*1878 Under the terms of 99 proprietary leases, assessments were levied by petitioner, a cooperative apartment house corporation, on its stockholder-tenants for the purpose of amortizing mortgages on its property, and were so used by petitioner and credited on its books to its capital stock account. Held, that such assessments were contributions to the capital of the corporation and not taxable income.
*400 This proceeding arises upon a determination of deficiencies in petitioner's income tax in the aggregate amount of $6,074.11, and for *401 the calendar years 1923, 1924, and 1925, distributed respectively as follows:
| 1923 | $2,011.54 |
| 1924 | 2,094.71 |
| 1925 | 1,967.86 |
The only issue involved is whether the payments to petitioner of certain assessments made upon its stockholder-lessees should be included in gross income as rent received from stockholder-tenants.
FINDINGS OF FACT.
The petitioner, 874 Park Avenue Corporation, was organized under the laws of New York in September, 1922, with an original authorized capital stock*1879 of $300,000, made up of 6,000 shares of $50 par value. Its principal office is with Pease & Elliman, 600 Madison Avenue, New York, N.Y.
The number of shares originally issued was 4,716 amounting, at $50 each, to $235,800. A year later additional shares were issued to persons already stockholders, making 4,842 shares outstanding through the taxable years in controversy. The petitioner was incorporated for the purpose of acquiring, maintaining, and operating an apartment house with the intent that the shareholders should have the right to lease and occupy apartments in the building so long as they should remain shareholders. In other words, its object was to operate a cooperative apartment house.
The petitioner bought the apartment building known by the street number 876 Park Avenue, on the southwest corner of 78th Street and Park Avenue, New York City, on September 14, 1922, and was the owner in fee simple of this property throughout the taxable years. Petitioner owned no other real property until 1925, when it bought 870 Park Avenue.
The purchase price of the apartment building was $950,000, made up as follows:
| Cash | $232,000 |
| First and second mortgages (consolidated) | 500,000 |
| Third mortgage | 200,000 |
| Purchase money mortgage | 18,000 |
| Total | 950,000 |
*1880 The third mortgage was to be amortized at $5,000 every quarter, and the purchase money mortgage amortized at $1,500 every quarter, both becoming due at the same time - December 1, March 1, etc.
Eight of the twenty-four apartments in the building were occupied during the taxable years by stockholders of the corporation under 99-year proprietary leases beginning October 1, 1922, and *402 ending September 30, 2021. The form of lease employed between the petitioner as lessor and its stockholders as tenants, after reciting the purposes of incorporation, the purchase of the apartment building, the amount of the mortgages on the property (hereinbefore set out), and stating that certain apartments have been chosen by and allotted to the particular lessee-stockholder, and that the lessee is the owner of so many shares of the lessor corporation's capital stock "by reason of which ownership and to accompany which this lease is granted, pursuant to a resolution of the Board of Directors of the lessor," concludes with the granting clause:
* * * and the Lessee hereby hires and takes, as Lessee, the apartment now known as * * * at the following rent, to wit: the payment of the fixed*1881 sum of One Dollar annually in advance and in addition the payment of the additional rent and assessments hereinafter provided for.
Thereafter follow certain covenants:
ARTICLE I.
The Lessor Hereby Covenants with the Lessee, as follows:
* * *
Third: That the Lessee, upon paying the rent, assessment, and additional rent herein provided for, and performing the covenants and complying with the conditions on the part of the Lessee herein set forth, shall at all times during the term hereby granted, quietly have, hold and enjoy the said demised premises and a way of ingress and egress without any let, suit, trouble or hindrance from the Lessor, its successors or assigns;
* * *
Fifth: That the Lessor shall keep full and correct books of account, and that the same shall be open during all reasonable hours to inspection by the Lessee, or a duly authorized representative of the Lessee.
ARTICLE II.
