Ernst Kern Co. v. Commissioner , 1 T.C. 249 ( 1942 )

The Ernst Kern Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Ernst Kern Co. v. Commissioner

Docket No. 104946

United States Tax Court

1 T.C. 249; 1942 U.S. Tax Ct. LEXIS 17;

December 15, 1942, Promulgated

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Decision will be entered under Rule 50.

1. During the taxable year, pursuant to a plan for the readjustment of the obligations of the petitioner and the Kern Realty Corporation, the petitioner acquired leasehold estates of the realty company in business premises occupied by the petitioner; the defaulted first mortgage leasehold bonds of the realty company were canceled; the petitioner issued to the holders of such bonds debentures and shares of its preferred and common stock; the petitioner's indebtedness of $ 80,000 to a bank was canceled; and the petitioner paid additional rent and interest on its debentures and dividends on its preferred stock for the period beginning with the time when the plan was by its terms to become effective and ending with the time when it was consummated. Held:

(a) There was not a statutory reorganization within clauses (C) and (D) of section 112 (g) (1), or a nontaxable transfer within section 112 (b) (5), Revenue Act of 1934.

(b) The petitioner, in computing its deductions for depreciation on the property acquired from the realty company, may not use as a basis the basis of such property in the hands of the realty company.

(c) The petitioner did not realize a gain of $ 536,578.66 when it issued its debentures and stock to the holders of the leasehold bonds, since it never assumed an obligation to pay the amount of principal and interest due on the leasehold bonds.

(d) The petitioner realized income to the extent of $ 80,000 from the cancelation of its indebtedness to the bank.

(e) The payments of additional rent and of interest on the debentures are deductible as rent and interest. Such payments and the dividends paid on the preferred stock were not part of the cost of the property acquired from the realty company, and they should be excluded from such cost in computing deductions for depreciation.

2. The petitioner purchased real property in the city of Detroit on May 1, 1937. Held, city taxes paid thereon, which, under the city charter, became a personal obligation of the petitioner's vendor on April 1, are not deductible by the petitioner; but Wayne County taxes which, under the state law, became both a lien and a personal liability subsequent to May 1, 1937, are deductible.

Thomas G. Long, Esq., and H. A. Mihills, C. P. A., for petitioner.

Philip M. Clark, Esq., for the respondent.

Tyson, Judge .

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TYSON

The respondent determined deficiencies of $ 88,295.51 in income tax and $ 30,735.24 in excess profits tax for the fiscal year ended January 31, 1936, and deficiencies of $ 3,775.36 and $ 2,255.31 in income tax for the fiscal years ended January 31, 1938, and January 31, 1939, respectively.

The issues presented, except the sixth mentioned below, arise from the consummation, in the fiscal year ended January 31, 1936, of a plan for the readjustment of obligations of the Kern Realty Corporation and the petitioner. They are as follows:

(1) Whether the petitioner realized a taxable gain of $ 536,578.66 from the transaction, or whether the transaction was tax-free under section 112 (b) of the Revenue Act of 1936.

(2) Whether, for the purpose of computing depreciation for the fiscal years ended January 31, 1936, 1938, and 1939, with respect to the property acquired in the transaction, the petitioner is entitled to use as a basis the adjusted basis of such property in the hands of its transferor or the cost of such property to the petitioner; and also whether the deduction for depreciation for the fiscal year ended January 31, 1936, should be allowed for 344/365 or 11/12 of that year.

(3) Whether petitioner realized taxable income in the amount of $ 80,000 from the cancelation of that much of its indebtedness to the First National Bank of Detroit.

(4) Whether the amount of $ 3,719.17 is deductible in the fiscal year ended January 31, 1936, as rent accrued for the period August 1, 1934, to January 31, 1935.

(5) Whether the amount of $ 14,663.86 is deductible in the fiscal year ended January 31, 1936, as interest accrued for the period August 1, 1934, to January 31, 1935.

(6) Whether the petitioner is entitled, in computing its net income for the fiscal year ended January 31, 1938, to deduct the amounts of $ 2,605.64 and $ 577.48, paid to the city of Detroit and Wayne County, respectively, as taxes on real estate purchased on May 1, 1937.

The petitioner assigns error in the disallowance of a deduction of $ 9,243.51 for wages paid to carpenters and painters for the fiscal year ended January 31, 1938. The deduction of that amount is conceded to be correct by the respondent.

Petitioner claims an overpayment of $ 375.80 as income tax for the fiscal year ended January 31, 1936.

Most of the facts are stipulated and the stipulation, with the exceptions hereinafter shown in our opinion, is hereby adopted as part of our findings of fact. The stipulation provided, inter alia, that the facts stated in the exhibits attached thereto are to be taken as true. In the following findings of fact we set forth those portions of the stipulation and its accompanying exhibits which are deemed necessary for consideration of the issues presented, together with our findings on the additional evidence introduced at the hearing.

FINDINGS OF FACT.

The petitioner is a corporation which was organized under the laws of the State of Michigan in 1923, and it has its principal office and place of business in Detroit. The petitioner has employed the accrual method of accounting in keeping its books and has regularly filed Federal income tax returns on the accrual basis. It filed returns for the fiscal years here involved with the collector for the district of Michigan.

The petitioner is, and for many years has been, engaged in the operation of a department store at the southeast corner of Woodward and Gratiot Avenues in Detroit. During the year 1934, and up to February 21, 1935, the petitioner's outstanding capital stock, consisting of 13,000 shares of common stock, was owned as follows: Ernst Kern, president, 4,999 shares; Otto Kern, vice president and general manager, 4,999 shares; Christopher Wagner, Jr., secretary, 2 shares; and Kern Realty Corporation, 3,000 shares. The Kern Realty Corporation, hereinafter referred to as the realty company, is a Michigan corporation, and throughout the period here involved it had outstanding 4,000 shares of common stock, all of which, except two shares owned by Christopher Wagner, Jr., were owned in equal proportions by Ernst and Otto Kern.

On October 26, 1925, the realty company executed and delivered to the Detroit Trust Co., as trustee, a trust mortgage dated September 15, 1925, to secure an issue of $ 2,000,000 of first mortgage leasehold bonds, bearing interest at the rate of 5 1/2 percent per annum, payable semiannually on the 15th day of March and September, and maturing serially, in stated amounts, on September 15 of each year from 1926 to 1940, inclusive. As security for the bonds, which are hereinafter referred to as "leasehold bonds," the realty company conveyed to the trustee leasehold estates in lots 40, 41, 42, and 43, and the west 30 feet of lot 79, all in section 7, Governor and Judges Plan of the City of Detroit, situated at Woodward and Gratiot Avenues. The leasehold estates ran for varying terms, all expiring in 1946 or subsequent years, and were acquired by the realty company in June 1923 by assignment from lessees of the owners of the fee.

Of the above mentioned lots, lots 40 and 41, the north 30.52 feet of lot 42, and the west 30 feet of lot 79, constituted a single parcel improved by a department store building. By the terms of the trust mortgage the realty company agreed to lease that parcel to the petitioner for a term of 15 years at a rental which at all times was to be equal to the ground rents and other charges payable on the underlying leases covering all the mortgaged parcels and the interest on the bonds and the amounts required to meet the serial maturities thereof. The rental from the lease to petitioner was assigned to the trustee as further security for the bonds. Pursuant to this provision of the trust mortgage, and on October 26, 1925, the realty company executed a lease to the petitioner of the above mentioned lots 40 and 41, the north 30.52 feet of lot 42, and the west 30 feet of lot 79. The lease, which is hereinafter referred to as the "store lease," was for a term beginning September 15, 1925, and expiring September 15, 1940. It provided for annual rentals ranging from $ 370,750 for the first year to $ 538,750 for the last year. Since the execution of the store lease, the petitioner has continuously occupied the building on the leased parcel and has conducted a department store business therein.

