancy.*— Having informally rented certain premises for a term of five years, with privilege of renewal for another five years, a national bank in the State of Washington, lessee, without obligation to do so, made certain permanent improvements for the conduct of its business, occupied the premises for the first five years and continued -to occupy them thereafter under a new lease which provided that said improvements were the property of the lessee. *Held,*that the expense of the improvements was a capital expenditure for which the taxpayer was entitled in his income-tax return to a deduction for exhaustion for each tax year, and not, within the meaning of section 234 (a), revenue act of 1918, an ordinary and necessary expense deductible for the year in which expended.

*The Reporter's*statement of the case:

*Mr. Robert Ash*for the plaintiff. *Messrs. Thomas J. Reilly axid.*Abnon Ray Smith*were on the briefs.

*Mr. Dwight E. Rarer,*with whom was *Mr. Assistant Attorney General Herman J.*Galloway, for the defendant.

The court made special findings of fact, as follows:

I. The plaintiff is a corporation organized under the national banking laws, having its principal office in Seattle, Washington.

II. In 1917 the National City Bank of Seattle was confronted with the necessity of finding suitable quarters in which to transact its banking business. After search it was determined that the only suitable quarters in the city of Seattle were those located on the ground floor of the Marion Building.

III. J. W. Maxwell, president of the plaintiff bank, interviewed L. J. Colman, president of the J. M. Colman Co., the owner of the Marion Building. Mr. Colman refused to give the National City Bank a written lease, but verbally *237agreed ,to rent the premises to the bank for a period of five years at a rental of $1,000 a month for the first two and one-half years and $1,100 a month for the remaining two and one-half years. This arrangement was confirmed by letters in words and figures as follows:

Seattle, Wash., *Deo.*10th, *1917.*

Mr. J. W. Maxwell,

*Pres. National City Bernik,*Seattle, *Wash.*

Dear Sir: Confirming our verbal understanding of the Marion Building lease for your files: You are taking over the ground floor of the Marion Building, exclusive of the elevator entrance, to be occupied by your bank for a period of five (.5) years at the rate of one thousand ($1,000.00) dollars per month for the first two and one-half (2%) years and eleven hundred ($1,100.00) dollars per month for the second half of the five-year period, with privilege of an additional five (5) years at a rate to be agreed upon between ourselves later, and if we fail to come to an understanding the matter is to be adjusted by outside parties, as we may choose.

The building to be overhauled and refinished in conformity to the sketches which we have already gone over together and which are now in the hands of Mr. A. L. Loveless, architect, for refinements and adjustments.

The rent includes heat and water but not light.

The main lobby floor to be covered with marble and the córner space for the manager’s offices to.be floored with oak or some other hardwood suitable to you; balance of floor smooth cement finish for linoleum.

If your bank sustains any money loss caused by moving from your present location before the term of your present lease expires, we are to divide said loss with you on a fifty-fifty basis.

Trusting that this covers the main points in the understanding, we are,-

Sincerely yours,

The J. M. Colman Company.

L. J. Colman.

J. W. Maxwell acknowledged Mr. Colman’s letter as follows :

“ Deo. 11, 1917.

“ J. M. Colman Co.,

“ *Seattle.*

“(Attention Mr. L. J. Colman.)

“Dear Sir: We have yours of the 10th inst. confirming our verbal understanding of ,the lease for the ground floor of the Marion Building.

*238“ Your outline of same appears to be in line with my understanding, except we desire the privilege of other tenants occupying space with us, provided they are of a character that would maintain the standard of the bank and the building.”

IV. Pursuant to this arrangement the National City Bank entered into possession of the premises in question, consisting of the first floor of ,the Marion Building, on October 1, 1918, and installed therein certain bronze cages, painted the walls and ceiling, and installed wainscoting and marble-work. Such permanent improvements cost the plaintiff bank $33,413.99.

V. These permanent improvements were not required by the lessor, but were installed by the bank for the proper conduct of its business. There was no arrangement between the bank and the lessor whereby either or both was bound to make any improvements, temporary or permanent, for the benefit of the other. There was no deposit of money by the plaintiff to secure the payment of rent, and there was no consideration by the lessee for the privilege of occupying the premises other than the monthly rental therefor.

