24 B.T.A. 1096">*1096 This is a proceeding for the redetermiantion of deficiencies in income tax for the calendar years 1922 and 1923 in the amounts of $3,206.82 and $4,262.25, respectively. The only error alleged is the action of the respondent in disallowing as a deduction, as an ordinary and necessary business expense, payments made by the petitioner to 24 B.T.A. 1096">*1097 the Transit Supply Company in the amounts of $17,232 in 1922 and $26,817 in 1923.
There was another allegation of error with regard to the proper allowance for depreciation, but this was waived by the petitioner.
FINDINGS OF FACT.
The petitioner was a corporation organized under the laws of Illinois, with its principal office in Galesburg. It was dissolved on June 4, 1927. The instant proceeding was filed on August 10, 1927, by the former officers of the petitioner, who are authorized under the law of Illinois to act for the corporation for a period of two years.
The payments, the deduction of which is in controversy here, were those made by the petitioner to the Transit Supply Company, a Minnesota corporation, 1931 BTA LEXIS 1544">*1545 hereinafter referred to as the Transit Company, under a contract between the petitioner and the Transit Company dated August 1, 1921. The circumstances leading up to the execution of that contract are as follows:
The Transit Company was the purchasing agent for certain street railroads in St. Paul and Minneapolis. In 1917 it was unable to obtain a sufficient supply of coal of the grade required by those companies. Accordingly, W. J. Hield, the purchasing agent of the Transit Company, and one W. R. Hawkins, at the suggestion of Horace Lowry, the president of the Transit Company, obtained leases on about 2,500 acres of coal land in Illinios and the petitioner, the Cripple Creek Coal Company, was organized to take over these leases. Hawkins became the general manager and Hield, president. Hield still continued to act as purchasing agent for the Transit Company.
After the incorporation of petitioner its officers entered into negotiations with the Chicago, Burlington & Quincy Railroad, hereinafter referred to as the Railroad, for the construction of a spur track to the mine. The Railroad agreed that if the Transit Company would take its coal from the petitioner for a number of1931 BTA LEXIS 1544">*1546 years the Railroad would assist in the construction of a railroad track from the village of Bryant, Ill., to the mine, a distance of about three miles. The Transit Company agreed to enter into such a contract with the petitioner.
As a result of the negotiations with the Railroad a contract was entered into on October 4, 1917, between the Railroad Company, as party of the first part, and the petitioner, as party of the second part, providing for the construction of a track at an estimated cost of $90,372, $10,000 of which was to be paid by the Railroad, $24,000 by the petitioner upon the execution of the contract, and the balance of $56,372 to be paid by the petitioner in four equal installments 24 B.T.A. 1096">*1098 upon demand. If the cost exceeded this amount the excess was to be immediately paid by the petitioner to the Railroad. The contract further provided, in Paragraph XI, that the Railroad would reimburse petitioner the amount of $80,372, or such other sum as the petitioner had to pay towards the construction of the railroad at the rate of $3 per car on each carload of coal shipped over the railroad from which the Railroad derived a revenue of not less than $15; that if a sufficient1931 BTA LEXIS 1544">*1547 number of cars of coal should not be shipped to permit the payment of the said amount, the balance should be permanently borne by the petitioner without recourse to the Railroad; and that the termination of the agreement for any cause should not give the petitioner any right of reimbursement for any amount advanced but not then repaid.
The contract between the Transit Company and the petitioner whereby the Transit Company agreed to buy all of its coal from the petitioner for a term of fifteen years beginning April 1, 1918, at a price equal to the actual cost of such coal to the petitioner, f.o.b. the mine, was executed on on October 6, 1917.
The petitioner did not have the money to make the payments provided for in its contract with the Railroad Company and the Transit Company agreed to and did advance the money to petitioner to make the payments under the contract. The railroad track was completed in about six months after the contract between the petitioner and the Railroad was entered into.
On February 20, 1919, Hield agreed to sell to R. J. and Thomas Fairbairn all of the capital stock of the petitioner, which was owned by Hield and his nominees, and to procure from the1931 BTA LEXIS 1544">*1548 Transit Company a release to the petitioner of its obligations under the contract of October 6, 1917, said release to be effective from April 1, 1916. In accordance with this agreement, on February 21, 1919, the Transit Company and the petitioner entered into a contract relieving the petitioner from furnishing coal under the contract of October 6, 1917, after April 1, 1919. Under this contract of October 6, 1917, coal was to be furnished to the Transit Company at cost, f.o.b. the mine, for fifteen years. After April 1, 1919, petitioner continued to furnish coal to the Transit Company, but not at cost price.
