Kingsford Co. v. Commissioner , 41 T.C. 646 ( 1964 )

Kingsford Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Kingsford Co. v. Commissioner

Docket No. 88648

United States Tax Court

41 T.C. 646; 1964 U.S. Tax Ct. LEXIS 148;

February 24, 1964, Filed

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Decision will be entered under Rule 50.

1. Petitioner's predecessor sold a hydroelectric plant for a minimum sales price of $ 1,522,000, payable after a cash downpayment of $ 100,000, over a 12-year period at the rate of 3.75 mills per kilowatt hour of power generated by the plant, but subject to a yearly minimum of 31,600,000 kw.-hrs., or, stated in dollars, $ 118,500. The minimum purchase price was subjected to upward adjustments, depending upon the amount of electrical energy generated over the 12-year period. In specifying the minimum purchase price as $ 1,522,000, the contract stated "including both principal and interest on deferred payments." Held, from the circumstances underlying the sale, the $ 1,522,000 minimum purchase price constituted principal only.

2. Organization expenses of $ 8,625 were capitalized by petitioner's predecessor upon incorporation. Held, upon liquidation, petitioner's predecessor properly deducted these organization expenses on its final tax return.

3. Accounting expenses of $ 3,905.67 were incurred in the preparation of financial statements of petitioner's predecessor as of June 30, 1957. These statements were to be consolidated with financial statements of petitioner as of that date. Held, these accounting expenses were properly disallowed on the final tax return of petitioner's predecessor.

Joseph H. Fink, Manning K. Leiter, and Joseph P. Antonow, for the petitioner.

Julian R. Ettelson and Robert B. Pearce, for the respondent.

Fisher, Judge.

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FISHER

Respondent determined deficiencies in income taxes of the petitioner for the taxable years and in the amounts as follows:

Taxable year ended:		Amount
	Nov. 30, 1955	$ 29,201.02
	Nov. 30, 1956	10,971.52
	Dec. 1, 1956, to Sept. 30, 1957	17,732.00

The issues presented for our decision are:

(1) Whether any part of the "purchase price" paid by WisconsinMichigan Power Co. under a written purchase contract dated February 26, 1953, to Kingsford Chemical Co. for a hydroelectric plant represents income as interest on deferred payments.

(2) Whether (a) organization expenses of $ 8,625 capitalized by Kingsford Chemical Co. in 1951, and whether (b) accounting fees billed to Kingsford Co. in the amount of $ 3,905.67, were deductible by Kingsford Chemical Co. on its final income tax returns for the taxable period ended September 30, 1957.

FINDINGS OF FACT

The parties have entered into stipulations of fact with exhibits attached thereto which are, accordingly, incorporated in our findings by this reference.

Kingsford Co. (hereinafter sometimes referred to as petitioner) is an Illinois corporation with its principal office at Louisville, Ky. As of July 1, 1957, petitioner acquired all of the assets and assumed all of the liabilities of Kingsford Chemical Co. (hereinafter referred to as Kingsford, as distinguished from petitioner), a corporation then existing under the laws of the State of Delaware. After the transfer petitioner changed its name from Fox De Luxe Beer Sales, Inc., to Kingsford Co. The deficiencies in issue relate to taxable years of Kingsford and are determined by respondent against petitioner as successor to Kingsford. Returns of Kingsford for the periods here involved were filed with the district director of internal revenue, Detroit, Mich.

Kingsford was organized in December 1951. Its principal place of business was in the town of Kingsford, Mich., where it manufactured charcoal and derivative chemicals. After the transfer petitioner continued Kingsford's business and Kingsford was dissolved in November 1957.

During the taxable years in issue, Kingsford kept its books and prepared its income tax returns on an accrual method using a fiscal year ending November 30, except for its final returns which covered the period December 1, 1956, to September 30, 1957.

On September 30, 1951, a group of investors entered into a contract with Ford Motor Co. to purchase certain properties located at Kingsford, Mich., for $ 2,338,000. The properties included a dam and hydroelectric generating plant on the Menominee River, partly in Dickinson County, Mich., and partly in Florence County, Wis. A cash payment of 10 percent of the purchase price was made and the balance of the purchase price was paid prior to December 17, 1951, the date possession was acquired. The purchasing group included Arthur and William Grede of Milwaukee; Thomas Brittingham and Martin Fenton of Wilmington, Del.; and L. F. Flodin and Martin Thomas of Iron Mountain, Mich.

The investing group organized the Kingsford Chemical Co. on December 7, 1951. The Wilmington group, Brittingham and Fenton, owned 50 percent of the stock; the Iron Mountain group, Flodin and Thomas, owned 25 percent of the stock; and the Milwaukee group, the Grede brothers, owned the remaining 25 percent of the stock. All the properties acquired from Ford were transferred to the newly formed corporation, Kingsford. Funds were needed to complete the purchase. Kingsford unsuccessfully attempted to borrow $ 1,800,000 from the First Wisconsin National Bank of Milwaukee (hereinafter sometimes referred to as First Wisconsin) and ultimately borrowed this amount from the Wilmington Trust Co. secured by a first mortgage on the real property. This money was used to complete the acquisition of the properties from Ford.

