International Trading Co. v. CIR

• Decision Date: 07 March 1960
• Docket Number: No. 12790.,12790.
• Citation: 275 F.2d 578
• Parties: INTERNATIONAL TRADING CO., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Seventh Circuit

275 F.2d 578 (1960)

INTERNATIONAL TRADING CO., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 12790.

United States Court of Appeals Seventh Circuit.

March 7, 1960.

COPYRIGHT MATERIAL OMITTED

A. L. Skolnik, Milwaukee, Wis., for petitioner.

Charles K. Rice, Asst. Atty. Gen., Melvin L. Lebow, Lee A. Jackson, Harry Baum, Attys., Tax Division, U. S. Dept. of Justice, Washington, D. C., for respondent.

Before DUFFY and SCHNACKENBERG, Circuit Judges, and STECKLER, District Judge.

STECKLER, District Judge.

This is a petition for review of the decision of the Tax Court of the United States determining deficiencies in the petitioner's income tax for its taxable years ending August 31, 1951, and August 31, 1952.

The issue before this court is whether the Tax Court erred in disallowing a portion of the maintenance expenses and depreciation claimed by the corporate taxpayer under § 23(a) (1) (A) and (l) (1) and (2) of the Internal Revenue Code of 1939.¹

The Tax Court found and concluded that although certain residential property owned by the corporation at Beaver Lake, Wisconsin, some thirty miles from Milwaukee, may have been used at times for entertaining, in the taxable years ending in 1951, 1952 and 1953, it was maintained primarily for the personal benefit of the stockholders and had little or no business use.

The taxpayer, International Trading Co., is a Wisconsin corporation. In the fiscal years ended in 1948 through 1952, the corporation was engaged in the brewery supply business, and sold containers on a commission basis. The corporation also held real estate and collected rents therefrom. In the years 1950 and 1951, it was also engaged in licensed warehousing. In each of the years involved, the officers of the corporation were Michael Shapiro, Julius Rubin, Bernard Libowsky and Jack LaKam, the latter three being sons-in-law of Michael Shapiro. In the taxable years ending August 31, 1951 and August 31, 1952, all of the stock in the corporation was held in the names of Doris Libowsky, Lillian LaKam and Beatrice Rubin, daughters of Michael Shapiro; Cynthia Libowsky, Nancy Libowsky, Patricia LaKam, Bruce LaKam, David Rubin and Harley Rubin, grandchildren of Michael Shapiro; and by Michael Shapiro, Beatrice Rubin, Lillian LaKam and Doris Libowsky, as trustees of a voting trust for the benefit of the grandchildren of Michael Shapiro.

The parties stipulated in the proceedings before the Tax Court that the Beaver Lake property was purchased by the taxpayer in 1944 for the sum of $23,875.36, but the record shows that the corporation was not organized until May 19, 1946. The buildings on the property were remodeled and new buildings erected, making the property usable for summer residences and entertainment. The costs of additions and improvements prior to August 31, 1952, amounted to $344,953.62, including boating equipment in the amount of $3,082.50, landscaping in the amount of $42,564.66, and furniture and fixtures in the amount of $58,569.46. The property included a large residence consisting of living room and dining room combination, three bedrooms, kitchen, bathroom, two washrooms, and porch; a small house, consisting of two bedrooms, living room, kitchen, and bathroom; one apartment located over a boat house, consisting of two bedrooms, living room, kitchen, breakfast room and bath; one small dwelling house, consisting of four bedrooms, two baths, and a kitchen which had attached to it a community entertainment room with complete facilities for entertaining large groups; and at a lower level of that house, several dressing rooms with showers for guests and a rest room; a guest house capable of accommodating six people; a horse stable with caretaker's loft above; a boat house; a rock garden; a playground; a floodlighted tennis court; and a small screen house.

The large house was occupied by Michael Shapiro and his wife for about three months during each summer in 1950, 1951 and 1952. The small house was occupied by Jack LaKam and his family consisting of his wife and two small children during the years 1950, 1951 and 1952 for periods of about nine or ten weeks. The apartment above the boat house was occupied by Ben Libowsky and his family consisting of his wife and three small children during the years 1950, 1951 and 1952 for similar periods. The small dwelling house was occupied for similar periods by Julius Rubin and his family consisting of his wife and two small children during the years 1950 and 1951, and three small children during the year 1952.

During the years 1950, 1951 and 1952, when the premises were occupied by the above-named individuals and their families, they paid the following as rental to the corporation: Michael Shapiro, $3,600; Julius Rubin, $2,400; Jack LaKam, $1,200; and Ben Libowsky, $1,200. The Tax Court found that the fair rental value of such premises for a three-month summer period was not in excess of the amounts paid.

