Opinion
Docket No. 31622.
1952-10-30
MEYER BROS., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Morris D. Meyer, Esq., for the petitioner. Paul M. Newton, Esq., and J. Marvin Kelley, Esq., for the respondent.
Morris D. Meyer, Esq., for the petitioner. Paul M. Newton, Esq., and J. Marvin Kelley, Esq., for the respondent.
1. Held, rental expenses, taken as a deduction by a corporation should be reduced in the amount of an allowance granted by the lessor to the corporation for replacement and repair of rented items.
2. Held, deduction for contributions should be increased to 5 per cent statutory limit on the increased net income.
The respondent determined a deficiency in the income tax of the petitioner for the fiscal year ended January 31, 1947, in the amount of $826.53. The issues presented are whether rental expenses should be reduced in the amount of an allowance made by a lessor to the petitioner to replace and repair rented equipment, and whether the petitioner's deductions for contributions are in excess of the statutory limitation.
FINDINGS OF FACT.
The facts stipulated are so found.
The petitioner, Meyer Bros., Inc., is a corporation organized in 1945 under the laws of the State of Texas, which is engaged in operating neighborhood department stores in and around Houston, Texas. Its income tax return was prepared on the accrual basis for a fiscal year beginning February 1 and ending January 31. The return for the fiscal year ended January 31, 1947, was filed with the collector of internal revenue for the first district of Texas.
On November 16, 1945, the petitioner entered into a lease agreement with Suburban Building Company of Houston, Texas, and others. The lease provided, in part, as follows:
4.
Lessor warrants that Lessor has good title, free and clear of all encumbrances and liens of every kind and character, to all of the furniture, fixtures, equipment, machinery, and all other fixed assets other than merchandise, located in, upon, or connected with said hereinabove described premises, that is, not only the premises owned in fee by Lessor, but likewise with regard to the premises leased by Lessor from the said Klein.
5.
Lessor has leased, let, and rented, and by these presents does lease, let, and rent, unto the Lessee for a period of twenty-five (25) years, commencing on the first day of JANUARY, 1946, and ending on the 31st day of DECEMBER, 1971, together with all of the furniture, fixtures, equipment, machinery, and all other fixed assets other than merchandise, the four (4) store buildings and land described in Paragraph 1 of this agreement.
Lessor assigns and transfers to Lessee the unexpired portion of the lease existing between Nathan Klein, as Lessor, and the herein named Lessor in the capacity of Lessee, covering the premises at 2525 University Boulevard, together with all of the furniture, fixtures, equipment, machinery, and all other fixed assets other than merchandise.
6.
In consideration of the lease of the premises hereinbefore described and consisting of the five (5) store locations mentioned in Paragraphs 1 and 2 of this lease, Lessee has agreed and does hereby agree to pay to Lessor, as rental, five (5%) per cent of the annual net sales of all merchandise sold in the above stores for each fiscal year ending January 31st, not, however, including net sales by leased departments. In this connection a leased department is defined as a department not owned by Lessee, but which is operated in the leased premises by some other person or firm on a percentage basis, with or without a fixed minimum rental. With regard to leased departments Lessee agrees to pay to Lessor two (2%) per cent of the amount of the net sales of said leased departments.
It is understood, however, that in the event that the net sales of the leased departments exceed fifteen (15%) per cent of the total net sales, then such excess net sales of leased departments shall be subject to the application of the five (5%) per cent rental basis.
In the event that the rental figured on the above basis does not aggregate as much as FIFTY THOUSAND ($50,000) DOLLARS, then Lessee agrees that the minimum rental for the hereinbefore described property shall be FIFTY THOUSAND ($50,000) DOLLARS per year. In other words, Lessor shall pay to Lessor a minimum of $50,000 per year as rental, unless the rent figured on a percentage basis is greater than $50,000 a year, in which event the amount of rent to be paid by Lessee to Lessor shall be on the percentage basis.