The Lessee Hereby Covenants with the Lessor, as follows:
First: That the Lessee will pay to the Lessor, or its agent, said rent, and all additional rent herein provided for, at the times and in the instalments herein provided, IT BEING UNDERSTOOD AND AGREED that the Board of*1882 Directors of the Lessor shall each year by resolution adopted in or about the month of October, or some other month, estimate the sum of money which, in their judgment, will be required by the Lessor during the current or ensuing year (in addition to its other prospective income for said year and the surplus, if any, earned during the preceding year) for the payment of all prospective expenses and outlays by the Lessor, in connection with the ownership, maintenance and operation of said real estate so purchased by the Lessor, including among other things the payment of taxes, assessments, water rates, insurance premiums, operating expenses, the cost of repairs, all mortgage interest, required mortgage amortization payments, a sinking fund for the payment of mortgage indebtedness, the payment of any other liens and the meeting of deficits in previous years, if any; and it being ALSO UNDERSTOOD AND AGREED that if at any time the Board of Directors of the Lessor shall resolve that a special emergency exists requiring *403 additional funds, they may make a supplemental estimate of the sum to be required by the corporation for the purposes above mentioned for the year ending on the*1883 succeeding September 30th; and it being ALSO UNDERSTOOD AND AGREED that the amount of each and every estimate and supplemental estimate so made, shall be, and be deemed to be an assessment of rent imposed by the Lessor upon, and apportioned among, the several proprietary lessees in proportion to the number of shares of the capital stock of the Lessor issued to them respectively to accompany their several proprietary leases; and IT BEING FURTHER UNDERSTOOD AND AGREED that the resolution of the Board of Directors making the estimates and assessments above provided for shall not be subject to question or objection by the Lessee, but may be subsequently changed in amount by such Board or by its successors; and IT BEING FURTHER UNDERSTOOD AND AGREED that the right to establish the amount of and to require payment of any of the above provided for assessments shall be possessed only by the Board of Directors of the Lessor, and shall not pass to any Receiver or creditor of the Lessor, and IT BEING FURTHER UNDERSTOOD AND AGREED that so much of such assessments collected by the Lessor as shall be devoted to the payment of the principal of a mortgage or mortgages, or to other capital expenditure, *1884 shall be credited by the Lessor upon its books to the account of "paid in surplus."
The Lessee will, except as hereinafter in this paragraph provided, pay to the Lessor, each year ending September 30th as an assessment of rent, that proportion of each estimate made as hereinbefore provided, which the number of shares of capital stock of the Lessor issued to the Lessee to accompany this lease as above recited bears to the total number of shares of such stock accompanying all proprietary leases issued by the Lessor and in force at the time of the adoption of the resolution embodying such estimate, and will pay the same in equal monthly instalments on the first day of each month, or in such other instalments and at such other times as the Board of Directors of the Lessor may designate; and the Lessee will thereafter, except as hereinafter in this paragraph provided, pay to the Lessor, as an assessment of rent, a like amount or instalment on the first day of each month until a superseding estimate shall have been adopted as hereinbefore provided. * * *
Under the above provisions of the lease the board of directors of petitioner met in October of each year from 1922 to 1925, inclusive, *1885 estimated the amount that would be required for the ensuing fiscal year, and imposed assessments upon the stockholder-tenants which were duly paid by the stockholder-tenants to the petitioner.
While the estimates ran for the year October 1 to September 30, the petitioner files its returns on a calendar year basis. The assessments paid in each calendar year, therefore, are paid under two estimates: the one made in October in the preceding year and the one made in October in the current calendar year.
The amounts received by the petitioner in the respective calendar years from such stockholder-tenants were as follows:
| 1923 | $16,604.84 |
| 1924 | 16,947.64 |
| 1925 | 16,781.26 |
All of these assessments received in 1923 to 1925, inclusive, were applied on amortization payments in the respective calendar years.
*404 Petitioner's books show that during the taxable years the following sums were paid by petitioner on account of the principal of the mortgages:
| 1923 | $26,000 |
| 1924 | 26,000 |
| 1925 | 24,500 |
The procedure of assessment and collection was as follows:
Pease & Elliman kept petitioner's books and made all disbursements and collections of money, *1886 including both rent from nonstockholder-lessees and the assessments already mentioned.
Petitioner's assistant secretary and assistant treasurer, Bancroft, who was also a vice president of Pease & Elliman, prepared petitioner's annual budget, estimated the amount of the assessment necessary, and reported it to directors and to stockholders of petitioner. Meetings of the petitioner's directors and of its stockholders were held annually in October of each year, and on this account the auditor's reports were made on a fiscal year ending September 30.
