Davis v. Commissioner , 46 B.T.A. 663 ( 1942 )

MAX THOMAS DAVIS (ALSO KNOWN AS M. T. DAVIS) AND ALMA ARLENE DAVIS (HUSBAND AND WIFE), PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

THE M. T. DAVIS COMPANY, A CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Davis v. Commissioner

Docket Nos. 103725, 103726.

United States Board of Tax Appeals

46 B.T.A. 663; 1942 BTA LEXIS 835;

March 17, 1942, Promulgated

---

">*835 1. Held, that Max Thomas Davis was not entitled to a deduction of $2,000 for 1936 as a bad debt.

2. In 1937 the Government was claiming that Max Thomas Davis and the M. T. Davis Co. owed certain amounts of additional income taxes, penalties, and interest for certain prior years and Max Thomas Davis was indicted in connection therewith. As a part of an offer in compromise which was accepted, Davis and the corporation agreed to and did pay all the taxes, penalties, and interest, totaling $104,131.96, claimed by the Government to be due. Held, that of said amount the portion attributed to interest was interest within the meaning of the statute and petitioners are entitled to the deductions claimed therefor.

Harold K. Bell, Esq., for the petitioners.

W. W. Kerr, Esq., for the respondent.

---

TURNER

">*663 The respondent determined deficiencies in income and excess profits taxes as follows:

	Docket No.	Year	Income tax	Excess profits tax
		1936	$425.52
Max Thomas Davis	103725	1937	1,063.90
M. T. Davis Co	103726	1937	6,639.42	$760.38

The issues presented are (1) whether Max Thomas Davis was entitled">*836 to a deduction of $2,000 taken for 1936 as a bad debt, and (2) whether Max Thomas Davis and the M. T. Davis Co. were entitled to deductions of $9,066.63 and $24,437.15 in 1937 as interest on additional Federal income taxes for certain prior years.

">*664 FINDINGS OF FACT.

Max Thomas Davis is a resident of Cleveland, Ohio, and for the taxable years 1936 and 1937 filed joint income tax returns with his wife. The M. T. Davis Co. is an Ohio corporation, with its principal office and place of business in Cleveland. Both Davis and the corporation filed their income tax returns for the years here under consideration with the collector of internal revenue for the eighteenth district of Ohio.

The M. T. Davis Co. is engaged in the wholesale meat business and Davis is the president, general manager, and sole stockholder. The income tax returns of Davis for 1936 and 1937 were filed on the cash basis, while the corporation's return for 1937 was filed on the accrual basis.

On February 6, 1934, the bookkeeper of the M. T. Davis Co., at the direction of Davis, issued two checks for $2,000 each, drawn on the corporate bank account, to John E. Holmes. Holmes was manager of the Cleveland">*837 branch of Armour & Co. and the money was to be used in a stock venture with some of his associates at Armour & Co. When the transaction should be concluded Davis expected repayment of the $4,000 and one-half of the profits. The agreement between him and Holmes was not reduced to writing, however, and nothing was said between them about losses. Holmes had been an employee of Armour & Co. for a number of years and had come to Cleveland about 1932, at which time Davis became acquainted with him. The M. T. Davis Co. purchased 75 percent of its meat from Armour & Co. and all transactions were carried on by Davis directly with Holmes. The amount of the above mentioned checks was charged to the personal account of Davis on the books of the corporation. Explaining that only $2,000 was needed for the investment, Holmes a week or so later returned $2,000 of the $4,000 previously received. The check covering the $2,000 returned was deposited to the credit of the corporation and the personal account of Davis on the books of the corporation was credited with that amount.

Holmes continued with Armour & Co. in Cleveland until some time in 1935, when he was transferred to Tifton, Georgia, ">*838 as general manager of the Armour & Co. packing plant at that place. Holmes died from a heart attack in August 1936, having made only one trip to Cleveland following his transfer to Tifton. He was forty years of age at the time of his death. Davis never at any time asked Holmes to repay the $2,000 above described.

Under date of August 14, 1936, Holmes' widow addressed a letter to Davis and his wife informing them of the death of her husband and asking Davis if he would be kind enough to find out if anything was ">*665 collectible on some insurance policies which had been taken out by Holmes while in Cleveland. Shortly thereafter and under date of August 19, 1936, A. W. Loewenthal, attorney for Davis, wrote Mrs. Holmes a letter reading in part as follows:

Mr. M. T. Davis has retained me, free of any expense to you, to examine the policies of insurance that you spoke of in your letter to Mr. & Mrs. Davis, and also to see if the said insurance policies are in full force and effect so that they are collectible.

