*1054 1. A percentage of gross sales, set up on petitioner's records as "Improvement Fund", to be expended for permanent improvements of property, held includable in petitioner's income because not received upon trust, and consequently subsequent disposition, assignment or restriction as to use did not affect taxability when received.
2. Costs of defending a suit to enjoin petitioner from using its property for cemetery purposes held to be ordinary and necessary expense of business, deductible from income.
3. Where petitioner's accounts were kept on the basis of cash receipts and disbursements, officer's salary held to be deductible from income when paid.
*1037 Petitioner asssils respondent's determinations of deficiencies in income tax of $584.37 and $3,609.96 for the years 1927 and 1928, respectively. Upon motion, the proceedings were consolidated for hearing and report. Three issues are raised by the pleadings; (1) whether there should be deducted from income 25 per centum of *1038 petitioner's gross sales to cover cost of*1055 improvements; (2) whether amounts expended in litigation should be deducted from income as ordinary and necessary expenses; (3) whether $5,000 should be deducted from income for 1928 as salary of petitioner's president. By amendment at trial, an additional issue was raised respecting the allowance against income for the years before us of net losses incurred by petitioner in prior years. The existence of such losses depends upon our determinations of the first two issues raised by the pleadings, and for that reason petitioner asks us to consider the prior years, although no deficiencies have been determined therein.
FINDINGS OF FACT.
Petitioner is a Tennessee corporation maintaining its principal office in Memphis, where it is engaged in the business of developing and selling burial lots in a "park plan" cemetery. Upon its organization in December 1924, it acquired, in exchange for capital stock, a tract of 54 acres of land which had been purchased earlier in the year at a price of $34,000 by E. C. Hinds, who became president and manager of the corporation. Between the time he bought the property and the time it was taken over by petitioner, Hinds had expended about $17,000*1056 for improvements. All then existing liabilities with respect to the property were assumed by petitioner. The initial surveys of the tract divided it into 6,000 burial lots. Revision of these surveys, required by plans for necessary or desired improvements, reduced the number of lots available for sale to 5,400. Respondent has based him computations of profits from sales upon a reserve of 6,000 lots.
As permitted under the laws of Tennessee, petitioner established a perpetual maintenance fund of 25 per centum of all gross sales and deposited such amounts with a bonded trust officer. Respondent has not included the amounts of such deposits in gross income in the years now before us.
On its records, in addition to the perpetual care fund, petitioner set up a reserve of 10 per centum of gross sales as an improvement fund, from which to meet the cost of improvements to the cemetery. Investigation of the practices of leading cemeteries operated upon the plan adopted by petitioner, and inquiry among the officials of such concerns, disclosed that this percentage was insufficient and that at least 25 per centum of gross sales was required for the construction of desirable permanent*1057 improvements. Accordingly, the allocation on petitioner's records was increased from 10 to 25 per centum. While the company's records carried this reserve, it never, in fact, existed as a fund set aside or in special deposit, but remained within petitioner's control, unsegregated from its general funds.
*1039 Shortly after the organization of the company, its officers, after visits made to quite a number of established cemeteries, and consultation with architects and contractors, agreed upon the nature of the permanent improvements to be constructed and received tentative estimates of cost which totaled $399,500. However, it was not until 1930 that a written, detailed estimate of construction costs was drawn up, and this was revised later to include a Masonic memorial changed from the type originally contemplated to meet the ideas of representatives of the lodge who approved the purchase by the members of lots in a certain section of the cemetery. By this revision the estimated total cost of the contemplated improvements was increased to $420,777. Immediately after its organization petitioner undertook the development of its property and has since constructed various*1058 permanent improvements, has graded the tract, laid out roads, landscaped, fenced and, in general, improved the cemetery as rapidly as its funds would permit. In each year prior to 1929 it expended toward that end more than 25 per centum of its gross sales. At the time of the trial of this cause, several of the major construction projects had been completed, while on others the work was well under way, and about 32 acres of the tract had been improved, platted, and were available for sale.
