Ticket Office Equipment Co. v. Commissioner , 20 T.C. 272 ( 1953 )

Ticket Office Equipment Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent

Ticket Office Equipment Co. v. Commissioner

Docket No. 31072

United States Tax Court

20 T.C. 272; 1953 U.S. Tax Ct. LEXIS 174;

April 30, 1953, Promulgated

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Decision will be entered under Rule 50.

1. Petitioner's equity invested capital held properly computed by respondent on failure of proof as to value of property paid in for stock.

2. Petitioner's deductions for compensation of officers, held reasonable, on facts.

3. Cost of welding machine held a capital expenditure and not deductible as an ordinary business expense.

4. (a) Insurance proceeds from partial destruction of a building by fire held taxable to extent not expended for replacement. (b) Insurance proceeds on contents of building destroyed in fire, totally exhausted to replace various destroyed items, not being allocable to any part of unreplaced inventory and other items, loss held not compensated for by insurance proceeds. (c) Amounts expended on temporary building repairs prior to replacement of building and on other non-capital and recurrent repairs held deductible as ordinary and necessary expenses.

5. Attorney and adjuster fees paid to negotiate insurance settlement held deductible as ordinary and necessary expense.

Richard W. Wilson, Esq., for the petitioner.

Arthur L. Nims, Esq., for the respondent.

Opper, Judge.

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OPPER

Respondent determined deficiencies in petitioner's income tax, declared value excess-profits tax, and excess profits tax liability as follows:

Year ending June 30	Tax	Deficiency
1943	Excess profits	$ 1,260.90
1944	Income	154.01
	Declared value excess-profits	80.09
	Excess profits	5,837.73
1945	Declared value excess-profits	4,500.16
	Excess profits	25,960.65
1946	Income	3,370.32
	Excess profits	847.18
1947	Income	1,264.12

Petitioner also claims certain overpayments. Some issues are no longer contested. The remaining questions are:

1. Whether respondent properly computed petitioner's excess profits tax credit for the years involved.

2. Whether respondent's disallowance of part of deductions taken for compensation of officers of petitioner in taxable years ended June 30 of 1944 and 1945 was justified.

3. Whether the cost of a new welding machine purchased in the taxable year ended June 30, 1946, constituted a nondeductible capital expenditure.

4. (a) Whether any part of insurance proceeds recovered for the contents of a building destroyed by fire constitutes ordinary income for the year ended June 30, 1947.

(b) Whether assets which were destroyed in the fire and not replaced are deductible as casualty losses not compensated for by insurance or otherwise for the year ended June 30, 1947.

(c) Whether petitioner realized a taxable gain on the receipt of insurance proceeds covering the building partially destroyed by fire, in the year ended June 30, 1947.

(d) Whether amounts of $ 5,702.93 and about $ 2,250 expended for repairs to the building before and after permanent reconstruction of fire damage are deductible as ordinary and necessary expenses or as a casualty loss not compensated for by insurance or otherwise, for the year ended June 30, 1947.

5. Whether adjuster and legal fees paid during the taxable year ended June 30, 1947, were properly allocated by respondent between capital and non-capital items of the insurance recovery, in computing petitioner's taxable income for that period.

6. Whether petitioner sustained a net operating loss for the taxable year ended June 30, 1947, entitling it to carry-back losses to the year ended June 30, 1945, for excess profits and declared value excess-profits tax purposes.

FINDINGS OF FACT.

Petitioner is a corporation organized in 1941 under the laws of the State of New York. Its principal office was located in Bronx County, New York, during all times material herein. It filed Federal income and excess profits tax returns on the accrual basis for fiscal years ended June 30, 1943, and June 30, 1944, in the fourteenth collection district of New York. Returns also using the accrual method for years ended June 30, 1945, through 1947, were filed in the third collection district of New York.

Petitioner is in the business of manufacturing ticket office equipment and other metal products. Prior to petitioner's incorporation its president, Harold Ruscher, operated two sole proprietorships under the names of Sunvent Metal Awning Company and Ticket Office Equipment Co. The business of Ticket Office Equipment Co. was the design and sale of railroad and bus ticket office equipment. A model of the Sunvent metal awning was built by Harold Ruscher in 1935. A patent application was made thereon in that year, and a patent was issued in 1939. The Sunvent awning had no commercial value to petitioner or its predecessors, and was never actually manufactured by petitioner. One or two of the awnings were transferred to certain individuals for use on their houses for test purposes. The awnings so tested were models, and the purchase price of $ 15 was eventually refunded on each of the models transferred.

Prior to petitioner's incorporation Harold Ruscher kept a single set of books and records for both of his enterprises, including one set of single-entry books of account to reflect cash receipts and disbursements. No effort was made to distinguish the transactions of one company from those of the other at the time the transactions were entered.