For a time not clearly disclosed by the record the petitioner produced substantially all of the income required by the realty company to meet its obligations to the holders of the leasehold bonds and to the fee owners and lessors of the parcel occupied by the store building, who are hereinafter referred to as the "landlords." Because of the economic conditions prevailing in October 1932, and the decline in the volume of the department store business and the falling off of collections, the petitioner and the realty company were in financial difficulties and were unable to meet their respective obligations. The petitioner had been unable to pay the full rental due to the realty company up to October 1, 1932, under the store lease. A committee representing the holders of the leasehold bonds, hereinafter referred to as the bondholders' committee, was claiming a deficiency in rental due to the realty company, but such deficiency was not admitted by the petitioner. The petitioner was indebted to the First National Bank of Detroit, hereinafter referred to as the "bank," in the amount of $ 372,000, on short term notes and the bank and other creditors were insisting upon payment. The petitioner was having difficulty in obtaining credit for immediate purchases. The realty company, in turn, was in default in the payment of the interest due on its leasehold bonds on March 15 and September 15, 1932, and in the payment of the serial maturity of $ 100,000 due on such bonds on September 15, 1932.

On December 15, 1932, for the purpose of effecting a temporary readjustment of the obligations of the petitioner and the realty company and thereby enabling the petitioner to continue in business until economic conditions should improve and a permanent plan of readjustment could be formulated, the petitioner, the realty company, the landlords, the bondholders' committee, and the bank entered into a so-called "standstill" agreement. The landlords and the bondholders' committee regarded participation of the bank in the standstill agreement and the plan and the spreading of payment of its claim over a long term as essential to the operation of the agreement and plan, and they insisted that the bank be brought in as a party.

The standstill agreement, which was to be operative for the period October 1, 1932, to February 28, 1935, or until the plan of readjustment became operative, provided, inter alia, that during that period the landlords should receive minimum annual rentals under their leases aggregating $ 120,062.50; that the bank should renew the notes of the petitioner and be paid interest thereon at 3 percent in lieu of 5 1/2 percent; and that the bondholders should be paid interest on their leasehold bonds at 1 1/2 percent; but, if the net earnings of the petitioner, after payment of such rentals and interest, exceeded $ 10,000 per year, the net earnings in excess of that amount were to be distributed, in stated proportions, in discharge of the balance of the rentals due the landlords under their leases and of the additional interest and part of the principal payments due, respectively, to the bank and to the bondholders. The store lease was modified by fixing the annual rental payable by the petitioner to the realty company at an amount equal to the total annual payments to be made by the petitioner on behalf of the realty company to the landlords and the bondholders, plus taxes and repairs, and during the term of the standstill agreement the petitioner was not required to pay any amount to the realty company on account of rentals and taxes due up to October 1, 1932, under the store lease.

Throughout the period January 1, 1934, to February 21, 1935, $ 1,545,000 out of the $ 2,000,000 of leasehold bonds originally issued by the realty company were outstanding. During the calendar years 1934 and 1935, $ 1,250,000 of other bonds of the realty company, secured by a trust mortgage on real estate owned in fee by the realty company, were outstanding, but it is stipulated that no issue with regard thereto is presented in this proceeding.

On September 19, 1934, the bondholders' committee presented a plan for the readjustment of the leasehold bonds of the realty company and of the lease and other obligations of the petitioner. After due consideration of the plan the Michigan Public Trust Commission, on October 4, 1934, directed that the plan be accepted. The bondholders' committee, prior to presenting the plan, sought to induce the bank, which was then in the hands of a receiver, to accept preferred stock of the petitioner for part of its claim, but the receiver insisted upon receiving a note maturing prior to the maturity of the debentures that were issued to the bondholders. The plan, hereinafter referred to as the "plan of readjustment," contained, among others, the following provisions:

The leases involved [leases from the landlords to the realty company] will be assigned to and the Store Company will assume the obligations of the Realty Company thereunder, provided rental payments for the premises now occupied by the Store are reduced, the several leases are modified as hereinafter specified, and the Plan becomes operative. All obligations between the Store Company and the Realty Company, including lease obligations, will be cancelled. [Parenthesis supplied.]

The obligations of the Realty Company with respect to its leasehold bonds will be cancelled and in lieu thereof the Store Company will issue the following securities pro rata to the holders of the leasehold bonds:

1. $ 154,500 principal amount of ten year debentures bearing interest at the rate of 5% per annum; appropriate provision for amortization of this issue at or prior to its maturity and subsequent to the payment of the bank indebtedness shall be made;

2. $ 772,500 of preferred stock bearing dividends at the rate of 6% per annum -- 2 1/2% of such dividends to be cumulative from the date of the original issue, whether earned or not, and 3 1/2% of such dividends to be non-cumulative, provided, however, that no dividends will be paid in any year on the common stock of the Company until the full dividend at the rate of 6% per annum on this preferred stock for that year shall have been paid;

3. 3,090 shares of common stock of the Store Company out of a total authorized issue of 20,000 shares, of which 18,090 shares shall be issued and outstanding upon the completion of the readjustment.

As stated, there are outstanding leasehold bonds in the principal amount of $ 1,545,000. Upon the exchange contemplated by this subdivision, the holder of a leasehold bond of the principal sum of $ 1,000 will receive therefor one (1) debenture of the face value of $ 100.00, ten (10) shares of preferred stock of the par value of $ 50.00 per share, and two (2) shares of common stock of the Store.

The leases for the premises now occupied by the Store Company * * * will be readjusted * * * and assigned to and become the obligations of the Store Company. * * * Such leases as readjusted will require that the Store Company shall pay a minimum annual rent from and after August 1, 1934 in an aggregate amount not in excess of $ 150,479.48 * * *. In addition to such minimum annual rent the landlords shall receive 2 1/4% of gross annual sales of the Store Company in excess of $ 6,500,000 * * *. The readjustment of lease rentals as above stated shall be effective for a period of ten years only from and after August 1, 1934, upon the termination of which period each of the leases involved shall revert to the terms of the original lease as then effective. * * *

The bank indebtedness of the Store Company in the amount of approximately $ 392,500, including interest to August 1, 1934, shall be reduced by application of offsets, amounts realized on collateral pledged by Ernst and Otto Kern, and by direct waiver and cancellation on the part of the Bank of $ 80,000.00, to approximately $ 230,000.00 to be evidenced by a six year note of the Store Company bearing interest at the rate of 5% per annum and to be payable in five equal annual installments * * *.

The Bank shall release to Messrs. Ernst and Otto Kern all shares of common stock of the Store Company now held as collateral for store obligations.

The lease from the Realty Company to the Store Company and all obligations in connection therewith shall be cancelled. The Realty Company shall be released from all underlying leases covering premises occupied by the store in its operations, and such leases shall be assigned to and assumed by the Store Company, subject to the specified terms of the Plan as herein set forth.

The Realty Company will transfer to the Store Company 3,000 shares of common stock of the Store Company now held by it to be held as treasury shares.

All inter-company credits and debits will be cancelled.

* * * The preferred stockholders voting as a class shall be entitled to elect one director. * * * The majority of the Board of Directors shall at all times be elected by the vote of the common stock.

No dividends shall be paid on the preferred or common stock unless earned. * * *

The Plan shall be binding and become operative when it shall have been consented to by all the landlords interested, the Bank, the Store Company, the Realty Company, and shall have been consented to by the holders of leasehold bonds in such amount as in the opinion of the interested parties may be necessary to make the Plan workable * * *. Upon the Plan being declared operative, the effective date of readjustments thereunder shall be as of August 1st, 1934.