Therefore, please mail me the following information:

The number of each policy

The name of the insurance company

The amount of the policy

The date of its">*839 issuance

Upon receipt of that letter Mrs. Holmes, under date of August 21, 1936, wrote a second letter to Davis reading as follows:

I just received a letter from your attorney stating that you had asked him to investigate the value of these policies.

I am sending the policies direct to you, so that he will be sure to have all the information necessary.

John took out these policies in Cleveland and I know very little about them, how much has been paid on them or anything.

I do know however that with your business ability and strong friendship for John I can depend on you to do better than any one else could or would.

I know that John borrowed some money from you to invest with McKinley and Bruhn in some stock of some kind. I do not know what his part of the loss or profit was, but I want to straighten that up too.

Let me know how much he was indebteded to you on that deal and I will try to pay it as soon as possible.

I certainly appreciate your interest in this matter.

Shortly thereafter Davis or his attorney or both wrote Mrs. Holmes advising her that the insurance policies had been found to be of no worth, and, further, that $2,000 was owing from Holmes to">*840 Davis. No reply was ever received and at no time has any effort been made to collect $2,000 or any amount from Mrs. Holmes. Information obtained upon inquiry among Holmes' friends at Armour & Co. in Cleveland indicated to Davis that Holmes left no estate. Davis thereupon concluded that nothing would be recovered with respect to the $2,000, and prior to the end of the year instructed the bookkeeper to make proper entries on the book. The item was written off under date of December 31, 1936, and Davis claimed a deduction therefor in his 1936 income tax return, and the respondent, in determining the deficiency against him for that year, disallowed the deduction on the ground that it had not been substantiated.

Prior to or during January 1937, the Commissioner claimed that Davis for the years 1925 through 1928 and 1930 through 1934 and the corporation for the years 1924 through 1928, 1930, and 1932 through ">*666 1934 had understated and underpaid their Federal income taxes and charged violation of the law with respect thereto. On or about January 16, 1937, Davis submitted to the Commissioner through the collector at Cleveland an offer of $17,706.92 in compromise thereof and">*841 to secure his release from all civil and criminal liability for the years 1925 through 1934. At or about the same time the corporation submitted a similar offer of $14,505.38 to secure its release from all civil and criminal liability for the years 1924 through 1934.

Following the rejection of these offers, two indictments were returned against Davis in the United States District Court for the Northern District of Ohio on March 10, 1937. One indictment in five counts charged that he had attempted to evade and defeat his individual income taxes for the years 1930 through 1934. The other indictment in four counts charged that he had attempted to defeat and evade the income taxes of the corporation for the years 1930 and 1932 through 1934. Preliminary to the preparation and submission of a further offer in compromise, Charles I. Russo, who only recently had been retained by Davis as counsel, obtained from the United States District Attorney's office a statement of the claims of the Government with respect to the liability of Davis and the corporation for additional income taxes, penalties, and interest. In this statement the amounts of such claims for the respective years were">*842 shown as follows:

M. T. Davis Co.
Year	Additional income tax	Excess profits tax	Penalty	Interest	Total tax, penalty, and interest
1924	$1,626.68		$813.34	$2,192.05	$4,632.07
1925	4,549.68		2,274.84	5,585.01	12,409.53
1926	5,465.91		2,732.96	6,053.82	14,252.69
1927	3,446.50		1,723.25	3,403.62	8,573.37
1928	2,434.34		1,217.17	2,111.94	5,763.45
1930	2,702.22		1,369.06	1,695.80	5,767.08
1932	2,545.59		1,272.80	986.57	4,804.96
1933	4,112.50	$1,372.21	2,742.36	1,467.49	9,694.56
1934	4,472.43	1,633.63	3,188.03	940.85	10,504.94
Total	31,625.85	3,005.84	17,333.81	24,437.15	76,402.65
Max Thomas Davis
1925	$1,845.63		$922.82	$2,265.62	$5,034.07
1926	2,290.35		1,145.18	2,536.70	5,972.23
1927	159.56		79.78	157.58	396.92
1928	2,835.34		1,417.67	2,454.83	6,707.84
1930	1,034.91		517.46	649.47	2,201.84
1931	287.58		143.79	145.96	577.33
1932	476.56		338.57	184.7	999.83
1933	1,361.78		680.89	364.37	2,407.04
1934	2,083.21		1,041.60	307.40	3,432.21
Total	12,374.92		6,287.76	9,066.63	27,729.31

">*667 The above mentioned amounts were">*843 obtained by the district attorney from the office of the collector of internal revenue.

