*885 1. The petitioner at time of organization acquired a business lot subject to a 99-year lease, and improved by a building constructed by the lessee in a prior year. Upon default of the lessee the lease was canceled, and the property with improvements surrendered to petitioner in the taxable year. Held, that petitioner realized no income through the cancellation of the lease.
2. After organization the petitioner, in consideration of capital assets transferred to it, assumed and paid a portion of losses which its incorporators had agreed to share with another corporation, growing out of the latter's guarantee of a lease. Held, under the facts shown, the payments so made by petitioner are regarded as part consideration for capital assets, and not losses deductible under section 23(f) of the Revenue Act of 1932.
3. Claim for larger salary deductions than allowed by the Commissioner is not supported by the evidence.
*303 This case involves income and excess profits tax liability for the year 1933, *886 which the respondent has determined at the gross sum of $25,884.77. The principal issue relates to whether or not the petitioner realized taxable gain through the surrender to it, under forfeiture of a 99-year lease, of property improved by the lessee. Other claims for deduction of alleged losses and expense items are involved.
FINDINGS OF FACT.
Petitioner is a Washington corporation, with its office at Seattle.
On March 14, 1928, the F. S. Stimson Co., herein called the Delaware corporation, owned an improved city business lot in the city of Seattle, Washington. The lot, described as lot 2 in the city plot, adjoined lot 1, in the same block, which was owned by the Center Investment Co. On the above date the Delaware corporation leased its lot *304 for 99 years, beginning December 1, 1928. Through assignment the Center Investment Co. became the lessee. The lease provided that the lessee should at his own expense demolish the building on said lot and replace it with a modern business block, to cost no less than $75,000. The Center Investment Co. leased its lot 1 for a period of 99 years and subleased lot 2 to the United Pine Center Corporation, on the condition*887 that the latter would construct a single business block covering both lots, but so planned as to admit of severance into two buildings in case for any reason the tenancy was terminated before expiration of the lease. To allow for such joint use of the two lots the Delaware corporation agreed to a modification of its lease, and, as security to compensate it against loss in event a severance of the buildings should become necessary, the lessee deposited with the Seattle Trust Co. $10,000 in securities. The building provided for in these leases was erected at a cost of $213,399.50 and was completed by September 30, 1930. Title to the portion located on lot 2 vested in the Delaware corporation on that date.
The capital stock of the Delaware corporation was divided into 1,000 shares, of which H. C. Stimson and his mother, Nellie C. Stimson, owned respectively 283 and 150 shares. On March 4, 1931, the Stimsons surrendered their said stock back to the Delaware corporation in exchange for a portion of its capital assets. The assets transferred to the Stimsons in that exchange included title to lot 2 aforesaid, and also an interest equal to 43.3 percent of the capital stock of Hollywood, *888 Inc., a subsidiary of the Delaware corporation which was engaged in operation of a restaurant known as the "Hollywood Tavern," under a lease the rentals for which were guaranteed by the Delaware corporation. It was known at the time of the last mentioned transaction that the Delaware corporation would be called upon to make good said rentals, but the whole amount it would have to pay under its guaranty was not known. In their stock surrender agreement the Stimsons and the Delaware corporation agreed that Hollywood, Inc., should continue operation of the Hollywood Tavern until expiration of its lease and then be "dissolved and disincorporated." In the meantime, the agreement provided that any and all losses resulting from the Delaware corporation's guaranty of the lease should be born by the parties "in proportion to their present stockholdings in Hollywood, Inc."
Petitioner was incorporated on April 7, 1931. On April 8, 1931, H. C. Stimson and Nellie C. Stimson conveyed to it all assets acquired from the Delaware corporation, and received therefor 433 shares of petitioner's stock, which constituted the entire issue of stock.
The Center Investment Co. defaulted in its lease, *889 and, after considerable litigation and negotiations, a compromise was made which *305 resulted in cancellation of the lease and surrender of the premises to the owner on March 31, 1933. The monthly rental under the 99-year lease was $1,250. In the months of April to July, inclusive, the petitioner received rentals of $500 per month from the building. A new lease was negotiated, effective August 1, 1933, which provided for a monthly rental of $1,375. Expenses aggregating $1,032.90 were incurred in negotiating the new lease.
The petitioner assumed its incorporations' share in Hollywood, Inc., rent, which the incorporators had agreed to pay in their aforesaid contract with the Delaware corporation, and from time to time made payments thereon. In 1933 the Delaware corporation made a final settlement with the lessor on account of the Hollywood, Inc., lease, and the petitioner paid to it in 1933 the gross sum of $8,419.66 on that account. In its income tax return for 1933 the petitioner claimed the right to deduct the last mentioned expenditure as a loss resulting to it from the Hollywood Tavern lease settlement. The respondent denied the claim.
In the same return the*890 petitioners claimed "miscellaneous expenses" amounting to $2,059.65, which the respondent disallowed. During 1933 the petitioner paid to its sole stockholders, as president and vice president, a total of $12,600, which it deducted from gross income under the head of "officers' salaries." The respondent redeuced the deduction claimed on such account, and allowed the gross sum of $7,000. The sum of $7,000 represented reasonable compensation for services rendered by petitioner's officer-stockholders. The respondent also held that the petitioner realized a taxable profit through the cancellation of the lease on its lot 2, in the amount of $143,479.21, which latter sum he added to petitioner's gross income for the year.
