June 30, 1930
ONE HUNDRED FIVE WEST FIFTY-FIFTH STREET, INC.,
COMMISSIONER OF INTERNAL REVENUE
Appeal from the United States Board of Tax Appeals.
Before L. HAND, CHASE, and MACK, Circuit Judges.
CHASE, Circuit Judge.
The petitioner claims that the $40,480 paid Hearn was either a maintenance expense or a loss deductible under the provisions of the Revenue Act of 1918, c. 18, 40 Stat. 1057, 1077. The applicable portion of the statute follows:
"Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
"(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. * * *
"(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *"
The claim that the payment to Hearn was a deductible loss is ill-founded. At the time of this settlement payment, the corporation had the stock and could have defeated his action by issuing it to Hearn at any time, since his suit was brought solely to establish his right to subscribe for it and have it issued to him. Moreover, it could have received from Hearn $30,000 in cash for the stock. It elected to keep it, freed from his claim, forego the $30,000, and pay him $40,480 in addition. In reality, it saw fit to make available to him $70,480 which it would and could have had in exchange for whatever right he had to subscribe for the stock at par. Possibly it was worth what it cost to get rid of his claim. If it could sell the stock for as much or more, it could replenish its treasury whenever it chose. But as to that the record is silent, and no issue turns upon the fact whatever it may be. The petitioner, in any event, did not prove a loss, for it kept the stock and there was nothing more than a distribution of assets to a minority stockholder to preserve the existing stockholding ratio of two to one between the two sole owners of the corporation. It was merely a matter affecting the capital structure of a corporation which, whenever the two stockholders who owned it could agree, was but a puppet in their hands. The rights of no one else were affected, and the corporation, although its assets were diminished, lost no more than it would have lost had the same sum been distributed to this stockholder by dividends eo nomine on the stock he already owned. His ownership of that stock was the basis of his claim of right to purchase the new stock at par; that is, it lost nothing.
Nor was it an ordinary or necessary expense in carrying on its trade or business. Apart from the fact that the capital structure of this corporation was not the trade or business it carried on, the payment to Hearn was, as we have already seen, wholly gratuitous so far as it was concerned. It was quite unnecessary to pay him anything. Had he been able to have established his claim fully, the corporation need only have issued the stock to him and taken his $30,000. It had no financial interest in a transaction that had for its object and attained by its result nothing more than the settlement of a dispute between its stockholders over the right of one of them to subscribe for its stock.
We do not overlook the fact that in the settlement other matters were adjusted between Mathews and Hearn, but from the findings of fact it appears that those matters were wholly the concern of the two stockholders who together were in full and complete control of the corporation, were treated as such in the settlement agreement to which they alone were parties, and that "Hearn acknowledged receipt of $40,480 from the petitioner corporation in full settlement of the disputed right to subscribe." No more is required to make it plain that the $40,480 now sought to be deducted was paid solely to permit the stock to remain in virtual control of the majority stockholder of the corporation. The petitioner relies on Murray Hospital v. Rasmussen (C.C.A.) 20 F.2d 29 but the payments there alleged were made to settle controversies in which the corporation itself had a financial interest.
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