*1398 Petitioner, a domestic corporation, all of the stock of which was owned by citizens of the United States, paid to the Union of Socialist Soviet Republics an amount equal to 17 per cent of the value of exports and imports effected, which payment was necessary in order for petitioner to secure a license to transact business in the country. Held, that the payment made is deductible as an ordinary and necessary expense.
*1276 Proceeding for the redetermination of a deficiency of $1,390.05 in income tax for 1923. The issue is whether the sum of $30,327.59 paid to the Union of Socialist Soviet Republics under a certain contract is deductible either as a tax or an ordinary and necessary business expense.
FINDINGS OF FACT.
The stock of petitioner, a Delaware corporation, is, and was in 1923, owned entirely by citizens of the United States. In addition to its principal office in New York, petitioner had offices in London, Berlin and other foreign cities.
In 1921 and 1922 petitioner did business with the Union of Socialist*1399 Soviet Republics, hereinafter called the Soviet Republics, by exchanging wheat exported from the United States for furs, hides and other property.
In 1923 the Soviet Republics prohibited the transaction of business within its territory without its written consent under penalty of death. In that year petitioner sought permission of the Soviet Republics to engage in business in Russia. The negotiations which it carried on for several months with officials of the Peoples Commissariat of Foreign Trade, a Bureau of the Soviet Republics, hereinafter referred to as "NKVT," resulted in an understanding which was incorporated in an agreement executed on July 14, 1923.
*1277 The agreement provided, among other things, that the petitioner should export to the Soviet Republics from the United States each month for one year various kinds of articles, but chiefly agricultural and mining machinery, including spare parts therefor, of not to exceed 200,000 gold rubles in value, the kinds of goods to be exported to be agreed upon for each six months in advance: that the petitioner should have the right to export from the Soviet Republics articles on which exportation was not forbidden*1400 by general acts of the government, the cost of the goods so exported each month to be not less than 200,000 gold rubles and in no event to be less than the value of goods imported during the same period: that goods exported from the Soviet Republics should be sold by petitioner at prices established by a representative of the NKVT; that the petitioner should include among its board of directors two persons selected by the NKVT with powers equal to other directors in carrying out the contract; and that 10 per cent of petitioner's profits, under the contract, should be paid to the Soviet Republics and the remaining 90 per cent divided equally between them, provided, however, that in case the amount accruing to petitioner exceeded 50 per cent of the value of the articles imported and exported, 70 per cent of the excess should be paid to the KNVT and the remainder to of the excess should be paid to the NKVT and the remainder to
The accounting between the "NKVT" and the "Corporation" as to the profits accruing to each, is to be made up as follows:
"a/" At the expiration of every three months, counting from the start of the operations, the "Corporation" pays the "NKVT" on account of*1401 accruing "NKVT" profits 17% (seventeen per cent) of the value of the imported and exported goods for this three-month period; these 17% (seventeen per cent) are in no case subject to return to the "Corporation" by the "NKVT."
"b" At the expiration of every six-month period of duration of this agreement and at time of making up of the final balance sheet of the "Corporation" in gold roubles upon all of the operations of this Agreement, the "Corporation" pays out to the "NKVT" the excess between the amount accruing to the "NKVT" and sums received by the "NKVT," in accordance with point "a/".
On October 10, 1923, the petitioner entered into an agreement with the Allied American Fur Sales Agency, Inc., a New York corporation, Sutta & Fuchs, a partnership, and Armand Hammer, president of petitioner, and Harry J. Hammer, wherein for one-half of the Agency's capital stock, petitioner assigned to the Agency certain of its rights covering furs under the agreement of July 14, 1923. Under this contract the furs were to be purchased by petitioner in the Soviet Republics in its own name for the account of the Agency with funds supplied by the Agency; the rights assigned were subject to the*1402 terms and conditions of the agreement of July 14, 1923, and the Agency agreed to pay to petitioner, for the account of the *1278 NKVT, "such amounts at such times as the Corporation [petitioner] would be required by the concession [July 14, 1923, agreement] to pay to Peoples Commissariat had it transacted the fur business instead of the Agency."
The first purchase of furs by petitioner under the October 10, 1923, agreement was made the same month. The goods were delivered to the New York Auction Company, a corporation in which the partnership of Sutta & Fuchs was heavily interested, in November, 1923, for the account of the Agency. Of the amount of $171,124.71 paid for the furs, $138,000 was paid to petitioner in Moscow in November, 1923, by a letter of credit obtained by the New York Auction Company, and the balance during the early part of 1924. The minimum fee of 17 per cent of the cost of the furs charged by the NKVT under paragraph 10 "a" in the agreement of July 14, 1923, was an expense of petitioner, and it was not to be reimbursed by the Agency or anyone else.