In connection with the payment of the rental, Lessee shall pay to Lessor the sum of FORTY-ONE HUNDRED SIXTY-SIX AND 66/100 ($4166.66) DOLLARS each month, beginning on the 1st day of January, 1946, and an equal amount on the first day of each and every succeeding month, up to and including May 31, 1951, at which latter date the lease agreement with Nathan Klein expires. In calculating the rental on the percentage basis, the same shall be calculated on an annual basis in accordance with the fiscal year that Lessee has adopted, which fiscal year ends on the 31st day of January of each year. However, Lessee agrees to calculate the sales for each six (6) months of said fiscal year and on or before August 31st and February 28th of each year beginning with the year 1946, Lessee shall submit to Lessor a statement setting out the amount of the net sales made by Lessee for the previous six (6) months, showing a break-down as between a) net sales made by all departments other than leased departments and b) net sales made by leased departments. Lessee shall thereupon calculate whether any additional rental is due to Lessor and if there be additional rental due by Lessee to Lessor, Lessee shall forward to Lessor a check covering the difference between the rents calculated on the percentage basis set out herein, on the one hand, and the actual amount of rental paid, on the other hand. In the event that Lessee shall pay to Lessor for any six months' period an excess over and above the minimum rental and should it occur that during a subsequent six months' period of the same annual fiscal year the rent figured on a minimum basis is greater than on the percentage basis, an adjustment shall be made between Lessor and Lessee so that for the entire fiscal year Lessor shall be paid by Lessee either the minimum for the full fiscal year or on the percentage basis for the entire fiscal year, whichever is the greater.
8.
Lessor shall be required to maintain the exterior of the premises, both those owned by Lessor and that one under lease to Lessor, in good and presentable appearance and shall further be required to assume and take care of each and every expense necessary to keep the said exterior of premises in a good and presentable appearance and in good and tenantable condition, including, but not limited to, sewage and plumbing outside of the buildings, repairs of structural nature, and the maintenance of main walls, main timbers, exteriors, foundations, roofs, and plate glass. Lessee shall maintain all heating, air-conditioning, lighting installations, and equipment, as well as all machinery installed in the premises or which may hereafter be installed in said premises. All cash registers, adding machines, calculating machines, typewriters, and billing machines shall be repaired at the expense of Lessee.
Lessee shall not be required to purchase any equipment of any kind or character, but if Lessee so chooses to do so, then, such fixtures, equipment, etc., purchased at the expense of Lessee shall at all times remain the property of Lessee.
In order to replace, repair, and otherwise take care of any fixtures, furniture, machinery, or other equipment which becomes obsolete or wears out or which is not deemed by Lessee to be usable, it is particularly and especially understood and agreed that Lessor shall make an allowance to Lessee of a) eight (8%) per cent of one-fifth (1/5) of the minimum rental for each fiscal year during the term of this lease or b) eight (8%) per cent of one-fifth (1/5) of the amount of rental paid in each fiscal year during the term of this lease by Lessee to Lessor,— whichever is the greater. The sum in question shall be retained by Lessee and shall be set up in a Reserve Fund and shall be used by Lessee for the purpose of replacing, repairing, and otherwise taking care of any fixtures, furniture, machinery, and other equipment as mentioned herein.
For the fiscal year ended January 31, 1947, an amount, calculated on the basis of the provisions of paragraph 6 of the lease, was deducted on petitioner's income tax return as rent. A sum was retained by the petitioner in accordance with paragraph 8 of the lease in the amount of $1,641.56. This amount was not deposited in a special bank account or escrow nor was it physically segregated from the petitioner's general funds. The amount was entered on the petitioner's books as a credit to a reserve account and designated for income tax purposes as ‘Reserve replacement fixtures.‘ No debits to this account were entered by the petitioner during the taxable year.
OPINION.
VAN FOSSAN, Judge:
The initial question to be determined is the proper amount deductible as rent by the petitioner.
The lease agreement for the five buildings, equipment, machinery, and fixtures rented by the petitioner for 25 years required the petitioner, in paragraph 6, to pay a fixed percentage of net sales as rent with a minimum of $50,000 annually. This amount was accrued and deducted by the petitioner upon its return. The amount of $1,641.56 was accrued on the petitioner's books as a reserve for the replacement of equipment. This amount was not paid or accrued to the lessor. The character of this item is the matter at issue.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a 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.
