*2161 Petitioner employed a certain individual to advise and aid him in the consolidation and incorporation of his business with that of another competing concern, and the petitioner, in 1920, agreed to pay such individual $10,000. The corporation was organized and petitioner, not having the cash to pay said adviser for his services, gave said individual one hundred voting trust certificates, par value $100, as security for the $10,000 agreed to be paid, with the right of petitioner to reacquire said certificates upon the payment to said individual of $10,000. Petitioner kept his accounts upon a cash receipts and disbursements basis and made payment of $10,000 in 1922. Held that petitioner is not entitled to a deduction of $10,000 from gross income for 1921.
*1268 The Commissioner determined a deficiency in income tax of $1,709.52 for 1921 in Docket No. 13766. The deficiency arises from the refusal of the Commissioner to allow petitioner a deduction of $10,000 alleged to have been spent by petitioner for the services of a financial adviser*2162 in the consolidation of petitioner's business with that of another in the form of a corporation. Petitioner claims this was error, as said payment was an ordinary and necessary business expense. In Docket No. 29156, the Commissioner determined a deficiency in income tax of $185.40 for 1923. At the hearing the deficiency for 1923 was agreed to by stipulation.
FINDINGS OF FACT.
Petitioner is a resident of Riverside, Calif. For many years prior to 1921 he had been the sole proprietor of a general machine shop and foundry business and made a specialty of manufacturing equipment for citrus fruit packing plants. In connection therewith he devised and secured patents for various mechanical devices for sorting, washing, testing, drying, and packing oranges and lemons.
During the same period George D. Parker was engaged in a similar business in the same locality. Parker also invented various appliances and secured patents. Sharp competition developed between them and patent litigation ensued, which proved costly to both.
In 1920 petitioner and Parker, and certain business associates, realizing the folly and cost of the keen rivalry and patent litigation between petitioner*2163 and Parker, entered into negotiations for the purpose of adjusting the differences and combining the two businesses or having petitioner or Parker purchase the interest of the other. W. B. Clancy, president of the Citizens' National Bank & Trust Co., of Riverside, Calif., was chosen to represent petitioner as his financial adviser and negotiator and George X. Wendling was chosen to represent Parker. Petitioner and Parker each agreed to pay his representative for his services. Petitioner agreed to pay Clancy $10,000. The result of the negotiations was that petitioner and Parker agreed to form a corporation in which both would be equally interested and to which both would transfer and convey the assets of their individual businesses.
This was first evidence by a written agreement dated December 29, 1920, which was modified by a subsequent agreement dated January 5, 1921. By the latter it was provided that the capital stock of the corporation should be $750,000, divided into 3,000 shares of preferred stock, 1,500 shares of convertible common stock, and 3,000 *1269 shares of common stock. It was agreed that 1,500 shares of preferred stock and 100 shares of common stock*2164 should be issued to Parker and 100 shares of common stock and 1,500 shares of common convertible stock to the petitioner. There were certain other agreements looking to the issuance of additional stock and equalizing the interests of the parties not material to this controversy.
When it had been agreed between all parties concerned that a corporation would be formed and that petitioner and Parker would transfer to it their businesses, petitioner and Parker did not have the cash with which to pay Clancy and Wendling the amounts agreed upon and they agreed in the instrument of December 29, 1920, to transfer to Clancy and Wendling each $10,000, par value of common Class "A" stock, as appears from the testimony at the hearing, "simply to guarantee to them [Clancy and Wendling] that they would be paid or would have the means of realizing $10,000." In the agreement of December 29, 1920, which was between petitioner and George B. Parker, it was set forth, among other things, that the petitioner and Parker were each to receive, among certain other stock, 100 shares of Class "A" stock of equal par value, to wit, $100 a share, and the said agreement between petitioner and Parker further*2165 provided as follows:
It is further agreed that when permitted to do so by the Corporation Commissioner, the parties hereto will transfer to W. B. Clancy and to George S. Wendling, to each of them, 100 shares of the common Class "A" stock referred to in said voting trust agreement, provided, however, that said Clancy and Wendling shall give and grant to said Parker and Stebler, an option to purchase, during the life of said voting trust agreement, said 200 shares of the capital stock at the par value thereof, and provided further that in the event of the exercise of said option within said time by said Stebler and Parker, that said shares shall be offered equally to said Parker and said Stebler, it being the intent hereof that said Stebler and Parker shall have equal rights under said option to purchase equal parts of said 200 shares of said stock.