The investing group had made attempts to dispose of the dam and hydroelectric plant as soon as the purchase agreement had been consummated with Ford. Negotiations had been commenced with WisconsinMichigan Power Co. (hereinafter sometimes referred to as Wisconsin) as early as October 1951. The cities of Escanaba and Iron Mountain were also contacted. The group was unable to negotiate a quick sale of these facilities and was therefore required to negotiate the loan from the Wilmington Trust Co. to finance the acquisition of these properties from Ford.

The investment group considered Wisconsin as the logical purchaser for the generating facilities because it was already serving the adjacent territory and appeared to be in need of an additional power source. Wisconsin was an electric utility company operating in the Fox River Valley and served the principal cities of Appleton and Neenah, Wis., and the Iron Mountain area of the Upper Peninsula of Michigan. It was and is a wholly owned subsidiary of Wisconsin Electric Power Co. which also operates in southeastern Wisconsin, including the Milwaukee metropolitan area.

On October 10, 1951, Arthur Grede conferred with several representatives of Wisconsin in regard to the possibility of the purchase of the hydroelectric plant. G. W. Van Derzee, then the president of Wisconsin, sent an offer for the purchase of the generating facilities to Arthur Grede on October 31, 1951. In this offer Wisconsin was to purchase the plant by making quarterly payments based on the plant's kilowatt-hour output over a period of 10 years from the date of transfer of title at the rate of 3.167 mills per kilowatt-hour, with a total minimum purchase price based on an average annual output of 31,600,000 kw.-hr. In dollars this amounted to a total minimum purchase price of approximately $ 1 million. This offer did not provide for payment of any interest on the purchase price. The proposed offer further provided that the purchaser operate the plant upon taking possession thereof and pay the operating and maintenance expenses as well as the taxes and make any necessary replacements.

On November 12, 1951, Wisconsin offered to increase the proposed purchase price by making a cash payment of $ 100,000 on transfer of title, and by extending the period over which kilowatt-hour payments would be made from 10 years to 12 years, with minimum payments still based on an average annual output of 31,600,000 kw.-hr. over the 12-year period. The new offer, in effect, increased the minimum purchase price to $ 1,300,800. It contained no provisions for the payment of any interest. This offer was rejected.

Kingsford then engaged Ebasco Services Incorporated, appraisers of public utility properties, to make an appraisal of the plant. Ebasco appraised the value of the plant as falling between $ 1,500,000 and $ 2,200,000. After reviewing this appraisal, Kingsford, in a letter written by Martin Fenton, the president of Kingsford dated March 26, 1952, offered to sell the plant to Wisconsin for $ 2 million cash. This offer was rejected by Wisconsin.

Negotiations between Kingsford and Wisconsin were reopened by a letter dated October 21, 1952, sent from Fenton, then the chairman of the board of Kingsford, to Van Derzee, stating, in part, as follows:

We have reviewed your offer of November 12, 1951 which was renewed on April 9, 1952. This offer was and is unsatisfactory to us based on the appraisals of the plant which have been made for us, and our experience with it. It appears, however, that these tentative terms could be made satisfactory to our company by the following changes:

(1) The exclusion of the three underground feeders from the hydro plant to our plant.

(2) An increase in the rate of payment per kilowatt-hour of output from 3.167 to 3.3 mills. As we calculate it, this would give us interest on our money on the unpaid balance of the purchase price.

On November 11, 1952, Fenton telephoned Van Derzee and told him that there had been a mistake in his letter and that the increase in the rate per kilowatt-hour of output should have been from 3.167 to 4 mills rather than from 3.167 to 3.3 mills. Fenton stated he was wrong in assuming that the increase to 3.3 mills would accomplish the purpose of giving Kingsford interest on the unpaid balance of the purchase price and that to accomplish this it was necessary to receive 4 mills per kilowatt-hour. Fenton confirmed this telephone conversation with Van Derzee by letter dated November 11, 1952, in which he advised that the figure of 3.3 mills in his prior letter should be corrected to 4 mills.

In response to Fenton's request for a rate of 4 mills per kilowatt-hour, Van Derzee sent a letter dated December 1, 1952, to Fenton stating, in part, as follows:

Our revised offer of November 12, 1951 contemplated a cash payment of $ 100,000 upon conveyance of the property, and a payment per kilowatt-hour of 3 1/6 mills, which based on the guaranteed average annual payment would produce revenues to you of $ 1,200,800 over a 12-year period, making a total payment of $ 1,300,800. Under our offer the aforegoing payments were the complete consideration. The total was not considered to be a principal payment on which interest on deferred balances was to be paid. You were at liberty to assume that whatever part you wished was principal and the balance interest.

In order to dispose of our differences, we were leaning toward making the concession involved in raising the rate from 3 1/6 mills per kilowatt-hour to 3.3 mills per kilowatt-hour, but it is not in the picture, as far as we are concerned, to make a payment on a 4 mill per kilowatt-hour basis, as this would lead to a total guaranteed minimum payment of $ 1,616,800.

