Indus. Addition Ass'n v. Comm'r of Internal Revenue

• Decision Date: 30 December 1942
• Docket Number: Docket No. 103753.
• Citation: 1 T.C. 378
• Parties: INDUSTRIAL ADDITION ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

1 T.C. 378

INDUSTRIAL ADDITION ASSOCIATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 103753.

Tax Court of the United States.

Promulgated December 30, 1942.

1. Petitioner, a corporation which in its inception was not organized for profit, constructed approximately 100 houses and leased them to a milling company at a rental sufficient to amortize petitioner's indebtedness and to pay 6 percent per annum on its outstanding certificates of beneficial ownership. Held, petitioner is not exempt from tax under section 101(7) or (8) of the 1936 Act and corresponding sections of the 1934 and 1932 Acts; held, further, petitioner was not engaged in carrying on or doing business during the years 1933 to 1936, inclusive.

2. Payments to certificate holders designated interest held not deductible as interest paid, inasmuch as the certificates were not evidences of indebtedness. H. A. Mihills, C.P.A., for the petitioner.

Frank M. Thompson, Jr., Esq., for the respondent.

The Commissioner determined deficiencies in income tax and excess profits tax, together with penalties for failure to file returns within the time prescribed by law, as follows:

+-------------------------------------------+
                ¦    ¦Income tax         ¦Excess profits tax¦
                +----+-------------------+------------------¦
                ¦Year¦Deficiency¦Penalty ¦Deficiency¦Penalty¦
                +----+----------+--------+----------+-------¦
                ¦1932¦$640.74   ¦$160.19 ¦          ¦       ¦
                +----+----------+--------+----------+-------¦
                ¦1933¦177.05    ¦44.26   ¦$64.38    ¦$16.10 ¦
                +----+----------+--------+----------+-------¦
                ¦1934¦2,327.44  ¦581.86  ¦846.34    ¦211.59 ¦
                +----+----------+--------+----------+-------¦
                ¦1935¦4,339.50  ¦1,084.88¦1,578.00  ¦394.50 ¦
                +----+----------+--------+----------+-------¦
                ¦1936¦1,080.68  ¦270.17  ¦882.33    ¦220.58 ¦
                +-------------------------------------------+
                

The principal issue is whether petitioner is exempt from taxation under section 103(7) or (8) of the Revenue Act of 1932 and section 101(7) or (8) of the Revenue Acts of 1934 and 1936. If petitioner is not exempt, the alternative issues are (1) whether it was carrying on or doing business during the years 1933 to 1936, inclusive, and (2) whether amounts paid as interest upon certificates of beneficial ownership are deductible as interest paid, or in reality constituted dividends.

FINDINGS OF FACT.

Petitioner is a corporation, with its principal office in Dyersburg, Tennessee. No returns for the periods here involved were filed.

During the year 1926 certain business men and other individuals in the city of Dyersburg were desirous of inducing industry to locate in Dyersburg or its vicinity in order to relieve an unemployment problem which then existed. The Civic Club of Dyersburg was interested in the project, and a committee of five individuals conducted preliminary negotiations with certain cotton milling companies in Michigan and New York. After a tentative agreement was reached, and to accomplish the purpose of procuring industry to locate in Dyersburg, petitioner was incorporated under the laws of Tennessee on November 27, 1926. The charter provided that the general welfare of society, not individual profit, was the object for which the charter was granted, and the members were not stockholders in the legal sense of the term and no dividends or profits should be divided among the members. Petitioner was incorporated, as stated in the charger, ‘for the purpose of encouraging, inducing, and contracting with industrial institutions to locate in the Town of Dyersburg, or the immediate vicinity thereof, to raise the necessary funds by such means as they may deem wise, and to disburse said funds so raised by gift, purchase of stock or loan to any such industry, and for the general welfare of the community.‘

The general powers of the corporation were to sue and be sued, use a common seal, establish bylaws, acquired and sell personal property and real estate necessary for the transaction of its business, and appoint subordinate officers and agents. The board of directors was granted the power to elect other members, who, upon acceptance of membership, were to become corporators equal with the original corporators; and the board of directors was granted the further power to determine the amount of money required to be paid for membership, whether to be paid in a lump sum or annually, and failure to pay such amount would justify expulsion of a defaulting member in the discretion of the board of directors. In all elections each member was to be entitled to one vote. The corporation could be voluntarily dissolved by the members by a conveyance of its assets to another corporation not organized for individual profit; and the corporation was subject to dissolution at the instance of the state upon violation of any provision of its charter.

