Court Opinion

ID: 4623277
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:52:37.070937+00
Date Added: 2024-06-11T07:56:19.977088
License: Public Domain

W. W. WATTERSON ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.W. W. Watterson Asso. v. CommissionerDocket No. 8099.United States Board of Tax Appeals14 B.T.A. 370; 1928 BTA LEXIS 2979; November 20, 1928, Promulgated *2979  1.  Lease of a manufacturing plant which had never been operated commercially, and was a new venture, nothing being paid for the lease except an agreement to share in future profits if any were realized, held to have no value as invested capital.  2.  Options to buy capital stock of a corporation which was bankrupt and had never operated commercially held to have no value as invested capital.  P. S. Mathews, Esq., for the petitioner.  J. Arthur Adams, Esq., for the respondent.  MARQUETTE *370  This proceeding is for the redetermination of a deficiency in income taxes of $2,413.11 asserted by the respondent for the year 1917.  The petition assigns two errors: (1) The classification of petitioner and his associates as an association, and (2) the disallowance of the estimated value of the leasehold and option as invested capital.  The first specification of error was abandoned by the petitioner.  FINDINGS OF FACT.  Some years prior to 1915 the Natural Soda Products Co. was organized for the purpose of extracting crude soda from the waters of Owens Lake, lying in Inyo County, California.  After building and equipping its plant at an expense*2980  of nearly $200,000, the company found itself in debt, out of funds, involved in litigation, and unable to operate.  This was in the early part of 1915.  In May of that year the petitioner, who was a banker of Inyo County, agreed with the company substantially as follows: That the said party of the second part hereby agrees at his own cost and expense to make a test run of the Soda Plant of said party of the first part, situate at Keeler, California, for a period of not less than fifteen days, nor to exceed the period of forty days.  IN CONSIDERATION THEREOF, the party of the first part agrees that at the termination of said test run, the party of the second part, at his option, shall have the right to continue the operation of said plant for a period not to exceed three years upon the following terms and conditions, to-wit: FIRST: The party of the second part to have the right to make such expenditures for operation, repairs, improvements, additions or alterations of the plant *371  and to construct spur railway tracks as he may deem necessary or convenient - not to exceed the total sum of twenty thousand ($20,000.00) dollars.  The amount of such expenditures shall be considered*2981  a loan by the party of the second part to the party of the first part.  SECOND: From the profits, if any, arising from the operation of the plant, said party of the second part shall have the right - (1st) To reimburse himself for any loss or expense theretofore incurred in the operation of the plant; (2nd) To reimburse himself for any moneys theretofore laid out or expended by him for the purposes above mentioned; (3rd) If the profits arising from the operation of said plant during the period of its operation by the second party shall be more than sufficient for all of these purposes, then such surplus shall be applied to the payment of presently existing obligations of the party of the first part.  THIRD: If during the period of such operation, the party of the first part shall make a settlement of its pending litigations with the City of Los Angeles, IT IS AGREED that half of the net amount received by the party of the first part by virtue of such settlement shall be paid to the party of the second part, if such an amount be necessary, to reimburse him for the moneys theretofore expended or advanced by him under the terms hereof, and that the remainder of said net proceeds*2982  of such settlement shall be applied to the payment or reduction of the presently existing liabilities of the company.  IT IS EXPRESSLY UNDERSTOOD AND AGREED That if at the termination of the test run above provided for, party of the second part desires to proceed no further, then the party of the first part shall not be liable to the party of the second part for any losses or expenses incurred by him in said test run, but the said party of the second part shall have a right to all the products produced and the same shall be and become his property.  If, however, party of the second part shall decide to exercise the option hereby granted, he shall be entitled to reimburse himself for any loss or expense of this test run out of the profits of the operation of the plant thereafter.  The test was made, petitioner was convinced the plant could be profitably operated, and on December 23, 1915, the lease was executed.  The petitioner, on May 25, 1915, also took options to purchase 11,491 shares of the capital stock of the Soda Products Co. at a price of $2.50 per share.  The par value was $10 per share.  During the next year and one-half the petitioner secured further options on stock, *2983  bringing the total number of shares under option to him up to 14,001.  This was more than 50 per cent of the authorized capital stock of the Soda Company.  The optioned stock was placed in a voting trust, the trustees being named by the petitioner.  In order to finance the business, petitioner obtained from business associates an aggregate amount of $30,000.  