In your letter of October 21 one of the conditions named is the exclusion of the three underground feeders from the hydro plant to your plant.

In contemplating further the use of power from the plant which you have for sale, it appears that we would need a connection between the said plant and the Quinnesec Falls plant of the company. The right of way over a considerable portion of the distance is apparently available over lands controlled by Kingsford Chemical Company. If your company is willing to provide for us a suitable right of way for a 69,000 volt or 13,800 volt line between the terminals indicated in so far as such right of way is available over property owned by you, we are willing to have you retain the three underground feeders from the hydro plant to your plant, and as a final proposal, will compromise the rate per kilowatt-hour in between our offer of 3 1/6 mills per kilowatt-hour and your proposal of 4 mills per kilowatt-hour, namely, at 3.5833 mills per kilowatt-hour, all other conditions of our offer remaining in effect and subject to incorporating our mutual understandings as to detail in a mutually satisfactory agreement conveying clear and sufficient title and operating rights to the property purchased.

Fenton was most anxious to sell the hydroelectric plant for $ 1,300,000 cash or under a contract which could be sold or discounted for $ 1,300,000 in order to reduce the $ 1,800,000 mortgage loan indebtedness to the Wilmington Trust Co. The loan had been renewed for an additional year pending the final disposition of the hydroelectric plant. Arthur Grede was determined not to agree to sell the plant under a contract which could not be discounted for $ 1,300,000 and so advised Arthur Sells, one of the directors of Wisconsin.

After Van Derzee advised Kingsford that Wisconsin would not be able to make one lump-sum payment but that it would spread the payments out over a period of years, a discussion resulted as to the effect this would have on Kingsford securing the cash which it needed. Fenton told Van Derzee that Kingsford was considering the possibility of discounting or selling the proposed contract in an attempt to realize an immediate cash amount. Thereafter, discussions were had as to the possible interest rate at which third parties might loan money on the contract or discount the contract. On several occasions representatives of Kingsford called Van Derzee in regard to the amount which would result after discounting the proposed purchase contract at various interest rates.

In December of 1952, Fenton requested Van Derzee to have prepared a form of a purchase agreement so that it might be exhibited to some of the parties interested in discounting the contract. The proposed agreement stated the purchase price consisted of a $ 100,000 cash payment to be made upon execution of the contract, plus monthly payments based on the plant's kilowatt-hour output over a period of 12 years at the rate of 3.5833 mills per kilowatt-hour, but not less than the total sum of $ 1,458,787, based, as before, on an average annual output of 31,600,000 kw.-hr. The draft stated that the minimum purchase price shall be "the sum of $ 1,458,787.00, including both principal and interest on deferred payments."

During the preparation of this draft Lawrence Seybold, then a Wisconsin vice president, recommended that the contract specify that each monthly payment constitute payment on principal, together with interest on the unpaid principal balance, at the rate of 3 1/2 percent. He feared that the approval of the Federal and State regulating authorities requisite to Wisconsin entering into the contract would not be obtained unless the contract contained a specific interest rate. He further stated that it would be in their interest to have even a higher interest rate if it could be supported. The first draft of the contract provided that interest was to be paid on the unpaid principal balance at the rate of 4 percent.

Van Derzee instructed that any reference to a specific rate of interest be deleted from all drafts. Thereafter Seybold no longer pushed for a specific interest rate being specified in the formal document. Accordingly, a specified interest rate was excluded from all forms of contract documents submitted to Kingsford. In discussions with Kingsford's representatives Van Derzee stated that it was immaterial to Wisconsin whether Kingsford regarded any part of the purchase price as interest. At a meeting held on February 4, 1953, between representatives of Kingsford and Wisconsin, Fenton was told that the phrase "including both principal and interest on deferred payments" was intended by Wisconsin to eliminate any possible liability for interest in addition to the stated purchase price.

At that same meeting of February 4, 1953, Arthur Grede and Fenton told Van Derzee, Seybold, and other representatives of Wisconsin that the Kingsford board had directed them to obtain $ 1,300,000 cash from the sale of the plant, and, consequently, Wisconsin's previous offer was still unsatisfactory. They said it was absolutely necessary for Kingsford to receive not less than $ 1,300,000 cash immediately upon the sale. Van Derzee thereafter wrote a letter dated February 11, 1953, to Fenton in which he stated:

Subsequent to our conference on February 4, 1953, we have given further consideration to the comments as made by you and Mr. Arthur Grede concerning the purchase price which we had suggested for your company's hydro plant. In the light of our subsequent discussions we have concluded that we would be willing to pay $ 1,522,000, including both principal and interest on deferred payments, provided other mutually satisfactory terms and conditions may be agreed upon between the parties.

Mr. Paulsen has redrafted the contract in an effort to incorporate the suggestions as made by you and Mr. Grede and I am enclosing herewith for your information three copies of his proposed drafts. * * *

On February 16, 1953, the Kingsford board of directors met and approved the acceptance of Wisconsin's offer of February 11, 1953. After the meeting, Fenton telephoned Van Derzee and accepted Wisconsin's offer on behalf of Kingsford.