Respondent determined the value of the Sunvent patent at the time it was transferred to petitioner at $ 5,128.26.

The parties agree that the following property, transferred to petitioner on incorporation along with the Sunvent patent, should be valued as follows:

Machinery, tools, and equipment	$ 9,563.32
Patents, less amortization	57.91
Inventories	560.00
Total	$ 10,181.23

In exchange for this paid-in property, petitioner issued capital stock as follows:

Name	Shares (common)
Harold Ruscher	125
Dorothy M. Ruscher	125
Carl Reschenberg	12 1/2

The par value of petitioner's stock was $ 100 per share. Neither Ruscher individually nor petitioner reported any capital gain on any income tax return on the basis of this transaction.

Petitioner was required to compute its excess profits tax credit for the years in controversy by the invested capital method.

The fair market value of the Sunvent patent at the time it was paid in for stock in petitioner was not in excess of $ 5,128.26.

During the taxable years ended June 30, 1944, and 1945, petitioner's officers received the following compensation:

Name	Title	1944	1945
Harold Ruscher	President	$ 14,882.25	$ 14,618.25
Dorothy M. Ruscher	Secretary	9,788.25	12,690.25
Carl Reschenberg	Vice president	10,602.75	9,474.25
F. H. Newhardt	Vice president and treasurer	10,626.00	9,451.00

Petitioner's gross income for the year ending June 30, 1944, totaled $ 85,880.40. Its net income was $ 21,677.59. Dividends paid totaled $ 1,935. Petitioner's gross income for the year ended June 30, 1945, was $ 127,725.22. Its net income was $ 39,023.61. Dividends paid totaled $ 10,642.50.

Harold Ruscher was chief executive and general manager of the company. Carl Reschenberg was shop manager in charge of all sheet metal work. F. H. Newhardt was general sales manager and responsible for all matters pertaining to priorities and government regulations. All were employed on a full time basis. The services of Dorothy M. Ruscher, wife of petitioner's president, included special shopping assignments for tools and materials needed in the business which were difficult to obtain in the wartime conditions existing in 1944 and 1945. She made telephone calls from her home in efforts to obtain various merchandise, and helped her hubsand in preparing and verifying estimates and extensions, and in making up the payroll. She occasionally substituted as a secretary, and took customers to lunch. She spent less than half of the working days of both years at the office. She was a member of the board of directors and had a voice in all company policies. Her salary was fixed by the directors. Her previous business experience consisted of supervisory work with the New York Telephone Company, at the time when the dial system was being introduced in New York City. She had also assisted her husband in patent research and bookkeeping for the businesses which were petitioner's predecessors. Petitioner developed no patents while Dorothy Ruscher was an officer.

The salaries paid by petitioner for compensation of officers during the years in controversy were reasonable in these circumstances.

Petitioner purchased a Nelson stud welding machine from Atlantic Specialties Co. during the year ending June 30, 1946, for $ 762.55, in order to fill a special contract with the Electronics Division of General Electric Company. The job called for the welding of studs around an open hole for the mounting of a certain type of meter. Filling the contract took about 3 or 4 months. It was the only such contract ever obtained by petitioner, and the machine was purchased solely for the purpose of filling that contract. The welding machine thereafter became obsolete, and petitioner's efforts to sell the machine were fruitless. It was then stored in a garage owned by petitioner. No effort was made to dismantle it and sell its individual parts. No attempt was made to salvage the machine or to ascertain its salvage value. The machine was not abandoned in the year ended June 30, 1946.

In the fall of 1946 petitioner's building and its contents were partially destroyed by fire. Insurance coverage with the Merchants and Business Men's Insurance Company of Harrisburg, Pennsylvania, aggregated $ 20,000 on the building and $ 25,000 on its contents. Under the co-insurance clauses in these policies, petitioner collected proceeds of $ 16,290.44 on the building and $ 18,880.21 on its contents, including machinery, supplies, and inventory items.

The insurance policies covered the entire building and its contents. The insurance proceeds received represented only partial reimbursement for the actual losses sustained on the building and its contents. Petitioner expended $ 13,766.17 in the replacement of the building, consisting of payments of $ 10,763.86 to the Baltz Construction Company and $ 3,002.31 to Max Rosenberg, electrician. It expended $ 5,702.93 in removal of damaged properties and temporary protective enclosures and electrical work, preliminary to permanent reconstruction, consisting of payments of $ 4,862.93 to Baltz Construction Company and $ 840 to Max Rosenberg, electrician. During the same taxable year, ending June 30, 1947, petitioner also employed the Baltz Construction Company to repair certain cracks in the exterior walls of the building which were due to conditions existing in and around the building, and were of a temporary and recurring nature, and to repaint the surface, at a cost of $ 2,260.45. The total amount of these costs was paid by petitioner.