Using the amounts set forth above, and particularly those in the column with the heading "Total tax, penalty, and interest", Russo prepared and on April 23, 1937, Davis and the corporation submitted to the Commissioner of Internal Revenue and the Attorney General of the United States, through the collector of internal revenue at Cleveland, a joint amended offer in compromise of the $76,402.65 tax penalty and interest claimed to be due from the corporation and the $27,729.31 tax penalty and interest claimed to be due from Davis, or a total of $104,131.96. To secure their respective releases from all civil and criminal liability for the years involved, they offered to pay the sum of $104,131.96, payable $34,131.96 therewith and the remaining $70,000 within 30 days from the acceptance of the offer. On September 17, 1937, the offer was rejected by the Attorney General.

Thereafter Russo, using the same amounts as before, prepared and on October 29, 1937, Davis and the corporation submitted a joint supplemental amended offer in compromise. To secure their respective releases from all civil and">*844 criminal liability for the years involved, they offered to pay the sum of $104,131.96, payable $64,131.96 therewith and the remaining $40,000 within 90 days of the acceptance of the offer. In addition, Davis offered to plead guilty to count two of the indictment charging him with attempted evasions and defeat of his individual income taxes and to abide by the sentence of the court. With respect to this offer, Russo, under date of December 20, 1937, was advised by letter from the Attorney General as follows:

Reference is made to the offer in compromise submitted by the above-named taxpayers under date of October 29, 1937, entitled "Supplemental Amended Offer in Compromise." Under this offer taxpayers agree to pay the sum of $104,131.96 in settlement of all liability with respect to income taxes, penalties and interest of the corporation for the years 1924 to 1934, inclusive, and of the individual for the years 1925 to 1934, inclusive. Of this amount it is stated that $64,131.96 has been paid and that the remaining $40,000 will be paid within ninety days of the acceptance of the offer.

In addition to the payments mentioned, Mr. Davis agrees to plead guilty to the second count">*845 of indictment number 15780, charging him with wilful attempt to defeat and evade his individual income taxes and abide by the sentence of the court.

The offer was accepted by the Attorney General under date of December 16, 1937, subject to the following terms: when the full amount of the civil liability has been paid the taxpayer [Davis] shall enter his plea of guilty and a full and complete written statement of the case will then be made to the court; it is understood that no recommendation as to severity or leniency of punishment has been or will be made, and that there has been and will be no agreement for any recommendation. When final payment has been made and the ">*668 plea of guilty has been entered and the court has passed sentence, the United States Attorney will dismiss the remaining counts of both indictments.

The balance due should be forwarded to this office in the form of a certified check to the order of the Collector of Internal Revenue. The statement of the case to be made to the court will be prepared in this office.

Thereafter and prior to June 2, 1938, the corporation paid the remaining $40,000 pursuant to the terms of the supplemental amended">*846 offer submitted on October 29, 1937.

On June 2, 1938, Davis pleaded guilty as he had agreed. The statement prepared by the office of the Attorney General as mentioned in his letter of December 20, 1937, was submitted to the court by the district attorney and Davis was sentenced to a year and a day in a penitentiary and ordered to pay a fine of $500 and costs. The sentence was suspended and he was put on probation for a period of one year upon payment of the fine and costs. All other counts in the above mentioned indictments were thereupon dismissed.

The statement submitted by the district attorney to the court contained the following:

Under date of October 29, 1937, Mr. Davis submitted an offer in compromise to pay $104,131.96, representing the full amount of income taxes found to be due with 50 per cent penalties and interest for all years [1924 through 1934] involved. In addition, Mr. Davis agreed to plead guilty to count two of indictment No. 15780 and abide by the sentence of the court. Of the amount agreed to be paid, $47,006.61 represents taxes, $23,621.57 represents 50 per cent ad valorem penalties, and $33,503.78 represents interest on the taxes.

* * *

">*847 It is to be noted that the 50 per cent ad valorem penalty provided by Section 293(b) of the Revenue Acts of 1928, 1932 and 1934, has been held to be a civil penalty and constitutes an addition to the tax itself. (C.C.A. 4th); , (C.C.A. 3rd), certiorari denied, ; (C.C.A. 7th). See also (C.C.A. 7th), certiorari denied, .

The amount of the offer having been fully paid and the defendant having pleaded guilty to count two of indictment No. 15780, this statement is respectfully submitted to the court.

