American Hotels Corp. v. Commissioner , 46 B.T.A. 629 ( 1942 )

AMERICAN HOTELS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

American Hotels Corp. v. Commissioner

Docket No. 105555.

United States Board of Tax Appeals

46 B.T.A. 629; 1942 BTA LEXIS 839;

March 13, 1942, Promulgated

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The taxpayer on the accrual basis may not accrue within the year 1937 a sum that it is under no legal liability to pay simply because of the fact that within that year it made a compromise offer of settlement as a matter of good business policy, where the facts show that the settlement agreement was not entered into until 1938.

Anthony J. Vaughn (an officer), for the petitioner.

James C. Maddox, Esq., for the respondent.

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ARUNDELL

Deficiencies in income and excess profits taxes have been determined for the year 1937 in the respective amounts of $6,985.36 and $954.56. The right of petitioner to accrue as a deduction an item of $25,000 is the point in issue.

FINDINGS OF FACT.

The petitioner is a corporation organized under the laws of Delaware, with its principal office at 570 Lexington Avenue, New York, New York, and filed its return for the year 1937 with the collector for the third district of New York.

Petitioner is engaged in the business of supervising a large number of hotels, of which 13 or 14 were supervised during the year 1937 for the Metropolitan Life Insurance Co.

The Hotel Operating & Management Corporation (hereinafter referred to as the Management Corporation) is a wholly owned subsidiary of the petitioner. Under date of December 9, 1931, the Management Corporation entered into a lease agreement with the Metropolitan Life Insurance Co. (hereinafter referred to as the Metropolitan Life), which agreement was in effect up to and including February 28, 1937. The lease provided that the Management Corporation should operate the Carter Hotel of Cleveland, ohio, which was owned by the Metropolitan Life. The lease agreement further provided that the Management Corporation was to pay the Metropolitan Life the entire net earnings of the hotel, which term "entire net earnings" was defined by the agreement to mean the gross earnings less the expenses of operation, including a management fee. The management fee provided for was to be paid to petitioner in the amount of $20 per room per year in consideration of the supervision of the hotel by petitioner. Any deficit in the operation of the hotel was to be borne by the Metropolitan Life. Following the signatures of the parties there appeared on the lease agreement the guarantee of the petitioner which reads as follows: "The American Hotels Corporation hereby guarantees to the Metropolitan Life Insurance Company the performance of all of the terms and conditions of the above lease."

Upon the expiration of the term of the lease heretofore mentioned, a new lease was entered into between Metropolitan Life and the Management Corporation, which lease provided for a fixed rental to be paid Metropolitan Life and made provision for that company to share in the profits derived from the operation of the hotel. It was further provided in the second lease that no remuneration or fees for management supervision would be charged or paid other than reasonable salaries to the customary hotel executive staff.

During the years 1933 and 1934, F. B. Taylor, a manager of the Carter Hotel, misappropriated funds of the hotel to finance a liquor company. The funds of the hotel misappropriated amounted to $64,000, which, after certain recoveries from bonding companies and otherwise, was reduced to about $42,000. On March 30, 1934, Taylor executed a note payable to the Management Corporation in the sum of $8,000 and a statement acknowledging indebtedness to the Management Corporation on four items totaling $35,121.85.

Under date of December 9, 1937, theMetropolitan Life addressed a letter to the president of the petitioner in which reference was made to the deficit of some $42,000 in connection with the Hotel Carter, caused by the misappropriation of funds by Taylor, and in the letter inquired what the petitioner proposed to do to make good this shortage. The petitioner replied to this communication under date of December 17, 1937, and, after discussing the transaction, concluded as follows:

While we are not conceding any legal liability in this situation, but in order to get the whole matter out of the way, the Hotel Operating and Management Corporation is willing to pay the Metropolitan Life Insurance Company ten percent (10%) of the amount of $42,000 or $4,200 - the terms of payment to be arranged later on; this payment to close the matter up and to satisfy any possible claim which the Metropolitan Life Insurance Company might have against the Hotel Operating and Management Corporation.

Under date of January 28, 1938, the Metropolitan Life advised petitioner of its willingness to settle its claim in full by the payment to it by petitioner of $25,000 provided petitioner would secure for it the note of Taylor in the amount of $12,000. The letter requested that petitioner advise the Metropolitan Life of its approval of the terms suggested. Thereafter, a number of communications passed between the parties as to the exact manner in which the $25,000 would be liquidated and, under date of April 11, 1938, it was finally agreed that petitioner would pay to the Metropolitan Life $1,000 per month for 25 months. Thereafter, beginning in April 1938, it paid to Metropolitan Life $1,000 per month until the full sum was liquidated.

The petitioner never at any time admitted any legal or moral liability to the Metropolitan Life with respect to the so-called Carter claim. Its offer to settle the claim of Metropolitan Life was prompted by its desire to retain the good will of that company, from which it was receiving business approximating $50,000 per year.

Petitioner kept its books and rendered its Federal income tax returns on the accrual basis. Petitioner deducted on its 1937 Federal income tax return the sum of $25,000 representing the amount agreed upon in 1938 as in settlement of the claim of Metropolitan Life.

The petitioner denied all liability and no liability existed during the year 1937 with respect to the claim of the Metropolitan Life and the amount of the payments to be made in settlement of the claim was not determined until year 1938.

OPINION.

ARUNDELL: The petitioner insists that it was at no time either legally or morally liable to make good the shortage caused by the misappropriation of the funds of the Carter Hotel. It is clear that if it was so liable, that liability arose in 1933 and 1934, when the funds were embezzled. But petitioner asks that it be permitted to accrue in 1937 an amount it was under no liability to pay because near the close of the year it had determined that it was good policy to make some settlement with the Metropolitan Life in order to retain the good will of that company. Accrual of liabilities in order to be used as a basis for income tax deductions must have a more substantial basis. On petitioner's own statement of its case, no definite liability might arise until 1938, when the parties agreed upon the terms of settlement and, in the circumstances here present, no liability could arise, if at all, before that year. ; Trippensee ; ; .

The conclusion here reached makes unnecessary any discussion of the fact that the lease was one between Metropolitan Life and the Management Corporation and not one made directly with petitioner. It also appears in evidence that the Management Corporation held during the taxable year certain obligations of Taylor to cover the funds embezzled by him, which obligations he was currently, if slowly, liquidating. It is also worthy of comment that if petitioner's liability was that of a guarantor and thus a secondary liability there is no evidence that it could not have recovered from the Management Corporation a substantial part of the money it was paying to Metropolitan and there is at least some latent evidence in the record to support this observation.

Decision will be entered for the respondent.