Mims Hotel Corp. v. Comm'r of Internal Revenue

• Decision Date: 08 December 1949
• Docket Number: Docket No. 19327.
• Citation: 13 T.C. 901
• Parties: MIMS HOTEL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

13 T.C. 901

MIMS HOTEL CORPORATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 19327.

Tax Court of the United States.

Promulgated December 8, 1949.

1. The taxpayer corporation's two principal stockholders each took out a $50,000 insurance policy on his life, designating his estate as beneficiary, and they immediately assigned the policies to the issuing insurance company as security for a loan which the company made to the taxpayer. In the assignment it was specified that proceeds be applied to liquidation of the loan; the taxpayer paid the policy premiums and carried the policies on its books as an asset at cash surrender value. Application for and assignment of the policies were conditions prescribed by the insurance company for making the loan. The insurance proceeds applied to the loan upon a stockholder's death, held, not includible in equity invested capital as defined in section 718(a), Internal Revenue Code, since under the wording of the assignment the stockholder's estate had no right of subrogation against the taxpayer. Walker v. Penick's Executor, 122 Va. 664; 95 S.E. 428.

2. The depreciable life of slip covers and reupholstered hotel furnishings, held, on the evidence to be four years. Richard G. Herndon, Esq., for the petitioner.

Paul E. Waring, Esq., for the respondent.

The Commissioner determined deficiencies of $665.32 and $355.87 in petitioner's income and declared value excess profits taxes, respectively, for the fiscal year ended May 31, 1944, and a deficiency of $10,201.73 in excess profits tax for the fiscal year ended May 31, 1945. As to fiscal 1944 petitioner assigns error in the disallowance as a deduction of amounts expended for new slip covers and the reupholstering of its hotel furniture. As to fiscal 1945, it claims the right to include in equity invested capital the proceeds of an insurance policy taken out on the life of a large stockholder and assigned as security for petitioner's loan from the insurance company, the proceeds on the stockholder's death being applied directly in payment of the loan.

FINDINGS OF FACT.

Petitioner, a Virginia corporation with principal office at Luray, Virginia, filed its income tax, declared value excess profits tax, and excess profits tax returns for the fiscal years ended May 31, 1944 and 1945, with the collector of internal revenue for the district of Virginia. Its books are kept and its returns prepared on an accrual basis of accounting.

Petitioner was engaged during the taxable years in the operation of a tourist hotel, known as the Mimslyn, located at Luray. It was organized in 1930 by John W. and Ralph E. Mims, brothers, to each of whom it issued 500 shares of its stock of a par value of $100 a share in consideration of $25,000 cash and their transfer to it of property having an agreed value of $75,000. This property consisted of 5 parcels of land in Luray and some personalty. Petitioner also issued 127 shares to 20 other individuals, including 15 shares to Henry T. Mims, a brother of John W. and Ralph E. Mims, who was engaged in the operation of hotels in Pittsburgh, Pennsylvania.

Pursuant to an understanding reached prior to the issuance of the shares, petitioner procured a $150,000 loan from the Shenandoah Life Insurance Co. (hereinafter called Shenandoah), of Roanoke, Virginia, with which to erect a new hotel on part of the land transferred to it. This loan was evidenced by eight 6 per cent bonds for $10,000 each, dated October 21, 1930, of which one was to mature on October 21, 1932, and one on October 21 of each succeeding year, and by one 6 per cent bond for $70,000, dated October 21, 1930, which was to mature on October 21, 1940. On May 19, 1931, petitioner borrowed from Shenandoah an additional $15,000 and gave an additional bond in that amount which was to mature on May 19, 1941. These bonds, evidencing an aggregate indebtedness of $165,000, were endorsed by John W. and Ralph E. Mims and were further secured by a first deed of trust on all petitioner's property. In agreeing to make the loan Shenandoah also required that John W. and Ralph E. Mims:

* * * each take out $50,000.00 of ordinary life insurance (first premium to be taken out of loan), which is to be kept in force unencumbered during the life of the loan, and to be assigned to us as further security for the loan; proceeds of either policy, in the event of the death of insured, to be applied to the liquidation of the loan, that is, assuming that you are both insurable.