The plan was consummated and became operative on February 21, 1935, and, pursuant thereto, readjustments, effective as of August 1, 1934, were consummated on February 21, 1935, as stated in the following paragraphs (a) to (i).

(a) The realty company assigned to the petitioner its entire interest, as lessee, in lots 40 and 41, the north 30.52 feet of lot 42, and the west half of lot 79, being the parcels which it had leased to the petitioner by the store lease, and its interest in the south 31.52 feet of lot 42, and the north 9 feet of lot 43, covering the leasehold estate which it had conveyed by the trust mortgage as security for the leasehold bonds.

(b) The original lessors of the lots mentioned in paragraph (a) or their successors in title, hereinafter referred to as the "landlords," entered into a "Rent Agreement" with the petitioner and the realty company, dated February 21, 1935, by the terms of which the landlords consented to the assignment of the leasehold estates owned by the realty company to the petitioner, releasing the realty company from all liabilities thereunder, and the petitioner assumed all liabilities under these leases, subject to such modifications of the leases as were provided for in the "Rent Agreement." The landlords further agreed that the leases should be so modified that, for the 10-year period August 1, 1934, to August 1, 1944, the petitioner should pay to them, in lieu of the aggregate annual rentals of $ 203,100 reserved in the original leases, a minimum aggregate rental of $ 150,384.58, plus 2 1/4 percent of the gross sales of the petitioner in excess of $ 6,500,000. This agreement was to be binding upon the parties only if and when the plan of readjustment should be adopted, and only if and when executed by all the parties thereto.

(c) The store lease was canceled, and the realty company and the petitioner, as parties thereto, were each released from all of their past or future liabilities or obligations thereunder.

(d) The leasehold bonds were canceled, and in lieu thereof the petitioner issued its securities pro rata to the holders of the $ 1,545,000 outstanding bonds, as follows: (1) $ 154,500 principal amount of 10-year 5 percent debentures, dated August 1, 1934, due August 1, 1944; (2) $ 772,500 par value of 6 percent preferred stock, dividends cumulative as to 2 1/2 percent and noncumulative as to 3 1/2 percent; and (3) 3,090 shares of common stock, out of 18,090 shares to be issued and outstanding upon completion of the adjustment.

(e) The realty company transferred to the petitioner its 3,000 shares of common stock of the petitioner, and all indebtedness of the petitioner and the realty company to each other was canceled.

(f) The indebtedness of the petitioner to the bank, which with interest to August 1, 1934, amounted to approximately $ 392,500, was reduced to the amount of $ 202,789.31 by applying against it certain offsets and the proceeds realized from the sale of collateral which had been pledged by Ernst and Otto Kern as security for the indebtedness, and by a direct waiver and cancelation on the part of the bank of $ 80,000 of the indebtedness, and the petitioner gave its note to the bank for the said amount of $ 202,789.31.

(g) An indebtedness of Otto Kern to the petitioner was liquidated by a transfer by him to petitioner of 625 shares of the common stock of the petitioner owned by him.

(h) The petitioner declared a 60 percent stock dividend on the 9,375 shares of its common stock which remained outstanding after it had acquired the 3,000 shares from the realty company and the 625 shares from Otto Kern, as stated in paragraphs (e) and (g), supra. That stock dividend required 5,625 shares of common stock, and it was paid by using the 3,625 shares which the petitioner had acquired from the realty company and Otto Kern and by issuing 2,000 shares of its authorized but theretofore unissued common stock.

(i) The petitioner's authorized capital stock was changed from 15,000 shares of common stock to 20,000 shares of preferred stock and 20,000 shares of common stock, each class of stock having a par value of $ 50 per share.

Immediately preceding the consummation of the plan of readjustment on February 21, 1935, the petitioner owned $ 33,000 in par value of the leasehold bonds of the realty company and the bank owned $ 4,500 in par value of such bonds. Upon the consummation of the plan of readjustment, the $ 4,500 of leasehold bonds owned by the bank were offset against an indebtedness of the realty company to the bank and were acquired by the petitioner. In cancelation of the $ 37,500 of leasehold bonds thus held by it, the petitioner, upon consummation of the plan of readjustment, acquired $ 3,750 in principal amount of its 10-year 5 percent debentures, $ 18,750 in par value of its 6 percent preferred stock, and 75 shares of its common stock.

After the consummation of the plan of readjustment, the petitioner had outstanding 18,090 shares of common stock of the par value of $ 50 per share, of which 15,000 shares, or 82.9 percent, were owned by Otto Kern, Ernst Kern, and Wagner, and 3,090 shares, or 17.1 percent were owned by the former holders of the leasehold bonds. The petitioner also had outstanding 15,450 shares of preferred stock of the par value of $ 50 per share and $ 154,400 in principal amount of 10-year 5 percent debentures, all of which preferred stock and debentures were owned by the former holders of the leasehold bonds. The realty company, which prior to the consummation of the plan, owned 3,000 shares of the common stock of the petitioner, owned none of the common or preferred stock or debentures.

In its return for the fiscal year ended January 31, 1936, the petitioner did not report any gain from the transactions which were consummated pursuant to the plan of readjustment. The respondent added the amount of $ 536,578.66 to the petitioner's income as "gain on exchange of leasehold bonds," and explained his action in the notice of deficiency as follows:

During the taxable year you acquired property from the Kern Realty Company for which you assumed an underlying bond liability. Thereupon you issued new debentures, preferred and common stock to retire the underlying bond liability so assumed.

It is held that gain in the amount of $ 536,578.66 was realized in the taxable year * * * as a result of the transaction whereby you were relieved of a liability to that extent.

The respondent computed the gain in the following manner:

			Interest
			Sept. 15, 1931	Aug. 1, 1934
			to	to
		Principal	Sept. 30, 1932	Feb. 21, 1935
Bonds assumed		$ 1,545,000	$ 88,515.63	$ 12,939.38
Less:
	Bonds acquired in connection with
	properties acquired	4,500	257.81	37.69
	Bonds acquired prior to
	acquisition of properties	33,000	1,890.62	276.37
Total net liability assumed on
leasehold bonds		$ 1,507,500	$ 86,367.20	$ 12,625.32
Total principal and interest assumed				$ 1,606,492.52
Exchanged for:
	3,015 5% debenture notes, at $ 50 par value		$ 150,750.00
	15,075 shares preferred stock, at $ 50 par
	value		753,750.00
	3,015 shares common stock, at $ 50 par value		150,750.00
Accrued interest on debenture notes and
cumulative dividends on preferred stock
assumed from Aug. 1, 1934 to Feb. 21, 1935			14,663.86	$ 1,069,913.86
Gain on exchange				$ 536,578.66

The respondent also added the amount of $ 80,000 to the petitioner's income for the fiscal year ended January 31, 1936, as "cancellation of bank indebtedness," and stated in the notice of deficiency that such amount, which was owed by the petitioner to the bank and canceled pursuant to the plan of readjustment, constituted taxable income of the petitioner.

In its income tax returns for the fiscal years ended January 31, 1936, 1938, and 1939, the petitioner computed depreciation on the store building and part of the equipment therein on the basis of its cost to the realty company at January 31, 1935, of $ 1,626,593.54. It claimed deductions for depreciation with respect to such property of $ 77,708.99 for the fiscal year ended January 31, 1936, and $ 77,702.94 for each of the fiscal years ended January 31, 1938, and 1939. The respondent computed the deductions for depreciation for the three years mentioned on the basis of the cost of the property to the petitioner. He determined such cost to be $ 1,542,231.20, and, of the deductions which the petitioner had claimed in its returns, he disallowed $ 9,920.61, $ 3,751.98, and $ 3,753.68 in the respective fiscal years ended January 31, 1936, 1938, and 1939. His allowance for the fiscal year ended January 31, 1936, was made for a period of 11 months of that year.