OPINION.
ARUNDELL: The petition contains five assignments of error. One, which relates to a disputed depreciation claim amounting to $197.73, has been abandoned. Others, numbered 1, 2, 3, and 4 in the petition, remain in issue, and are controlled by provisions of the Revenue Act of 1932, reading as follows:
SEC. 22. GROSS INCOME.
(a) GENERAL DEFINITION. - "Gross income" includes gains, profits, and income derived from * * * dealings in property, whether*891 real or personal, growing out of the ownership or use of or interest in such property; * * *
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) EXPENSES. - All the ordinary and necessary expenses paid or incurred during the taxable year * * * including a reasonable allowance for salaries or other compensation for services actually rendered * * *.
* * *
*306 (f) LOSSES BY CORPORATIONS. - * * * losses sustained during the taxable year and not compensated for by insurance or otherwise.
Assignment of error No. 1 is based upon respondent's rejection of a deduction from gross income of the amount of $8,419.66 which petitioner paid as its part of the rental obligations of Hollywood, Inc. Petitioner claims this sum represented a loss under subdivision (f), supra. We think the petitioner wrong in this claim. The record shows that the Delaware corporation and not petitioner was guarantor for the rents of Hollywood, Inc. The Delaware corporation's liability, however, was no longer contingent, but an acknowledged loss when the petitioner's incorporators accepted their ratable part and agreed to pay it. The Stimsons*892 did pay a part of the debt before petitioner was incorporated and stood bound to pay the fixed ratable portions of the balance to the end of the lease. They paid $2,000 on March 18, 1931, before petitioner's incorporation, which amount petitioner entered in its ledger account as a charge against Hollywood, Inc. The petitioner concedes that the only reason why the entire obligation was not made a matter of record when it took it over was due to the fact that the full amount of it was then unknown. We think the amount was reasonably ascertainable at that time, but in any event, it was a fixed liability, primarily of the Delaware corporation, and, secondarily, to the part agreed upon, a debt of petitioner's incorporators. The petitioner's payment of its incorporators' part of these debts, if voluntary as respondent contends, was a distribution to them. If paid because it was bound under the transaction through which it acquired its assets, such payments must be regarded as part of the cost of the assets and therefore a capital expenditure. In either view the petitioner's claim on this item must be denied.
In assignment of error No. 2 petitioner complains of respondent's having*893 reduced the amount claimed for officers' salaries from $12,600 to $7,000. Deductions claimed under this class are allowable only to the extent that they are shown to be reasonable and for services actually rendered. The evidence fails to convince us that either of the petitioner's two officers, who shared in the payments involved, performed services of greater value to the corporation than the sums allowed by the respondent for their compensation, and his determination on this item is therefore sustained.
Assignment of error No. 4 relates to claims made for "miscellaneous expenses", the amounts of which the respondent allocated to capital expenditures in reacquiring leased property. The gross sums rejected by the respondent on this account amount to $2,059.65. The respondent determined that the expenditures claimed were part of the cost of repossessing the property leased to the Center Investment Co. and treated them as reduction of the profit realized on the repossession. Evidence was offered as to two itmes making up the total *307 amount claimed. One of the items is in the amount of $500 and the other is in the amount of $532.90. Both are identified by the testimony*894 as incurred in connection with negotiating a 15-year lease of the repossessed property for the period beginning August 1, 1933. Consequently, the respondent erred in his classification of these two items, but was correct in his disallowance of them as expenses. Expenditures in connection with long term leases are not deductible as current expenses but are to be spread over the life of the lease. ; affd., ; ; . Under the rule of the cited cases the sum of the two items, $1,032.90, should be amortized over the 15-year life of the lease and the part allocable to the period August 1 to December 31, 1933, allowed as a deduction for the year 1933.
The respondent determined that the petitioner realized a profit from the cancellation of its 99-year lease in the amount of $143,479.21, which sum he added to its 1933 income. In a recomputation set forth in his brief the respondent now determines the profit attributable to cancellation of the lease to be the net sum of $101,845.78. The petitioner argues*895 that the present case is controlled by the decision in ; petition for review dismissed, , in which we held that repossession of leased premises did not result in income to the lessor. The respondent, on brief, admits some similarity between the cases. The principles announced in the Slack case are, in our opinion, controlling here and it must be held that the repossession did not result in income to the petitioner. If a distinction between the Slack case and this one can be spelled out of the fact that the petitioner was not the lessor of the premises when the building was erected by the lessee, such distinction makes no difference in the result. A predecessor of the petitioner was the owner-lessor of the premises when the building was erected by the lessee in 1930. If there was gain at the time of erection, cf. , it was not the gain of this petitioner. After improvement of the premises by the lessee the petitioner acquired the property by purchase. There was no gain to the petitioner on the purchase even if the price was less than value. *896 . When the petitioner acquired possession in 1933 it acquired nothing except possession of property previously acquired by purchase and in this there is no element of income. Accordingly, we hold that the respondent erred in his determination that petitioner realized income upon the cancellation of the 99-year lease.
The petitioner offered evidence of the value of its building on lot 2 at the date of acquisition and at the time of cancellation of the lease. In view of our conclusion on this issue we have omitted any findings on the matter of value.
Decision will be entered under Rule 50.