VI. The sum of $33,413.99, spent by the plaintiff bank in equipping and decorating the room of the Marion Building for bank purposes in the year 1918, was deducted by the bank from gross income for that year in computing its net income, subject to the provisions of the revenue act of 1918. Said, sum was deducted by plaintiff on the theoiy that same was an ordinary and necessary expense incurred by it in the year 1918, and plaintiff claimed it should be allowed as a deduction under section 234 (a) (1) of the revenue act of 1918.

VII. The Commissioner of Internal Revenue disallowed the said sum of $33,413.99 to be deducted as an expense as comprehended by section 234 (a) (1) of the revenue act of 1918, but held that said sum was a capital expenditure upon which the taxpayer was entitled to claim a deduction for exhaustion for each of the tax years to the end of the term of the lease. This decision and ruling was approved by the United States Board of Tax Appeals in a proceeding brought by the same plaintiff herein. (1 B. T. A. 139; Decision No. *23964, Docket No. 95, appeal of the National C,ity Bank of Seattle, Commerce Clearing House, vol. II, 1925, p. 2096.)

Article 109 of Eegulations 45, 1920 edition, as follows:

“Aet. 109. * * * The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected or of the improvements made, this deduction shall take the form of an allowance for depreciation.”

VIII. The lessor and the'plaintiff lessee both understood and intended that the plaintiff should have the use of the property for five (5) years in accordance with the terms of the lessor’s letter of December 10, 1917. The plaintiff did have the use of the property in accordance with that agreement for the full five-year period. At the end of said five-year period a new lease was entered into between the same parties for another five years, and said lessee is still in possession of the property and improvements. In the new lease it was provided that the improvement made and the fixtures put in by the lessee covered by the expenditure of the said $33,413.99 are all the property of the lessee, plaintiff herein.

The court decided that plaintiff was not entitled to recover.

1

 Certiorari denied.

Booth, *Judge,*

delivered the opinion of the court:

The plaintiff, the National City Bank of Seattle, Washington, in December, 1917, was compelled to seek a new location and quarters for its banking operations. A lease was negotiated between the plaintiff and the owners of the Marion Building in said city. The parties finally agreed upon a fixed rental and other details of the transaction, among which the plaintiff was to expend the sum necessary to make the quarters suitable for banking business, and to *240hold possession and occupancy of the premises for a period of five years. The plaintiff expended in equipping and decorating the rooms rented the sum of $33,413.99. In making its income-tax return for the year 1918, the plaintiff having gone into possession on October 1, 1918, this sum was deducted from the gross income of the bank as an expense under section 234 (a) (1) of the revenue act of 1918 (40 Stat. *1057).*The Commissioner of Internal Revenue declined to allow the deduction, holding that said sum was a capital expenditure, which entitled the plaintiff to a deduction for exhaustion for each of the tax years to the expiration of the lease. Plaintiff, displeased with this decision, appealed to the Board of Tax Appeals. The decision of the board affirmed the commissioner. Thereafter the full amount of the tax was paid, a claim for refund denied, and this suit brought to recover the same, judgment for $30,688.34, with interest, being asked. The amount of the tax imposed, if plaintiff’s contention is untenable, is not disputed, and the facts are not disputed.

Plaintiff presses in this court the identical contention advanced before the commissioner and the Board of Tax Appeals. Relief from the payment of the additional tax is predicated upon the statutes of the State of Washington prescribing express formalities as to the execution of leases covering the occupancy of real property for a term of years, plaintiff insisting that under local laws the legal status of the rental transaction brings about a month-to-month tenancy, and hence precludes the action of the commissioner. The Board of Tax Appeals in a written opinion (1 B. T. A. 139) discussed .the issue extensively. This court can add nothing to the discussion and finds itself in accord with what the board said.

We think the petition is without merit and should be dismissed. It is so ordered.

Moss, *Judge;-*Graham, *Judge;*and Campbell, *Chief*Justice, concur.

Hay, Judge, absent.