1929 BTA LEXIS 2770">*2770 The petitioner kept its books of account for 1923 upon the accrual basis. Held, that it is entitled to deduct from gross income interest accrued upon its indebtedness at the close of 1923 and charged as a liability upon its books.
15 B.T.A. 870">*870 This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1923 in the amount of $704.16. Petitioner alleges that respondent erred in that he disallowed a deduction taken by the petitioner on account of interest in the amount of $5,633.33.
FINDINGS OF FACT.
Petitioner is a New York corporation conducting an automobile sales agency in the City of Buffalo. It was incorporated on January 31, 1923, with an authorized capital stock of $200,000 divided into 1,000 shares of common stock and 1,000 shares of preferred stock of a par value of $100 each.
Mason B. Hatch and Allen T. McKay, residents of the City of Buffalo, in 1922 had the opportunity to acquire the general agency in Buffalo and vicinity of Overland-Knight automobiles and associated products. 1929 BTA LEXIS 2770">*2771 Neither had the capital necessary to assume the agency and their overtures to banks and acquaintances in Buffalo for capital were unsuccessful. They then appealed to George A. Ball, Muncie, Ind., a brother-in-law of Hatch and a man of means, for a loan of $100,000. They proposed to him the incorporation of a company with that amount of capital to operate the sales agency. He finally agreed to and did loan the money to the corporation, informing them at the time that he did not want to make a long-time investment 15 B.T.A. 870">*871 in anything. As security Hatch and McKay gave Ball their individual notes secured by the total shares of stock of the company. Interest was to be paid upon the loan at the rate of 6 per centum per annum. No note of the petitioner was given to Ball for it was the desire of Hatch and McKay that the indebtedness of the petitioner to Ball should not appear in any statements made by the petitioner to banks or dealers.
The understanding of all the parties concerned was that Ball should return to Hatch and McKay the $100,000 of preferred stock and $60,000 par value of common stock turned over to Ball as security. Ball was, however, to retain $40,000 of the common1929 BTA LEXIS 2770">*2772 stock. The issuance of the preferred stock was never authorized by any action of the board of directors of the petitioner, and, of the common stock turned over to Ball, $40,000 was issued to him direct and the balance, $60,000, was endorsed to him by Hatch, McKay, and Beardsley, the incorporators of the company.
The books of account of the petitioner for 1923 were kept upon the accrual basis. The cashbook of the company shows the receipt from Ball of $100,000. Upon closing the books of account at December 31, 1923, there was set up a liability to Ball under the title of "Payment of Interest on Preferred Stock" in the amount of $5,633.33. In its tax return for 1923, the petitioner claimed the deduction from gross income of this amount as interest accrued. The deduction was disallowed by the respondent in the computation of the deficiency.
OPINION.
SMITH: The issue in this case is whether or not the petitioner was entitled to a deduction from gross income for the calendar year 1923 of a sum amounting to $5,633.33. In the deficiency notice mailed to the petitioner the respondent disallowed the deduction on the ground that it represented a dividend on preferred stock. In1929 BTA LEXIS 2770">*2773 its petition the petitioner alleges as follows:
4. The determination of tax set forth in the said notice of deficiency is based upon the following errors:
The Commissioner of Internal Revenue has incorrectly disallowed interest paid as an item of interest on preferred stock.
5. The facts upon which the petitioner relies as the basis of this proceeding are as follows:
The interest item in question was accrued on the books of the petitioner as due on a loan of monies. Shares of preferred stock were held as security for the loan. An error in bookkeeping termed the interest as "payment of interest on preferred stock."
These allegations were denied by the respondent in his answer as follows:
4. Admits that in determining the deficiency the Commissioner disallowed as a deduction an item alleged to be interest paid on preferred stock, denies that 15 B.T.A. 870">*872 the said item was in fact interest paid, and denies that the Commissioner erred in disallowing a deduction on account thereof.
5. Denies that the item in question was accrued on the books of the petitioner as due on a loan of monies. Denies that shares of preferred stock were held as security for the said alleged1929 BTA LEXIS 2770">*2774 loan. Admits that the item was termed "payment of interest on preferred stock", and denies that the item was erroneously so termed.
On brief, counsel for the respondent argued (1) that if the charge of $5,633.33 is to be regarded as a charge for an accrued dividend, it can not be allowed as a deduction; (2) that the petitioner incurred no liability for interest and paid no interest during the taxable year under review; and (3) that the loan was in fact made to the individuals for the purpose of forming the petitioner corporation, Ball taking all the security he could get. Counsel for the respondent further argues on brief that the test of the transaction is against whom could Ball recover a judgment should he sue to recover the money advanced?
In this proceeding Ball testified that he loaned the money to the petitioner corporation. The evidence indicates that he was to receive interest upon the loan from the corporation at the rate of 6 per centum per annum. The books of account were kept upon the accrual basis and the petitioner's tax return for 1923 was made upon that basis. There appears to be no question that the corporation was to pay the interest upon the indebtedness1929 BTA LEXIS 2770">*2775 and that the amount of $5,633.33 set up on the petitioner's books of account at the close of 1923 as interest which had accrued upon the debt was a proper accrual of the interest. The claim of the petitioner that the amount is a legal deduction from gross income is sustained.
Judgment will be entered under Rule 50.