The adjusted basis of the leasehold estates of the realty company was $ 1,626,593.54 at January 31, 1935, and $ 1,620,117.79 at February 28, 1935. The property which the petitioner acquired from the realty company in the transaction of February 21, 1935, was carried on the books of the petitioner at an arbitrary amount of $ 1,000,000 and was included at that value in the balance sheet attached to the petitioner's income tax return for the fiscal year ended January 31, 1936. The petitioner's surplus at January 31, 1936, as disclosed by that return and by its books, was $ 160,143.61.

Pursuant to the plan of readjustment, the petitioner paid $ 3,719.17 more rent for the period August 1, 1934, to January 31, 1935, than it was required to pay under the standstill agreement of December 15, 1932; and it also paid $ 14,663.86 as interest on its debentures and cumulative dividends on its preferred stock for the period August 1, 1934, to January 31, 1935. In its income tax return for the fiscal year ended January 31, 1936, the petitioner deducted both of those amounts as increased rentals and interest on its debentures and preferred stock for the period August 1, 1934, to January 31, 1935. The deductions were disallowed by the respondent, on the ground that the amounts in question represented a part of the purchase price of the properties acquired by the petitioner from the realty company. Of the payment of $ 14,663.86, the sum of $ 3,768.75 constituted interest on petitioner's debentures.

The petitioner entered into a contract on May 1, 1937, to purchase real estate situated in the city of Detroit which it proposed to use as a warehouse. The petitioner made an initial cash payment of $ 15,000 and agreed to pay the remainder of the purchase price of $ 95,000 in installments over a period of years. The vendor, upon payment of all sums owing on the contract, agreed to deliver to the petitioner a warranty deed conveying a marketable title. The petitioner has since regularly paid the installments as they became due.

The general city taxes of the city of Detroit on the property, for the fiscal year of the city beginning July 1, 1937, and ending July 30, 1938, amounted to $ 2,605.64; and the county taxes of Wayne County, for the fiscal year of the county beginning December 1, 1937, and ending November 30, 1938, amounted to $ 577.48. The petitioner paid the city taxes in two installments of $ 1,302.82 each, on August 2, 1937, and December 30, 1937. It paid the county taxes of $ 577.48 on January 11, 1938. In its return for the fiscal year ended January 31, 1938, the petitioner claimed as a deduction $ 1,616.19 of such taxes -- the amount which it had charged to expense on its books. The respondent disallowed the deduction and added the amount thereof to the cost basis of the property for the purpose of computing the petitioner's deduction for depreciation.

The charter of the city of Detroit contains the following provisions:

Title VI

Finance and Taxation

Chapter II

Assessments -- General

Section 1. All real * * * property within the city subject to taxation * * * shall be assessed * * * by the board of assessors * * *. There shall be an assessment roll in book form for each such [assessment] district. * * *

Sec. 2. In all assessments, the lands * * * shall be described by referring to the number and section of the lot and the name of the owner or occupant thereof * * *.

Sec. 3. The board of assessors shall have, * * * power and authority to demand of every person owning or having charge as agent, or otherwise, of any taxable property, a list of such property, * * * and if the person of whom such demand is made, shall not, * * * deliver to such board a list of the property * * * it shall be its duty to assess such property, * * *

Sec. 4. Notice that the assessment rolls will be completed on the first day of April in each year shall be given as herein provided. * * * The board [of assessors], having completed the review and correction of said assessment rolls, shall sign, and on the third Tuesday of April in each year return the same to the common council. * * *

Sec. 5. The common council, after receiving said assessment rolls, shall * * * [on] the first succeeding day, proceed to consider the same, and any person considering himself aggrieved by the assessment of his property, and the decision of the board of the assessors thereon, may appeal to the council; * * *

Sec. 6. The council * * * shall hear and determine all appeals in a summary manner and correct any errors which they may discover in the assessment rolls; * * * The consideration of the assessment rolls and hearing of appeals may be continued from session to session for a period not exceeding sixteen days after the date of their delivery to the council. * * * After due consideration thereof, said rolls shall be fully and finally confirmed by the council, and shall remain as the basis, according to property valuation, of all taxes to be levied and collected * * *

Sec. 7. After the assessment rolls shall have been fully and finally confirmed, it shall, * * * be the duty of the board of assessors to cause the amount of all taxes, in dollars and cents, authorized to be assessed and collected in each year, to be ratably assessed to each person named or lots described, * * * Such ratable assessment shall be entered in a book prepared for that purpose to be known as the tax roll * * * When said tax rolls shall have been completed, the board shall deliver the same to the controller, who shall cause the same to be delivered to the city treasurer on the first day of July, * * * All city taxes shall become a debt against the owner from the time of the listing of property for assessment by the board of assessors.

Chapter IV

Taxes

Section 1. All city taxes shall be due and payable on the fifteenth day of July in each year, and on that date shall become a lien on the property taxed. The owners or occupants or parties in interest to any real estate assessed hereunder shall be liable to pay such taxes, and all assessments levied in accordance herewith. * * *

Sec. 27. All city taxes upon * * * real estate * * * in addition to being a lien upon the property assessed shall become a debt against the owner from the time of the listing of the property for assessment, and shall remain a debt against the owner of the property or his estate after his death, until the same are paid.

OPINION.

The various issues will be discussed in the order in which they have been stated.

I and II.

To its return for the fiscal year ended January 31, 1936, petitioner appended a memorandum entitled "Information Relating to Reorganization Consummated February 21, 1935," stating therein that it believed the plan as consummated qualified as a tax-free exchange under section 112 of the Revenue Act of 1934. A copy of the plan of readjustment was attached to the memorandum. Accordingly, in its return for the fiscal year ended January 31, 1936, petitioner reported no gain from the transaction and in that return and its returns for the fiscal years ended January 31, 1938, and 1939, it used the cost of the store building and equipment to the realty company as the basis for computing deductions for depreciation on such property. The respondent found that the petitioner had acquired property from the realty company in consideration of the assumption by petitioner of the liability of the realty company on the leasehold bonds, and he held that it realized taxable gain in the amount of $ 536,578.66 when it issued its debentures and preferred and common stock to the bondholders in discharge of the liability under those bonds; and that the deductions for depreciation should be computed on the basis of the cost of the building and equipment to the petitioner. The issues arising from this action are (1) whether the petitioner realized a taxable gain in the amount of $ 536,578.66, and (2) whether the amounts allowable for depreciation of the building and equipment should be computed on the basis of the cost of the property to the petitioner or its cost to the realty company.

As regards these two issues the petitioner contends that the transaction constitutes a "reorganization" within the meaning of clauses (C) and (D) of section 112 (g) (1) of the Revenue Act of 1934, and that it also constitutes a transfer of the kind described in section 112 (b) (5) of that act; that, therefore, no gain or loss is to be recognized on the transfer of the various properties to it in exchange for its stock and debentures; and that it is entitled to use the cost of the building and equipment to the realty company as the basis for computing deductions for depreciation thereon. These contentions will be considered in order.