During its fiscal years ended August 31, 1951, 1952 and 1953, the taxpayer incurred expenses for the upkeep and maintenance of the Beaver Lake property, in addition to interest expenses and taxes, for caretaker salaries, repairs and maintenance, insurance, light and heat, and stable supplies. These expenses amounted to $14,294.15 for 1951, $15,219.96 for 1952, and $18,227.28 for 1953. In addition to the expenses for upkeep and maintenance, the taxpayer deducted depreciation on the Beaver Lake property in its 1951, 1952 and 1953 federal income tax returns in the amounts of $20,002.87, $19,761.90 and $20,021.00, respectively. The combined expenses for maintenance and depreciation thus amounted to $34,297.02 for 1951, $34,981.86 for 1952, and $38,248.28 for 1953.

The taxpayer attempted to sell the Beaver Lake property in 1950, and listed it for sale in the summer of 1951 for $200,000. An offer of $105,000 was received and rejected.

The taxpayer's merchandise sales for the years ended August 31, 1951, 1952 and 1953 amounted to $362,919.73, $17,834.51 and $1,615.13, respectively.

In the fiscal year ended August 31, 1951, the corporation collected rents in the amount of $75,867.04, and in the year ended August 31, 1952, in the amount of $18,533.30.

With respect to the Beaver Lake property, the Commissioner allowed the taxpayer to deduct $9,000 in each of the taxable years, that is, to the extent of the aggregate rent received from its stockholders and included in the corporation's income, disallowing all other deductions for maintenance and upkeep and depreciation. Subsequently, the Tax Court, affirming in part the Commissioner's action found that the taxpayer could not deduct the maintenance expenses and depreciation on the Beaver Lake property for its 1951 to 1953 fiscal years in excess of the deductions allowed by the Commissioner, because the property had little or no business use and was held primarily for the personal use of the taxpayer's stockholders.

The decisions of the Tax Court are to be reviewed in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury. The findings and decision of the Tax Court must be accepted as correct unless, of course, they are not based upon substantial evidence or if the proper rules of law are not applied.

Although the Tax Court simply found that the Beaver Lake property in the taxable years was maintained primarily for the personal benefit of the stockholders and had little or no business use, it did not specifically find that the claimed expenses were not incurred in the taxpayer's trade or business or with respect to property held for the production of income. From a reading of the Tax Court's Memorandum Findings of Fact and Opinion, it is implicit that that court found that the property was not used in the trade or business of the taxpayer, nor held for the production of income, within the meaning of § 23(a) (1) (A), and (l) (1) and (2). The question presented here is whether the Tax Court upon the factual record before it, correctly so found.

This court is mindful of the rule that substance controls over form in the application of Internal Revenue laws which are regarded as having a practical, not theoretical application. Western Maryland Ry. Co. v. Commissioner, 4 Cir., 1929, 33 F.2d 695, 698. As the Supreme Court has repeatedly held, it is the underlying essence of a transaction that determines its taxability. Helvering v. Tex-Penn Oil Co., 1937, 300 U.S. 481, 493, 57 S.Ct. 569, 81 L.Ed. 755; Bowers v. Lawyers' Mortgage Co., 1932, 285 U.S. 182, 52 S.Ct. 350, 76 L.Ed. 690; United States v. Phellis, 1921, 257 U.S. 156, 168, 42 S.Ct. 63, 66 L.Ed. 180; United States v. Merchants Nat. Trust & Savings Bank, 9 Cir., 1939, 101 F.2d 399. It is the origin and nature and not the legal form of the expense sought to be deducted that determines the applicability of the statute. Interstate Transit Lines v. Commissioner, 319 U.S. 590, 63 S.Ct. 1279, 87 L.Ed. 1607, rehearing denied 1943, 320 U.S. 809, 64 S.Ct. 26, 88 L.Ed. 489.

In the Tax Court, the petitioner's contentions were that it purchased and maintained the property as an investment and for the purpose of entertaining its customers and suppliers in connection with its brewery supply business. Thus, it argued, the maintenance expenses and depreciation were incurred in its trade or business and in maintaining the investment in good condition as a high grade piece of resort property.

Here on appeal the petitioner does not press the theory that the Beaver Lake property was purchased principally for the entertainment of customers and suppliers. Rather, it now posits its case on the proposition that it was engaged in the business of holding real estate and collecting rents therefrom, and that it received a rental income from the Beaver Lake property of an amount equal to its fair rental value; that this, as a matter of law, entitles petitioner to the deductions claimed. Further, in...