With respect to the insurance proceeds of $ 18,880.21 covering the contents of the building, petitioner established a replacement fund in accordance with the provisions of section 112 (f) of the Internal Revenue Code. Thereafter, petitioner expended that sum as follows:

Machinery	$ 9,906.93
Office equipment	2,256.72
Shop tools	1,111.86
Shop supplies	592.45
Office supplies and stationery	1,259.07
Replacement parts	2,038.14
Labor and supplies for salvage	1,791.13
Total	18,956.30

At the time of the fire in 1946 there were on petitioner's premises certain assets that had been acquired from Sunvent Metal Awning Company. These assets were completely destroyed in the fire. The Sunvent assets destroyed in the fire had a cost of $ 4,600 which had been reduced by depreciation at the time of the fire to $ 3,500. No part of the replacement fund was used to replace these assets.

Petitioner employed attorneys and adjusters in connection with the fire loss settlement. It paid fees totaling $ 3,517.06 in the taxable year ending June 30, 1947, on the basis of 10 per cent of the total recovery. No part of these fees was paid from the insurance proceeds.

OPINION.

The first issue depends upon the amount to be determined as petitioner's invested capital for excess profits tax purposes. The sole controversy involves the amount to be attributed to the so-called Sunvent patent. The record is silent as to any value attributable to it at the time petitioner was organized and indeed the indications are that it was worth considerably less than the figure allowed by respondent, if not entirely worthless. Since the patent was transferred to petitioner in exchange for the issuance of its stock, the value of the stock and hence of the patent would be determinable from the fair market value of the patent at that time, there being no other evidence of the value of the stock. Estate of Isadore L. Myers, 1 T. C. 100, 111.

The only other possibility would be the assumption that under Internal Revenue Code, section 113, petitioner would carry over the basis of its transferor. This would be permissible under section 113 (a) (8) only if petitioner's organization constituted a transaction in which gain or loss was nonrecognizable within section 112 (b) (5) or if the property was paid in as surplus. ¹ The former is impossible since Ruscher who was the transferor received less than half of petitioner's stock and hence under section 112 (h) was not "in control of the corporation" immediately after the exchange. Fahs v. Florida Machine & Foundry Co., (C. A. 5) 168 F. 2d 957; see Muskegon Motor Specialties Co., 45 B. T. A. 551, affd. (C. A. 6) 134 F. 2d 904, certiorari denied 320 U.S. 741. And the latter brings us back to the proposition that without valuing the patent above the figure determined by respondent, the total assets received were worth less than the par value of the total stock, ² and accordingly left no room for any contribution to surplus since there was no surplus. ³ We must accordingly conclude that whatever the transferor's basis may have been, petitioner has failed to show that respondent's determination on the first issue is erroneous.

The second and third questions are disposed of by our findings. On the second we have found as a fact that the salaries paid by petitioner during the years in controversy were reasonable under all the circumstances. It is of course impossible to measure precisely the value of services of corporate officers, especially where the sums involved are blanketed under one undivided disallowance. ⁴ But we think enough has been shown to carry petitioner's burden that in the light of all the facts the total salaries paid were not unreasonable. H. V. Greene Co., 5 B. T. A. 442.

We have also found as a fact that petitioner did not abandon prior to the end of the tax year a piece of machinery, the cost of which was claimed as a deduction in full. The property admittedly had a value at least for salvage and perhaps something in excess of that amount, ⁵ and for that reason its disposal was evidently postponed beyond the instant years. Respondent has permitted the deduction of depreciation and this in our view is the limit to which petitioner is entitled.

A group of issues arises by reason of damage and partial destruction to petitioner's plant by fire. As to the first assertion of error there seems now to be no disagreement between the parties, petitioner conceding that it is liable for a taxable gain on the insurance paid for the building in the amount of $ 2,524.27 represented by the difference between the insurance received by it and the cost of replacement of the property. And notwithstanding respondent's suggestions to the contrary this gain, as petitioner agrees, is wholly recognizable under section 112(f).

A second subissue involves amounts expended for cleaning up and removing debris, for temporary electrical installation, and other emergency activities to place the plant in temporary running order, undertaken by petitioner without regard to the repair and permanent replacement of its facilities. As to these items, we conclude that they were ordinary and necessary expenses and not capital items of a permanent nature. Illinois Merchants Trust Co., 4 B. T. A. 103; Brier Hill Collieries v. Commissioner, (C. A. 6) 50 F. 2d 777; cf. Hubinger v. Commissioner (C. A. 2), 36 F. 2d 724, certiorari denied 281 U.S. 741.

