*122 Decision will be entered under Rule 50.
1. On April 23, 1948, petitioner entered into a lease for a period of 7 years 8 months from February 1, 1947. Therein, petitioner agreed to expend $ 250,000 for improvements to the property during the term thereof, and in the event it spent a lesser sum to pay the lessor at the expiration of the lease the difference between the amount called for and the amount actually so spent. There was provision for renewal of the lease for 2 additional terms of 10 years each. Held, petitioner's obligation to expend the $ 250,000 was not contingent. Such obligation constituted consideration for a lease and as such is amortizable over the term of the lease plus 1 renewal period, i. e., 17 years 8 months.
2. Held, petitioner may not deduct any amount for accrued accounting fees in excess of that allowed by respondent in his determination.
*1083 Respondent determined deficiencies in income tax of petitioner for years and in amounts, as follows:
| Fiscal year ended January 31 | Deficiency |
| 1947 | $ 1,287.30 |
| 1948 | 12,188.16 |
| 1949 | 10,809.78 |
*1084 By stipulation, petitioner has withdrawn and conceded certain assignments of error contained in the petition as filed, leaving only the following issues for decision:
1. Whether petitioner is entitled to a deduction for depreciation or amortization of leasehold expenses in each of its fiscal years ended January 31, 1948 and 1949.
2. Whether petitioner may deduct accrued accounting fees in the full amount of $ 10,000 for its fiscal year ended January 31, 1947.
FINDINGS OF FACT.
Part of the facts have been stipulated and are accordingly so found.
Petitioner, the Jos. N. Neel Company, is a corporation organized under the laws of the State of Georgia in 1906, with its principal place of business in Macon, Georgia. It filed its income tax returns for its fiscal years here involved on the*124 accrual basis with the collector of internal revenue for the district of Georgia.
Petitioner operates a retail specialty store selling men's, women's, and children's clothing and accessories, in Macon.
The Jos. N. Neel Investment Corporation (hereinafter referred to as the investment corporation) is a corporation organized June 1, 1945, under the laws of the State of Georgia, with its principal place of business in Macon, Georgia. It is a real estate holding corporation, and throughout the years involved, owned all of the real estate occupied by the petitioner. Joseph N. Neel organized both petitioner and the investment corporation. He was active in the management of both corporations during the years involved herein. The investment corporation was organized by Neel in order to distribute part of his estate before his death. Throughout such years and particularly throughout the calendar years 1947 and 1948, the total outstanding capital stock of the investment corporation consisted of 100 shares of common stock owned by the following persons and in the following proportions:
| Roland H. Neel | 25 shares |
| Leonora N. Krenson | 25 shares |
| Blanche N. Earnest | 25 shares |
| Gladys N. Dickey | 25 shares |
*125 These four persons are the children of Joseph N. Neel.
Throughout the period herein involved the total outstanding capital stock of petitioner, the Jos. N. Neel Company, consisted of 1,000 shares of common stock of which Roland H. Neel owned a majority. The stockholders of the Jos. N. Neel Company during this period were as follows: *1085
| As of January 1, 1947. | |
| Stockholders | Shares |
| Joseph N. Neel | 200 |
| Roland H. Neel | 501 |
| Blanche H. Neel | 30 |
| Leonora N. Krenson | 30 |
| Blanche N. Earnest | 30 |
| Gladys N. Dickey | 30 |
| C. D. McCowen | 72 |
| M. R. Dixon | 36 |
| H. W. Bronson | 36 |
| W. P. Mahone | 25 |
| J. C. Algee | 10 |
| Total shares outstanding | 1,000 |
| As of April 1, 1948. | |
| Stockholders | Shares |
| Joseph N. Neel | 48 |
| Roland H. Neel | 552 |
| Blanche H. Neel | 30 |
| Leonora N. Krenson | 68 |
| Blanche N. Earnest | 68 |
| Gladys N. Dickey | 68 |
| M. R. Dixon | 50 |
| H. W. Bronson | 46 |
| W. P. Mahone | 35 |
| J. C. Algee | 20 |
| George W. Grier, Jr | 10 |
| W. M. Giles | 5 |
| Total shares outstanding | 1,000 |
Joseph N. Neel was president of the investment corporation in 1947 and 1948. During such years, the board of directors of the investment corporation consisted of Joseph N. Neel, Roland H. Neel, Leonora N. Krenson, Blanche*126 N. Earnest, and Gladys N. Dickey. The gross sales volume of all departments in petitioner's store was as follows:
| Fiscal year ended January 31 | Gross sales |
| 1946 | $ 1,561,376.58 |
| 1947 | 1,482,161.41 |
| 1948 | 1,514,840.19 |
| 1949 | 1,343,252.35 |
On January 1, 1947, and throughout the period here involved, petitioner occupied 2 adjoining store buildings on Cherry Street in Macon, Georgia. These buildings were 50 years old or more, were in need of substantial repairs, and were too small for the business conducted *1086 by petitioner. These buildings did not cover the entire premises occupied by petitioner. Such premises also included a vacant lot immediately to the rear of the building, running the entire width of the property, with a depth of 70 feet at one end and 55 feet at the other end.
