1929 BTA LEXIS 2236">*2236 1. There is no abnormal condition affecting the capital of a corporation because its business is conducted upon leased property, although the value of the fee of such property is several times the statutory invested capital of such corporation. The value of the fee of leased premises is no part of the capital of the business of the lessee.
2. Large earnings due to a favorable location or to the unique character of the business carried on are not grounds for computing excess-profits tax under section 328 of the Revenue Act of 1918.
3. Assessment under section 328 of the Revenue Act of 1918 denied.
17 B.T.A. 814">*814 This proceeding is before the Board on petition from a determination of a deficiency in income and excess-profits tax for the calendar year 1920 in the amount of $401.21. The petitioner contends that the respondent erred in failing and refusing to compute the petitioner's excess-profits tax under the provisions of sections 327 and 328 of the Revenue Act of 1918.
FINDINGS OF FACT.
The petitioner is a New York corporation, incorporated on1929 BTA LEXIS 2236">*2237 January 1, 1914, and has its principal place of business at 150 West 38th Street, New York, N.Y., where it has conducted a retail lumber business since its incorporation. It is the successor to the partnership of Wright and Austin, which was organized in 1864, and of the sole proprietorship of A. E. Wright and the Wright Lumber Co., which respectively succeeded the partnership. Wright and Austin, A. E. Wright, and Wright Lumber Co., respectively and successively, conducted a retail lumber business from 1864 to the date of the petitioner's incorporation, at the same location as that occupied by the petitioner.
During the year 1920 the petitioner was the lessee of the following described New York City real estate, used and employed in its business, and paid as rent the amounts stated below for the parcels described:
| 140-142 West 38th Street | $6,664.80 |
| 144-146-148 West 38th Street | 9,956.44 |
| 150 West 38th Street | 2,919.85 |
| 521-527 Seventh Avenue | 1,033.34 |
| 152 West 38th Street | 1,374.40 |
| Nelson Stable | 840.60 |
| Magovern Yard - 58th Street | 3,676.68 |
| 26,466.11 |
17 B.T.A. 814">*815 The assessed value in 1920 of the real property described as 140-150 150 West 38th Street, 1929 BTA LEXIS 2236">*2238 and 521-527 Seventh Avenue, for purposes of real property tax, was $719,000. The fair market value in 1920 of the said property was in excess of $719,000.
The property described as 140 to 152 West 38th Street had structures upon it as follows: 140, a two-story building about half the depth of the lot; 142, a two-story building to about one-third the depth of the lot; 144, 146 and 148, vacant lots with tin covered frame office of the petitioner in the corner; 150 and 152, one-story buildings. The property known as 521 to 527 Seventh Avenue consisted of four vacant lots and was diagonally across the street from the West 38th Street property.
In 1920 the theatre district of New York City was located along Broadway in the neighborhood of 42nd Street. The petitioner's location was one block west of Broadway on 38th Street, and was five blocks from the Pennsylvania Station and four blocks from Times Square.
The petitioner employed no salesmen. It did about 75 per cent of the business of supplying the theatres with lumber for stage and scenery and supplying lumber for motion picture studios, which was a business requiring prompt and immediate delivery. The petitioner also did1929 BTA LEXIS 2236">*2239 a considerable cash business. In both these classes of business the customer ordinarily came for the lumber and hauled it away.
There was no other lumber yard operated in the immediate vicinity of the petitioner's location and trade, the nearest one being at Twenty-fifth Street and Eighth Avenue.
The petitioner had the reputation of having the only lumber yard in the heart of New York City and the one occupying the most valuable land in the world used as a lumber yard.
The real estate, of which the petitioner was lessee, was used and employed in the petitioner's business to the fullest possible extent. The petitioner could not have carried on the business it did if it had not had the premises, and the use and employment thereof in the petitioner's business was a material income-producing factor.
It is the normal condition for retail lumber yards in New York City to own the premises used in their business.