On October 1, 1928, petitioner's directors adopted a resolution providing that 25 per centum of the contract price of all lots should be set aside as an improvement fund and instructing the manager to notify old lot owners "that this expenditure would be made on their lots." A meeting of lot owners was held at a local hotel and announcement made of the directors' action. In addition, early in 1929 the following notice was sent by postcard to all lot owners (then numbering about 500):
GROWING MORE BEAUTIFUL EVERY YEAR.
To our Lot Owners: -
Due to our ambition to give Memphis one of the most beautiful cemeteries in the South, the Board of Directors have passed a resolution authorizing the*1059 expenditure of 25% of the selling price of your lot for the improving and beautifying of Memorial Park. This does not cost you anything. Wish you would drive out and see just how well Memorial Park is keeping faith with the public.
You will be delighted.
[Signed.]
Thereafter the following provision was contained on the reverse side of all contracts for lot sales:
Improvement Fund.
Twenty-five per cent of the total selling price of this contract with the Memphis Memorial Park shall be set aside and shall constitute an improvement *1040 Fund. The moneys so set apart for the Improvement Fund shall be expended for the purpose of developing, enlarging, improving, and beautifying Memphis Memorial Park, including real estate, the landscaping of the grounds, construction of roads, entrances, fencing, Masonic shaft, a memorial chapel, Superintendent's home, office, the purchase of equipment and for any other charges which, in the judgment of the Board of Directors shall be necessary or proper for the establishment of a memorial park, or burial ground to be known as Memphis Memorial Park. The collections and disposition of the Improvement Fund is hereby made a part*1060 of this contract.
Most of petitioner's sales were made under contracts extending payment over a period of 18 to 24 months. Its accounts were kept on a basis of cash receipts and disbursements. Respondent has included in petitioner's gross income for each of the years here involved that portion of its gross sales (25 per centum) which was set up on its accounts as "improvement fund" and which it here contends is not income. To the original cost of the property he has added, as the expenditures were made, amounts spent for permanent improvements, and in computing the profit on sales has used this increased cost as the basis.
In 1925 a bill in equity was brought by neighboring property owners seeking to have the cemetery declared a nuisance and to enjoin petitioner and its officers from improving and using the land and selling lots therein for cemetery purposes. This cause was successively tried in the several state courts having jurisdiction, including the supreme court, all decisions being against the complainants, and final adjudication being obtained in April 1927. While this litigation was in progress sales of lots were almost entirely suspended and the sales campaign*1061 halted, but petitioner continued to make collections under its contracts outstanding. Petitioner paid as attorney fees, witness fees, costs, and other expenses of litigation, $4,944.97 in 1925, $4,199.27 in 1926, and $1,104.01 in 1927.
In 1927 Hinds discussed with M. M. Bosworth, his son-in-law, the difficulties the company was experiencing, particularly because of the pending litigation and the suspension of its sales on that account, and offered him $5,000 if he would lend the company $14,000 and serve as its president for a year, to which Bosworth agreed. While no formal action was taken by the directors of the company regarding the matter, Hinds mentioned it to them individually and found them agreeable to the plan. Bosworth served as president of the company throughout the year 1928, being at the office nearly every day attending to the company's affairs. The company's books were not closed for 1928 at the end of the year, but were held open until after the annual meeting of the stockholders on January 15, 1929, at which a resolution was adopted allowing Bosworth "a salary of $5,000 for services rendered, and helping finance the company through its difficulties," and authorizing*1062 the manager to sell *1041 him 50 shares of the company's stock at par. On February 28, 1929, Bosworth received petitioner's note for $5,000 representing this compensation. This note was paid on May 31, 1930.
OPINION.
GOODRICH: Petitioner's first issue is enlarged upon brief to provide alternative contentions; first, that 25 per centum of the amounts received upon all contracts for sale of lots should be regarded as received upon trust to meet the cost of future construction of improvements, and hence be eliminated from gross income; or, second, that the estimated cost of contemplated improvements should be included as a part of the cost of the property to be used in computing gain upon sales of plots as made. There is ample authority for the proposition that moneys received upon trust are to be excluded from gross income; ; ; ; ; *1063 ; ; ; ; ; but the question here is whether a portion of the selling price of petitioner's lots was so received.
