Court Opinion

ID: 4604341
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:34:02.009606+00
Date Added: 2024-06-11T07:53:00.011321
License: Public Domain

105 WEST 55TH STREET, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.105 West 55th Street, Inc. v. CommissionerDocket No. 16301.United States Board of Tax Appeals15 B.T.A. 210; 1929 BTA LEXIS 2903; February 5, 1929, Promulgated *2903  A payment made by a corporation to one of its stockholders, who had brought suit to enforce his alleged right to subscribe for his proportion of the stock representing an increased capitalization, pursuant to a compromise agreement between its two stockholders, is not deductible by the corporation.  Archibald Douglas, Esq., Paul Armitage, Esq., and Charles E. F. McCann, Esq., for the petitioner.  Bruce A. Low, Esq., for the respondent.  SIEFKIN*210  This proceeding results from respondent's determination of a deficiency of $15,317.16 in petitioner's income and profits taxes for the calendar year 1920.  The entire deficiency is in controversy.  The sole error alleged is respondent's disallowance of a deduction of $40,480 claimed as legal expenses.  The amount was paid by petitioner to one of its stockholders pursuant to a settlement agreement *211  between stockholders of a suit instituted by such stockholder to enforce alleged rights to subscribe to shares of increased capital stock.  Petitioner now claims the payment represented maintenance expense incurred in the elimination of the necessity to defend in the suit brought.  FINDINGS*2904  OF FACT.  Petitioner is a corporation organized and existing under the laws of the State of New York, with principal place of business at 22 East 49th Street, New York City.  The corporation was organized in 1916 with an authorized capital stock of $60,000, consisting of 600 shares of a par value of $100 each.  All of the capital stock of the corporation was subscribed and paid for in cash by Harold C. Matthews and John H. Hearn, in equal proportions.  George J. Gillespie was attorney for both parties and for the corporation.  He, with his office associate, a Mr. McCarthy, held 10 shares each of Hearn's stock in order to qualify them as directors of the company.  Upon incorporation Hearn became president of the company and Matthews, secretary and treasurer.  Immediately after incorporation the company proceeded to erect a building at 105 West 55th Street (from which it took its name) and undertook the remodeling and reconstruction of a building at 100 Central Park, South.  The original paid-in capital was found insufficient to finance the projects undertaken and from time to time, as additional capital was required, funds were advanced by Matthews, such advances being treated*2905  as loans to the company.  In January, 1917, the capital stock of the company was increased by an amendment to the certificate of incorporation, by $60,000, or a total capitalization of $120,000.  The laws of the State of New York provide that when new stock is to be issued each stockholder has the right to subscribe to an amount of new stock equal in proportion to the stock already held by him, in order to permit each stockholder's voting power to remain in relatively equal proportion.  Matthews immediately subscribed to his pro rata interest in the new stock and paid for the same, thereupon becoming the holder of $60,000 par value capital stock.  Hearn either refused or neglected to exercise his subscription rights to the new stock.  In the meantime, the two building operations previously referred to had proceeded to completion and one of them, the 105 West 55th Street property, had been sold.  The stock of the company at this time had greatly increased in value.  At this point Hearn demanded that he be permitted to subscribe for his additional $30,000 worth of stock without any increase in price.  Matthews took the position that he was too late; that his rights to subscribe had*2906  expired; that the company did not *212  then need the money and that Hearn, by his refusal and neglect, had lost his right to subscribe.  This claim was a source of constant friction between Hearn and Matthews.  During the absence of Matthews in May, 1918, Hearn, president of the company, called a meeting of the board of directors, at which there were present Messrs. Gillespie, McCarthy, and Hearn, the three directors present being a majority, elected McCarthy president pro tem, and as such he issued the remaining 300 shares of the company's stock to Mr. Hearn.  Hearn, however, instead of paying the subscription price into the company's treasury, deposited $30,000 in payment therefore in a special fund over which he had sole control.  Upon Matthews' return and with knowledge of what had transpired in his absence, he immediately protested against the issuance of the additional shares of stock to Hearn and on July 9, 1918, after demanding its return and cancellation, commenced an action in the Supreme Court of New York to have the stock declared void.  A temporary injunction against the using or voting of the stock was applied for, which injunction, after appropriate hearing, *2907  was made permanent.  The order upon appeal by Hearn was duly affirmed by the Appellate Division in the fall of 1918.  The action came up for trial in June, 1919, before the Appellate Division.  In October, 1919, judgment was entered in favor of Matthews and against Hearn, canceling as spurious the stock issued to the latter.  In December, 1919, Hearn commenced a new action against Matthews and the corporation, giving his version of the facts and asking for a judgment directing that the corporation issue 300 shares of the stock to him on payment by him to the company of $30,000.  This action was never tried and, as a result of negotiations had between the parties, Hearn's claim as set forth in his action and all other matters in dispute between him and Matthews were settled in an agreement dated December 16, 1920.  Pursuant to this agreement the corporation paid to Hearn the sum of $40,480, which it deducted on its books and in the return filed for that year, as an expense.  This settlement agreement above referred to was entered into December 16, 1920, between Matthews and Hearn.  It recites the dispute between the parties regarding Hearn's right to subscribe, and that certain*2908  details of corporate management therein agreed upon were for the best interests of the corporation.  By its terms the parties agreed upon the offices to be held by them and their respective salaries.  