Court Opinion

ID: 4630471
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:07:32.98855+00
Date Added: 2024-06-11T07:57:33.334821
License: Public Domain

PANYARD MACHINE & MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Panyard Machine & Mfg. Co. v. CommissionerDocket No. 20341.United States Board of Tax Appeals17 B.T.A. 1053; 1929 BTA LEXIS 2195; October 24, 1929, Promulgated *2195  1.  Payment of $25,000 in addition to cost of inventory, less discounts, held to be made for the acquisition of capital assets and not deductible as an expense.  2.  Deduction of reserve for bad debts disallowed for failure of proof of worthlessness of accounts and reasonableness of amount of reserve claimed.  Albert W. Torbet, C.P.A., for the petitioner.  C. H. Curl, Esq., for the respondent.  VAN FOSSAN *1053  In this proceeding petitioner asks to be relieved of a deficiency of $3,371.33 in income taxes for the fiscal year ended November 30, 1923.  It alleges two errors: (a) disallowance of a bad debt reserve of $5,000, and (b) disallowance of a deduction of $25,000 claimed to represent a cash payment for cancellation of a contract.  FINDINGS OF FACT.  Petitioner is a corporation under the laws of Michigan engaged in the business of manufacturing patented piston rings.  Under date of December 31, 1920, Alfred A. Panyard, owner of the patent, entered into an exclusive sales contract for piston rings manufactured under said patent with James F. Kelly.  The term of this contract was ten years with right of renewal.  On June 21, 1921, said*2196  Alfred A. Panyard sold the exclusive right to manufacture piston rings under the patent, but subject to the sales contract with Kelly, to petitioner, Panyard Machine & Manufacturing Co., of which company Alfred A. Panyard was president.  On April 14, 1923, Panyard Piston Ring Sales Co., a partnership operating under the exclusive sales contract made with Kelly, and which company included Kelly and others, granted an option to petitioner to buy the business of the sales company under the following terms and conditions: The Panyard Piston Ring Sales Co., of Detroit, Michigan, hereby agrees to sell their business to the Panyard Machine & Mfg. Co., of Detroit, Michigan, under the following conditions: X.  In consideration of a payment of $100.00 which is hereby acknowledged by the Panyard Piston Ring Sales Co., the Panyard Mach. & Mfg. Co., is hereby granted an option on the Panyard Piston Ring Sales Co., under the following conditions: - 1.  The Panyard Mach. & Mfg. Co., agree to pay the Panyard Piston Ring Sales Co. in cash an amount equal to the net worth of the Panyard Piston Ring Sales Co., as shown by their books on the date this option is closed plus *1054  $25,000.00. *2197  This option to be closed not later than May 1st, 1923.  It is understood that the inventory is to be taken at the price of merchandise to us less our present rate of discount from the Panyard Mach. & Mfg Co.  2.  The Panyard Mach. & Mfg. Co., agree to assume all the outstanding liability that may exist under the sales agreements between the Panyard Piston Ring Sales Co. and their distributors.  3.  The Panyard Mach. & Mfg. Co., agree to take over the lease on the building at 3154 Cass Ave., which lease runs from the Potts Motor Co., to the Panyard Piston Ring Sales and which lease expires January 1st, 1925.  4.  The Panyard Mach. & Mfg. Co., agree to assume the advertising contract between the Chilton Automobile Directory and the Panyard Piston Ring Sales.  5.  In view of the efforts made by the Panyard Piston Ring Sales Co., in connection with the Oakland Motor Car Co., of Pontiac, Mich. the Panyard Mach. & Mfg. Co. agree to pay the Panyard Piston Ring Sales Co., any monies in excess of $2.40 per set of 12 rings on all rings ordered by the Oakland Motor Car Co., said payment to be made on the 15th of each month, for rings purchased during the preceding month, this agreement*2198  to be in force as long as the Oakland Motor Car Co. purchase rings under any agreement and terms consumated by the Panyard Piston Ring Sales Co., within a 90 day period from the date this option is closed.  6.  It is hereby expressly understood and agreed that Dr. J. F. Kelly and C. A. Allshouse of the Panyard Piston Ring Sales Co. will not engage in the Piston Ring business for a period of two years from the date of consumation of this sale.  7.  This option agreement is binding on the Heirs, executors administrators and assigns of the respective parties hereto.  By agreement dated May 2, 1923, the option was exercised and the business sold under the following terms and conditions: Agreement made and entered into this second day of May 1923, by and between the Panyard Piston Ring Sales Company, of Detroit, Michigan, parties of the first part, and the Panyard Machine & Manufacturing Company, party of the second part.  The Panyard Piston Ring Sales Company having this day sold their business to the Panyard Machine & Manufacturing Company, under terms and conditions as outlined in option agreement dated April 14th, 1923 agree as follows: 1st.  