Likewise, it has been recognized that the estimated expenditures for improvements which the vendor is bound to make may be included as a part of the cost of the property; ; ; but the question here is whether petitioner was bound to make improvements.
We are of opinion that both petitioner's claims must be denied. From the onset it must be remembered that petitioner is not seeking to exclude from its income amounts received upon trust to meet the cost of perpetual care, a service which would be to the benefit of the lot owners. A fund for that purpose was established as provided by statute and respondent has eliminated from petitioner's gross*1064 income the proper additions to that fund. Here petitioner seeks to exclude from its income amounts expended, or to be expended, for improvements to its own property. From those improvements it reaped a benefit through increased sales, at increased prices. As a practical matter, it is obvious that some expenditure for improvements was necessary if petitioner was to carry out the purpose for which it was organized - the sale of burial plots - for some rearrangement of unimproved property is necessary, not only to induce purchases of plots therein, but to create the plots to be sold. Such improvements had to be made before petitioner could carry on its business; whether *1042 the cost thereof was met from income derived from sales of lots or from capital funds derived from sales of stock, or other means, seems immaterial. Also obvious is the desirability of constructing, as early as possible, permanent improvements beyond those essential to a beginning of operations for the reason that, as the property in general is improved, it becomes easier to make sales, and prices may be increased. This is borne out by the fact that petitioner's expenditures for permanent improvements*1065 during the first five years of its operations were considerably in excess of 25 per centum of its sales, and that as the improvements progressed, the scale of prices increased.
Excerpts from some of petitioner's printed advertising matter, of evidence in the case, serve to illustrate. Leaders such as "Continual adding of improvements increases values and means higher prices" and "Prices are advancing" call attention to sales of lots in specified sections at a "Special Pre-Development Price", or at "Attractive Prices - Prior to Completion of Development", and the following shows the effect of successful development of the property:
Nearly one hundred leading newspapers * * * carried a telegraphic story * * * which referred to Memphis Memorial Park as "one of the bright spots of the nation's business horizon." The story was inspired by the fact that our sales volume is greater than in the last three years.
The record before us does not disclose to what extent petitioner, through its literature and its salesmen, represented to the public that one fourth of the selling price of every lot was to be applied to permanent improvements of the cemetery, but assuming that it did so, *1066 it would seem that in making that representation, and in including such a provision in its contracts of sale with its purchasers, it was not assuming an obligation to do specific acts with respect to any particular plot conveyed, but was promising only to make improvements to its own property - a course which doubtless was desired by the purchasers but which certainly was sound business policy for the company. That fact, in our opinion, is sufficient to distinguish this case from those of , and (reversing ), upon which petitioner relies.
Examining the resolution of the directors, the notice to the lot owners, and the provision incorporated into the contracts respecting the improvement fund, we are not convinced that a fourth of petitioner's gross sales was received upon trust and therefore should be excluded from its gross income. It is to be noted that this appropriation of sales proceeds was not made until October 1928, and that the record contains no segregation of sales made thereafter, but even though we assume (but do not so decide) that the attempt*1067 to make *1043 this action retroactive was successful, as petitioner contends it was, still we see, not a trust, but a contract, for the breach of which the law provides adequate remedy and which does not remove the proceeds of sale from the statutory definition of income (sec. 213, Revenue Act of 1926). Receipts cannot be deemed trust funds unless the trust is definitely established and maintained, and its funds so controlled (barring fraudulent misapplication) as to insure their application to the ends for which the trust was created. We conclude that here no trust fund was established. Although an account was set up on petitioner's records to which was credited a fourth of the amounts of its sales contracts, such amounts were commingled with the company's general funds and always within its control. Petitioner carried on its improvement program apparently without regard to the amount which, according to the account, was available for that purpose, and the nature and extent of the improvements to be made was entirely within the discretion of petitioner's directors. Moreover they, having established the fund by resolution, might eliminate it by the same means, for while*1068 the contract mentions certain improvements for which the fund was to be used, it fails to provide expressly that such amounts were to be received upon trust. Then, too, the contract leaves the expenditure of the fund so far to the discretion of the directors as to prevent the establishment of a definite trust for a specific purpose. The "purpose of developing, enlarging, improving, * * * including real estate" might well authorize the purchase of additional property, and it would be difficult to conceive of a broader provision respecting improvements for the benefit of a lot owner than "the purchase of equipment and for any other charges which, in the judgment of the board of directors, shall be necessary or proper for the establishment of a memorial park, or burial ground."