In clause (C) of section 112 (g) (1) it is provided that the term "reorganization" means "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred." In section 112 (h) it is provided that the term "control" as used in section 112 means "the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation." The realty company owned leasehold estates which were subject to the lien of a bonded indebtedness. It transferred those estates, which constituted only a part of its property, together with 3,000 shares of the common stock of the petitioner, to the petitioner, and the petitioner issued to the bondholders 3,090 shares of its common stock, 15,450 shares of its new preferred stock, and its debentures of the face value of $ 154,500, whereupon the leasehold bonds were canceled. After the completion of the transfer and continuously thereafter until after the consummation of the plan of readjustment, the realty company (the transferor) owned none of the stock of the petitioner; Otto Kern, Ernst Kern, and Wagner, the owners of all of the stock of the realty company, owned 15,000, or 82.9 percent, of the 18,090 outstanding shares of the common stock of the petitioner; and the former holders of the leasehold bonds owned 3,090 shares, or 17.1 percent, of the common stock of the petitioner, together with all of the outstanding preferred stock and all of the debentures of the petitioner. While the stockholders of the realty company owned over 80 percent of the common stock of petitioner at the crucial time, they then owned none of its preferred stock, and thus the requirement of section 112 (h), that there be ownership of "at least 80 per centum of the total number of shares of all other classes of stock," is not satisfied.

In order to establish control to the extent required by the statute the petitioner urges that we treat the former bondholders of the realty company as preferred stockholders of that company. This we can not do. There is no proof establishing the insolvency of the realty company or that the bondholders' interest ever attained the status of a proprietary interest such as was true in Helvering v. Limestone Co., 315 U.S. 179">315 U.S. 179. Moreover, clause (C) "contemplates that the old corporation or its stockholders, rather than its creditors, shall be in the dominant position of 'control' immediately after the transfer, and not excluded or relegated to a minority position," Helvering v. Southwest Corporation, 315 U.S. 194">315 U.S. 194; Helvering v. Cement Investors, 316 U.S. 527">316 U.S. 527. See also Mahlon D. Thatcher, 46 B. T. A. 869, 882.

The petitioner attempts to bring the case within clause (D) of section 112 (g) (1), which provides that the term reorganization means a recapitalization, by an argument based on the assumed premise that in the readjustment there were involved two separate and independent transactions represented by two steps therein, i. e., (1) the assumption by petitioner of the leasehold bond issue and (2) the issuance of the petitioner's debentures and preferred and common stock in exchange for the assumed leasehold bond liability; asserting that the second step constituted an exchange of petitioner's direct assumed liability on the leasehold bonds for its own debentures and preferred and common stock, and that it therefore was a recapitalization within clause (D). We think it obvious that these steps were not independent and separate transactions even if it were true that there was an assumption by petitioner of liability on the leasehold bond issue, which, as we later point out, there was not, because the issuance of petitioner's stock and debentures was inseparably connected with the cancellation of the bonds and the one step to be taken was entirely dependent upon the other being also taken. The two steps were component parts of a single transaction.

In our opinion, there was not a reorganization within the meaning of either clause (C) or clause (D) of section 112 (g) (1), and we so hold.

However, even if the transaction were a reorganization within the statutory definition of either clause (C) or clause (D), that alone is not enough to require nonrecognition of gain. It would be necessary to further show an exchange of a kind described in section 112 (b) (4), and no such exchange is so shown since the property transferred by realty company to petitioner was not solely, or even partly, for stock or securities in any corporation a party to the reorganization, the realty company having received no stock or securities by reason of the exchange. Connecticut Power Co., 28 B. T. A. 38; Rudolph Boehringer, 29 B. T. A. 8; National Bank of Commerce of Seattle, 40 B. T. A. 72, 77; affd., 115 Fed. (2d) 857; and Gutbro Holding Co., 47 B. T. A. 374, 379.

The petitioner's next contention is that the transaction falls within section 112 (b) (5), which provides as follows:

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

The leasehold estates were transferred by the realty company to the petitioner, together with 3,000 shares of the petitioner's common stock. The realty company received no stocks or securities of petitioner in exchange for its property. The transfer by the realty company was made with the consent of the bondholders and assuming, although not so deciding, that the bondholders, because of their first lien through their trust mortgage on the leasehold estates, and the realty company were transferors of the entire interest in the leasehold estates, yet the requirement of the first clause of section 112 (b) (5) as to control is not met, because the realty company received no common or other stocks and the bondholders received only 17.1 percent of the common stock and all of the preferred stock, the preferred stock having voting rights only to the extent of the election of one director while the common stock had the exclusive right of electing, at least, a majority of the directors. In this situation, ownership to the extent of 80 percent of the voting stock is not here shown as required by section 112 (h).

Also, it is to be noted that the petitioner has not shown the value of the leasehold estates transferred, and we can not assume that the realty company did not own and transfer an interest therein which had some value. But the realty company received no stock or securities of the transferee, while the bondholders received all of the stock and debentures that were issued for the property. Thus there could be no determination on this record that the amount of stock and securities received by each transferor is substantially in proportion to his interest in the property prior to the exchange, within the requirement of the last clause of section 112 (b) (5). United Carbon Co. v. Commissioner, 90 Fed. (2d) 43; Blair v. Commissioner, 91 Fed. (2d) 992;Commissioner v. Lincoln-Boyle Ice Co., 93 Fed. (2d) 27; Poncin Corporation, 27 B. T. A. 328, 333; Miller & Paine, 42 B. T. A. 586, 594; B. Cohen & Sons Co., 42 B. T. A. 1137.

In our opinion, the transaction was not a nontaxable transfer within the provisions of section 112 (b) (5), and we so hold.

Since the transaction was neither a reorganization nor a nontaxable transfer, the gain thereon, if any, must be recognized. The respondent in determining the gain of $ 536,578.66 considered only the acquisition of the leasehold estates and the discharge of the bonded indebtedness thereon. His position is, that the petitioner under the plan of readjustment became obligated to pay the bondholders the entire amount of principal and interest due on their bonds and that the petitioner effected a saving and thereby realized income when it settled that obligation for less than its full amount. United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1; Helvering v. American Chicle Co., 291 U.S. 426">291 U.S. 426; United States v. Little War Creek Coal Co., 104 Fed. (2d) 483; and Estate of W. R. Whitthorne, 44 B. T. A. 1234, and authorities cited therein. The parties have stipulated that certain adjustments were consummated on February 21, 1935, "pursuant to the plan of readjustment", including the following adjustment set forth in paragraph 12 (d) of the stipulation:

(d) In lieu of its obligation under the lease the petitioner assumed the payment of the First Mortgage Leasehold * * * Bonds of Kern Realty Corporation. The First Mortgage Leasehold * * * Bonds were cancelled, and in lieu thereof the petitioner issued its securities pro rata to the holders of the $ 1,545,000.00 outstanding bonds, as follows:

(1)	$ 154,500.00	principal amount of Ten Year Five Per Cent
		Debentures * * *.
(2)	$ 772,500.00	par value of Six Per Cent Preferred Stock, * * *.
(3)	3,090	shares of common stock * * *.

