Colony, Inc. v. Comm'r of Internal Revenue
| Decision Date | 09 April 1956 |
| Docket Number | Docket No. 53681. |
| Parties | THE COLONY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Andrew W. Duncan, Esq., and Don S. Sturgill, Esq., for the petitioner.
James F. Shea, Esq., for the respondent.
1. The petitioner is a corporation organized to acquire, subdivide, and sell real estate. It was organized with a total capital of $1,000. It obtained bank loans, secured by liens on its real estate, in an amount in excess of $149,000. Five of petitioner's stockholders paid over a total of $57,800 to petitioner and received petitioner's interest-bearing promissory notes in that amount. Held, the $57,800 paid over to petitioner by its stockholders constituted contributions to capital, rather than bona fide loans, and amounts paid by petitioner to the stockholders in 1948, 1949, and 1950 constituted nondeductible distributions in the nature of dividends rather than interest on indebtedness which is deductible under section 23(b) of the 1939 Code.
2. In determining its basis for gain or loss in the subdivision lots which it sold in 1946, 1947, and 1950, the petitioner added to its cost of the lots a pro rata portion of improvement expenses which it incurred or estimated that it would incur in developing the subdivision. Held, the cost of a water supply system which petitioner continued to own and operate during the taxable years did not constitute a development expense which could be added to petitioner's basis in the subdivision lots; held, further, petitioner's basis in the subdivision lots includes the amount of payments made by petitioner to two utility companies to induce the latter to extend their services to petitioner's subdivision; held, further, the respondent's determination that petitioner overestimated its development expenses in the amount of $5,590.82 is sustained.
3. For the taxable years ended October 31, 1946, and October 31, 1947, the petitioner omitted from gross income an amount properly includible therein which was in excess of 25 per cent of the gross income stated in its returns. The understatements of gross income resulted from overstatements of cost of goods sold, rather than from omissions of gross receipts. Held, the 5-year statute of limitations contained in section 275(c) of the 1939 Code is applicable, and the deficiencies determined for the years ended October 31, 1946, and October 31, 1947, are not barred. Estate of J. W. Gibbs, Sr., 21 T.C. 443, followed.
The Commissioner determined deficiencies in income tax and excess profits tax as follows:
+---------------------------------------------------------+
¦Year ended October 31 ¦Income tax ¦Excess profits tax ¦
+-----------------------+------------+--------------------¦
¦1946 ¦$7,988.72 ¦$2,356.71 ¦
+-----------------------+------------+--------------------¦
¦1947 ¦1,194.29 ¦ ¦
+-----------------------+------------+--------------------¦
¦1948 ¦987.31 ¦ ¦
+-----------------------+------------+--------------------¦
¦1950 ¦224.23 ¦ ¦
+---------------------------------------------------------+
The year ended October 31, 1949, also is involved because the amount of net operating loss sustained in that year will determine the amount of net operating loss deduction allowable for the year ended October 31, 1947. The issues to be decided are: (1) Whether payments made by petitioner to its shareholders in the amounts of $8,988.41, $3,468, and $3,468, in the taxable years ended October 31, 1948, 1949, and 1950, respectively, were deductible by petitioner as interest payments, or whether such payments were nondeductible distributions in the nature of dividends; (2) whether petitioner's cost of subdivision lots includes the expenditures made to construct a water supply for the subdivision and the payments made to public utilities in order to induce the utilities to extend their service to the subdivision; and (3) whether the deficiencies determined for the years ended October 31, 1946, and October 31, 1947, are barred by the statute of limitations.
The petitioner is a corporation organized under the laws of the State of Kentucky. Petitioner kept its books and filed its returns on an accrual method for fiscal years ended October 31. Petitioner's returns for the taxable years were filed with the collector of internal revenue for the district of Kentucky.
The petitioner's principal business is the development and sale of lots in a subdivision called The Colony, which is located outside the city limits of Lexington, Kentucky. The petitioner also owned a water supply and distribution system, and beginning in 1949, sold water to houses which were built in the subdivision.
Issue 1. Deduction of Payments to Stockholders.
The petitioner was incorporated on or about November 14, 1949. Its authorized capital stock, which was all issued, consisted of 400 shares of capital stock without par value. Its paid-in capital was $1,000, or $2.50 per share of capital stock.
