Summary
In International Textbook Co. v. United States, 1930, 44 F.2d 254, 71 Ct.Cl. 132, taxpayer had incurred substantial expenses in obtaining the right to market certain educational programs.
Summary of this case from Houston Chronicle Publishing v. United StatesOpinion
No. J-634.
November 3, 1930.
Suit by the International Textbook Company against the United States.
Petition dismissed.
This suit is for the recovery of $1,098.36, together with interest from December 10, 1925, representing income and profits tax of $943.66 and interest and penalty thereon of $154.70 alleged to have been erroneously and illegally collected for the calendar year 1918.
The question is whether a consolidated group of which plaintiff is the parent corporation is entitled to a deduction of $15,787.72 as an ordinary and necessary expense for 1918 under a contract between a subsidiary of plaintiff and another corporation.
Special Findings of Fact.1. The plaintiff is now and was at all times hereinafter mentioned a Pennsylvania corporation with principal office at Scranton.
It filed a consolidated income and profits tax return for 1918 for itself and its affiliated corporations, to wit: Foster Building Corporation of New York, International Correspondence Schools of Pennsylvania, Victor Typewriter Company of New York, Technical Supply Company of New Jersey, and the Woman's Institute of Domestic Arts and Sciences, Inc., of Delaware. This return showed a tax of $55,472.43, which plaintiff paid.
2. Thereafter the Commissioner of Internal Revenue audited the return and determined that the correct tax liability for 1918 was $59,973.44, resulting in a deficiency of $4,501.01. Plaintiff paid this additional tax by two payments of $3,553.75 on November 19, 1925, and $947.26 on December 10, 1925. It also paid interest in respect of the deficiency of $372.64 on November 18, 1925, $107.93 on December 5, 1925, and a penalty of $47.36 on December 5, 1925, totaling $527.93.
3. Thereafter, January 13, 1926, plaintiff filed a claim for refund of $947.26, being a portion of the additional tax paid for 1918. This claim was filed within the time prescribed by law. It was rejected by the commissioner October 20, 1926, and this suit was commenced by the filing of a petition on October 20, 1928.
4. Prior to May 5, 1916, the International Educational Publishing Company, hereinafter referred to as the publishing company, a New Jersey corporation, was the owner of certain copyrighted courses of instruction in domestic science. These courses were incomplete and not in immediately marketable form, some of the courses being hardly more than started. In order to complete them, the expenditure of a substantial sum of money was required.
On and immediately prior to this date, the publishing company was in a straightened financial condition, having not more than $5,000 in cash. It was not in a position to borrow funds with which to complete the aforesaid courses in domestic science.
In these circumstances negotiations were entered into between the publishing company and the Woman's Institute looking to the execution of an agreement between the corporations whereby the publishing company would grant the right and license to the Woman's Institute to sell said domestic science courses. During the negotiations the parties agreed upon the amount of 6 per cent. of the gross receipts up to $3,000,000 and 3 per cent. of the gross receipts thereafter as the amount which the Woman's Institute would pay to the publishing company for such right and license. At the same time it was agreed that, in order that the publishing company might complete the courses, the Woman's Institute would immediately, or as soon as required, pay the amount of $90,000, $50,000 in cash upon the execution of the agreement and $40,000 as needed by the publishing company, for writing, editing, illustrating, and making plates for said domestic science courses. The amount of $90,000 represented the sum required by the publishing company to complete said courses.
5. Immediately thereafter and on May 5, 1916, an agreement, which is in evidence as Exhibit A and by reference is made part of this finding, was entered into between the publishing company and the Woman's Institute. The third paragraph of the agreement provided as follows:
"Third. In consideration for the rights and licenses hereby conveyed by the Publishing Company the Woman's Institute has covenanted and agreed, and hereby does covenant and agree to pay to the Publishing Company as follows:
"(a) The sum of fifty thousand dollars ($50,000) in cash on the execution of this present agreement.
"(b) The sum of forty thousand dollars ($40,000) to be paid in installments from time to time as the same may be required by the Publishing Company for the writing, editing, illustrating and making plates for said domestic science courses now in process of preparation and hereafter to be prepared.
"(c) The Woman's Institute shall further pay a royalty of three per cent (3%) of the gross cash receipts from the sale by said Institute of courses of instruction, instruction papers, bound or unbound volumes, the copyrights of which are or may be owned by the Publishing Company, and appliances patented or owned by the Publishing Company, and all other appliances used in teaching and included in the price of the scholarship courses until the gross amount of three million dollars ($3,000,000) has been so received in cash by the Woman's Institute from such sales; and thereafter the Woman's Institute shall pay the Publishing Company a royalty amounting to six per cent (6%) upon the gross amount of the cash so received by the Woman's Institute on such sales."