The statement contained in the first sentence of paragraph 12 (d) has not been found as a fact. This part of the stipulation undertakes to interpret the meaning of a written instrument, i. e., "the plan of readjustment." It is not within the province of the parties to construe the meaning of a written instrument as to the facts to be determined therefrom. The interpretation of the meaning and the construction to be placed upon a written instrument is a question of law, Dillon v. Barnard, 21 Wall. 430">21 Wall. 430, 437; and the determination of a question of law is for the court, regardless of a stipulation of the parties. Swift & Co. v. Hocking Valley Railway Co., 243 U.S. 281">243 U.S. 281; Estate of Sanford v. Commissioner, 308 U.S. 39">308 U.S. 39, 51; Case v. Los Angeles Lumber Co., 308 U.S. 106">308 U.S. 106; Nelson v. Montgomery Ward, 312 U.S. 372">312 U.S. 372, 376; Smith v. Commissioner, 59 Fed. (2d) 533; Nelson Co. v. Commissioner, 75 Fed. (2d) 696, affirming 28 B. T. A. 529; reversed, but not on this point, 296 U.S. 374">296 U.S. 374; Commissioner v. Cummings, 77 Fed. (2d) 670; Commissioner v. Ehrhart, 82 Fed. (2d) 338; First-Mechanics National Bank v. Commissioner, 117 Fed. (2d) 127;Ohio Clover Leaf Dairy Co., 8 B. T. A. 1249; affd. per curiam, 34 Fed. (2d) 1022; certiorari denied, 280 U.S. 588">280 U.S. 588; William Ernest Seatree, 25 B. T. A. 396; affd., 72 Fed. (2d) 67; Volunteer State Life Insurance Co., 35 B. T. A. 491, 496; reversed, but not on this point, 110 Fed. (2d) 879; certiorari denied, 310 U.S. 636">310 U.S. 636. In accordance with this rule we turn to an examination of the plan of readjustment and find that it contains no provision for the assumption by the petitioner of the indebtedness of the realty company to its bondholders. With respect to this indebtedness the plan provides only that "the obligations of the Realty Company with respect to its leasehold bonds will be cancelled and in lieu thereof the [petitioner] will issue the following securities pro rata to the holders of the leasehold bonds." The securities so to be issued are specified in the plan to be securities of the classes and amounts described in paragraph (d) above having an aggregate value of $ 1,081,500, and it is expressly stated in the plan that the holders of the $ 1,545,000 of bonds should receive for each $ 1,000 bond one $ 100 debenture, $ 500 in par value of preferred stock, and $ 100 in par value of common stock. It is thus apparent that the plan provided only for the discharge by the petitioner of the outstanding mortgage debt of the realty company through payment by petitioner of $ 1,081,500 in its securities to the holders of the leasehold bonds and it nowhere provided for the assumption by the petitioner of a liability to pay, to the extent of $ 1,545,000, the obligation of the realty company on the leasehold bonds. It, therefore, can not be said that, as a matter of fact, such liability was assumed pursuant to the plan of readjustment as, in effect, stated in paragraph 12 (d) of the stipulation and as contended by respondent.

Not only does nothing appear in the plan of readjustment to show that there was an assumption by petitioner of the bonded indebtedness of the realty company, but also there is nothing elsewhere in this record to show such assumption, unless the bare statement in the first sentence of paragraph 12 (d) of the stipulation is regarded as making such a showing and, as we have pointed out, that sentence is not to be so regarded.

Since neither by the terms of the plan of readjustment nor by other facts of record is petitioner shown to have assumed the payment of the leasehold bonds and interest thereon, but it merely agreed to issue to the bondholders a specified amount of its own debentures and stock in lieu of the cancellation of such bonds, we are unable to say that it realized any gain under the principle of the Kirby case, supra. When the petitioner issued its debentures and stock to the bondholders in the amounts agreed upon it discharged its obligation in full and not for any lesser sum than that obligation. It, therefore, realized no gain. Cherokee Co., 41 B. T. A. 1212. See also Des Moines Improvement Co., 7 B. T. A. 279; General Utilities & Operating Co., 29 B. T. A. 934; affd., 296 U.S. 200">296 U.S. 200; Columbia Pacific Shipping Co., 29 B. T. A. 964; affd., 77 Fed. (2d) 759; Pinkney Packing Co., 42 B. T. A. 823.

The determination of the respondent that the petitioner realized gain of $ 536,578.66 is disapproved.

Since we have concluded that there was neither a reorganization nor a nontaxable transfer within the meaning of sections 112 (g) (1) and 112 (b) (5), the petitioner is not entitled to have its allowances for depreciation computed upon the basis of the cost of the store building and equipment to the realty company, under section 113 (a) (7) and (8) of the Revenue Act of 1934. The proper basis, therefore, is the cost of the property to the petitioner. Section 113 (a); Sacramento Medico Dental Building Co., 47 B. T. A. 315, 328. The basis which the respondent used in his determination of a deficiency was $ 1,542,231.20, the amount of the bond liability alleged to have been assumed, with some adjustments.

The respondent says that he properly measured the cost to the petitioner on the basis of the amount of the leasehold bond liability which it is alleged to have assumed in order to acquire the property; but he suggests that the property may be said to have been acquired for the common stock, preferred stock, and debentures issued to the bondholders, so that, in reality, the cost to the petitioner was the aggregate par value of such stock and debentures, or $ 1,081,500. The parties have stipulated that the adjusted basis in the hands of the realty company was $ 1,626,593.54 at January 31, 1935, and $ 1,620,117.79 at February 28, 1935. Under the pleadings, the only issue presented is whether the petitioner is entitled to the higher basis of the realty company, and the case was tried on the theory that either $ 1,542,231.20 or the adjusted basis of the realty company was proper, dependent upon whether or not there was a tax-free exchange. The suggestion that the lower basis of $ 1,081,500 be used was made by the respondent for the first time in his brief, but at no time during this proceeding has he asserted a claim for an increased deficiency on the ground that additional amounts should be disallowed for depreciation. The transaction of February 21, 1935, involved some considerations passing from the petitioner in addition to the debentures and preferred and common stock, such as, for instance, the cancellation of all obligations between the petitioner and the realty company, the respective amounts of which are not shown, and, in the absence of evidence that those other considerations were of no value, we are unable to find that the cost to the petitioner was lower than that found by the respondent, to wit, $ 1,542,231.20; except that there should be eliminated from such amount $ 3,719.70 which we hereinafter find, under issue IV, to be rent, and $ 14,663.86 which we hereinafter find, under issue V, should be eliminated in computing the cost of the properties involved for the purpose of depreciation allowances, both of the latter amounts having been included by respondent in determining that the cost to petitioner of the properties was $ 1,542,231.20.

For the fiscal year ended January 31, 1936, the respondent allowed depreciation on the store building and equipment for the period of eleven months of that year. The properties were acquired by the petitioner on February 21, 1935, and the petitioner therefore is entitled to depreciation for the full period of its ownership, namely, from February 21, 1935 to January 31, 1936. The respondent makes no argument on this issue.

III.

The question next to be decided is whether the petitioner realized taxable income as a result of cancellation of $ 80,000 of its indebtedness to the bank. The respondent included that amount in income pursuant to article 22 (a)-14 of Regulations 86. ¹

The petitioner was solvent and the respondent contends that under the rule in United States v. Kirby Lumber Co., supra;Helvering v. American Chicle Co., supra; and United States v. Little War Creek Coal Co., supra, the petitioner realized taxable income. The assets of the petitioner were freed from the claims of its creditor to the extent of $ 80,000 without any offsetting liability and, under the authority of the cases just cited, we hold that the respondent's action was proper. See also Lakeland Grocery Co., 36 B. T. A. 289.

The petitioner contends that the cancellation of its indebtedness to the extent of $ 80,000 was in substance a contribution to petitioner's capital.

The bank was not a stockholder in petitioner and consequently the last sentence in the cited regulation does not apply to the cancellation of the $ 80,000 owed by petitioner to the bank. The reasons petitioner assigns in support of his contention that the $ 80,000 was a contribution to petitioner's capital are that in the negotiations preceding the consummation of the readjustment efforts were made to induce the bank to accept debentures or stock for all, or part, of its debt; that this would have been done if the bank had not gone into a receivership; and that the receiver finally agreed to cancel part of the debt and take a note for the balance provided the new note be given priority over the claims of the bondholders and certain other creditors. We find nothing in these facts to warrant the conclusion that the status of the bank was equivalent to that of a stockholder and that the cancellation of the indebtedness was therefore a capital contribution within the rule set out above.

The action of the respondent in including the amount of $ 80,000 in income of the petitioner is approved.

IV.

