*2946 1. The R. L. Brown Coal & Coke Co. received a charter from the State of Kentucky in 1919. Organization was not fully completed. It operated the coal-mining business of R. L. Brown during the years 1920 and 1921 and made income and profits-tax returns for those years. Held, that it was liable to income tax as a corporation for those years.
2. In 1921 the petitioners sold certain property which was owned by R. L. Brown individually. Payments for property were made to the latter. Held, that any profit realized upon the sale was taxable income of R. L. Brown.
3. The sale price of the property was $80,000, only $11,390 of which was paid in 1921, the balance being represented by promissory notes of the vendee. Held, that the sale was an installment sale.
*609 These proceedings are for the redetermination of deficiencies in income and profits tax of the R. L. Brown Coal & Coke Co., Docket No. 12079, for the years 1920 and 1921 in the respective amounts of *610 *2947 $7,500.52 and $5,443.11, and of income tax of R. L. Brown, Docket No. 16200, for the year 1921 in the amount of $2,920.14. The appeals were consolidated for hearing and decision. The allegations of error stated in the petition of R. L. Brown Coal & Coke Co. are:
(a) The Commissioner has included as taxable income for the calendar year 1920
| Employees Liability Insurance - Accounts Payable | $357.99 |
| Capital Items Charged to Expenses | 20,733.23 |
The life of the mine being about 7 years depreciation should not be less than 12 1/2% (mine capacity 20,000 tons total tonnage 50 acres 125,000), machinery $4,085.73 acquired 7/17/20 was not depreciated in 1920.
(b) There has been included as additional profit on sale of taxpayer's capital assets for the calendar year 1921 $16,268.96. Taxpayer's income for 1921 was increased $16,268.96, and a tax charged thereupon by the Commissioner in error. The plant was sold for $80,000.00, only $2,390.00 and $9,000.00 cash was collected during 1921. $24,000.00 of the $80,000.00 in notes was never collected and the actual damage done by the would-be purchasers to the plant was more than $17,000.00 actual cash outlay.
By an amendment*2948 to the petition under date of May 24, 1928, the company alleged:
It has just recently been learned for the first time that the Petitioner while a Charter was secured under the laws of Kentucky is not in fact a Corporation for the reason that no stock was ever issued and the mining property which it was supposed to own was never transferred to it and therefore the Petitioner was not an actual Corporation or an actual owner of the property which it is charged with having sold.
That the property sold was not sold by the Petitioner, R. L. Brown Coal & Coke Co., but by specific contract of sale it was sold by other parties and that when sold the sale was upon the deferred payment basis and that the cash payment received in 1921 was only $11,230.00.
The allegation of error in the petition of R. L. Brown is that:
The Commissioner has assessed a tax for the calendar year 1921 based upon his inclusion as taxable income $29,425.33, being a liquidated dividend from R. L. Brown Coal & Coke Company.
FINDINGS OF FACT.
The petitioner, R. L. Brown, acquired in 1918, at a cost of approximately $16,000, a leasehold interest in a tract of coal land in Kentucky comprising about 89 acres, *2949 and certain mining equipment thereon. It was his intention to form a corporation to operate a coal mine on the property. In 1919 he secured a charter for such corporation from the State of Kentucky. Articles of incorporation, bearing the date January 11, 1919, were duly filed, providing in part as follows:
*611 1.
The name of the corporation shall be R. L. Brown Coal and Coke Company.
* * *
4.
The amount of the capital stock shall be Thirty Thousand ($30,000) Dollars, divided into three hundred shares of one hundred dollars each.
5.
The name and place of residence of each of the present stockholders of said company and the number of shares of stock subscribed by each of them are as follows, to-wit:
| Name | Residence | Number of Shares |
| R. L. Brown | Middlesboro, Ky | 3 |
| Charles O. Brown | Middlesboro, Ky | 3 |
| L. I. Brown | Middlesboro, Ky | 3 |
6.