In view of the efforts made*2199  by the Panyard Piston Ring Sales Company in connection with the Oakland Motor Car Company at Pontiac, Michigan, the Panyard Machine & Manufacturing Company agree to pay the Panyard Piston Ring Sales Company any moneys in excess of two dollars and forty cent ($2.40) per set of twelve (12) rings on all rings ordered by the Oakland Motor Car Company.  Said payment to be made on the fifteenth of each and every month for rings purchased during the preceding month.  This agreement to be in force as long as the Oakland Motor Car Company purchase rings under any agreement and terms consummated by the Panyard Piston Ring Sales Company, as constituted on May 1st, within a ninety day period from this date.  If the Panyard Piston Ring Sales Company as constituted on May 1st, 1923 are unable to close with the Oakland Motor Car Company on the price quoted by the Panyard Piston Ring Sales Company, to the Oakland Motor Car Company of two dollars and ninety cents ($2.90) per set of twelve (12) rings, and it should become necessary to quote a lower price than two dollars and ninety cents ($2.90) a set of twelve (12) rings, a new agreement to cover the compensation that the Panyard Piston Ring Sales*2200  Company will receive on this business will be executed by *1055  J. F. Kelly of the Panyard Piston Ring Sales Company as constituted May 1st, 1923 and the Panyard Machine & Manufacturing Company.  2.  It is hereby expressly understood and agreed that J. F. Kelly, R. V. Kelly, E. B. Kelly and C. Allshouse of the Panyard Piston Ring Sales Company will not engage in the piston ring business for a period of two years from the date of this instrument.  This agreement is binding on the heirs, executors, administrators and assigns of the respective parties hereto.  On the same date, May 2, 1923, by endorsement on its face, John F. Kelly assigned the exclusive sales contract of December 31, 1920, to petitioner.  The individuals composing the sales company partnership had no financial interest in petitioner and petitioner's stockholders had no financial interest in the sales company.  In its tax return for 1923 petitioner claimed the sum of $25,000 as a deduction, making the following explanation: In explanation of the deductions - bonus paid $25,000.00.  The distribution of our product by Panyard Piston Ring Sales Company of Detroit, Michigan (a separate organization) who*2201  had had the exclusive sale Panyard Piston Rings for the United States, not being conducted in such a manner as we thought it should was taken over by us, we paying them $25,000.00 over and above their net worth.  The deduction was disallowed by respondent.  By the terms of the agreement when it purchased the business of the sales company the petitioner assumed all liability of the sales company toward its distributors.  Some of the accounts so assumed were uncollectible.  At November 30, 1923, petitioner set up a reserve of $5,000 to cover uncollectible accounts and deducted the same on its tax return.  The respondent disallowed the deduction.  No other deduction on account of bad debts was claimed.  OPINION.  VAN FOSSAN: Two questions are presented - first, the interpretation of the payment of $25,000 under the agreements of April 14, 1923, and May 2, 1923, and, second, the allowability of a deduction of a reserve for bad debts.  By interpretive reference to the contracts involved, it appears that petitioner acquired thereby all of the partnership assets, tangible and intangible.  For the tangibles it agreed to pay the inventory cost less discounts; for the intangibles it*2202  paid $25,000.  Petitioner's sole witness said the additional sum was a bonus "to get them out of the way." It appears to be more than that.  It was for the acquisition of whatever in addition to tangibles the partnership possessed.  Among these was the exclusive contract right originally granted to *1056  Kelly to sell petitioner's product.  That this right was an asset of permanent value to petitioner needs no demonstration.  Petitioner also acquired the business organization, sales contracts with distributors and users of the product, and such good will as was inherent in the business.  To protect this good will from encroachment a covenant was made forbidding the members of the partnership from engaging in the same business for a period of two years.  All of these acquisitions were of a capital nature.  It follows that the payment of $25,000 was not deductible as an expense in 1923.  The testimony in support of the reserve for bad accounts was vague and uncertain.  So far as figures appeared, they were the barest approximations and estimates.  There is no specific evidence of the efforts, if any were made, to collect or of the worth of the customers.  A careful study of*2203  the evidence fails to produce a conviction either as to the fact of worthlessness of the several accounts or of the reasonableness of the amount set up as a reserve.  A reserve for bad debts can not serve to screen the failure to determine the actual worthlessness of the debts or to establish with fair precision the correctness of the amount of the reserve.  Decision will be entered for the respondent.