Opinion
No. 138.
March 6, 1943.
Petition for Review of a Decision of the Tax Court of the United States.
Petition by the American Hotels Corporation for review of a decision of the Tax Court of the United States holding petitioner liable for deficiency in income and excess-profits taxes determined by the Commissioner of Internal Revenue for the taxable year 1937 under the Revenue Act of 1936.
Affirmed.
The taxpayer is engaged in the business of supervising the operation of hotels for the Metropolitan Life Insurance Company and other hotel owners. The taxpayer has a wholly owned subsidiary named the Hotel Operating and Management Corporation. On December 9, 1931, the Management Corporation entered into an agreement with Metropolitan. This agreement provided that the Management Corporation was to operate the Carter Hotel of Cleveland, Ohio, on behalf of Metropolitan; that the Management Corporation was to pay to Metropolitan the entire net earnings of the hotel, the "entire net earnings" being defined as the gross earnings less the expenses of management and less a management fee of $20 per room per year which was to be paid to the taxpayer; and that any deficit in the operation of the Hotel was to be borne by Metropolitan. The agreement contained the following guarantee of the taxpayer: "The American Hotels Corporation hereby guarantees to the Metropolitan Life Insurance Company the performance of all of the terms and conditions of the above lease." At the expiration of this agreement, on February 28, 1937, the Management Corporation and Metropolitan entered into a lease providing for the lease of the hotel to the Management Corporation for a fixed rental; Metropolitan was to share in the profits derived from the operation of the hotel and no fees for management supervision were to be paid to the taxpayer.
During 1933 and 1934, F.B. Taylor, a manager of the hotel, misappropriated funds of the hotel to finance a liquor company. The amount of the misappropriation amounted to $64,000, which was reduced to approximately $42,000 by recoveries from bonding companies and otherwise. On March 30, 1934, Taylor executed a note payable to the Management Corporation in the sum of $8,000 and a statement acknowledging indebtedness to the Management Corporation on four items totaling $35,121.85. On December 9, 1937, Metropolitan, in a letter to the taxpayer, inquired what the taxpayer proposed to do concerning the shortage of $42,000. On December 19, 1937, the taxpayer replied as follows: "While we are not conceding any legal liability in this situation, but in order to get the whole matter out of the way, the Hotel Operating and Management Corporation is willing to pay the Metropolitan Life Insurance Company ten percent (10%) of the amount of $42,000 or $4,200 — the terms of payment to be arranged later on; this payment to close the matter up and to satisfy any possible claim which the Metropolitan Life Insurance Company might have against the Hotel Operating and Management Corporation." Taxpayer's offer to settle Metropolitan's claim was prompted by its desire to retain the goodwill of Metropolitan with which corporation the taxpayer did a substantial business. Taypayer's president testified: "I never at any time admitted any legal or moral liability on the so-called Carter claim. My reason for making this offer of the percent was based on the fact that the goodwill of the Metropolitan Life Insurance Company was very important to the American Hotels Corporation * * *. Therefore it was very important for us to keep on the best of terms. I was perfectly willing to make any kind of settlement I could * * *. I was prepared to go beyond the $42,000 figure."
On January 28, 1938, Metropolitan advised the taxpayer that it would be satisfied if the taxpayer would pay $25,000 and if the taxpayer would secure for Metropolitan Taylor's note for $12,000. After some negotiation concerning the method of payment, it was agreed on April 11, 1938 that the taxpayer would pay to the Metropolitan Life $1,000 a month for 25 months. Beginning in April, 1938, the taxpayer paid $1,000 a month to Metropolitan until $25,000 was fully paid.
Taxpayer kept its books and made its income tax returns on the accrual basis. It deducted on its 1937 income tax return the $25,000 representing the amount agreed upon in 1938 as in settlement of the claim. The Tax Court held that the deduction for 1937 was not proper because, inter alia, no definite amount had been fixed in that year.
Henry A. Mulcahy, of New York City, for petitioner.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Helen R. Carloss, and Carolyn E. Agger, Sp. Assts. to Atty. Gen., for respondent.
Before L. HAND, CHASE and FRANK, Circuit Judges.
We assume, arguendo and without so deciding, that the taxpayer was liable to Metropolitan for the $25,000 which it paid to Metropolitan in 1938, and that, even if there was no liability, that amount was one of "the ordinary and necessary expenses * * * incurred" by the taxpayer within the meaning of 26 U.S.C.A. Int.Rev.Code § 23. For, even if we do so assume, still the taxpayer cannot win.
Under 26 U.S.C.A.Int.Rev. Code, § 43, when, as here, the taxpayer keeps its books on an accrual basis, such a deduction can be taken only for the taxable year in which the expense was "incurred." That means that there must be some reasonably clear definitization, within that year, of the amount of the expenses. Whether or not there was, depends upon the peculiar facts of each particular case. We think that here there was substantial evidence to sustain the finding of the Tax Court that there was no such definitization in the taxable year 1937.
In that year the taxpayer offered to pay $4,200. Had it then said unconditionally that it would pay that sum, leaving open for further negotiations any greater liability, perhaps it could have deducted $4,200 for 1937. But that it did not do; it offered that amount only on condition that it be released in full. The amount claimed by Metropolitan was $42,000, and the taxpayer, although it did not so advise Metropolitan, was then prepared to go even beyond that limit; but taxpayer, in 1937, did not know how far it would go; it was ready to pay anything from $4,200 up to an undetermined maximum. In fact, in 1938, it agreed to pay $25,000. But, as there was no expression in 1937 of a willingness unconditionally to pay any definite amount, we cannot say that the Tax Court was not justified in finding that no expense was then incurred.
The order of the Tax Court is affirmed.