On March 22, 1928, a contract was executed between petitioner and cotton milling companies whose plants were then located in Michigan and New York, whereby the latter agreed to locate their plants in Dyersburg on a site to be donated by petitioner, and petitioner agreed to pay to the companies the amount of $100,000 to defray expenses involved in moving. In addition, the milling companies received assurances that their plants would be relieved of city and county taxes for a period of 10 years. Petitioner's expenses in negotiating the contract, including railroad fares to Michigan and New York, were borne by the individuals who were acting in behalf of petitioner. Performance of the contract on the part of petitioner was guaranteed by 47 individuals of Dyersburg.

The parties connected with the cotton mills subsequently formed a corporation known as the Dyersburg Cotton Products Co. Petitioner acquired a tract of land of approximately 100 acres, and in order to raise cash funds proceeded to sell undivided interests in the land on the basis of $300 per unit. The purchasers of the undivided interests in the land allowed title to remain in the name of petitioner. Many of the subscribers considered that they were making donations to a civic cause. On April 13, 1928, certain of the purchasers entered into a ‘lot-pool agreement‘ which recited that they had purchased lots in the addition of the Industrial Addition Association; and they agreed to pool the number of lots set opposite their names and to ‘pay for the number of lots set opposite our names at the rate of $300 per lot and after a certain portion of land is set apart so as to divide 100 lots, said land so set apart not to exceed 25 acres, we hereby agree to permit the title to said lots to remain in the Industrial Additional Association and will permit the said association or corporation to borrow money on the strength of said title * * * and execute a mortgage upon said lots to secure the necessary funds with which to erect 100 houses * * * .‘ The agreement also provided that the houses so built by petitioner would be rented to the employees of the milling company or other suitable persons, and that the rents collected would be used to discharge the mortgage indebtedness. It was further agreed that petitioner's officers would have the right to sell any or all of the houses and lots and to use the proceeds to discharge the mortgage indebtedness and to divide any excess proceeds arising from such sale ‘among the undersigned certificate holders in proportion to the number of certificates held by each of them.‘

On September 5, 1928, an agreement supplemental to that of March 22, 1928, between petitioner and the milling company was executed whereby petitioner agreed to construct upon lots belonging to it or to its members adjacent to the mill site 100 dwellings houses and to rent all of the houses to the company. The milling company agreed to rent all of the houses from petitioner at a rental charge which would yield to petitioner a net return of 6 percent per annum on its investment, and it further agreed to maintain the houses in a reasonable state of repair. The contract granted the milling company the option to purchase the houses at any time within 10 years at actual cost of construction plus the value of each lot.

In order to procure funds for the construction of the houses petitioner sold first mortgage 6 percent bonds dated February 1, 1929, having an aggregate principal of $75,000, for $67,500. On February 1, 1929, petitioner leased the lots which were the subject of the ‘lot-pool agreement‘ to the Dyersburg Cotton Products Co., and obligated itself in the lease to erect on the leased premises 95 dwelling houses and to deliver possession thereof to the lessee. As rent, the lessee agreed to pay ‘the lessor, or its assigns, or as otherwise directed in said mortgage‘ amounts sufficient to discharge the interest and principal of the $75,000 mortgage, and, in addition, to pay to the holders of petitioner's certificates of beneficial ownership the sum of 6 percent per annum on the face value of such certificates. The lessee further agreed to pay all assessments, taxes, and insurance. The lease was for a period of 13 years from February 1, 1929, to January 31, 1942, and the lessee was granted the option to renew for a period of five years, that is, to January 31, 1947, upon the same terms and conditions, except that the rental during the renewal period was to be an amount to net petitioner or the holders of its ownership certificates then outstanding 6 percent per annum on the value of the leased land, exclusive of buildings and improvements. For the purposes of the lease the value of the leased premises, exclusive of buildings and improvements, was determined and agreed to be $300 per lot. The lessee was also granted the option to purchase the leased premises, together with the buildings and improvements thereon, at any time during the term of the lease or renewal thereof by the payment or assumption of any balance remaining due on the mortgage, principal or interest, plus the...