On February 26, 1953, Kingsford and Wisconsin executed a contract for the sale of the plant by Kingsford to Wisconsin. The contract provided that the purchase price would consist of a $ 100,000 cash payment to be made upon the conveyance of the property, plus monthly payments based on the plant's kilowatt-hour output over a period of 12 years beginning March 1, 1953, at the rate of 3.75 mills per kilowatt-hour, with a total minimum purchase price of $ 1,522,000 based on an average annual output of 31,600,000 kw.-hr.

The contract stated, in part, as follows:

Seller agrees to sell and the Purchaser agrees to purchase the said hydroelectric plant and all appurtenances thereto, except as otherwise specified in paragraphs 7 and 8 hereof, for the sum of $ 1,522,000.00, including both principal and interest on deferred payments, provided, however, said purchase price shall, as hereinafter set forth, be subject to an upward adjustment depending upon the amount of generation of electrical energy by said plant during a period of twelve (12) years commencing at 12:01 A.M. on the first day of March, 1953, (hereinafter referred to as the "Initial Date").

2. The said purchase price shall be payable by the Purchaser as follows: One Hundred Thousand Dollars ($ 100,000.00) upon the delivery of possession of the premises, and the remainder thereof, as hereinafter provided, shall be paid in monthly installments during said period of twelve (12) years. On or before the fifteenth day of each calendar month after the date when the Purchaser shall enter into possession (hereinafter called the "Possession Date"), the Purchaser shall pay to the Seller a sum calculated at the rate of 3.75 mills per kilowatt-hour applied to the kilowatt-hour output of the plant as delivered during the preceding calendar month to the electric system of the Purchaser. The aforesaid kilowatt-hour output and the term "Kilowatt-hour output" as hereinafter used shall mean the kilowatt-hours actually generated in the plant less the energy used in operating the generating equipment and auxiliaries and station lighting. If at the end of the first twelve (12) month period after the Initial Date, or any such subsequent twelve (12) month period thereafter, the kilowatt-hour output of the plant does not equal 31,600,000 kilowatt-hours for such period, the Purchaser agrees that it will nevertheless, within thirty (30) days after the end of such period, pay to the Seller a sum equal to the difference between the amount actually paid and an amount calculated at the rate of 3.75 mills per kilowatt-hour for a minimum of 31,600,000 kilowatt-hours; provided further, however, that if at the end of any such period the kilowatt-hour output of the plant for such period was less than 31,600,000 kilowatt-hours and there has been such output for any preceding such period or periods, beginning not earlier than the Initial Date, exceeding 31,600,000 kilowatt-hours per twelve (12) month period, such excess may, until the exhaustion thereof, be used as a credit in respect of any deficit in output for any such twelve (12) month period, it being understood and agreed that at the end of the twelve (12) year period of the contract any payment for kilowatt-hours output for the entire twelve (12) year period in excess of the average of 31,600,000 kilowatt-hours per year at the rate of 3.75 mills per kilowatt-hour shall belong to the Seller, as part of the purchase price hereof. * * *

After receipt of the proposed purchase contract from Van Derzee, Arthur Grede outlined the contract provisions to Clarence Bickel, president of Robert W. Baird & Co., Inc., Milwaukee investment bankers. Bickel had computations made of the present value of the total contract payments at various interest rates of from 3 to 5 percent. Within a week or two, Ludlow North, a partner of Robert W. Baird & Co., Inc., arranged a meeting for Bickel and Grede with John Owen, a first vice president of First Wisconsin, who headed the commerical loan division.

Fenton had anticipated that a lender would discount the contract solely on the basis of Wisconsin's credit. He anticipated that the lender would take into consideration the credit of Wisconsin in determining what interest rate Kingsford would pay. Bickel attempted to negotiate a loan at an interest rate of 3 1/2 percent. Owen told Bickel that the bank would be interested in loaning Kingsford money secured by the purchase contract at an interest rate of 3 3/4 percent. Thereafter, Owen and North negotiated an interest rate of 3.6 percent. Once Owen expressed an interest in making the loan, no further contact was made with any other lending institutions.

In a letter dated March 25, 1953, addressed to the president of Kingsford, Owen indicated that the bank was willing to make a loan to Kingsford on or before November 1, 1953, upon its promissory note secured by the assignment of the Kingsford-Wisconsin contract for the sale of the hydroelectric plant. The letter stated that the loan was subject to the obtaining of the requisite approval of regulatory authorities and that the principal amount of the loan would not be determined until after the possession date November 1, 1953, because of the possibility that there would be a substantial offset due Wisconsin under certain provisions in the contract, thus reducing the total amount payable to Kingsford.