The petitioner's 1920 gross sales, other income, total gross income, cost of sales, depreciation, rentals, paid, interest paid, other expenses, and net income, were as follows:
| Gross sales | $1,248,354.70 | |
| Miscellaneous income | 4,424.63 | |
| Total income | 1,252,779.33 | |
| Cost of sales | $823,145.16 | |
| Depreciation | 5,346.06 | |
| Rentals | 26,466.11 | |
| Interest paid | 710.38 | |
| General expenses not included above | 176,116.28 | |
| $1,031,783.99 | ||
| Net income | 220,995.34 |
1929 BTA LEXIS 2236">*2240 17 B.T.A. 814">*816 The assets, liabilities, capital and surplus of the petitioner as of December 31, 1919, were as follows:
| Assets | |
| Cash | ($26.69) |
| Accounts receivable | 142,470.78 |
| Notes | 5,119.60 |
| Loans receivable | 1,367.34 |
| Merchandise Inv | 115,323.56 |
| Liberty bonds | 66,000.00 |
| Emp. loans | 145.28 |
| Prepaid Ins | 1,797.11 |
| Coupons due | 1,496.74 |
| Buildings | 4,920.00 |
| Delivery Equipment | 9,995.19 |
| Office | 1,603.67 |
| Machinery | 721.74 |
| 350,934.32 | |
| Liabilities and capital | |
| Capital stock | $50,000.00 |
| Bonds payable | 16,000.00 |
| Accounts payable | 22,928.54 |
| Freight payable | 2,056.84 |
| Tax reserve | 6,158.97 |
| Surplus | 253,780.97 |
| 350,934.32 |
The respondent determined the petitioner's net taxable income for 1920 to be $220,995.34, its statutory invested capital to be $290,001.60, and its excess-profits tax under section 301 to be $71,558.04, and denied the petitioner's claim for a determination of its excess-profits tax under the provisions of sections 327 and 328 of the Revenue Act of 1918.
OPINION.
PHILLIPS: The points upon which the petitioner relies are summarized in the brief of its counsel as follows:
The petitioner is entitled to the assessment of its 1920 excess profits1929 BTA LEXIS 2236">*2241 tax under section 328 of the Revenue Act of 1918, because the 1920 excess profits tax determined without benefit of section 327 of the same act would, owing to abnormal conditions affecting the capital of the petitioner, work upon it an exceptional hardship evidenced by gross disproportion between its tax and the tax of representative corporations.
The capital employed by the petitioner during the calendar year 1920 was in a large part borrowed, which constituted an abnormal condition affecting its capital within the meaning of section 327(d) of the Revenue Act of 1918.
In any event, the fact that the use and employment of other capital several times greater than its statutory invested capital was a material incomeproducing factor in the petitioner's business constituted an abnormal condition affecting the petitioner's capital within the meaning of section 327(d) of the Revenue Act of 1918.
The argument urged in support of this position is that an abnormal condition affecting capital exists where a large part of the 17 B.T.A. 814">*817 capital used in the business is borrowed; that the real estate used in the business was borrowed capital and was three times the amount of the invested1929 BTA LEXIS 2236">*2242 capital.
Considering the history of the enactment of sections 327 and 328 of the Revenue Act, the rulings of the Commissioner of Internal Revenue and the decisions of the courts and the Board, there can be no reasonable doubt that an abnormal situation affecting capital may arise where there is a gross disproportion between invested capital and borrowed capital. Whether an abnormal situation exists in the capital structure must be determined from the peculiar circumstances in each case; no rule of general application may be laid down. In the present case we are not called upon to determine whether a capital structure, three-fourths borrowed and one-fourth invested, is or is not abnormal in the retail lumber business in New York, for we are clearly of the opinion that the value of leased property is no part of the capital of the lessee.
When one borrows money, there is the obligation to repay a like amount. The borrowed money, however, becomes the property of the borrower. Ordinarily he may use it as he choses. It is part of his capital. The lender assumes the risk of securing repayment in the future. He no longer has any claim upon the funds loaned; his position is that1929 BTA LEXIS 2236">*2243 of a creditor and no longer that of an owner. If the borrower uses the money in his business, it is as mcuh a part of his capital as money which he may have furnished from other funds; it is all subject to the risks of the business, although there may be various priorities among different creditors. But the position of a lessor and lessee are wholly different. The lessor grants only the right to use the property for a limited time, always retaining the title as his own. He risks no part of the value of the fee. At most he risks nonpayment of the stipulated rental. The value of the fee of the rented property is never at the disposal of the lessee and is never any part of his capital. The only asset he acquires is the lease. Other distinctions exist between borrowed capital and property used under a lease, but enough have already been pointed out to indicate the reasons for our opinion that the value of the property occupied by petitioner under a lease can not be considered as a part of the petitioner's capital, borrowed or otherwise.
There is testimony in the record that the rental paid for the leased premises was low. While it was less than 4 per cent of the market value1929 BTA LEXIS 2236">*2244 of the property, the testimony is that at that time property in this section of New York City had been more or less stagnant and was just beginning to "boom"; that there were a considerable number of small buildings occupied for business purposes on the ground floor and residence purposes above. In the words of the witness, 17 B.T.A. 814">*818 "they were erected to get any income from the property they could." The situation is one which frequently occurs where property has a value for future use but little present earning capacity. There is nothing to indicate that the rent paid was such as to create any abnormal condition.
The record leaves no doubt that the petitioner was so situated that it obtained much profitable business which would not have come to it in a location less central to the theatres, hotels and other places of business. In several respects it was unique. It earned almost 100 per cent upon its invested capital. But none of these are grounds for computing its tax under section 328 of the Revenue Act. Section 217, Revenue Act of 1918; 1929 BTA LEXIS 2236">*2245 ; .
Decision will be entered for the respondent.