The petitioner made the following entry in its books on November 30, 1923, in connection with the*1403 transaction:
| Allied American Fur Sales | $171,124.71 | |
| Moscow a/c Rec | $171,124.71 | |
| To record shipment of furs to A. A. Fur Sales Ag. |
The first quarter of operations under the contract of July 14, 1923, ended on December 9, 1923. On that date the petitioner paid to the NKVT in Moscow the sum of $30,327.59 in gold. The receipt given for the payment recited that the sum paid "is the amount of profit due to the People's Commissary [Commissariat] for Foreign Trade according to item 'a' of paragraph 10 of the agreement of July 14, 1923." The transactions, on account of which the payment was made, consisted chiefly of the shipment of furs to the Agency.
The petitioner did not close its books at the end of 1923. It kept its books on the accrual basis.
In its return for 1923, filed in November, 1924, the petitioner claimed as a deduction a reserve of $11,120.36 for a license tax paid under the agreement of July 14, 1923. In an amended return filed in 1928, the amount of the deduction was increased to $30,327.59. The closing inventory of petitioner for 1923 contained no item for furs.
In determining in 1927 the deficiency involved herein, the respondent*1404 disallowed the claimed deduction of $11,120.36 on the ground that the sum represented a distribution of profits.
OPINION.
ARUNDELL: From the course that this case took at the trial it becomes desirable for its better understanding that we relate something *1279 of its historical background. It appears that in its original return for the year 1923 petitioner sought to deduct $11,120.36, which amount it designated as "license tax to Russian Government." Thereafter in 1927 the respondent issued a notice of deficiency, and in said notice stated that the deduction claimed was disallowed, "* * * for the reason that the evidence submitted indicates the item to be distribution of profits and is disallowed in accordance with Article 1541, Regulations 62." Thereupon the petitioner instituted these proceedings. In 1928 and during the pendency of these proceedings petitioner filed with the Commissioner an amended return for the year 1923 in which it sought to deduct in lieu of the $11,120.36 the sum of $30,327.59, which amount it claimed as that paid to the Soviet Republics. The following errors were cited by petitioner:
(a) The payment to the Russian Government, which the Commissioner*1405 claims is a taxable distribution of profits to a shareholder, was an absolute fixed minimum license fee for the privilege of doing business in territory controlled by the payee (Russian Government).
(b) The payment was not from profits, nor based thereon, but was based on the value of goods imported and exported by the petitioner during a fixed period.
(c) Regardless of the presence or absence of profits, the payment had to be made by the petitioner, and was not refundable.
(d) The payee (Russian Government) was neither a shareholder nor a stockholder in the petitioner.
Respondent's answer was a general denial.
The testimony offered by the petitioner clearly established the payment by it to the Soviet Republics in December, 1923, of gold rubles of the value in American money of $30,327,59; that the amount so paid was an absolute fixed minimum license fee for the privilege of doing business in Russia and was based on the value of goods imported and exported by the petitioner during a fixed period and no part of it was refundable; and, further, that the payee, the Soviet Republics, was not a stockholder of petitioner. On these undisputed facts petitioner claims that it*1406 is entitled to deduct the $30,327.59 either as a tax or as an ordinary and necessary expense of carrying on a trade or business.
The petitioner had been carrying on business in Russia for some time prior to 1923, when apparently there were no trade restrictions. In 1923 the Soviet Republics enjoyed a monopoly of buying and selling within its territory as well as the importation into and exportation of goods out of the country and forbade others under penalty of death to engage in such trade without first entering into an agreement with the Peoples Commissariat of Foreign Trade of the form executed by the petitioner. Petitioner's president in 1923 commenced *1280 negotiations with the proper officials of the Soviet Republics for a trading permit or concession, and, after discussing the subject for a "few months," reached an understanding, the terms of which were embodied in the agreement of July 14, 1923. Thus, it appears that the concession agreement was reached only after prolonged negotiations carried on at arm's length between parties each striving for the best possible bargain. Had petitioner been able to negotiate a more advantageous contract we have no doubt that*1407 it would have done so. Then it was confronted with the problem of either paying for the privilege of doing business in the Soviet Republics or remaining out. We have no reason for questioning its motives for electing to do the former.
In this respect the instant case is unlike . That case was submitted on a stipulation of facts which failed to show the necessity of the agreement as a prerequisite to doing business. There the holder of the concession was shown to have been indirectly owned by the Soviet Republics.
On the issue as directly framed it would seem that the petitioner should prevail and that the amount of $30,327.59 paid to the Soviet Republics is properly deductible as an ordinary and necessary expense under section 234(a)(1) of the Revenue Act of 1921.