Throughout the negotiations between Kingsford and Wisconsin it was understood and expressly provided for in the formal contract that any agreement would be contingent upon approval of the State of Wisconsin, State of Michigan, and the Federal regulatory authorities. Approval of the classification of accounts by the State of Wisconsin and the State of Michigan Public Service Commissions and the Federal Power Commission, was a matter of great concern to Wisconsin. Wisconsin's experience had been that the Commissions of the States of Wisconsin and Michigan consistently recognized depreciated original cost to the party first devoting the facility to public service as the figure at which a purchase price could be taken into the rate-making base. Any amount paid in addition to the depreciated original cost would have to be charged as an acquisition adjustment to earned surplus. The plant was first devoted to public service on December 1, 1942, by Ford Hydro Electric Co., a subsidiary of the Ford Motor Co.

On April 7, 1953, Wisconsin filed an application with the State of Michigan Public Service Commission. Attached was a sworn statement of Edward Schmidtman, research engineer of Wisconsin and vice president of the parent Wisconsin Electric Power Co. It represented that the principal amount of such consideration was $ 1,253,280, including a downpayment of $ 100,000, and that the amount of the deferred interest payment was $ 268,720. Schmidtman stated therein that an interest rate of 3.6 percent was a reasonable rate in view of the fact that Kingsford was able to obtain a bank loan commitment at this rate by pledging as security its interest in the purchase contract. The statement showed Schmidtman had examined the records of the original construction costs of the plant made by Stone and Webster, Inc., and by Daniel W. Mead and Charles Seastone, consulting engineers who were involved in the original design and construction of the plant which was placed in operation in 1924. He further claimed he had examined cost records of acquisitions of lands and easements the firm of Mead and Seastone had prepared which revealed the original investment in the property covered by the purchase contract was $ 1,897,755.33. By the application of what he believed were reasonable rates of depreciation, Schmidtman determined that depreciated original cost would be $ 1,289,381.56, and that the amount of $ 1,253,280 was less than the depreciated original cost of such property.

On May 8, 1953, said Commission issued its order authorizing Wisconsin to issue the purchase contract dated February 26, 1953. The order reads, in part, as follows:

Assuming a rate of interest of 3.6% per annum on the unpaid portions of the purchase price, payable in monthly installments over a period of 12 years, it is estimated that the principal amount of such consideration is $ 1,253,280, including a down-payment of $ 100,000.00, and that the amount of the deferred interest payments is $ 268,720. * * * [Emphasis added.]

On March 30, 1953, Wisconsin filed three separate applications with the Public Service Commission for the State of Wisconsin. On July 7, 1953, said Commission issued a certificate of authority authorizing the issuance of the purchase contract providing for the payment of an indebtedness of $ 1,522,000 and calculated the present worth or principal to be $ 1,253,280. The certificate of authority did not find that Kingsford and Wisconsin bargained for any rate of interest, although it did state that the estimated rate of interest appeared "reasonable." This finding was based on the testimony that Kingsford had obtained a loan carrying interest at the rate of 3.6 percent for which the contract was pledged as security.

Pursuant to the terms of the purchase contract, possession of the hydroelectric plant was transferred to Wisconsin on November 1, 1953. Wisconsin made a cash payment of $ 100,000 to Kingsford by a check dated October 31, 1953.

Kingsford executed a promissory note dated March 1, 1953, in favor of First Wisconsin in the principal amount of $ 1,153,000. The note, by its terms, was secured by an assignment from Kingsford to First Wisconsin of Kingsford's right in the purchase contract dated February 26, 1953. The promissory note provided for payment in installments over a period of 12 years together with interest on the unpaid principal amount of the note at the rate of 3.6 percent per annum. It provided for a minimum annual payment including principal and interest of $ 118,500. The promissory note stated the interest was to run from December 3, 1953, at 3.6 percent.

Kingsford's interest in the purchase contract was assigned to First Wisconsin pursuant to an assignment executed December 3, 1953. On that date $ 1,153,000 was credited by the bank to Kingsford's account. Under the terms of the assignment, Wisconsin is to make its payments directly to First Wisconsin until the note is paid in full and any payments owed Kingsford by Wisconsin after Kingsford's indebtedness to the bank is discharged are to be made directly to Kingsford.

On its Federal income tax returns for the periods indicated below, Kingsford claimed the following deductions for interest expenses incurred in connection with the loan of $ 1,153,000 made by First Wisconsin to Kingsford:

Taxable year ended:	Amount
Nov. 30, 1954	$ 33,551.00
Nov. 30, 1955	33,068.25
Nov. 30, 1956	30,251.00
Dec. 1, 1956, to Sept. 30, 1957	16,342.96

On its return for the taxable year ended November 30, 1953, Kingsford reported the minimum sale price of the hydroelectric plant as $ 1,522,000 and elected to report gains from such sale on the installment basis. Respondent's position is that the following portions of the installment payments received from the sale of such plant during the periods indicated below constitute interest.

Taxable year ended:	Amount
Nov. 30, 1954	$ 68,887.91
Nov. 30, 1955	34,652.44
Nov. 30, 1956	31,785.46
Dec. 1, 1956, to Sept. 30, 1957	17,173.00

Petitioner maintains that the said minimum sale price does not include any amount of interest income.