6. The gross receipts of the Woman's Institute from the sales made by it and coming within subdivision (c) of the third paragraph of the agreement for the years 1916 to 1920, inclusive, were as follows:
Year: Amount 1916 ....................... $ 45,683 36 1917 ....................... 143,447 64 1918 ....................... 263,128 71 1919 ....................... 911,834 75 1920 ....................... 1,857,925 37 _____________ $3,222,019 83
7. Pursuant to the agreement and in respect to the above-mentioned cash receipts of $3,222,019.83, the Woman's Institute paid or credited to the publishing company an aggregate of $193,321.19, as follows:
Pursuant to subdivision (a) of the third clause of the said agreement: On May 24, 1916 .................................. $ 50,000 00 Pursuant to subdivision (b) of the third clause of the said agreement: On September 22, 1916 ................ $ 4,000 00 On April 30, 1917 .................... 15,552 60 On April 27, 1918 .................... 13,000 00 On December 31, 1918 ................. 7,447 40 _________ 40,000 00 Pursuant to subdivision (c) of the third clause of the said agreement: In 1916 .............................. $ 842 26 In 1917 .............................. 4,502 20 In 1918 .............................. 7,240 01 In 1919 .............................. 25,144 07 In 1920 .............................. 56,188 15 In 1921 .............................. 9,440 70 ___________ $103,357 39 Refunded by International Educational Publishing Company ................. 36 20 ___________ Total payments under subdivision (c) 103,321 19 ___________ $193,321 19
No other credits or payments were made to the publishing company by the Woman's Institute in respect of the total gross receipts above mentioned.
The payments agreed to be made by the Woman's Institute under subdivision (c) of the third paragraph of the agreement of May 5, 1916, were 3 per cent. on the first $3,000,000 of the gross cash receipts, as defined in said subdivision, and 6 per cent. of such gross cash receipts in excess of $3,000,000.
The aggregate payment of $90,000 agreed to be made by the Woman's Institute, pursuant to subdivisions (a) and (b) of the third paragraph of the agreement, was equivalent to 3 per cent. of $3,000,000. The aggregate amount of $193,321.19 paid or credited to the publishing company by the Woman's Institute, pursuant to the third paragraph of said agreement, as set forth above, is equivalent to 6 per cent. of the gross cash receipts of $3,222,019.83 for the years 1916 to 1920, inclusive.
8. The Commissioner of Internal Revenue, in reaching his final decision that the correct tax upon the consolidated return for 1918 was $59,973.44, allowed as a deduction from gross income only $7,893.86, being an amount substantially equivalent to 3 per cent. of the aforesaid gross cash receipts of $263,128.73 for the taxable year 1918. The commissioner allowed no other deduction for 1918 in respect of the payments made by the Woman's Institute pursuant to the agreement of May 5, 1916.
9. The Woman's Institute kept its books of account on the accrual basis.
Dean G. Acheson, of Washington, D.C. (Raymond B. Goodell, of New York City, and Covington, Burling Rublee, of Washington, D.C., on the brief), for plaintiff.
Ralph C. Williamson, of Washington, D.C., and Charles B. Rugg, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, and WILLIAMS, Judges.
It is the contention of plaintiff that in respect of the payments to the publishing company, pursuant to the agreement of May 5, 1916, it was entitled to deduct $15,787.72 as an ordinary and necessary expense in determining consolidated net income for the year 1918, such amount being equal to 6 per cent. of the gross cash receipts of $263,128.71 for 1918.
It is agreed that if plaintiff is correct in this contention, the correct amount of tax for 1918 is $59,029.78 instead of $59,973.44 as collected by the defendant. The amount of interest and penalty collected by the defendant in respect of the difference between the tax paid and the aforesaid amount of $59,029.78 is $154.70.
The defendant contends that, since the royalties provided for under said contract were limited to 3 per cent. of such gross receipts, the sum of $7,893.86 is the total amount of payment by the Woman's Institute that accrued in the year 1918 and that no greater amount may be considered as a deductible expense for that year.
The defendant further contends that payments made or credited in 1918 to the publishing company under subdivisions (a) and (b) of the third paragraph of the contract accrued prior to 1918, and, in any event, such payments represented capital expenditures and consequently were not to be treated as expenses of conducting the business.
We are of opinion that the decision of the Commissioner of Internal Revenue was correct and that plaintiff was not entitled to recover.
Under the contract the amount of $90,000 was paid or accrued prior to the taxable year 1918. No portion of the amount therefore was a proper deduction as an ordinary and necessary expense of doing business in the year 1918.
The contract provided for the payment of a royalty of 3 per cent. upon the first gross cash receipts of $3,000,000, and thereafter a royalty of 6 per cent. The fact that the royalty of 3 per cent. on the first $3,000,000 provided in the contract may have been arrived at because of the first payment of $90,000 did not entitle the plaintiff to deduct in each year, until the gross receipt of $3,000,000 had been received, an amount equal to 6 per cent. of the gross receipts each year. The payments totaling $90,000 were in no way dependent upon the amount which the Woman's Institute might receive from the sale of the courses. The whole amount was a fixed obligation from the time the contract was signed. It was an obligation arising at the time the contract was made and was a payment for property rights of an income-producing nature available to the plaintiff from that time forward as long as the courses were desired.
It is argued on behalf of the plaintiff that if a proportionate part of the payments totaling $90,000, equal to 3 per cent. of the gross cash receipts in 1918, is not a proper deduction for that year as an ordinary and necessary expense, it was entitled to a deduction in that year of that amount for exhaustion of the capital assets acquired by payment of such $90,000. We are of opinion that there is no merit in this contention. The rights granted under the contract to the Woman's Institute to sell the courses in domestic science were of indefinite duration, and there is no basis for the computation of exhaustion under the statute. Coca Cola Bottling Co., 6 B.T.A. 1333.
The petition must be dismissed. It is so ordered.