On the same date that Hield agreed to sell all the capital stock of petitioner to the Fairbairns, the petitioner and the Transit Company entered into another contract, which, after referring to the contract of October 4, 1917, between the petitioner and the Railroad, and after reciting Paragraph XI of said contract and also reciting that the Transit Company had furnished the money to the petitioner to make the payment to the Railroad for the construction of the track, provided as follows:
24 B.T.A. 1096">*1099 WHEREAS there is still due to the Transit Supply Company from the Cripple1931 BTA LEXIS 1544">*1549 Creek Coal Company on account of the moneys so forwarded to it in the payment of said eighty thousand, three hundred seventy-two dollars ($80,372.00) the sum of sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars,
NOW, THEREFORE, the Cripple Creek Coal Company does hereby sell, assign, transfer and set over all of its right, interests, title in and to the subject matter of said paragraph eleven of said contract hereinbefore mentioned and to all moneys hereafter that may be earned or accumulated to it, its successors or assigns, by and on account of the terms and conditions of the said paragraph eleven (11) of said contract until the said Transit Supply Company shall have received thereon, under and by virtue of the terms and conditions thereof, the said sum of sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars, without interest, but in no event shall the said Cripple Creek Coal Company be liable to pay any portion of the said sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars, it being the understanding and agreement hereto that in consideration of the transfer to the said Transit Supply Company of the1931 BTA LEXIS 1544">*1550 moneys to be earned by and under the terms and conditions of said paragraph eleven (11) of said contract up to the sum of sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars it does hereby forever release and discharge the Cripple Creek Coal Company from the indebtedness of said sum of sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars, and the Transit Supply Company does further agree that at the time when it shall receive from the said Chicago, Burlington & Quincy Railroad Company the moneys due it as aforesaid from the Cripple Creek Coal Company, to-wit, the said sum of sixty-two thousand, seven hundred twenty-four and 02/100 ($62,724.02) dollars under the provisions of paragraph eleven of said contract and of this instrument, then it will immediately transfer to the said Cripple Creek Coal Company, its successors or assigns, every interest of any kind, class or nature that it may have in or to said contract and especially to the said paragraph eleven (11) hereinbefore mentioned.
On March 7, 1919, Hield contracted with the petitioner to indemnify the petitioner from the payment of the $62,724.02 to the Railroad or the Transit1931 BTA LEXIS 1544">*1551 Company "excepting in the manner and to the extent provided in the contract of February 21, 1919," between the Transit Company and the petitioner referred to above.
After the execution of the contract of October 4, 1917, between the Railroad and petitioner, the railroads were taken over by the United States Government. About a year after the Fairbairns had bought all the stock of petitioner and had taken over the mine, the petitioner received a bill from the Railroad Administration for $52,955.16, representing the difference between the estimated and the actual cost of the track. The petitioner did not have the money to pay this bill and the Railroad Company refused to pay the $3 per car by way of reimbursement under Paragraph XI of the contract until the $52,955.16 had been paid to it. After negotiations the Railroad finally agreed that the bill might be paid by applying as a credit $3 per car on all commercial coal that was shipped until the bill of 24 B.T.A. 1096">*1100 $52,955.16 was paid. After such bill was paid in this manner the petitioner was entitled to be reimbursed for the amount of $62,724.02 in the manner provided in Paragraph XI of the contract of October 4, 1917.
1931 BTA LEXIS 1544">*1552 The Railroad having refused to pay the Transit Company any amounts under Paragraph XI of the contract of October 4, 1917, and the assignment of February 21, 1919, and the Transit Company being unwilling to wait for the payment of the amount due it until the Railroad had been paid the amount of $52,955.16, the petitioner and the Transit Company entered into a contract on August 1, 1921, which, after reciting the terms of the assignment of February 21, 1919, between the same parties and that since that time the Railroad had presented an additional claim, provided as follows:
NOW, THEREFORE, in consideration of the premises and of One ($1.00) Dollar in hand paid by second party to first party and for the purpose of more fully carrying out the intent of said assignment it is agreed by and between the parties hereto as follows:
1. During the time that first party, or the Star Coal Company of Galesburg, Illinois, its selling agent, supplies second party with all of its steam coal, first party shall pay to second party a sum equal to Three ($3.00) Dollars per car for each and every car of coal of all kinds shipped on or after the First day of August 1921 from the mine of First party1931 BTA LEXIS 1544">*1553 over said mine track, unless the aggregate amount of such payments shall sooner equal the sum of Sixty-two Thousand Seven Hundred Twenty-four and 02/100 ($62,724.02) Dollars without interest, or such lesser sum as may remain unpaid, after crediting payments, if any, received from said Chicago, Burlington and Quincy Railroad Company by second party as hereinafter provided. Said payments shall be made by first party to second party on or before the twentieth day of each month for cars shipped during the next preceding month.
2. Said second party, upon having received said sum of Sixty-two Thousand Seven Hundred Twenty-Four and 02/100 ($62,724.02) Dollars, shall at once duly assign, transfer and set over to first party its successors or assigns, every interest of every kind, claim or nature that it may have in or to said contract between said Chicago, Burlington and Quincy Railroad Company and said Cripple Creek Coal Company dated October 4, 1917 and especially to said Paragraph Eleven (XI) hereinbefore mentioned.