The corporation hereby formed shall commence its existence upon the filing and recording the articles and payment of incorporation tax as provided by law and the duration of the corporation shall be fifty years, unless sooner dissolved in the manner provided by law.
After the receipt of the charter*2950 the coal business theretofore carried on by R. L. Brown was carried on in the name of R. L. Brown Coal & Coke Co. Checks were made payable to and by the corporation. Of the 300 shares of stock authorized to be issued only 200 were issued, as follows:
| Shares | |
| R. L. Brown | 160 |
| C. O. Brown | 10 |
| L. I. Brown | 10 |
| E. H. Brown | 10 |
| R. L. Brown, jr | 10 |
| Total | 200 |
No assets were paid in to the corporation for the stock. No minutes of stockholders' or directors' meetings of the corporation were ever made. The corporation, however, filed income-tax returns for 1920 and 1921, which were executed by R. L. Brown as president, and C. O. Brown as treasurer. R. L. Brown died February 13, 1928.
In 1921 R. L. Brown entered into negotiations for the sale of the coal-mining property conducted under the name of R. L. Brown Coal & Coke Co. This consisted principally of a lease owned by him upon about 89 acres of coal lands at Middlesboro, Bell County, Ky., and all equipment thereon. The coal was nearly all mined out of this tract. R. L. Brown was, however, negotiating for the purchase of some adjoining coal lands and it was his purpose to permit the purchaser *612 *2951 of the coal-mining property to mine coal from the adjoining lands upon a royalty basis. He found a prospective purchaser by the name of T. C. Hughes, who desired to purchase the property as trustee for other parties. Brown called upon R. G. Anderson, a banker and attorney of Middlesboro, Ky., to draw up a contract for the sale of the property. Upon investigation, Anderson discovered that Brown had never made any conveyance of the property to the R. L. Brown Coal & Coke Co. and that the corporation owned no property in its own right other than certain tools and equipment which had been purchased out of operating funds from the date the charter of the corporation had been granted. To meet this situation Anderson prepared an agreement of sale, by the terms of which the R. L. Brown Coal & Coke Co. and R. L. Brown, individually, made a joint conveyance to T. C. Hughes, trustee of certain interests in the aforesaid properties. The contract of sale was dated April 1, 1921, and provided that the consideration for the sale should be $80,000, that $2,390 should be paid in cash, and that $17,610 should likewise be paid in cash -
and to secure said sum R. L. Brown accepts a certificate from*2952 the First State Bank of Pineville, Kentucky, to the effect that he is entitled to that much of the proceeds of a certain note for thirty-two thousand five hundred dollars, ($32,500) dated the 25th day of January, 1921, made by the Industries Fuel Co., a Kentucky corporation, payable to the Bowling Coal Mining Co., at the aforesaid First State Bank of Pineville, Kentucky, which bank holds said note for the purpose of collection and distribution in proportion to the certificates issued by it showing interest of various parties.
The contract further provided that the vendee should give to R. L. Brown 6 promissory notes of $9,000 each, payable serially at intervals of 6 months from April 1, 1921, and a further note of $6,000 payable 40 months from April 1, 1921, each note to bear interest from April 1, 1921. The last paragraph of the contract of sale provided:
The grantor R. L. Brown further agrees to lease to said second party a tract of One Hundred Ninety One Acres (191) bought by said R. L. Brown from one J. B. Carter for coal mining purposes with the coal mine lease in usual form, and with the usual and customary stipulations and forfeitures for his protection therein at ten*2953 cents (10) per short ton of two thousand pounds royalty and adding minimum rental of Six Dollars ($6.00) per acre which minimum is to begin Eighteen Months (18 from this date. And if the said Brown within said time purchases an additional one hundred acres adjoining said property for which he has been negotiating he will include same in said lease.
In accordance with the terms of the contract Hughes paid Brown $2,390 cash on April 1, 1921. He was unable, however, to pay the balance of the cash consideration of $17,610 and by an amendment to the contract Brown agreed to accept in lieu thereof two promissory notes of Hughes, each for $8,805, payable one in 1921 and one in *613 1922, with interest secured by certificates of interest of the State Bank of Pineville.