A building property owned by the corporation was not to be sold prior to 1924 for less than a specified price.  The corporation was to engage in no new enterprises and was to be dissolved as soon after the selling of the property as was conveniently possible.  Provision *213  was made for meeting obligations, running expenses, and a reserve, the remaining surplus to be distributed as dividends.  Pending litigation instituted by Hearn (as set out above) was settled and adjusted by payment of $30,000 by Matthews to Hearn, or, at the latter's option, by the corporation transferring certain lots then under a contract of sale for $47,500 to Hearn, and to turn over the proceeds of such sale ($15,000 cash and a purchase money mortgage of $32,500).  If Hearn elected to take the lots Matthews agreed to loan Hearn a specified sum of money for a time stated.  Hearn was to execute a release in the litigation pending.  The stock over which the dispute arose was to remain treasury stock and nothing*2909  contained in the contract was to prejudice the rights of either party in any future issue of such stock.  By an instrument dated December 17, 1920, and attached to the contract Hearn acknowledged receipt of $40,480 from the petitioner corporation in full settlement of the disputed right to subscribe.  OPINION.  SIEFKIN: The contention that the payment by petitioner to one of its stockholders is an allowable deduction is not persuasive.  Had Hearn been permitted to purchase the stock he claimed he was entitled to buy, the purchase would have been a capital transaction resulting in neither gain nor loss to the corporation, irrespective of the price paid therefor.  ; ; ; . As was pointed out in the Simmons case, the only result so far as the corporation is concerned is a change in the capital structure.  If stock is sold for less than the value of the net total of corporate assets divided by the number of shares outstanding, the increase in capital*2910  is not proportionate to the increase of shares into which it is divisible, and the value of the stock outstanding prior to the sale is reduced.  Such reduction, however, affects only the owners of the stock.  It thus appears that Hearn's alleged right to purchase stock is of primary concern only to the stockholders among themselves.  That this is true is strikingly illustrated by the fact that the corporation was not a party to the settlement contract, as well as by the terms of the agreement.  Under the agreement Hearn might have elected to receive $30,000 from Matthews for his release.  Had he so elected, the corporation would obviously have had no deduction claim.  In that event it would only have been saved an increase of stock without a corresponding increase of capital.  Are the fundamentals altered by reason of Hearn's election to take payment from the corporation?  The contract provided such payment was to be made in the form of a transfer of certain properties which the corporation had contracted *214  to sell, or the proceeds consisting of $15,000 cash and a $32,500 purchase money mortgage.  Such cash and mortgage had a face value of $47,500.  Why the discrepancy*2911  between the amounts of $30,000 if settled by Matthews and $47,500 if settled by the corporation?  Manifestly the difference is due to the recognition by the parties of the fact that any payment made by the corporation would decrease the value of Hearn's stock and the payment of $30,000 by the corporation would not represent the same adjustment between the two stockholders.  As their stockholdings were in the ratio of 2 to 1, it would have required a half larger payment in cash, or $45,000, if made by the corporation to be the equivalent of the payment of $30,000 by Matthews to Hearn.  [The discrepancy between $45,000 and the amount stated in the contract, $47,500, may be accounted for by a discounting of the face value of the mortgage to reach actual values.  The discrepancy between the contract sum and the $40,500 actually paid is unexplained.] It thus appears clear that the parties recognized the true character of the dispute, i.e., it was a matter of primary concern only to themselves as stockholders.  The cases cited by petitioner are wide of the mark.  They for the most part relate to compromise payments of claims arising by reason of business relations of corporations with*2912  third parties.  In such cases the claims, if paid, would have been allowable deductions, and it follows that the compromise settlements in lieu of full payments were likewise deductible.  Whether legal expenses incurred by a corporation in resisting such a claim as the one made in the instant case would be deductible, we need not decide, as the settlement payment was a compromise of the claim and not legal expense, though the saving of legal expenses may have been an inducement to compromise.  The case of , which is cited by petitioner as the controlling case, is clearly distinguishable on the facts.  The claims compromised by the payment therein related to claims for services rendered and for heating, as well as a stockholder's suit for appointment of a receiver and an injunction.  Petitioner urges that controversies, other than the disputed right to purchase stock, were settled by the contract between the parties in the instant case.  That is true, but it does not follow that the settlement was in any sense inspired or influenced by such other controversies which, apparently, were of minor consequence. *2913  The acknowledgment of payment clearly indicates that at least Hearn considered it made in settlement of the principal point of difference between the stockholders.  Furthermore, there is no attempt to apportion the payment made among the several controversial matters if it related to more than one.  Accordingly, we are in no position *215  to alter the respondent's determination, which is based on his finding that it was a settlement of the alleged right to subscribe.  Whether the suit by a stockholder for a receiver and injunction, which was under consideration in the cited case, is in any wise similar to the action started by Hearn to establish his right to purchase stock, we need not now consider, as the Murray case does not decide a payment in settlement of the receiver suit was deductible.  It merely overrules a demurrer giving the complainant an opportunity to present his case on the merits.  Reviewed by the Board.  Judgment will be entered for the respondent.VAN FOSSAN concurs in the result only.