We conclude that the portion of the amount of lot sales here in controversy was not received upon trust, but was properly a part of petitioner's gross income. Cf. . Since it was received as income its subsequent disposition, assignment, or restricted use did not affect the taxability upon receipt. *1069 ; ; ; ; certiorari denied, .
Nor do we think that petitioner's estimate of the cost of the contemplated improvements should be added to the cost of the plots in advance of expenditures made therefor. It is argued that, because certain of the improvements were mentioned specifically in the sales contracts, petitioner was bound to make them, and that therefore their estimated cost should be added to the cost of the property. *1044 But even assuming that petitioner was bound to make the improvements so mentioned, still it was bound for no specified expenditure. True, it had consulted architects and contractors and had settled upon the type, size, and construction of the permanent improvements it planned to erect and had drawn up a schedule showivg the estimated costs thereof. But it was not bound to abide by those plans, nor to spevd the amounts estimated. The matter was entirely within the control of petitioner's directors; *1070 the plans, and the amount of the expenditures, might be changed at will. The proof shows that this was done in one instance at least, that of the Masonic memorial, which was mentioned on the contract as a shaft but which a change of plan turned into a chime tower. There is nothing in the record before us to show that the construction schedule was a part of the agreement with the lot owners or, indeed, that they had knowledge of it. The cost of the improvements could be regulated by the directors as they desired, and still their representations to the public made good. For instance, to take another example of an improvement mentioned in the contract, a memorial chapel was promised, and its cost estimated at $40,000. Yet, had it been necessary to curtail this expenditure, the directors had power to do so, and a building costing one half or one third of that amount might still be a chapel, and its construction would doubtless discharge any obligation (the existence of which we are assuming) which petitioner assumed under its contracts and its advertising. It will be noted that in the cases previously cited and upon which petitioner relies, the expenditures which the vendor was bound*1071 to make, and which consequently were added to the cost of the property, were either fixed in amount or the improvements were so specifically described that their cost could be estimated with reasonable accuracy. Such is not here the case. Respondent has added to the cost basis of the property expenditures for improvements as made, and in that course we sustain him. However, we note that his computations of profits are based upon a reserve of 6,000 lots whereas the proof shows only 5,400 lots available for sale and that number, therefore, is the correct basis. This error may be corrected upon settlement.
With respect to the second issue we sustain petitioner, for, in our opinion, the suit which it defended proximately resulted from its business, and, consequently, its expenditures made in connection therewith are deductible as ordinary and necessary expenses. ; ; affd., .
We sustain respondent also in denying the deduction of $5,000 as salary to Bosworth in 1928, for we are not satisfied that petitioner's accounts were kept on an*1072 accrual basis so that this item was properly *1045 accruable in that year. While petitioner's chief witness testified that the accounts were so kept, that testimony is in conflict with the statement sworn to on the return that the accounts were kept on a basis of cash receipts and disbursements. This variance was not explained at trial; furthermore, the details of the return itself indicated that the statement thereon is correct. Consequently, we have relied upon it and found as a fact that petitioner's accounts were kept on the cash basis. The salary, therefore, is not deductible as an expense until paid.
Reviewed by the Board.
Judgment will be entered under Rule 50.