Welworth Realty Company v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 90897.

• Decision Date: 15 June 1939
• Docket Number: Docket No. 90897.
• Parties: THE WELWORTH REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

40 B.T.A. 97 (1939)

THE WELWORTH REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 90897.

Board of Tax Appeals.

Promulgated June 15, 1939.

Henry S. Gottfried, Esq., and George H. Drickamer, C. P. A., for the petitioner.

DeWitt M. Evans, Esq., for the respondent.

OPINION.

TYSON:

This proceeding involves an income tax deficiency of $1,607.27 for the fiscal year ended July 31, 1935.

The petitioner assigns as error the respondent's disallowance of a $12,000 adjustment, at the end of the taxable year, of its parent company's accrued rent of $24,000 for space occupied, during that year, in two buildings owned by the petitioner.

The question presented is whether the respondent properly exercised the authority granted him by section 45 of the Revenue Act of 1934 in determining that the sum of $12,000 should be allocated from the gross income of the L. N. Gross Co. to its subsidiary, the petitioner, in order to clearly reflect the latter's income.

The petitioner, a corporation, owns a four-story building containing 100,000 square feet of floor space, located at West 3rd Street and Lakeside Avenue, Cleveland, Ohio (hereinafter referred to as the Cleveland Building) and, also, a building at Kent, Ohio (hereinafter referred to as the Kent Building). During the taxable year and for several years prior thereto, 65 percent of the Cleveland Building and all of the Kent Building were rented to and occupied by the L. N. Gross Co., which owned and controlled 99.4 percent of the petitioner's capital stock. The other 35 percent of the Cleveland Building, comprising part of the basement, the first floor, and part of the second floor, was rented to the Newspaper Enterprise Association. During the taxable year petitioner's sole business activity was that of owning, renting, and managing the Cleveland Building and the Kent Building.

The L. N. Gross Co. is a close family corporation, engaged in the dress manufacturing business. The same individuals were the officers of that company and of petitioner. Both companies occupied the same office and had the services of the same bookkeeper.

The petitioner had no original books of entry. All of its receipts and disbursements were handled by the L. N. Gross Co. and entered on the latter's books to petitioner's account and then posted in a ledger of the petitioner. The L. N. Gross Co. collected the rent paid by the Newspaper Enterprise Association for space in the Cleveland Building, deposited such rent in its own bank account, and credited it to the account of petitioner. The rentals for the space in the Cleveland Building and Kent Building occupied by the L. N. Gross Co. were not paid in cash, but were merely entered on the books to petitioner's credit. The accounts of the L. N. Gross Co. and of the petitioner were kept on the accrual basis of accounting and their respective income tax returns have been filed on that basis.

For several years prior to, and during the fiscal year 1935, it had been the practice of the L. N. Gross Co. and the petitioner to accrue on their books of account the amounts of $2,000 per month, totaling $24,000 per year, as rental for the 65,000 square feet of space in the Cleveland Building and the entire Kent Building occupied by the L. N. Gross Co. That rental of $24,000 per year was fixed without any relation to what would be a fair rental value for that space, but was considered by the L. N. Gross Co. to be a very "excessive" rental. It was "just a stab at a figure" representing a "sizable amount of money" which, if the L. N. Gross Co. had a good year and could afford to pay such amount to petitioner, the latter would thereby have sufficient income to reduce its debt to the L. N. Gross Co. by such amount. That debt consisted of advances by the L. N. Gross Co. used to make payments of principal and interest on a mortgage of petitioner on the property involved. Such advances to petitioner were carried on the L. N. Gross Co.'s books as an account receivable, amounting to approximately $50,000 in the taxable year, and the L. N. Gross Co. desired to have such account retired for the purpose of its credit rating. No interest was ever charged to or paid by petitioner on account of those advances.

At the end of each year, for a number of years, it had been the practice of the L. N. Gross Co. and the petitioner to make some adjustment of the accrued rental, based on the results of the L. N. Gross Co.'s business for the particular year, that is, in general, the amount of its earnings or losses. The adjustment was not made upon a definite ratio to the L. N. Gross Co.'s current earnings nor was it based upon any investigation of actual fair rental values, but was determined by the officers of the two companies, in a round table discussion, based on what they thought represented a fair rental for the year, considering the relationship of the two companies and the fact that the L. N. Gross Co. paid all of the heating, elevator service, and ordinary maintenance expenses of the two buildings. Such expenses were approximately the same for the taxable year and several prior years and were taken and allowed as deductions on the income tax returns of the L. N. Gross Co. For the fiscal years ending July 31, 1932 to 1935, inclusive, the adjustments in the accrued rentals for each of those years for the space in the Cleveland Building and the Kent Building occupied by the L. N. Gross Co. resulted in...