At a meeting of petitioner's directors on October 17, 1922, Bancroft stated to the directors that it would be necessary to make amortization payments of $26,000 during the ensuing "fiscal year." He stated that the estimated income from rents of nonstockholdertenants of the apartment house would be sufficient to meet operating charges, but not amortization payments for the fiscal year October 1 to September 30, 1923. An assessment of $3.50 a share was advised on the then outstanding 4,716 shares. The petitioner's board of directors adopted a resolution imposing such an assessment in the total amount already stated. Each stockholder*1887 of petitioner was advised by Pease & Elliman of the nature and amount of the assessment by a copy of the minutes of the meeting and a monthly statement being sent him. The assessments were due monthly.
At the directors' meeting October 8, 1923, Bancroft stated the amount of assessments received from stockholders during the previous fiscal year, and informed them that the amount had been employed in amortization of mortgages. At the same time he stated the amount of the assessments estimated as necessary for the next fiscal year. The same procedure was employed for subsequent years; the board of directors authorizing the assessment, the stockholders paying it with the understanding that it was to be used for amortization, and a report being made to the stockholders each year that such a use had been made of the assessments. Stockholders' and directors' meetings were held on October 8, 1923, October 14, 1924, October 13, 1925, and October 11, 1926.
Each year when Pease & Elliman, petitioner's agents, received the assessments they applied them all on amortization payments, but *405 as the assessments were insufficient, the deficiency had to be supplied from other funds*1888 of petitioner.
The various tenants of the apartment house paid their rent by check to petitioner's agents, Pease & Elliman, and the agents obtained commissions on the amounts so paid by nonstockholder-tenants, but obtained no commission on the assessments paid by stockholder-tenants.
Petitioner had employed a firm of certified public accountants prior to the date for the directors' meeting in October, 1923, to audit petitioner's books, and Bancroft informed the accountants that the assessments were to be credited to the petitioner as paid-in surplus, as they were made for amortization purposes, and called their notice to paragraph 1, Article II, of the proprietary lease providing for assessments for this purpose. The accountants reported to petitioner on October 3, 1923. In this report it is stated with respect to the stockholders' assessments for the fiscal year 1922-1923, in the amount of $16,506.24: "This has been used to reduce the outstanding mortgages, that is, the purchase money mortgage and the third mortgage." In the same report the assessments appear in the balance sheet under "liabilities," and are not included in the income statement.
Subsequent reports by the*1889 auditors of petitioner's books for the fiscal years 1924, 1925 and 1926 show a similar statement with respect to use of assessments for amortization of the mortgages. These reports also show an addition to petitioner's capital account for the respective years in the amounts of the stockholders' assessments.
Rents and assessments were kept in a single account by the petitioner's agents, Pease & Elliman, but in the agents' statements to the petitioner they appeared as two separate items. A "surplus account" appears on petitioner's ledger, but there is no "paid-in surplus account." The assessments in the petitioner's ledger appear under the heading of "assessments."
No fees or salaries were paid to officers or directors of petitioner during the taxable years in question.
OPINION.
MATTHEWS: The only issue is whether the assessments paid to the petitioner by stockholder-tenants pursuant to the terms of their leases to be used by the petitioner for the amortization of the mortgages on the apartment house and so used constitute paid-in surplus capital to the petitioner or income in the nature of rent. We are of the opinion that the assessments so made and employed were contributions*1890 of capital to the petitioner and as such nontaxable.
*406 In relation to a state of facts in all essential respects identical with those here presented, the Commissioner of Internal Revenue in I.T. 1469, C.B. I-2, p. 191, stated the facts and his conclusion as follows:
Each of the stockholders of a corporation owning certain apartment buildings is a proprietary lessee holding a lease for 99 years at $1 per year on an apartment or apartments of the value of the shares owned. Under the terms of the lease, each stockholder, in addition to the nominal rent of $1 per year, agrees to pay, when required by the board of directors, his proportionate share, based upon the number of shares of stock held by him, (1) of any deficiency arising from the operation and maintenance of the apartment buildings; (2) such sums as shall be necessary to enable the corporation to pay interest and to amortize mortgages; and (3) any and all necessary expenses incident to the ownership, maintenance, and operation of the property. The lease provides that so much of the payments received from the lessees as may be devoted to the payment of the principal of a mortgage or any other capital expenditures*1891 shall be credited upon the lessor's books to "paid-in surplus" account. The lessor's books clearly reflect the application of the payments to the reduction of mortgage indebtedness and other capital expenditures, and the stockholders are advised of the amounts so applied.