A third set of expenditures was disallowed as a deduction because respondent considered them to be capital items. We have found as a fact that they were of a temporary nature consisting as they did of painting, filling cracks, and the making good of similar recurrent damage, and they are accordingly deductible as ordinary and necessary business expense. Salo Auerbach, 2 B. T. A. 67, acq. IV-2 C. B. 1.

Respondent's proposed addition to income because the insurance collected for fire damage to the contents of the building was compensation for an inventory loss taken in the course of petitioner's customary inventory accounting lacks persuasiveness. Petitioner suffered a loss of personal property by fire covering a number of miscellaneous items including inventory. It is apparently conceded that although it received some insurance, the entire compensation so represented was expended in replacement of other damaged and destroyed articles. And no income was realized on the unreplaced inventory. Petitioner had a loss of property including inventory which was not compensated for because the insurance fund was inadequate to cover all of the damage. It is not essential that insurance be allocated in any specific manner to individual items destroyed. Massillon-Cleveland-Akron Sign Co., 15 T. C. 79. We conclude that petitioner suffered a total loss in the amount claimed by it which was in excess of the insurance received, hence was not compensated for by insurance or otherwise, and hence was wholly deductible, without regard to the insurance fund exhausted for other purposes.

Finally, an item claimed by petitioner as the cost of hiring attorneys and adjusters to collect its insurance claim has been disallowed as not an ordinary and necessary business expense. We disagree. The purpose of the expenditure was to collect a sum of money, and the requirement arose in the ordinary course of petitioner's business. The item involved was a claim for money damages; the dispute did not concern title to a capital asset nor an additional expenditure undertaken to improve or increase the value of any capital item then owned by petitioner. Alexander Sprunt & Son, Inc. v. Commissioner, (C. A. 4) 64 F. 2d 424, 428. Even in condemnation proceedings, comparable perhaps to a forced sale, expenses of successful defense are deductible as ordinary and necessary. L. B. Reakirt, 29 B. T. A. 1296, affirmed per curiam (C. A. 6) 84 F. 2d 996. Much stronger is a case like the present where the loss if it occurred would be due to a casualty ⁶ and have no resemblance to a sale, voluntary or otherwise. Nor, although the occurrence of a fire may be an extraordinary event, is the payment of such amounts other than ordinary when a fire has occurred. See Kornhauser v. United States, 276 U.S. 145. We regard the items in question as deductible in full as ordinary and necessary business expense.

Decision will be entered under Rule 50.

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Footnotes

• 1. Internal Revenue Code, sec. 113:

  (a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --

  * * * *

  (8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --

  (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) * * *, or

  (B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor * * *↩

• 2. ↩

  Assets Transferred:
  Machinery, tools, equipment	$ 9,563.32
  Patents, less amortization	57.91
  Inventories	560.00
  Sunvent patent	5,128.26
  		$ 15,309.49
  Stock Issued:
  262 1/2 shares at $ 100 par value per share		$ 26,250.00

• 3. "* * * Surplus has been well defined as follows in Edwards v. Douglas, 269 U.S. 204, 214 * * * Brandeis J.: '* * * The surplus account represents the net assets of a corporation in excess of all liabilities including its capital stock. This surplus may be "paid-in surplus," as where the stock is issued at a price above par * * *'." Randall v. Bailey, et al., (N. Y.) 43 N. E. 2d 43, 48-49↩.

• 4. For 1944 respondent determined that "salaries in the amount of $ 44,000.00 are allowable" in place of a claimed amount of $ 45,899.25. For 1945 he allowed $ 45,000 in place of $ 46,233.75.↩

• 5. Petitioner's president testified as follows:Q. Well, you didn't give this particular machine to the dealer?A. No.Q. Why didn't you do that?

  A. Well, for no reason at all, but there is a machine that has a lot more, something to it than just scrap. I don't know.↩

• 6. Section 112 (f) deals with the recognition of gain upon an involuntary conversion. It does not on the one hand provide for nonrecognition of losses, see H. R. 798, 82d Cong., 1st Sess., p. 2, nor on the other does it concern the type of deduction which may be involved. Accordingly, while such an involuntary conversion as a sale in condemnation proceedings might partake of the nature of a capital transaction and give rise to a capital gain, a casualty loss such as the destruction by fire present here gives rise to an ordinary loss deductible and recognizable in full. E. g., Harris Hardwood Co., 8 T. C. 874; Greenwood Packing Plant, 46 B. T. A. 430, reversed (other grounds) (C. A. 4) 131 F. 2d 787. It would be anomalous in the extreme if expenses paid to reduce the amount of such an ordinary loss were not themselves deductible in full, as partaking of the nature of the loss to which they relate. See Arrowsmith v. Commissioner, 344 U.S. 6; cf. H. C. Naylor, 17 T. C. 959, reversed (C. A. 5) 203 F. 2d 346↩.