Each brother made application to Shenandoah on July 30, 1930, for a policy of insurance on his life, and on October 3, 1930, Shenandoah issued a policy to each, promising to pay $50,000 to the insured's executors or administrators on receipt of due proofs of death. Each insured reserved the right to change the beneficiary, and on October 31, 1930, each assigned his policy to Shenandoah ‘for value received and in further consideration of a mortgage loan made by the Shenandoah Life Ins. Co. to the Mims Hotel Corporation.‘ The assignments of the policies expressly conveyed:

* * * all right, title and interest therein, together with all moneys which may be now due or hereafter payable thereunder, and all dividends, benefits, options and advantages to be derived therefrom, including the right to surrender said Policy and to receive the surrender value thereof; * * *

The annual premium on the policy insuring John W. Mims was $1,332; on that insuring Ralph E. Mims, $1,191. On petitioner's books annual debits of $2,523, the sum of these figures, described as ‘Life Ins. Prem.,‘ indicate their payment by petitioner. In the surplus account there is a credit of $5,000 in 1936 ‘To set up cash value Life Ins.,‘ and credits in subsequent years ‘To adj. cash val. of Life Ins.‘

The Mimslyn Hotel was opened in 1932, but its operation for the next six years was not profitable. Petitioner defaulted in payment of three of the $10,000 bonds at maturity, and by April 5, 1939, it had reduced the indebtedness only to $125,000. On that date Shenandoah advised it by letter:

* * * that if these loans are reduced to the sum of $100,000.00 by October 21, 1940, we will renew this balance of $100,000.00 for a period of ten years, with interest at the rate of 5% per annum, payable semi-annually, to be repaid in principal curtailments during each year in the aggregate sum of $10,000.00

This extension will be based upon the same terms and conditions as set out in the original deed of trust as to your maintaining fire insurance, payment of taxes, etc., and the maintenance of the two life insurance policies of $50,000.00 each on the life of each of you gentlemen, which are now assigned, and are to continue to be assigned to us as additional protection in connection with this mortgage.

By September 1939 petitioner had made further payments of $4,000, reducing the indebtedness to $121,000. On September 24, 1939, John W. Mims died, and on October 5, Shenandoah advised petitioner that it was crediting on the indebtedness the $50,000 payable under the insurance policy on his life:

* * * this policy being assigned to this Company as collateral security for the re-payment of the above mortgage on which the said John Wright Mims was personal endorser. At petitioner's request Shenandoah returned the four remaining $10,000 bonds, with interest coupons marked paid, and acknowledged credits reducing the principal due on the two outstanding bonds to $71,000. On its journal petitioner debited $50,000 as ‘Bonded Debt‘ and credited surplus with a like amount, explained as:

Life Insurance policy carried on Jno. W. Mims, dec'd. by the Corp. for the benefit of the holders of the first mortgage bonds applied. See letter from Shenandoah Life Ins. Co. dated Nov. 21st, 1939.

By this credit of $50,000, entered November 22, 1939, a book deficit of $38,162.93 in the surplus account was converted into a surplus of $11,837.07. On its tax return for the fiscal year 1939 petitioner reported the $50,000 as nontaxable income from a life insurance policy.

By instrument dated October 21, 1940, Shenandoah agreed to payment of the remaining $71,000 due on the bonds in annual installments of $5,000, reduced interest to 5 per cent, and released Ralph E. Mims and the estate of John W. Mims from any liability by reason of their individual endorsements. But it specified that the $50,000 policy on the life of Ralph E. Mims ‘* * * be kept in full force and shall continue to be assigned to the first party as additional security for the payment of the balances due as aforesaid.‘

When John W. Mims died, he owed his mother $10,000 and Ralph E. Mims owed her $16,000 on the purchase price of some of the lands which they transferred to petitioner for its shares. She originally held a first mortgage on the lands securing payment of this indebtedness, but, to enable petitioner to procure the loan from Shenandoah in 1930, she released her mortgage, and each brother gave to her as security his 500 shares of petitioner's stock. After John W. Mims' death and on December 15, 1939, the third brother, Henry T. Mims, purchased his deceased brother's 500 shares from the estate for $30,000. He discharged $10,000 of the price by assuming the debt due to the mother. In the sale contract it was agreed that the estate had no interest in or claim against petitioner, and that, if any claim should later appear to exist, the estate would assign it without consideration to the...