The lease agreement required the lessor to maintain the exterior of the premises. The petitioner, as lessee, was required to maintain the fixtures and equipment. All cash registers, adding machines, calculating machines, typewriters, and billing machines owned and furnished by the lessor were to be repaired at the petitioner's expense. The petitioner was not required to purchase any equipment, and, if it chose to do so, the fixtures and equipment so purchased were to remain its property. An agreement was reached concerning replacement of equipment by which the lessor made an allowance to the petitioner calculated as a percentage of the minimum rental or rental paid, to replace, repair or take care of fixtures, furniture, machinery or other equipment becoming obsolete or deemed unusable by the petitioner. This allowance was to be retained by the petitioner and set up in a reserve fund to be used by it, if it so elected, for the purposes above specified.
The lease agreement entered into, thus provided for a division of obligations. The lessor was to maintain certain external features of the property. The petitioner bore the obligation to maintain and repair machinery and equipment but was not required to purchase any such items. The reserve fund was created for repair and replacement of machinery and equipment, to be so used at the petitioner's discretion. Incidentally, the effect of the arrangement was that the lessor's obligation for replacement of interior equipment was limited to the amount annually allowed to the petitioner for the reserve fund.
As a result of the agreement upon the problem of replacement of rented equipment, the lessor allowed the petitioner to retain $1,641.56 during the taxable year calculated on the basis of the rent to be credited to the reserve fund. Whether considered as a return of a portion of the rent paid, the practical result was that the lessor received a smaller amount annually for the rent of the building and equipment. The reserve fund was never paid to the lessor but was retained by petitioner.
In our opinion, the lease agreement, when read as a whole, as it must be, Estate of Budd Frankenfield, 17 T.C. 1304, grants the petitioner a reduced amount of rent so as to provide a fund for the replacement of whatever equipment petitioner desired to replace. The $1,641.56 cannot be considered rent for it was neither paid nor accrued to the benefit of the lessor but was an amount deducted from payments to the lessor in accordance with the mutual agreement covering the problem of replacement of rented equipment which becomes unusable. The cases of Broadcast Measurement Bureau, Inc., 16 T.C. 988, and Seven-Up Co., 14 T.C. 965, cited by petitioner, are not helpful to its contention that the amount of rent specified by paragraph 6 of the lease is deductible without diminution in the amount retained. Those decisions were concerned with the question whether or not amounts received and in the hands of the taxpayers were trust funds or income. Here we are concerned with the amount actually paid or accrued by the petitioner as rent. The sum in question in this proceeding was not received by the petitioner, it was retained by it.
Nor is the $1,641.56 entered on the petitioner's books in the taxable year as a reserve fund susceptible to deduction as repair expenses. No debits were made to this account in the fiscal year and it remained a reserve for its stated purpose. The expenses for which the reserve was created had yet to be incurred. No liability for expenses had accrued in the first year of operation of the lease. Until liability for such contingent expenses had been fixed and determined, a deduction could not be taken. Lucas v. American Code, Inc., 280 U.S. 445; Brown v. Helvering, 291 U.S. 193; Amalgamated Housing Corporation, 37 B.T.A. 817, affd. 108 F.2d 1010. Respondent's determination is affirmed.
The second issue in this proceeding is purely a matter of mathematical calculations and is entirely dependent upon the answer to the first issue. The 5 per cent limitation found in section 23 (q) of the Internal Revenue Code
on contributions, is related to net income. The petitioner's net income is, as a result of this decision, increased in the amount of $1,641.56 by the disallowance of the rental expense deduction in this amount. The parties agree that a larger deduction for contributions becomes proper when the percentage figure is applied to the increased net income. This increase in contributions deduction has already been included in the deficiency determined by the respondent.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(q) CHARITABLE AND OTHER CONTRIBUTIONS BY CORPORATIONS.— In the case of a corporation, contributions or gifts payment of which is made within the taxable year to or for the use of:to an amount which does not exceed 5 per centum of the taxpayer's net income as computed without the benefits of this subsection. Such contributions or gifts shall be allowable as deductions only if verified under rules and regulations prescribed by the Commissioner, with the approval of the Secretary.
Decision will be entered for the respondent.