The corporation was organized under the laws of California and stock issued in accordance with the written agreements above mentioned. In order to preserve the joint control of the corporation in petitioner and Parker on May 17, 1921, all of the issued common stock was placed in the hands of trustees by a voting trust agreement naming*2166 petitioner and Parker as trustees for a period of seven years, and voting trust certificates were issued to the stockholders. It was further provided in said agreement that petitioner was to assign and transfer to W. B. Clancy 100 shares of common stock, and that Parker should transfer a like amount to Wendling. This was accomplished by transfer of voting trust certificates upon the express agreement that the assignors had the exclusive right to reacquire the same at any time within the seven years the trust was to continue.
*1270 On May 17, 1921, a trust agreement was entered into between Parker, the petitioner, W. B. Clancy, and George K. Wendling, as parties of the first part, and George D. Parker and petitioner as voting trustees, parties of the second part, which provides that petitioner and Parker should at all times for a period of seven years have the exclusive management and control of the business and of the stock of the corporation, and the right to vote the same. In the preamble of said voting trust agreement it was set forth, among other things, that "Whereas in consideration of the services rendered to them personally by said W. B. Clancy and George K. Wendling*2167 in connection with said consolidation, said George D. Parker and said Fred Stebler have agreed to assign and transfer, subject to their agreement [of December 29, 1920], one hundred (100) shares of said common stock to said W. B. Clancy and one hundred (100) shares of said common stock to said George K. Wendling."
On April 17, 1922, petitioner paid $5,000 to W. B. Clancy by his check, and on the same date he paid $5,000 to Citizens' National Bank of Riverside, Calif., of which Clancy was president.
Thereafter, and in the year 1921, one hundred voting trust certificates, of the par value of $10,000, were given by petitioner to W. B. Clancy and a like amount by Parker to Wendling.
Petitioner kept his accounts on a cash receipts and disbursements basis. Petitioner claims that this total payment of $10,000 is a deductible expense for 1921, but the Commissioner disallowed same, resulting in the deficiency.
OPINION.
LITTLETON: Petitioner claims that $10,000 which he agreed to pay Clancy for his services in connection with the reorganization and consolidation of his business with that of George D. Parker was an ordinary and necessary business expense and was a proper deduction*2168 from his gross income for the year 1921. Upon the record we deem it unnecessary to discuss the question whether the amount agreed to be paid to Clancy for his assistance in this matter was of a capital nature and therefore not deductible as a business expense, since it appears that petitioner would not be entitled to the deduction in the taxable year 1921 even if it should be held that the amount agreed to be paid was an ordinary and necessary business expense. The petitioner testified that the voting trust certificates were given to Clancy as security for the $10,000 which he had agreed to pay for his services in the matter in connection with the incorporation and consolidation of the two businesses and this testimony does not contradict nor vary either the agreement between Parker and the petitioner on December 29, 1920, or the voting trust agreement of May 17, 1921.
*1271 The petitioner did not pay out the $10,000 until April, 1922, and even if the $10,000 which he agreed to pay to Clancy was a business expense, it would not be deductible in 1921, because it was not paid in that year. Counsel for petitioner argued in his brief that the petitioner employed the accrual*2169 method of accounting, but there is nothing in the record to support this contention; on the contrary the petitioner testified, in reply to a direct question concerning the method of accounting employed, that he kept his books on a cash receipts and disbursements basis.
Judgment will be entered for the respondent.