The R. L. Brown Coal & Coke Co. and R. L. Brown kept books of account and made tax returns upon the basis of cash receipts and disbursements.
Of the $80,000 named in the agreement of April 1, 1921, as the consideration for the sale of property, Brown received cash as follows:
| 1921 | $11,390 |
| 1922 | 26,805 |
| 1923 | 17,805 |
| Total amount collected | 56,000 |
The remaining $24,000 of notes (secured by*2954 the property of the petitioners), was never paid. Upon default, foreclosure proceedings were brought against the property and at a foreclosure sale the property was bought in by R. L. Brown at a nominal figure of $100 or $200.
Upon an audit of the income and profits-tax return of the R. L Brown Coal & Coke Co. for 1921, the respondent determined that the company realized a profit of $28,486.75 upon the sale thereof in 1921 and computed tax liability accordingly.
OPINION.
SMITH: It is the contention of the R. L. Brown Coal & Coke Co., one of the petitioners herein, that it was not legally organized as a corporation in either 1920 or 1921, and, accordingly, that it was not liable to any income or profits tax for either of those years. The record discloses, however, that the company filed income and profits-tax returns for those years as a corporation. It operated a coal-mining business as a corporation during the period. Even if not legally organized to carry on business with the public under the laws of the State of Kentucky, as contended by petitioners, the record warrants the conclusion that it was an association and required to make returns as a corporation for the years*2955 in question.
In defense of the deficiency determined for the year 1920, the company claims that the Commissioner has erroneously included as taxable income employees' liability insurance in the amount of $357.99 and has disallowed a deduction from gross income of expenses amounting to $20,733.23. Since the company kept its books of account upon the cash receipts and disbursements basis and made its returns accordingly, it is not entitled to deduct from gross income an account payable of $357.99 for employees' liability insurance. Only payments actually made can be deducted from gross income in a return *614 on a cash receipts and disbursements basis. The company has offered no evidence in support of its contention that it is entitled to deduct $20,733.23 disallowed as a deduction by the respondent. In its petition the company segregates these expenditures as follows:
| Machinery | $4,085.73 |
| Motors | 5,594.00 |
| Mine cars | 7,963.62 |
| Steel rails | 3,089.88 |
| Total | 20,733.23 |
These appear to be capital expenditures and in the absence of evidence showing that they were ordinary and necessary expenses of operation, the disallowance of the deduction from gross income*2956 by the respondent is sustained. The company has offered no evidence that it is entitled to any greater amount for depletion and depreciation than the respondent has allowed in his audit of the return. The deficiency found by the respondent for 1920 is therefore sustained.
Section 212(d) of the Revenue Act of 1926 provides as follows:
Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this subdivision. *2957 As used in this subdivision the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.
The sale price of the property in 1921 was $80,000. Of this amount $11,390 cash was received within the year of sale. The balance of the purchase price was represented by promissory notes of the vendee. Of this balance notes of a face value of $17,610 were secured by certain certificates of interest issued by the State Bank of Pineville. These notes, however, do not stand upon any different plane from the other notes of the vendee, which were secured only by the property sold. The contention of the petitioners that the sale was an installment sale is sustained. Tax liability should be determined accordingly, and since the property sold was the individual property of R. L. Brown and the consideration was made payable to him and received by him, the profit upon the sale should be taxed to him.
The respondent has determined that R. L. Brown, as an individual, received a liquidating dividend from R. L. Brown Coal & *615 Coke Co. in 1921 of*2958 $29,425.33. This is based in large part upon the proposition that the company received a profit of $28,486.75 upon the sale of capital assets to T. C. Hughes, Trustee, in that year. We have found, however, that any profit made upon this transaction is taxable to R. L. Brown as an individual and not to the company. The evidence indicates that R. L. Brown received no liquidating dividend from the corporation in 1921. The contention of the petitioners upon this point is sustained.
Judgment will be entered under Rule 50.