1432 Broadway Corp. v. Comm'r of Internal Revenue

• Decision Date: 20 April 1945
• Docket Number: Docket No. 1828.
• Parties: 1432 BROADWAY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

4 T.C. 1158

1432 BROADWAY CORPORATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 1828.

Tax Court of the United States.

Promulgated April 20, 1945.

Amounts accrued by a corporation as interest on debentures issued to its shareholders with shares at the time of incorporation, held, under the circumstances, not deductible as interest. A. Loeb Salkin, Esq., and David Boyd Chase, Esq., for the petitioner.

Sidney B. Gambill, Esq., and Laurence F. Casey, Esq., for the respondent.

The Commissioner determined deficiencies as follows:

+----------------------------------------------------------------+
                ¦                                 ¦1939     ¦1940      ¦1941     ¦
                +---------------------------------+---------+----------+---------¦
                ¦Income tax                       ¦$2,168.89¦$29,493.18¦$9,508.40¦
                +---------------------------------+---------+----------+---------¦
                ¦Declared value excess profits tax¦         ¦4,113.54  ¦5,829.12 ¦
                +---------------------------------+---------+----------+---------¦
                ¦Excess profits tax               ¦         ¦20,955.60 ¦26,478.41¦
                +----------------------------------------------------------------+
                

Of several adjustments, petitioner assails the disallowance of a deduction taken as interest.

FINDINGS OF FACT.

The taxpayer, a New York corporation, was incorporated May 23, 1932. Its books were kept and its returns were made on an accrual and a calendar year basis. Its returns were filed in the third district of New York.

Al Hayman, a resident of New York, died February 10, 1917, and by his will he bequeathed the residue of his estate in trust, the income to be paid to his wife, Minnie Hayman, during life and the remainder, after retaining in trust $250,000 and payment of specific bequests, to be divided equally among the surviving children of his sisters, Rose Hochstadter, Blanche Meyer, and Ella Bernheimer. Minnie Hayman died April 16, 1928. Five children each of Ella Bernheimer and Rose Hochstadter and four children of Blanche Meyer survived testator, and in 1931 they resided in various places in the United States. The property to be divided among the surviving children included real property and improvements at 1428-1432 Broadway and 116-132 West 40th Street, New York City. By a lease dated January 28, 1920, made by the executors with Famous Players-Lasky Corporation, the part of the above premises known as the Empire Theatre Buildings was leased for a term beginning May 1, 1922, and ending April 30, 1943, at an annual rental of $50,000. By a lease dated May 1, 1920, made with the New York Gekco Co., the remaining part of the premises was leased for a similar term at an annual rental of $35,000. The lessees were required to pay maintenance and operation expenses, alterations and repairs, taxes, assessments, water rents, and insurance.

At the incorporation of taxpayer the depreciated inheritance tax valuation of the real property as of the date of Al Hayman's death was:

+--------------------------------------------------------------+
                ¦Land                                         ¦       ¦$871,000¦
                +---------------------------------------------+-------+--------¦
                ¦Buildings                                    ¦$59,000¦        ¦
                +---------------------------------------------+-------+--------¦
                ¦Less depreciation (1917-1931), 15 years at 2%¦17,700 ¦        ¦
                +---------------------------------------------+-------+--------¦
                ¦                                             ¦       ¦41,300  ¦
                +---------------------------------------------+-------+--------¦
                ¦Total                                        ¦       ¦912,300 ¦
                +--------------------------------------------------------------+
                

Upon petition of Sanford J. Bernheimer, one of the children of Ella Bernheimer, the Surrogate's Court of New York, on August 17, 1931, ordered the sale of the above property at public auction for cash at any date after October 1, 1931, but not later than November 15, 1931. The other parties in interest wanted to avoid such a sale. Several plans were submitted to Bernheimer and were rejected. By order of the court the sale was postponed to December 10, 1931. An agreement was made December 5, 1931, by Bernheimer, as first party, and the others, as second parties, for the sale to them of Bernheimer's one-fourteenth interest for $85,714.28, payable $25,000 on December 30, 1931, and $60,714.28 on June 30, 1932, plus 6 percent interest from December 30, 1931, but subject to the deduction of one-fourteenth of all expenses incurred by the trustee of the residuary estate on or before December 30, 1931, for advertising the sale, auctioneers' fees, title examination, and trustee's commissions.