The amount set out in the statement represented the totals, respectively, of the additional taxes, penalties, and interest claimed by the Government to be due from Davis and the corporation as shown in the statement furnished by the district attorney to Russo prior to the submission of the amended offer in compromise on April 23, 1937. Throughout Russo's discussions with">*848 the office of the Attorney General that office took the position that under no circumstances would it consider anything less than payment of the full amount of the taxes, penalties, and interest claimed to be due and there was never any variance in the amounts of such items as shown in the statement furnished by the district attorney.

">*669 Of the $64,131.96 submitted with the compromise offer on October 29, 1937, $27,729.31 was paid by Davis as the taxes, penalty, and interest claimed to be due from him and $36,402.65 was paid by the corporation as taxes, penalty, and interest claimed to be due from it. The remainder of the taxes, penalty, and interest claimed to be due from the corporation, namely, $40,000, was accrued by the corporation on its books in 1937 and was paid by it in 1938, sometime prior to June 2. In his return for 1937, Davis took as a deduction for interest paid the amount of $9,066,63 representing the interest included in the payment made by him at the time of the submission of the compromise offer on October 29, 1937. In its return for 1937, the corporation likewise took a deduction for interest in the amount of $24,437.15 representing the interest accrued">*849 by it on its books in 1937 with respect to the claims of the Government for additional taxes, penalty, and interest due from it. In determining the deficiencies the respondent disallowed the interest deductions claimed.

OPINION.

TURNER: Davis contends that he is entitled to a deduction for 1936 of $2,000 as a debt due from Holmes to him, which debt he ascertained to be worthless and charged off in that year. The respondent claims that the payment to Holmes did not constitute a loan but represented money advanced to him for use in a stock venture in which Holmes and Davis were to share the profits and that the transaction was not a loan by Davis to Holmes. There is also some argument that on the evidence the advance was made not by Davis but by the M. T. Davis Co.

In our opinion, the evidence definitely shows that the money advanced, whether or not it was in the nature of a loan, was advanced by Davis and not by the corporation, and no extended discussion on that point is required. With respect to the character of the advance the record is not so clear. Davis in his testimony refers to it as a loan by him to Holmes and that characterization of the advance receives some">*850 support from the letter written by Mrs. Holmes to Davis under date of August 21, 1936. After carefully following the testimony of Davis while he was on the stand and later reviewing the transcript thereof and the exhibits introduced at the hearing, we are convinced that Holmes and Davis did not regard the advance as a loan at the time it was made and that the money was not repayable by Holmes in any event but only upon successful termination of the venture. The agreement between them was not reduced to writing and the matter of losses was not discussed. The record is silent as to whether or not Holmes personally was putting cash into ">*670 the venture and, if so, how much. The transaction with Holmes was summed up by Davis in the statement, "I wouldn't charge him any interest in view of the fact that he would give me half the profits of his dealings", and later, "I just gave him the $4,000 and the time that he was through with his dealings he would pay me the note. It wasn't a note. He would pay me the loan." The money was advanced in February 1934. It was not until some time in 1935 that Holmes was transferred to Tifton, Georgia, after which, according to the recollection">*851 of Davis, he made one trip back to Cleveland. At no time did Davis ask Holmes for a return of the money and he gives us no information as to whether prior to the receipt of the letter from Mrs. Holmes on August 21, 1936, he knew of the result or outcome of the stock venture, or, if so, when he obtained the information. In one part of his testimony he stated that at no time either while Holmes remained in Cleveland or after he moved to Tifton, Georgia, did he ever discuss with him the matter of the $2,000. At another place, in response to the question, "Did you keep track of that investment?", his answer was, "The bookkeeper does", and then in response to the question whether he made any inquiry as to whether the investment was producing income his answer was, "No."