Second party shall not assign, transfer or set over its right, title or interest or any part thereof, so acquired by said assignment to any person, firm or corporation.
1931 BTA LEXIS 1544">*1554 3. It is understood between the parties hereto that as soon as said claim of the Chicago, Burlington and Quincy Railroad Company for Fifty-two thousand Nine Hundred Fifty-five and 16/100 ($52,955.16) Dollars has been paid, that said Railroad Company intends then to pay to second party herein Three ($3.00) Dollars per car for all coal shipped over said mining spur from the mine of first party as provided in the said contract, between the said Railroad Company and said Cripple Creek Coal Company, but it is agreed between the parties hereto that said payments to second party, if made, by said railroad company, shall not relieve first party herein from making its payments to second party of Three ($3.00) Dollars per car as provided in this contract, but that all money received by second party from said Chicago, 24 B.T.A. 1096">*1101 Burlington and Quincy Railroad Company, by virtue of said assignment shall be applied and credited by second party on payment of said sum of Sixty-two Thousand Seven Hundred Twenty-four and 02/100 ($62,724.02) Dollars, the same as if paid by first party.
4. In no event shall said first party herein be liable to pay to second party herein any portion of said1931 BTA LEXIS 1544">*1555 sum of Sixty-two Thousand Seven Hundred Twenty-four and 02/100 ($62,724.02) Dollars except in the manner and to the extent herein set forth and provided.
Coal in the vicinity in which the petitioner operated its mine is screened over a shaker screen. The small coal is called screenings and the larger, egg and lump coal. Egg and lump coal are also known as commercial coal. About 30 per cent of the output of the petitioner's mine was screenings. It is impossible to operate a mine profitably without a market for its screenings. It was understood between the petitioner and the Railroad that the Railroad would take sufficient commercial coal from the mine to produce all of the screenings that was necessary to fulfill the requirements of the Transit Company. However, if it were possible for the petitioner to sell its commercial coal to others it was to do so, and, as a matter of fact, the petitioner did sell considerable commercial coal.
The petitioner paid the amounts of $17,232 in 1922 and $26,817 in 1923 to the Transit Company under the contract of August 1, 1921, and deducted them from its gross income for those years on its income-tax returns as "track rentals." The respondent1931 BTA LEXIS 1544">*1556 in the deficiency letter disallowed these deductions, upon the ground that "the payments to the Transit Company represent a reduction of a liability and as such are not allowable deductions."
Soon after the armistice was signed the board of directors of the petitioner decided that it could not be operated profitably and that they would close its mine. The petitioner, however, was not formally dissolved until 1927.
OPINION.
MATTHEWS: We are of the opinion that the action of the respondent in refusing to allow the deduction as an ordinary and necessary business expense of the amounts paid by petitioner to the Transit Company in the years in question is correct. The facts in this proceeding show that the petitioner had borrowed money from the Transit Company, and in order to repay such amount had assigned to the Transit Company its right to reimbursement from the Railroad under Paragraph XI of the contract of October 4, 1917, between the petitioner and the Railroad. Due to the fact that the Railroad later made a demand for an additional amount of $52,955.16, the difference between the actual and the estimated cost of the construction of the track, and refused to reimburse the1931 BTA LEXIS 1544">*1557 petitioner for the 24 B.T.A. 1096">*1102 amount already advanced by the petitioner until this amount was paid by a credit of $3 on all commercial coal shipped, the loan could not be repaid in the manner provided for between the petitioner and the Transit Company in the assignment of February 21, 1919. As a result of the Transit Company being unwilling to wait to be repaid until after the Railroad had received the $52,955.16 in the manner provided for, the petitioner and the Transit Company entered into the contract of August 1, 1921, which is set forth in our findings of fact. It is doubtless true that the petitioner entered into this contract in order to keep the business of the Transit Company, which was necessary if the petitioner was to continue to operate its mine. Nevertheless, as we construe this contract, in the light of the circumstances leading up to its execution, we consider that the amounts paid thereunder by way of a credit of $3 to the Transit Company on all coal shipped were payments on a loan, or, as the respondent stated in the deficiency letter, they constituted a "reduction of a liability." The fact that the contract did not provide any method for payment in case sufficient1931 BTA LEXIS 1544">*1558 coal was not shipped to make up the amount of $52,724.02 at the rate of $3 per car, does not change the essential character of the transaction.
The contract between the petitioner and the Transit Company was a separate transaction from that between petitioner and the Railroad, and the fact that the petitioner might not receive reimbursement from the Railroad does not have any effect on the transaction between the petitioner and the Transit Company. Regardless of whether the petitioner was reimbursed by the Railroad for the entire amount advanced for the construction of the track, it was still obligated to repay the Transit Company for the amounts loaned to it.
Judgment will be entered for the respondent.