Considering the specific provision of the proprietary lease for crediting payments made by the stockholders for the reduction of the mortgage indebtedness or for other capital expenditures to the "paid-in surplus" account in connection with the fact that the books of the corporation reflect the amount of the assessment payments used for such purposes and that the stockholders are advised of the respective amounts so applied, it is held that that portion of the assessment payments credited to the "paid-in surplus" account and devoted to the reduction of the corporation's mortgage indebtedness or for other capital purposes is in the nature of a voluntary assessment upon the stock held by the individual proprietary lessees, which, under article 544, Regulations 62, represents additional cost of such stock, and does not constitute income to the corporation. (I.T. 1302 (C.B. I-1, p. 193) overruled in part.)
We are*1892 unable to find that this ruling has been reversed or modified.
This Board has taken the same view. In a case analogous in principle, Paducah & Illinois Railroad Co.,2 B.T.A. 1001">2 B.T.A. 1001, two railroads had organized a bridge corporation, of which they owned all the capital stock, to provide bridge facilities across the Ohio River. The bridge company and the railroads entered into an agreement by which the latter were to make payments of the former's expenses, etc., and also to make contributions toward its sinking funds and retirement of its bonds in the proportion of their respective use of the bridge company's facilities. In return for the latter class of payments the bridge company was to issue preferred stock. The Board said:
From the beginning, the funds so contributed by the railroad companies were earmarked partly for the ordinary expenses of the taxpayer and partly for its capital requirements. In so far as the contributions were used or to be used for ordinary expenses, interest, taxes, and dividends, there can be no question *407 that the railroad companies were making payments for services rendered by the taxpayer, which constituted expenses to*1893 themselves and income to the taxpayer. To the extent, however, that their contributions were from the beginning required and, under the contract of July 1, 1915, were contemplated to be used for the retirement of debt and offset by preferred stock issued or to be issued to the railroad companies, the contributions were not expenses of the railroad companies, and were not income to the taxpayer. They were, on the one hand, investments of capital, and, on the other, receipts of capital for which stock was required to be issued. * * *
* * * As we view the case, whether stock was actually issued at the time is immaterial. * * *
In the third paragraph of Article I, containing the covenants of the lessor, reference is made to "the rent, assessments, and additional rent herein provided for." In the first paragraph of Article II, containing the covenants of the lessee, the lessee agrees that the assessments made by the board of directors "shall be, and be deemed to be an assessment of rent imposed by the Lessor," but that "so much of such assessments collected by the Lessor as shall be devoted to the payment of the principal of a mortgage or mortgages or to other capital expenditure, *1894 shall be credited by the Lessor upon its books to the account of 'paid-in surplus.'"
Because the assessments are referred to in Article II, paragraph 1, of the lease as assessments of rent, the respondent contends that they were in fact payments of rent, but this contention is completely refuted, it seems to us, when the lease is read as a whole and the purposes of the individual corporators of petitioner in creating the corporation are taken into account. We see no essential difference between the amortization assessments here imposed and those imposed and collected by an ordinary corporation from its stockholders.
The respondent also interposes the objection that the petitioner did not credit on its books to a "paid-in surplus" account the amount of such assessments used for the amortization of mortgages. The assessments were separately entered in petitioner's ledger under the heading "assessments," and were allowed to swell the amount of its capital stock account. On these facts we think that such a treatment amounts to a substantial compliance with the requirement that they be credited to the paid-in surplus account.
We hold that the assessments paid by petitioner's*1895 stockholders to be used for amortization of its mortgages and which were so used were contributions to petitioner's capital.
Reviewed by the Board.
Judgment will be entered for the petitioner.