Early in January 1947, petitioner undertook negotiations with the investment corporation, the owner of the property, for a new lease on the premises. In these negotiations, Roland H. Neel acted for and represented the petitioner, and his three sisters acted for the investment corporation, the lessor, with one sister, Leonora N. Krenson, constituting the principal spokesman for the lessor. *127 The three sisters were married and their families were self-supporting. They were assisted in the negotiations by their husbands and by some real estate brokers whose advice and counsel they sought. On January 14, 1947, the parties held a meeting in connection with the proposed new lease, at which meeting it was suggested that the investment corporation construct a new building on the premises with funds that would be loaned to it by petitioner. Further conversations and negotiations followed this meeting, and later meetings were held on this matter on February 26, 1947, January 28, 1948, and April 19, 1948. In these conversations and at these meetings several proposals were discussed and considered. No agreement being reached, the parties finally decided, following the meeting of January 28, 1948, to obtain the recommendations of a disinterested arbitrator. Thad Murphey, a prominent Macon realtor, was selected to act as the disinterested arbitrator. Murphey, after consulting with the parties, wrote out a lease that he recommended as fair to both sides. This lease, with slight changes, was accepted by the parties and executed on April 23, 1948.
The term of the lease thus accepted*128 and executed was stated to begin February 1, 1947, and to terminate on September 30, 1954. The lessee (petitioner) was given 2 successive options to renew the lease on the same terms, each renewal period to be for 10 years. The rental set therein was $ 20,000 per year, in addition to which petitioner agreed to pay an excess rental computed on the basis of 2 per cent of the annual volume of sales in excess of $ 1,000,000, such excess rental to be paid only on sales beginning on October 1, 1951, and continuing for the balance of the lease or any renewals thereof. The sales were to be those of all departments, including leased departments. The lessee was, at the request of the lessor, required to maintain insurance coverage on all the buildings for the protection of the lessor as its interest appeared.
In addition to the foregoing rental the petitioner agreed to pay all taxes, insurance, and assessments, and agreed to pay all maintenance costs of the building including structural repairs and roof expense. *1087 The lessors were not obligated to make any repairs or improvements whatsoever during the term of the lease, which also provided in paragraph 13 thereof as follows:
(13) *129 It is further agreed that the Lessee shall bind itself to improve the building at a cost of $ 250,000.00 during the term of this lease. However, in the event that the Lessee does not spend the full $ 250,000.00 on improvements, then at the expiration of this lease, the Lessee agrees to pay to the Lessor as additional rental the difference between the $ 250,000.00 and the sum it actually spent on the improvements.
Although the lease was executed on April 23, 1948, it was made effective February 1, 1947, in accordance with the agreement of the parties that any lease finally agreed to would become effective as of the time the negotiations first began.
The stipulated rent was suggested by Murphey on the basis that a fair excess rent would be 4 per cent of sales, and that by reducing it to 2 per cent the tenant would be able to amortize the cost of the improvements it was obligated to make over the terms of the contract, and thus refund itself out of the excess rent. The figure of 4 per cent was used by Murphey in appraising the property.
Both parties recognized that a new building was desirable, and petitioner agreed to the foregoing penalty clause obligating the tenant to build the*130 new building at the insistence of the lessors. The proposed new building to be built by the petitioners had not at the time of the hearing been built nor had construction started on it. The lease as finally executed is comparable to other leases in Macon, Georgia, involving similar properties and similar businesses.
Joseph N. Neel was active in the negotiations surrounding the new lease. Samuel C. Cutler, who was the accountant and tax consultant for both the petitioner and the investment corporation, took part in the discussions. The tax consequences of the $ 250,000 leasehold improvements clause were discussed with him.