This money was contributed upon certain terms and conditions, as follows: I hereby contribute and pay to W. W. Watterson, president of Inyo County Bank, Bishop, Inyo County, California, as trustee any treasurer of a to be formed corporation, the sum of $2,500.00 as part of a fund, not execeeding $100,000.00 to be used for our mutual benefit in acquiring shares of the Natural Soda Products Company, for acquiring outstanding notes and accounts against *372  said Company representing indebtedness, for paying assessments on shares of said Company's stock when owned by us or under option of sale to us, also for the purpose of advancing funds for the improvement of the plant of said Company and for the operation of said plant, and for such other purposes in connection thereto as may be deemed advisable by the majority of and*2984  for the mutual benefit of the contributors to this fund.  It is understood and agreed by all the parties contributing to said fund that out of the net profits arising from the use of these moneys there shall be returned to the contributors thereof, whthin five years, the sum or sums so contributed, with interest at the rate of seven per cent per annum cummulative.  It is further understood and agreed that after the repayment as above outlined, the interest of each in the remaining accumulative profits shall be in proportion to each one thousand dollars contributed as one is to one hundred and twenty-five, plus the units disposed of up to one hundred.  If at any time within the five year period during the existence of this arrangement, it shall be the desire of the majority interested herein to incorporate a company for the purpose of furthering the mutual interests of the parties hereto, I hereby agree to such incorporation and to accept certificates of stock representing my interests.  This agreement to be binding on the heirs, executors, administrators and assigns of all the signers and subscribers hereto.  Such additional working capital as was needed from time to time*2985  was furnished by the petitioner, through loans which he obtained as an individual.  Prior to May, 1915, when the petitioner leased this plant, the Soda Products Co. had produced nothing, except possibly some comparatively small, experimental amounts; but nothing had been done commercially.  Another company was located at Owens Lake, its plant adjoining that of the Soda Products Co.  This concern made a cured soda, but not a pure soda such as petitioner produced, suitable for the manufacture of soda and high-grade glass; there was no plant on the Pacific Coast then producing such pure soda.  As of December 31, 1917, petitioner sold to the Soda Products Co. the unexpired portion of its lease for $42,500.  The operation of the plant, under the lease, had produced net operating profits amounting, in 1916, to $26,139.53; and in 1917, $182,080.92.  The respondent classed petitioner and his associates as an association taxable as a corporation, and for the year 1917 allowed only $30,000 as invested capital.  Petitioner claims an additional allowance for invested capital, estimating the lease of the Soda Company's plant as worth $75,000 and the option to buy the capital stock as worth*2986  $50,000.  OPINION.  MARQUETTE: The sole question here involved is whether petitioner is entitled to include as invested capital any value of its lease of the manufacturing plant and of its option to purchase capital stock and, if so, what those values on December 23, 1915, were.  *373  Undoubtedly, a leasehold is property, and its value at the time it is acquired may be included in invested capital; and exhaustion of the leasehold is a proper deduction from gross income.  ; ; ; ; . What, then, was the value of the leasehold in question, on December 23, 1915? The petitioner placed that value at $75,000.  This, he admits, was a purely arbitrary figure, based upon his judgment and expectations for the future.  There was, as he says, nothing from the past upon which any calculations could be founded.  The Soda Company had produced nothing, in a commercial way; the petitioner had tested the plant*2987  for some time and had, perhaps, made some occasional sales of soda products.  His efforts, from May to December, 1915, had been devoted largely to putting the plant in better condition, getting railroad connections, raising working capital, and the like.  High hopes were entertained for a successful business, and in the years following those hopes were justified.  But in December, 1915, so far as the evidence discloses, they were expectations and nothing more.  The lease cost the petitioner nothing.  We can not find in the record anything tangible, anything in the way of business achievement from the plant upon which we can justify a valuation of $75,000 or any other sum for the leasehold at the time it was acquired.  The value of it then, in December, 1915, was purely speculative; and we must, therefore, sustain the respondent's determination on that point.  ; When . What has been said as to the value of the leasehold applies with like force and for the same reasons to the value of petitioner's option on the capital stock of the Soda Company.  It is true there was a plant and equipment which*2988  had cost about $200,000.  It is true that the tests made had been very satisfactory to the petitioner.  But it is also true that commercially, the whole project was as yet unproven.  Later years demonstrated that the proposition was a money-maker.  But in December, 1915, that had not been demonstrated.  If the project for soda products had not, in subsequent years, proved financially successful, what would have been the value of the plant?  The record is silent.  The equipment might, or might not have been sold as machinery for a good price; it might have brought only junk prices.  And the plant was the only asset which at that time gave any value to the stock.  The company was bankrupt.  We think, therefore, that the options to purchase stock were also purely speculative, as to value, in December, 1915.  Judgment will be entered for the respondent.