Petitioner acquired all of the assets subject to the liabilities of Kingsford solely for voting stock of petitioner on July 1, 1957. On that date petitioner issued to Kingsford in exchange for all of the property of the latter corporation 13,100 shares of its convertible preferred stock, par value $ 80 per share having a noncumulative dividend rate of $ 6 per year, and 1,523,500 shares of its common stock, $ 1.25 par value.

Kingsford neither assumed any liabilities of petitioner nor acquired any property subject to a liability.

The stock acquired by Kingsford was subsequently distributed, pursuant to a plan of reorganization, to its shareholders in the course of its complete liquidation on the basis of one share of petitioner's preferred stock for each share of Kingsford's preferred, and 55 shares of petitioner's common stock for each share of Kingsford's common stock. Kingsford was dissolved in November 1957.

The principal purpose of the reorganization was to enable petitioner to acquire the assets and business of Kingsford in order to accomplish a diversification of petitioner's own business which had not been consistently profitable during the last decade.

Organization expenses of $ 8,625 were incurred by Kingsford in 1951 which had remained on the books of Kingsford as an asset until they were deducted by Kingsford on its final Federal income tax return covering the period December 1, 1956, through September 30, 1957. This deduction was disallowed by respondent alleging that the act of reorganizing was a merger of the two corporations and did not constitute a complete extinction of Kingsford.

The Federal income tax return for the period ending September 30, 1957, contains a statement in reference to item D, page 1, ¹ of the return as follows:

On July 1, 1957 all of the capital stock of these companies was transferred to Kingsford Company, in connection with the merger described elsewhere in the return.

On the balance sheet submitted with the return, there appeared the following statement:

Note: Transferred to Kingsford Company on July 1, 1957 in accordance with a plan of merger in exchange for 1,523,500 shares of common stock and 13,100 shares of preferred stock of that company. The stock so received was the only asset of Kingsford Chemical Company until it was distributed to the Kingsford Chemical Company stockholders in exchange for the capital stock of the Chemical Company.

These two statements are the only references to a merger. Also included with the return was a Statement of Reorganization setting forth the findings pertaining to the reorganization as found above.

Accounting expenses of $ 8,424.34 were deducted on the Federal income tax return of Kingsford for the period ended September 30, 1957. A statement dated January 8, 1958, was submitted by Price Waterhouse & Co. to petitioner for that amount. The bill read:

Fee for services rendered to date in connection with examination of
financial statements of the company and its subsidiaries as
at June 30, 1957 and reporting thereon under date of
September 16, 1957	$ 7,500.00
Out of pocket expenses	924.34
	8,424.34

The total expenditure was incurred in connection with the preparation of financial statements of petitioner and of Kingsford and subsidiaries as of June 30, 1957. A printed report of petitioner and subsidiaries as of June 30, 1957, was prepared for the stockholders. A statement showing the financial condition of Kingsford as of June 30, 1957, was necessary because of its inclusion in the financial report submitted to the stockholders of petitioner. The audit was requested and paid for by petitioner.

Respondent disallowed this deduction in full. Petitioner concedes that $ 4,518.67 was properly disallowed by respondent but claims that Kingsford properly deducted $ 3,905.67 for accounting expenses alleging that this is the amount allocable to the work done in the preparation of the Kingsford statements and that the services required for the preparation of the Kingsford statement did not differ materially from the services that would have been required for the preparation of a year-end audit as of November 30, 1957, had one been made.

OPINION

The first question for our consideration is whether the purchase price of the property was $ 1,522,000 as petitioner contends or was $ 1,253,280 as respondent contends with $ 268,720 representing interest on deferred payments. The question must turn upon what was the actual agreement of the parties. Was it an agreement for Wisconsin to pay Kingsford so much as purchase price and the balance as interest? This must be determined from all of the evidence, documentary and otherwise. The evidence as a whole is that the amount stated in the contract is all principal, not the aggregate of principal and interest.

The final purchase price agreed upon consisted of a $ 100,000 cash payment, plus monthly payments over the 12-year period at the rate of 3.75 mills per kilowatt-hour of plant output, but not less than the sum payable at this rate for an average annual output of 31,600,000 kw.-hr., or a total minimum purchase price of $ 1,522,000. The provisions for a $ 100,000 cash payment and for a minimum price based on an average of 31,600,000 kw.-hr. annual output multiplied by a specific rate per kilowatt-hour, first appeared in Wisconsin's offer of November 12, 1951. All further negotiations were limited to the question of how many mills Wisconsin would pay for each kilowatt-hour generated by the plant, except for Kingsford's counteroffer of March 26, 1952, to sell the plant for $ 2 million cash.

Wisconsin's offer of November 12, 1951, provided a kilowatt-hour rate of 3 1/6 mills, resulting in a total minimum price of $ 1,300,800. In letters dated October 21, 1952, and November 11, 1952, Fenton requested that the rate be raised to 3.3 mills, in the first letter, and then to 4 mills in the second letter. Fenton's letters stated that the increase would give them interest on the balance due of the purchase price. In a letter dated December 1, 1952, offering an increase in the kilowatt-hour rate to 3.5833 mills, giving a minimum purchase price of $ 1,458,787, Van Derzee stated this increase was a "modification upwards" from the previous offer, and also requested additional property be included in the sale.