After further negotiations, the parties, other than Bernheimer, made a ‘Syndicate Agreement‘ on January 29, 1932, wherein Joseph Milner, Lionel Straus, and Lester Meyer were designated as ‘Managers‘ and the parties in interest ‘Syndicate Members,‘ and whereby, after reciting, inter alia, that:

the Syndicate Members are desirous of combining their several interests as beneficiaries under the said last will and testament, for the purpose of acquiring, in the manner hereinafter set forth, and operating and holding the said property,

the syndicate members formed a syndicate:

To acquire the said real and personal property, and to provide the finances required for the maintenance and operation thereof; and in order to facilitate their accomplishment of said purposes, said Syndicate Members do hereby designate and appoint Joseph Milner, Lionel Straus, and Lester Meyer, their Managers, and do hereby confer upon them the powers and authority hereinafter set forth.

To provide funds for the purchase of the Bernheimer interest, the syndicate members agreed to authorize the trustee of the Hayman residuary estate to pay $25,000 to Bernheimer without making similar payment to each of the syndicate members, and the managers were authorized at any time in their discretion to borrow on first mortgage maturing not less than three years thereafter covering the real estate, and to use the amount borrowed to pay the balance due Bernheimer and certain enumerated expenses. The balance, less $75,000, was to be distributed among the syndicate members ‘for their own use and benefit, pro rata, according to their respective distributive shares of said real property. ‘ The managers were authorized to form a corporation ‘to hold and operate real and * * * personal property,‘ to convey to the corporation the real estate and $75,000 or any lesser sum retained by them from the borrowed funds, and to cause the corporation to issue to them jointly in full payment all its capital stock and debentures, the capital stock to be assigned by the managers to themselves as voting trustees. It was provided that the voting trustees should not vote in favor of the sale of the real property unless the sales price be $1,200,000 or more, and:

That so long as the amount of cash or its equivalent in the form of liquid investments to the credit of the Reserve Fund for Contingencies of said corporation shall be not less than Seventy five thousand ($75,000) Dollars, said Voting Trustees shall, so far as they prudently may, cause said corporation to distribute quarter-annually to its Debenture holders and/or Stock holders, all surplus income of said corporation.

The primary purpose of the syndicate agreement was to provide for the ownership and operation of the property by a corporation until it could be sold and in the meantime to distribute all surplus earnings and profits, except for the reserve for contingencies, to the syndicate members.

At the time the syndicate agreement was executed, the thirteen parties in interest conveyed the property to the managers. The managers on June 3, 1932, borrowed $300,000 from the Bank for Savings in the city of New York, for a term of five years at 5 1/2 percent interest, payable semiannually, with the right to pay multiples of $10,000 of principal on any interest date, and as collateral security for the payment of the indebtedness a mortgage upon the property maturing June 3, 1937, was given to the bank. Out of such funds approximately $60,000, the balance due Bernheimer, was paid to him, and he conveyed his undivided one-fourteenth interest to the managers. Also out of such funds the managers paid to the members $195,000 and some miscellaneous expenses, leaving $40,000 in their hands.

Pursuant to the syndicate agreement, the taxpayer corporation was organized May 23, 1932, with a capital stock of 390 no par shares, consisting of 120 class A, 120 class B, and 150 class C. Holders of class A shares were entitled as a class to elect the class A director, and the holders of class B and class C were similarly entitled to elect the class B and the class C directors, respectively. The three class directors were not required to be shareholders. The duration of the corporation was to be perpetual and its purposes were, among other things, to acquire 1428-1432 Broadway and 116-132 West 40th Street; to maintain, operate, and develop such property, and any property for which it might be exchanged; to borrow money; and to issue its own shares and debentures for the acquisition of such real property.

At the first meeting of the corporation, May 23, 1932, the syndicate managers offered to transfer and convey to the corporation $40,000 and the real property upon the condition that the corporation issue all its authorized capital stock to voting trustees as designated and ‘Ten Year 7% Debenture Bonds‘ to the syndicate members in the amounts set opposite their names aggregating $1,170,000. This proposal was accepted.

On June 3, 1932, the syndicate managers made a voting trust agreement and assigned to themselves as voting trustees all the capital stock, to be held by them subject to the trust agreement. The voting trustees were to issue voting trust certificates to the syndicate members. Joseph Milner was designated as the...