While it was not entirely clear until the conclusion of the trial and the receipt of respondent's brief exactly what his position was, it now appears that he no longer contests the fact of payment or contends that the amount paid constituted a distribution of profits within the meaning of the revenue act. He advances, however, two grounds for sustaining*1408 the deficiency determined by him; first, that the goods were sold to the Allied American Fur Sales Agency, Inc., in 1923 under an agreement whereby petitioner was to be reimbursed for its entire cost in securing the furs, including the amount paid to the Soviet Republics, and that the right to receive payment from the Agency would serve as an offset against the payment made to the Soviet Republics; and, secondly, in the alternative, that the amount paid to the Soviet Republic constituted a part of the cost of the furs, and as these goods were still owned by petitioner at the end of 1923 they would properly be carried in its inventory and consequently no deduction would be allowed. Thus it will be seen that the grounds on which the proceedings first started have been materially shifted by the respondent.
To properly understand the grounds relied upon by respondent, a brief discussion of petitioner's relations with the Allied American Fur Sales Agency, Inc., is necessary.
*1281 Shortly after petitioner was granted the concession, Sutta & Fuchs, large fur dealers, who were unable to obtain a trading permit with the Soviet Republics, approached petitioner with a proposition*1409 to acquire the fur rights under its license. Subsequent discussions of the question led to the organization of the Agency to exploit the concession in so far as it related to furs, and to the execution of an agreement on October 10, 1923. This agreement provided for the issuance to petitioner of one-half of the Agency's stock for the assignment to it of the fur rights under the concession; for the purchase of furs in Russia by petitioner for the Agency with funds supplied by the latter; for payment of $200,000 by Sutta & Fuchs to the Agency for shares of its stock; that upon application of the Agency, Sutta & Fuchs should maintain irrevocable letters of credit in the minimum amount of $300,000 for the purchase of furs by petitioner; that the Agency would pay to petitioner for the account of the NKVT such amounts as petitioner would have been required to pay the Soviet Republics had it transacted the fur business instead of the Agency; that all losses should be borne equally by petitioner and Sutta & Fuchs; that neither of them should sell its stock of the Agency without obtaining the consent of the other, and that the rights assigned were subject to the terms and conditions of the*1410 concession agreement.
Thereafter within the month petitioner made a purchase of furs under the contract at a cost of $171,124.71 and promptly shipped them to the Agency in care of the New York Auction Company, which sold the consignment at auction sales conducted during the early part of 1924, and in February of that year rendered a statement to petitioner of the transaction. The original cost of the furs was charged to the Agency on the New York books of petitioner in November, 1923. During the same month the Agency paid to petitioner in Moscow on account of the transaction the sum of $138,000 in the form of a letter of credit obtained by the New York Auction Company for that purpose. The balance of the purchase price was paid during the early part of 1924.
The first point is based entirely on paragraph 9 of the contract between petitioner and the Allied American Fur Sales Agency, Inc., et al., wherein it is provided that "The Agency agrees with the corporation that it will pay over to the corporation for the account of the Peoples Commissariat for Foreign Trade such amounts at such times as the corporation would be required by the concession to pay to said Peoples Commissariat*1411 had it transacted the fur business instead of the Agency." There is no doubt that this provision of the contract tends to support the respondent's position. Unexplained, *1282 the language is, in our judgment, sufficient to indicate that petitioner was to be reimbursed for the fee paid by it incident to the shipment of furs. There is, however, in the case the positive testimony of petitioner's president who had negotiated both contracts, namely, the one with the NKVT and the Agency contract, to the effect that petitioner was neither directly nor indirectly reimbursed by the Agency or anyone else for the fee paid by it; that the goods were to be and actually were sold and billed to the Agency at the first cost of $171,124.71; and that any amount payable to the NKVT for the privilege of exporting furs from Russia was to be an expense of petitioner alone. We think that this direct testimony must prevail over the implications to the contrary that may be drawn from the language of the Agency contract. It would, no doubt, have been helpful if the other parties to the Agency agreement had been called and perhaps their books and returns produced. The respondent did not produce*1412 them, but rested his case solely on the implications to be drawn from the contract. The petitioner could hardly have been expected to be prepared in more detail on this point when neither the notice of deficiency, the pleadings, nor the respondent's opening statement gave any hint of the contention now being discussed.
We can find no basis in fact for respondent's alternative argument. It is clear that the furs had been disposed of by petitioner before the end of the year 1923 and they formed no part of its inventory. They were delivered to the New York Auction Company for the account of the Agency in 1923, and the books of petitioner show a charge to the Agency of $171,124.71 on November 30, 1923, for the goods.
We think the petitioner is entitled to deduct the item of $30,327.59 as an ordinary and necessary business expense. Having reached such a conclusion, we need not decide whether the payment is deductible as a tax under section 234(a)(3) of the taxing act.
Decision will be entered under Rule 50.