It is true that Davis in the course of his testimony characterized the advance to Holmes as a loan and that Mrs. Davis in her letter of August 21, 1936, referred to the matter as a borrowing of money from Davis stating, "I do not know what his part of the loss or profit was, but I want to straighten that up too." This letter was written, however, after she had made an inquiry of Davis as to the value of certain insurance">*852 policies and had received a reply from Loewenthal advising her that he had been retained by Davis to look into the matter for her free of any expense. In our opinion, the references made to the matter by Mrs. Holmes in her letter are not conclusive of the character of the transaction between Davis and Holmes, and, considering the facts as revealed by the testimony of Davis, we think it not unlikely that Mrs. Holmes, knowing the money used in the venture or a part of it came from Davis, assumed it was received as a loan without really knowing the terms of the agreement between her husband and Davis, or whether Holmes in fact owed Davis anything. Davis' explanation of the transaction, his attitude toward Holmes, and his conduct with respect to the transaction are much more revealing and, regardless of the use in his testimony of the term "loan", indicate to us that there was no intention as between him and Holmes that the money should be repaid by Holmes in any event, but that its repayment was dependent upon the outcome of ">*671 the venture, in which case and at which time he should receive a return of his money and one-half of the profits. Davis testified that nothing was">*853 said about losses and that he understood he was not "to receive any losses." These statements, in our opinion, are of no particular moment. Most likely Davis and Holmes were like most people indulging in a speculative venture; they were too engrossed in the contemplation of hoped-for profits to consider the possibility of losses. The transaction was, in our opinion, not a loan by Davis to Holmes but the joining with Holmes in a speculative venture with the hope of profits. Considering the facts of record with respect to the origin of the transaction, its terms, the possibility of repayment, and the conduct of the parties with respect thereto up to the time of Holmes' death, we are convinced that the idea of classifying the transaction as a loan was in the nature of an afterthought suggested to Davis by Mrs. Holmes' letter of August 21. It is our opinion and we find that the relationship of debtor-creditor did not exist between Davis and Holmes, and, there being no debt, the first issue is determined for the respondent. Davis may have sustained a loss in some year on the transaction, but he is not claiming a loss deduction here, and even if he were the record does not contain evidence">*854 establishing the year in which the loss was sustained.

The sole question remaining is whether that portion of the compromise amounts agreed to and paid by Davis and the corporation for prior tax years attributable to interest on the tax for such prior years was interest within the meaning of section 23(b) of the Revenue Act of 1936 and therefore deductible by them. The petitioners contend that said amounts were claimed by the Government to be due from them as interest and were paid by them as interest and are therefore deductible as such, while the respondent rests his case on the contention that the amount agreed to and paid was a lump sum compromise of liability for income tax, penalty, and interest and in mitigation of criminal liability for evasion of income taxes and that no portion thereof was interest within the meaning of the statute.

A compromise is a contract. Although compromises are favored in the law, nevertheless a compromise contract is a proper subject for judicial consideration as to its meaning, validity, or consideration, in the light of the language used and in the light of the circumstances surrounding the making of it. ">*855 ; . As was said in : "The practical interpretation of an agreement by a party to it is always a consideration of great weight. The construction of a contract is as much a part of it as anything else. There ">*672 is no surer way to find out what the parties meant, than to see what they have done." Examining the compromise contract here involved in the light of the foregoing, we find that the petitioners in their last compromise offer recited that they had been charged with an attempt to evade and failure to meet income taxes, together with penalty and interest, for the years and in the amounts set out therein. The offer further recited that to secure their respective releases for said years "from all civil and criminal liability, resulting from the violation or failure for the years mentioned, the sum of $104,131.96 is hereby tendered voluntarily with the request that it be accepted in compromise of the said liabilities." The agreement further recited that Davis would">*856 enter a plea of guilty to count two of indictment No. 15780 and abide by the sentence of the court. In the Attorney General's acceptance of the offer, he stated: "Under this offer taxpayers agree to pay the sum of $104,131.96 in settlement of all liability with respect to income taxes, penalties and interest of the corporation for the years 1924 to 1934 inclusive, and of the individual for the years 1925 to 1934 inclusive." In the statement prepared by the Attorney General's office and submitted to the court by the district attorney after Davis had pleaded guilty, the $104,131.96 is described as "representing the full amount of income taxes found to be due with the 50 per cent penalties and interest for all years." The statement also contained the following: "Of the amount agreed to be paid, $47,006.61 represents taxes, $23,621.57 represents 50 per cent ad valorem penalties, and $33,503.78 represents interest on the taxes." In the light of the foregoing, we think it is apparent that the petitioners and the Attorney General regarded the payment of the $104,131.96 as constituting the payment of the taxes, penalties, and interest that were claimed by the Government to be due from">*857 the petitioners.

Our conclusion is that, regardless of any additional purpose served, payment of the $104,131.96 did represent and effect the payment of the income taxes, penalties, and interest claimed by the Government to be owing. The parties having so regarded the payment, we shall do likewise here. Accordingly we hold that the amounts of $9,066.63 and $24,437.15 included in the $104,131.96 represented interest on the taxes of Davis and the corporation, respectively, for the years there involved. Interest paid on Federal taxes is interest on a debt and is deductible from gross income in computing income taxes. ; affd., . On this issue the contention of the respondent is therefore rejected.

Decision will be entered under Rule 50.