The premises occupied by the petitioner consist of two adjoining buildings located at 454-460 Cherry Street, Macon, Georgia. Prior to the execution of the foregoing lease, the petitioner occupied the buildings under two separate leases from Joseph N. Neel. The lease covering the building at 456, 458, and 460 Cherry Street had been executed in December 1930, and was to expire by its own terms on September 30, 1951. The lease covering 454 Cherry Street which had been executed on January 27, 1940, expired by its terms on September 30, 1944, but was extended by*131 the lessor to September 30, 1951. The lease for the building at 456, 458, and 460 Cherry Street contained the following provisions:
(a) Petitioner was to pay $ 700 per month rent. As additional rent the petitioner agreed to pay 4 per cent of its gross volume of annual *1088 sales less refunds in all departments operated by it (but not to include leased departments) in excess of $ 240,000 up to $ 400,000.
(b) Petitioner was to pay all taxes assessed against the property whether State, county, muncipal, or special and to keep the building fully insured payable to the lessor.
(c) Petitioner was to bear expense of all repairs necessary to keep the building in first class condition.
(d) Petitioner was given the right at its expense to alter or improve the existing building or to substitute another building for it.
The lease for the building at 454 Cherry Street contained the following provisions:
(a) Petitioner was to pay $ 250 per month rent.
(b) Petitioner was to bear expense of all repairs necessary to keep the building in first class condition.
(c) Petitioner was given the right at its expense to alter or improve the existing building or to substitute another building for it.
*132 Following the organization of Jos. N. Neel Investment Corporation, the two above mentioned leases and the property to which they related were assigned by Joseph N. Neel, lessor, to the Jos. N. Neel Investment Corporation for stock and debentures in the investment corporation.
In each of its fiscal years 1948 and 1949, petitioner, on its books and on its income tax returns, deducted $ 32,608.69 as depreciation on leasehold improvements over the term of the lease extended from February 1, 1947, to September 30, 1954, a period of 7 years 8 months.
For its fiscal year 1947 petitioner employed Samuel Cutler, an accountant and tax consultant, to do its tax and accounting work for that year. It agreed to pay Cutler $ 10,000 for these services, $ 5,000 to be paid at the end of the year and $ 5,000 when the year's business was completed. The same arrangements had been made with Cutler by petitioner for its fiscal years 1945 and 1946. His employment was ended before he completed the work for the fiscal year ended January 31, 1947.
Petitioner deducted $ 32,608.69 as amortization of the lease in each of the years 1948 and 1949. Respondent disallowed such deductions holding that the $ 250,000*133 provision was contingent. He also disallowed the $ 5,000 not actually paid to Cutler.
OPINION.
The first question involves the propriety of respondent's disallowance of a deduction claimed by petitioner in each of its fiscal years ended January 31, 1948 and 1949, for depreciation or amortization of leasehold expense.
*1089 The lease involved was executed on April 23, 1948, was for a term of 7 years 8 months from February 1, 1947, and was subject to renewal for 2 additional terms of 10 years each. Therein petitioner, the lessee, agreed, inter alia, to expend $ 250,000 to improve the demised premises. In the event it did not expend the entire amount for such purposes, petitioner further agreed to pay as additional rental to the lessor at the expiration of the lease the difference between the $ 250,000 and the sum actually so expended. As of the date of the hearing herein, no part of such amount had been paid.
It is petitioner's contention that its leasehold interest was acquired by it at a cost of $ 250,000 and that such cost is subject to being amortized over the original term of the lease.
Respondent maintains that while petitioner may be liable to pay the sum of $ 250,000*134 over the term of the lease or at the expiration thereof, nevertheless it is not irrevocably bound to make the improvements called for in the lease. He argues that petitioner's obligation under the lease was contingent and that, since the building contemplated therein had not been undertaken, nor any portion of the $ 250,000 paid, there is nothing that can be deducted.
We see nothing contingent about petitioner's obligation under the lease clause in controversy. True, petitioner was not unconditionally committed to make the improvements called for therein. But, should it choose not to do so or make improvements for which it would expend less than the designated $ 250,000 it was nevertheless and absolutely bound to pay to the lessor as additional rental, at the expiration of the lease the full amount called for or the difference between such amount and that actually so expended. Thus, upon execution of the lease, petitioner's obligation to its lessor to make the payment either in cash or in improvements or both became fixed both as to liability and amount although the specific time to make such expenditure was indefinite. This being true, such obligation was properly accruable *135 on petitioner's books of account, petitioner being on the accrual method of accounting. Moreover, for our purposes here, it makes no difference whether the accrued obligation be considered as the purchase price of the leasehold interest or as additional rental. In either event, it constituted consideration for the lease and, as such, an aliquot part is deductible each year in amortization or depreciation thereof. Regs. 111, sec. 29.23 (a)-10. Cf. ; ; ; .