The next question for determination is whether the petitioner is entitled to a deduction in the amount of $ 3,719.17 which it paid as rent for the period August 1, 1934, to January 31, 1935. The respondent disallowed the deduction on the ground that it represented part of the purchase price of the properties which the petitioner acquired from the realty company.

During the term of the standstill agreement and up to the time when it was supplanted by the plan of readjustment on February 21, 1935, the petitioner occupied the department store premises under its store lease from the realty company and, in lieu of the rentals reserved therein, it paid to the landlords on behalf of the realty company the rentals which were due them from the realty company as modified by the standstill agreement. Pursuant to the plan of readjustment, which had been formulated on September 19, 1934, and was to become effective as of August 1, 1934, the realty company on February 19, 1935, assigned the leasehold estates to the petitioner, and the landlords, the petitioner, and the realty company on February 21, 1935, signed the "rent agreement," in which the petitioner agreed to pay modified annual rentals to the landlords. The "rent agreement" provides that, "The readjustment of lease rentals * * * shall be effective for a period of ten years from and after the first day of August 1934." The amount sought to be deducted under this issue is the excess of the rentals payable under the "rent agreement" for the period August 1, 1934, to January 31, 1935, over those which the petitioner would have paid under the standstill agreement.

The respondent contends that, as the petitioner acquired all of the right, title, and interest in the property transferred by the realty company, the payments in question must be treated as part of the purchase price of the property, and that, even if they were expenses, they were neither ordinary nor necessary and they were not incurred in carrying on trade or business.

Section 23 (a) of the Revenue Act of 1934 authorizes the deduction of "All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity." [Italics supplied.] The term "rental" is to be read in its ordinary and usual sense, and it implies a fixed sum to be paid at stated times for the use of property. Duffy v. Central Railroad, 268 U.S. 55">268 U.S. 55. The payments in question were clearly of that character. The petitioner acquired the leasehold estates and paid a consideration therefor to the realty company; but it acquired no title to or other equity in the real property. Its status was merely that of a lessee, and the payments of rentals were due from and made by it directly to the landlords for the use of the premises by petitioner in its department store business. The contentions of respondent that the payments represented a capital investment and that they were neither ordinary nor necessary are untenable.

The respondent also contends that the payments are not deductible because they accrued in the taxable year ended January 31, 1935. The "rent agreement" states that it shall be binding only if and when the plan of readjustment is adopted and only if and when all parties have executed the rent agreement; and the stipulation shows that such adoption and execution took place on February 21, 1935, and within the taxable year ended January 31, 1936.

The payments were in fact rent and were proper accruals for the taxable year ended January 31, 1936, and the respondent erred in disallowing the deduction.

In the determination of the deficiencies, the respondent treated the payment of $ 3,719.17 as part of the cost to petitioner of the assets acquired by it from the realty company for the purpose of computing the deductions for depreciation on the store building and equipment. In view of our conclusion that the payment was a payment of rent, the amount of $ 3,719.17 should be eliminated from that cost basis in computing such deductions.

V.

The next question for determination is whether the petitioner is entitled to a deduction of interest in the amount of $ 14,663.86. The respondent denied the deduction in determining the deficiency for the taxable year ended January 31, 1936. The deficiency notice stated that the amount was interest accrued on the debentures and on the cumulative dividends on the preferred stock for the period August 1, 1934, to February 21, 1935, and that it was disallowed on the ground that it constituted part of the purchase price of the properties acquired from the realty company. The parties have stipulated that "Under the Plan of Readjustment the petitioner paid $ 14,663.86 more interest for the period August 1, 1934 to January 31, 1935 than was payable under the standstill agreement."

The respondent asserts that prior to the adoption of the plan of readjustment the petitioner was under no obligation to pay the interest due by the realty company on the leasehold bonds, and he contends (1) that the petitioner can not deduct interest paid on behalf of another, and (2) that the payment was part of the consideration paid for assets of the realty company. The petitioner takes the position (1) that the payment represents an increase, occasioned by the adoption of the plan of readjustment, in the interest payable under the standstill agreement for the period August 1, 1934, to January 31, 1935, and is deductible as interest which accrued on February 21, 1935, and (2) that the obligation is not one of the realty company which was paid by the petitioner.

The nature of the payment must be determined from the facts shown by the record, and, for reasons hereinbefore stated in our consideration of the question of whether or not petitioner assumed payment of the leasehold bonds, we are not bound by the stipulation of counsel characterizing the entire amount as "interest." Also, it may be said that this Court will disregard a stipulated fact if it is contrary to a fact otherwise established from the record. William Ernest Seatree, supra.

Under the standstill agreement, the petitioner was required to pay interest to the leasehold bondholders at a reduced rate, but those payments were not made on obligations of the petitioner. They were made on behalf of the realty company and from part of the rental payable by the petitioner to the realty company under the store lease. Under the plan of readjustment the leasehold bonds were canceled and then, for the first time, the petitioner, by issuing its debentures in the amount of $ 154,500, assumed a direct obligation upon which interest was payable from it to the former leasehold bondholders. The debentures were dated back to August 1, 1934, the effective date of the readjustment, and bore interest at the rate of 5 percent per annum from date.

Whether the payment is deductible as "interest paid or accrued within the taxable year on indebtedness," sec. 23 (b) of the Revenue Act of 1934, depends upon whether it is compensation for "the use or the forbearance of money" legally owing by the taxpayer, and the obligation on which it is paid must be an unconditional promise to pay a fixed sum at some specific time. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488; W. S. Gilman, 18 B. T. A. 1277.

No specific contention is made here that the preferred stock is anything other than what it is denominated, but in view of the fact that respondent in his determination found that petitioner had included in its return a deduction for interest on preferred stock and denied this deduction only on the ground that it constituted part of the purchase price of the property acquired from the realty company and, inasmuch as on arguments by both parties in their briefs on this question no point was made differentiating interest on the debentures from interest on the stock, we shall consider the question of whether or not it was preferred stock bearing only dividends, or preferred stock bearing interest. The provisions of the preferred stock certificates, as actually issued, have not been shown us, but, so far as we can ascertain their character from the facts set out in the plan of readjustment, under the terms of which the stock was issued, the holders thereof were investors in the corporation and not its creditors. There was, so far as is shown by the plan of readjustment and the whole record, no fixed maturity date for the payment of the principal of the preferred stock and no right in case of dissolution for the holders of that stock to share in the assets with creditors. In the plan the security is denominated "preferred stock" and the payments thereon are described as "dividends"; the dividends on the stock were payable only out of earnings; and the holders of all of such stock as a class had the right to elect one director. In these circumstances we are of the opinion, and so hold, that the preferred stock did not represent an indebtedness of petitioner and the amount paid thereon was not interest within the meaning of the applicable statute. Jewel Tea Co. v. United States, 90 Fed. (2d) 451; Dayton & Michigan Railroad Co., 40 B. T. A. 857; affd., 112 Fed. (2d) 627; Pacific Southwest Realty Co., 45 B. T. A. 426, and authorities cited therein; affd., 128 Fed. (2d) 815; certiorari denied, 317 U.S. 663">317 U.S. 663; cf. Meridian & Thirteenth Realty Co., 44 B. T. A. 865; reversed, 132 Fed. (2d) 182. That part of the claimed deduction for interest which represented payments made on the preferred stock should therefore be disallowed.

However, with respect to the debentures of petitioner, we are of the opinion, and so hold, that they constituted an indebtedness of petitioner and the amount paid thereon was interest within the meaning of the statute and deductible as such. The liability therefor accrued on February 21, 1935, and within the taxable year. The statute does not require that the indebtedness upon which interest has accrued and become a liability of the taxpayer must be outstanding during the entire interest accrual period. Columbia River Paper Mills, 43 B. T. A. 104; affd., 126 Fed. (2d) 1009; and Oregon Pulp & Paper Co., 47 B. T. A. 772.