When Fenton referred to "interest" he was contemplating the present worth of the future payments since Kingsford wanted to borrow an amount of not less than $ 1,300,000 by pledging the contract as security. Fenton was attempting to value the deferred payments on the purchase price in terms of present worth.

The last development in the negotiations over the purchase price occurred when Wisconsin raised the kilowatt-hour rate from 3.5833 mills to 3.75 mills, thereby increasing the minimum purchase price from $ 1,458,787 to $ 1,522,000.

The fact that Kingsford would have sold the plant for a cash price of $ 1,300,000 does not mean that the difference between that figure and the minimum purchase price of $ 1,522,000 represented interest. Often a seller will grant a reduction from a stated purchase price for immediate cash payment. The sale of property for cash is quite different from a sale upon a deferred payment plan and the fact that the deferred payment sales price is greater than the cash sale price does not make interest of the difference. Elliott Paint & Varnish Co., 44 B.T.A. 241">44 B.T.A. 241, 247 (1941); Anderson & Co., 6 B.T.A. 713">6 B.T.A. 713, 717 (1927).

We have refused to consider a portion of the purchase price as constituting interest where the agreement of the parties was for a price without interest. Clay B. Brown, 325 F.2d 313">325 F.2d 313 (C.A. 9, 1962), affirming 37 T.C. 461">37 T.C. 461, 488 (1961). See also Pretzer v. United States,     F. Supp.    , 1961 U.S. Dist. LEXIS 5527">1961 U.S. Dist. LEXIS 5527 (1961) (not reported). Where we have found interest it was because the agreement between the parties contemplated a payment in the nature of interest. Judson Mills, 11 T.C. 25">11 T.C. 25, 33 (1948), acq. 1 C.B. 2">1949-1 C.B. 2; Hudson-Duncan & Co., 36 B.T.A. 554">36 B.T.A. 554, 557 (1937), acq. 1 C.B. 5">1938-1 C.B. 5.

In Elliott Paint & Varnish Co., supra, the purchaser originally offered $ 27,500 in cash for a piece of property. The seller refused the offer preferring a deferred payment plan. The final purchase price of $ 40,000 was agreed upon after a computation had been made for the seller showing that $ 27,500 plus interest thereon at 5 percent per annum for 10 years would total $ 41,250. This or a similar computation was discussed by the parties in arriving at the purchase price of $ 40,000. The Court rejected the assertion that part of each payment constituted interest.

The discussions between Van Derzee and representatives of Kingsford about the interest rate a third party might charge for loaning money on the contract did not constitute an agreement, as asserted by respondent, whereby Wisconsin would pay interest to Kingsford at the rate Kingsford was charged by the third party lender.

Respondent claims that the fact that the payments due from Kingsford to First Wisconsin were identical with the payments due from Wisconsin to Kingsford was not a mere coincidence and in essence was the reason why the alleged interest rate charged by Kingsford to Wisconsin is necessarily the same as the interest rate charged by the bank to Kingsford. Respondent further contends that the execution of the contract and its being pledged with a bank were in effect simultaneous. We agree this is no mere coincidence. Kingsford all along intended to either discount the note or pledge it to secure a loan. All that was done was to take the payments that Wisconsin was to pay Kingsford and determine, at the agreed upon interest rate between Kingsford and the bank, what principal amount they would equal assuming a 12-year loan. It was merely working backwards; first, the payment was determined, then the interest rate agreed upon, and finally, working with the first two, the principal amount of the loan was reached. However, this in no way shows that Kingsford charged Wisconsin the same rate of interest or any other rate of interest.

In addition, Van Derzee told Kingsford in his letter of December 1, 1952, that Wisconsin would not pay interest in addition to the stated purchase price, and that if Kingsford felt entitled to interest payments it was "at liberty to assume that whatever part you wished was principal and the balance interest."

In Judson Mills and Hudson-Duncan & Co., both supra, a definitely ascertainable amount of interest could be computed from discussions or exchanges of documents during the negotiations where interest had been worked out and agreed to by the parties. No such document or agreement exists here.

A mere intent to pay some indefinite amount as interest must be disregarded, assuming it could be shown to exist, because interest must be susceptible of computation pursuant to the agreement of the parties. Kena, Inc., 44 B.T.A. 217">44 B.T.A. 217, 221 (1941). It follows, therefore, that the phrase in the contract "including both principal and interest on deferred payments" must either be construed as intending only to eliminate interest or it must be disregarded as being indefinite because the parties never agreed on how interest was to be computed.

Furthermore, if the true principal was $ 1,253,780 as claimed, the interest should stop after such principal amount is repaid even if this occurs several years before the 12-year contract term expires due to a high kilowatt-hour output. However, the contract under consideration allows no reduction from the minimum purchase price of $ 1,522,000 for an acceleration of payment. The contract also provided that upon any default by Wisconsin, the entire remaining balance of the minimum purchase price of $ 1,522,000 may be accelerated at the seller's option.