On or about April 19, 1946, Hugh Meriwether, L. J. Blakely, and Charles Sturgill, as owners of all of the petitioner's stock, entered into an agreement with Dr. Halbert Leet. The agreement recited that Dr. Leet agreed to lend petitioner, on petitioner's note, the sum of $17,500 for 5 years with interest at 6 per cent, payable semiannually; that Meriwether, Blakely, and Sturgill agreed that they would convey to Dr. Leet, without further consideration, 10 per cent of petitioner's stock, that is, 40 shares; and that no dividends would be paid by petitioner without Dr. Leet's consent until the note was paid. The agreement between Dr. Leet and petitioner's shareholders provides, in part, as follows:
This memorandum of agreement between Hugh Meriwether, L. J. Blakely and Charles Sturgill, of Lexington, Ky., owners of the capital stock of the Kentucky corporation The Colony, parties of the first part, hereinafter called the ‘Stockholders,‘ and Dr. Halbert Leet, of Lexington, Ky., party of the second part, hereinafter called ‘Dr. Leet,‘ witnesseth that it is agreed by and between the parties hereto as follows:
Dr. Leet shall lend to the said corporation, The Colony on or before the 25th day of April, 1946, the sum of Seventeen Thousand five Hundred Dollars ($17,500.00) upon the latter's negotiable promissory note in the said sum of money to be dated the day said loan is made, and to be payable on or before five years after date, with interest thereon at the rate of 6% per annum, payable semi-annually, from its date until its payment.
The Stockholders shall, at the same time with the making of said loan, cause the said corporation to execute and deliver said note to Dr. Leet, and will assign and transfer to Dr. Leet as his own— without further consideration—ten per cent (10%) of the capital stock of said corporation: and they, and their successors, if any, in the ownership of their respective shares of stock of said corporation, shall see to it that no dividend is paid by said corporation, (except with the consent of Dr. Leet or his successors in ownership of said 10% of the stock) until said note (and any similar note issued or to be issued by the corporation under similar circumstances) shall have been paid.
On April 24, 1946, Dr. Leet paid $17,500 to petitioner in exchange for its note, and received 40 shares of petitioner's stock from Meriwether, Blakely, and Sturgill. On the same day, L. B. Shouse also paid $17,500 to petitioner in exchange for its note, and received 40 shares of petitioner's stock from Meriwether, Blakely, and Sturgill. Also, on the same day, Meriwether, Blakely, and Sturgill each paid $7,600 to petitioner in exchange for similar promissory notes. The total amount received by petitioner on April 24, 1946, from the five individuals in exchange for its notes was $57,800. The notes issued by petitioner stated that repayment was to be made in 5 years, that is, on April 24, 1951, and that interest was payable at the rate of 6 per cent.
Prior to the end of petitioner's first fiscal year, on October 31, 1946, petitioner also issued notes in the amount of $149,403 to banks. The notes held by the banks were secured by liens on petitioner's real estate.
Also, prior to October 31, 1946, Gilmore N. Nunn acquired 4 shares of petitioner's stock from Meriwether, Blakely, and Sturgill. On October 31, 1946, petitioner's stock and notes payable were held as follows:
+-----------------------------------------------------------------------------+
¦ ¦Shares of ¦Investment in stock ¦Face amount of ¦
¦Name ¦petitioner's ¦at $2.50 per share ¦petitioner's notes¦
¦ ¦stock ¦ ¦ ¦
+-------------------+----------------+---------------------+------------------¦
¦Hugh Meriwether ¦105 1/3 ¦$263.34 ¦$7,600 ¦
+-------------------+----------------+---------------------+------------------¦
¦L.J. Blakely ¦105 1/3 ¦263.33 ¦7,600 ¦
+-------------------+----------------+---------------------+------------------¦
¦Charles Sturgill ¦105 1/3 ¦263.33 ¦7,600 ¦
+-------------------+----------------+---------------------+------------------¦
¦Dr. Halbert Leet ¦40 ¦100.00 ¦17,500 ¦
+-------------------+----------------+---------------------+------------------¦
¦L.B. Shouse ¦40 ¦100.00 ¦17,500 ¦
+-------------------+----------------+---------------------+------------------¦
¦Gilmore N. Nunn ¦4 ¦10.00 ¦ ¦
+-------------------+----------------+---------------------+------------------¦
¦Total--shareholders¦400...To continue reading
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