In the consummation of the plan of readjustment, the petitioner acquired $ 3,750 in face value of its own debentures for leasehold bonds of the realty company, thereby reducing its outstanding debentures from $ 154,500 to $ 150,750. The interest on the latter amount for the period August 1, 1934, to January 31, 1935, at the rate of 5 percent, which the debentures bore, is $ 3,768.75, and such amount should be allowed as a deduction. There is no merit in the respondent's contention that the amount of $ 14,663.86 constituted part of the purchase price of the property acquired from the realty company, and that amount should be eliminated in computing the cost of such properties for the purpose of depreciation allowances.

VI.

The final question is whether the petitioner is entitled to deduct real property taxes, imposed by the county of Wayne in the amount of $ 577.48 and by the city of Detroit in the amount of $ 2,605.64, which the petitioner paid during the fiscal year ended January 31, 1938. The petitioner purchased the property under a land contract dated May 1, 1937, and the equitable title vested in it on that date, City of Marquette v. Michigan Iron & Land Co., Ltd., 132 Mich. 130">132 Mich. 130; 92 N. W. 934. So we may, therefore, properly treat it as the owner as of that date. Pacific Southwest Realty Co., supra.If, prior to May 1, 1937, any lien for payment of the taxes existed on the real estate conveyed or if the petitioner's vendor was personally liable for the taxes, the deductions must be denied. Magruder v. Supplee, 316 U.S. 394">316 U.S. 394; Helvering v. Johnson County Realty Co., 128 Fed. (2d) 716.

In the consideration which follows of the question of whether petitioner is entitled to deduct the real property taxes imposed by Wayne County, the sections referred to below are as they appear in Michigan Statutes Annotated, vol. 6 (Ed. 1936).

In Michigan, real property must be assessed for taxes in the township or place where situated and to the owner, if known. § 7.3. As to state and county taxes the assessments must be made annually by the supervisors of the several townships, but in cities where provision is made in the charter for some other assessing officer, the assessment must be made by that assessing officer. § 7.10. The supervisor is required to make and complete an "assessment roll" on or before the first Monday in June in each year, setting forth the name of every person liable to be taxed and a description of the real property, its cash value, and the name of the owner. § 7.24. For counties having a population of more than 500,000, such as is Wayne County, in which the city of Detroit is located, a board of review is provided. § 7.41. On the Tuesday next following the first Monday in June, but not later than the third Monday in June, the county board of review must proceed to examine and review the assessment rolls as prepared by the supervisor, for the purposes, among others, of correcting errors and adding to the roll the names of persons and value of real property omitted from the roll. § 7.43. The assessment roll, with such changes as may have been made by the county board of review, must be returned to the supervisor so that persons assessed may file written objections on or before the fourth Monday in June. § 7.44.

The assessment roll, together with the objections filed, must be returned to the county board of review on or before the Tuesday following the fourth Monday in June and a final determination is then made by the board of the valuation of each description of real property with respect to which objection has been filed. §§ 7.45, 7.46.

The county board of review must complete the assessment roll on or before the third Monday in July, sign and endorse it as the assessment roll of the township for the year in which it had been prepared and affirmed by that board, and return the roll to the supervisor. § 7.47.

Sections 7.80 and 7.81 are as follows:

§ 7.80. The supervisor of each township or ward, and the assessing officer of each city or village, as provided by law, shall proceed to assess the taxes apportioned to his township , or assessment district, according and in proportion to the valuations entered by the board of review in the assessment roll of the township, ward, village or city of the year. * * * [Italics supplied.]

§ 7.81. The taxes thus assessed shall become at once a debt due to the township, city, village and county from the persons to whom they are assessed, and the amounts assessed on any interest in real property shall, on the first [1st] day of December, for state, county, village or township taxes or upon such day as may be heretofore or hereafter provided by charter of a city, become a lien upon such real property, and the lien for such amounts, and for all interest and charges thereon, shall continue until payment thereof. * * * [Italics supplied.]

With respect to the Wayne County taxes, it is established from the foregoing provisions of the statute: That the time when those taxes became a debt due the county was when the supervisor proceeded to assess the taxes in proportion to the valuations entered by the county board of review on the assessment roll. §§ 7.80 and 7.81, supra; that the county board of review did not proceed to examine and review the assessment roll for the purpose of fixing such valuations until on the Tuesday next following the first Monday in June. § 7.43, supra; that the time when the taxes became a debt by the supervisor proceeding to assess same in proportion to the valuations entered by the county board of review was subsequent to the Tuesday next following the first Monday in June; and that, therefore, the taxes could not have become a debt to the county earlier than on the latter date. It is consequently obvious that there existed no debt or personal liability of petitioner's vendor for the payment of the county taxes on May 1, 1937, when the real estate was conveyed to petitioner. It is equally obvious that under § 7.81, supra, no lien for such taxes existed on that date. The petitioner is therefore entitled to a deduction of the Wayne County taxes of $ 577.48. Magruder v. Supplee, supra;Helvering v. Johnson County Realty Co., supra.

With respect to the city taxes on the real estate involved in this issue, we are of the opinion that the vendor became personally liable therefor on April 1, 1937, and prior to its transfer of the real estate to petitioner on May 1 of that year.

The charter of the city of Detroit in Title VI, chapter IV, and both section 7 and 27 make the tax a debt of the owner "from the time of the listing of the property for assessment" by the board of assessors. Section 3 of Title VI, chapter II, of the charter provides that every person owning taxable property shall make a list thereof for the board of assessors, and, in case of failure of such owner to do so, it becomes the duty of the assessors to assess the property upon the assessment roll, which is to be completed by April 1. In the absence of citation to and our inability to find, after diligent search, a contrary holding by the courts of Michigan, we hold that petitioner's vendor became personally liable for the city taxes in question, by reason of the above provisions in the charter, on April 1, 1937, and for this reason petitioner is not entitled to the claimed deduction therefor. Magruder v. Supplee, supra.The deduction for the city taxes in the amount of $ 2,605.64 was properly denied by respondent.

On brief, petitioner asserts that under the laws of Michigan there is no personal liability for real estate taxes which can be enforced by proceedings in court, and in support of such assertion he cites Schaefer v. Woodmere Cemetery Assn., 256 Mich. 332">256 Mich. 332; 239 N.W. 300">239 N. W. 300, and Bankers' Trust Co. of Detroit v. Russell, 270 Mich. 568">270 Mich. 568; 259 N. W. 328. Petitioner, although not so expressly stating, apparently seems to thus invoke the principle that there can be no right of the city of Detroit or the county of Wayne, i. e., the debt to them for the real estate taxes, because there was no remedy for the enforcement of such right; but the Bankers' Trust Co. of Detroit case, supra (1935), cited by petitioner, involving taxes due the city of Detroit on real estate, quotes with approval from the Schaefer case, supra, as follows: "Taxes on real estate may be collected by distress on goods and chattels ([1 Comp. Laws 1871], § 1003), but if not so collected the tax is returned unpaid and the land sold to make it." Thus there is provided for the city of Detroit and Wayne County a remedy for the enforcement of their right to collect the debt represented by taxes on real estate. We are of the opinion that the method by which collection of such taxes is enforced is immaterial in determining the existence of the liability.

With regard to the claimed overpayment of $ 375.80 income tax for the fiscal year ended January 31, 1936, the record is devoid of proof as to when the income tax for that year was paid.

Decision will be entered under Rule 50.

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Footnotes

• 1. Art. 22(a)-14. Cancellation of indebtedness↩. -- The cancellation of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. A taxpayer realizes income by the payment or purchase of his obligations at less than their face value. * * * If a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation. * * *