Respondent insists that even if petitioner's commitment under the lease clause involved is not contingent, the addition of $ 250,000 to the other rent called for in the lease makes the over-all rental excessive and unreasonable due to the relationship of the lessor and the petitioner. *1090 The qualified identity of interests between the officers and stockholders of the lessor, the investment corporation, and the officers*136 and stockholders of petitioner prevents the transaction in question from assuming an arm's-length character in the ordinary sense of the term. Thus although a deduction for rent paid is not limited by the Internal Revenue Code of 1939, as in the case of salary or compensation, to a "reasonable allowance," see , under such circumstances as are here present a critical examination of all the evidence bearing upon the transaction involved, in the light of the situation known then to exist, is required to determine the true character of the item and to ascertain whether the rental arrangement was in fact sufficiently reasonable to achieve the same result as arm's-length dealings.
In this regard, the only direct evidence on the point, aside from the testimony of petitioner's president, is the expert testimony of the real estate agent in Macon, a disinterested third party who assisted in the negotiations and who drafted those portions of the instrument in controversy. Such testimony was to the effect that the rent called for in the lease including the addition of the $ 250,000 was fair to all parties concerned, and, moreover, *137 that all factors considered, it was a reasonable rent and in line with those paid for similar businesses in similar locations. Such testimony was not rebutted upon cross-examination, nor has respondent introduced any countervailing evidence.
While the actions of a family corporation or family group should be carefully scrutinized, it is entirely conceivable that the relations each with the other, or their respective personalities, may be such that they will deal with each other strictly at arm's length. In fact, it sometimes happens that their very nearness in blood leads them to be more independent in action than strangers in blood. We are constrained to hold upon the present record that the aggregate payment called for in petitioner's lease with its related lessor is fair and reasonable and had the same result as arm's-length negotiations between strangers.
In view of what we have said above, we conclude that petitioner is entitled to a deduction in the fiscal years 1948 and 1949, respectively, for amortization of the $ 250,000 commitment assumed by it in 1948.
Turning now to the period over which such amount is amortizable, it is petitioner's contention that such period includes*138 only the original lease term of 7 years 8 months without taking into account any right of renewal which it possessed. On the other hand, respondent maintains that the period over which the amortization should be spread consists not only of such original term but also of both renewal periods of 10 years each or an aggregate of 27 years 8 months. To bolster their respective positions, both parties cite and rely upon Regs. 111, *1091 sec. 29.23 (a)-10, supra, the pertinent portions of which are set forth in the margin. 1
*139 Viewing all of the facts as of the years in dispute and considering all inferences properly to be drawn therefrom, we are convinced that such facts show with a reasonable degree of certainty that petitioner could be expected to exercise its right of renewal at least for the first 10-year renewal period. Compare , with . Such is not true with respect to the second renewal of 10 years. Accordingly, we hold that the proper period over which the amortization in question should be spread is 17 years 8 months. ; .
There remains the question of whether petitioner is entitled to a claimed deduction for accrued accounting fees in the amount of $ 10,000 for the services of Samuel C. Cutler for the fiscal year ended January 31, 1947. Respondent has disallowed $ 5,000 of the amount so claimed and as his reason therefor points to the fact that Cutler's employment was terminated prior to his completing*140 the tax work for such year. We agree with respondent that under such circumstances petitioner is not entitled to deduct the amount in controversy unless it be shown actually to have been paid. Petitioner's evidence on the point is speculative and inconclusive and, in our opinion, does not establish that petitioner is entitled to the deduction sought. Consequently, as to this issue respondent is sustained.
Decision will be entered under Rule 50.
Footnotes
1. In cases in which the lease contains an unexercised option of renewal, the matter of spreading such depreciation or amortization over the term of the original lease, together with the renewal period or periods, depends upon the facts in the particular case. As a general rule, unless the lease has been renewed or the facts show with reasonable certainty that the lease will be renewed, the cost or other basis of the lease or the cost of improvements shall be spread only over the number of years the lease has to run, without taking into account any right of renewal. * * *↩