We are unable to find any probative warrant or rational basis for the respondent's assertion that the interest rate the bank charged Kingsford is the agreed upon rate of interest that Kingsford was to charge Wisconsin. We think it unequivocally appears from the circumstances underlying the parties' dealings that $ 1,522,000 constituted principal and nothing else.

The second issue involves the deductibility of organization expenses by Kingsford on its final tax return for the period ended September 30, 1957. In the notice of deficiency the sole ground asserted by respondent for the disallowance of the deduction is that "the merger of Kingsford Chemical Company with another company as of July 1, 1957, did not constitute a complete extinction of the company." It appears that respondent, in determining there was a merger, relies on the two footnotes in the tax return which refer to the transaction as merger.

In cases involving the deductibility of organization expenses a distinction has been made between instances where there has been an ordinary liquidation followed by a surrender of the corporate charter and dissolution and instances where there has been a statutory merger or consolidation. Malta Temple Association, 16 B.T.A. 409">16 B.T.A. 409 (1929); Pacific Coast Biscuit Co., 39">32 B.T.A. 39 (1935); Citizens Trust Co., 20 B.T.A. 392">20 B.T.A. 392 (1930). In the former a loss deduction has been allowed on the theory that when complete liquidation and dissolution occurred a capital asset acquired at the time of organization (the corporate franchise) was lost. In the latter no loss deduction has been allowed because the surviving or merged corporation continues to receive the benefit of the organization expenditures.

In order for there to be a statutory merger, the applicable State law dealing with corporate mergers must be adhered to. In the instant case, the record is completely void of showing any attempt to comply with the State law ² on corporate mergers.

The only evidence as to what transpired are the copies of the Statement on Reorganization and the Plan of Reorganization attached to the tax return. Paragraph 3 of the plan reads as follows:

3. As soon as practicable after Kingsford [Kingsford Chemical Co.] shall have acquired the stock of Fox [Kingsford Co., the present petitioner] as described in Paragraph 2 above, Kingsford shall distribute the Fox Stock so received. Such distribution shall be as of the record date established therefor by the Board of Directors of Kingsford. As soon as practicable after the completion of distribution provided for in this paragraph, Kingsford shall withdraw from all states in which it is qualified to do business and shall be formally dissolved.

It is our opinion that Kingsford liquidated and dissolved and that none of its corporate attributes, rights, privileges, powers, or franchises passed to or continued in petitioner. Only Kingsford's assets went to petitioner in exchange for stock of petitioner. We hold, therefore, that the organization expenses in controversy were a proper deduction on the final tax return of Kingsford. Pacific Coast Biscuit Co., supra.

The remaining issue for our decision is the deductibility of certain accounting expenses in the final taxable period of Kingsford. For the purpose of preparing a consolidated statement of petitioner and subsidiaries as of June 30, 1957, an audit of Kingsford's books and records was necessary. It is now claimed that expenses in the amount of $ 3,905.67 were incurred by Kingsford because of this audit, and are allowable deductions on Kingsford's final tax return.

It is petitioner's position that some of the services required for the preparation of the consolidated financial statements were similar to the services previously performed in the preparation of yearend audits of Kingsford. Petitioner further alleges that since the services are similar to those that would be required had Kingsford remained in existence and a yearend audit been made, the cost of the services actually performed should be deductible by Kingsford on its final return.

Respondent claims these services were performed at the request of petitioner, not at the request of Kingsford. The statement for these services was submitted to and paid for by petitioner. The examination and accounting services concerned the preparation of a financial report to the shareholders of petitioner and petitioner and its shareholders received the benefit of the accounting services.

Expenditures for accounting services are deductible when they are considered to be ordinary and necessary and result from the business of the one claiming the deduction. Cf. Alabama-Georgia Syrup Co., 36 T.C. 747">36 T.C. 747 (1961); Arc Realty Co., 34 T.C. 484">34 T.C. 484 (1960), affirmed in part and reversed in part without discussion of this point, 295 F. 2d 98 (C.A. 8, 1961); Charles Kay Bishop, 25 T.C. 969">25 T.C. 969 (1956).

In the present case there is no showing that these services were necessary to the business of Kingsford Chemical. It seems apparent that the accounting costs arose in furtherance of petitioner's business, not that of Kingsford Chemical. In any event, petitioner, bearing the burden of proof, has not established the contrary. The results of the audit were used in the preparation of petitioner's financial statement and petitioner received the benefits of the audit. Petitioner solicited the services and paid for them.

There has been no evidence from which the Court may conclude that Kingsford is entitled to the claimed accounting expense deduction. Accordingly, the respondent's determination as to this item must be sustained.

Decision will be entered under Rule 50.

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Footnotes

• 1. Question pertaining to ownership of 50 percent or more of voting stock of domestic corporations.↩

• 2. Ill. Ann. Stat. ch. 32, sec. 157.69a (Smith-Hurd 1954); Del. Code Ann. tit. 8, sec. 252↩.