*3909 1. The cost to the donor of property deeded to petitioner in 1920 held not to constitute income.
2. Invested capital may not be increased because of donations by nonstockholders.
3. Deductions for depreciation may not be taken for 1918, 1919 and the first half of 1920 on property to which petitioner did not have title.
4. Rate of depreciation to be applied determined.
*1317 Proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years and in the amounts as follows:
| 1919 | $2,970.32 |
| 1920 | 19,905.09 |
| 1921 | 402.77 |
| 1922 | 243.29 |
The issues are: (1) Whether the respondent erred in adding to income for 1920 the amount of $45,475.82, on account of the conveyance to petitioner of factory property costing that amount; (2) whether invested capital should be increased for 1919 and 1920, by *1318 the amount of $45,475.82; (3) whether deductions for depreciation should be allowed for 1918, 1919 and a part of 1920, on the factory building acquired; (4) the rate of depreciation applicable; *3910 As an alternative to the first issue petitioner asks special assessment. Other errors alleged in the petition were abandoned at the hearing.
FINDINGS OF FACT.
Petitioner is an Illinois corporation with its principal office at Elkhorn, Wis. It was incorporated in 1904 and has at all times been engaged in the manufacture of musical instruments. Prior to April 15, 1918, its plant and office were located at Chicago, Ill., and in each of the years that it operated there it earned a profit.
In the spring of 1916 there was a strike which lasted several months and petitioner's officers became dissatisfied with labor conditions in Chicago. In that year Frank Holton, president of the petitioner, visited his farm about five and a half miles north of Elkhorn, Wis., and while there a neighbor suggested that the petitioner move its plant to Elkhorn. No action was taken on the suggestion and later, about September of 1916, Holton was approached to determine whether he would consider moving the company to Elkhorn. He inquired what the town would offer as an inducement, and shortly thereafter a committee called upon Holton at Chicago and, after some negotiation, Holton advised them that*3911 the company would move to Elkhorn if a suitable plant with 40,000 square feet of floor space was erected. Residents of Elkhorn thereupon organized a corporation known as the Elkhorn Factory Co. for the purpose of acquiring a site and erecting a plant. That company started a compaign to raise funds for the project, and engaged an architect who prepared plans which were accepted by the petitioner. The company issued stock as receipts for contributions. In the latter part of 1916 it began to appear doubtful that the amount to be realized from subscriptions would be sufficient to construct the buiding planned, due in part to the advancing price of materials, whereupon representatives of the Elkhorn Factory Co. sought and obtained the consent of petitioner to a plan providing for less expensive construction than called for by the original drawings.
The directors of petitioner went to Elkhorn to inspect the sites offered for petitioner's use and found only one tract with which they were satisfied and that was held at a price higher than the Elkhorn Factory Co. felt that it could pay. In order to secure that particular parcel petitioner agreed to purchase stock of the Elkhorn Factory*3912 Co. in the amount of $2,000, as set forth in the agreement referred to hereinafter. The land was conveyed to the *1319 Elkhorn Factory Co. by deed dated February 15, 1917, for a consideration of $5,000.
In March, 1917, petitioner and the Elkhorn Factory Co. entered into a written agreement, setting forth the terms of the arrangement theretofore made, and which provided, with material parts quoted, as follows:
The Elkhorn Factory Co. agreed:
1. To erect on said site [above referred to] a factory building with Thirty Thousand (30,000) square feet of floor space in accordance with the plans and specifications * * *.
2. To Transfer and convey the said site and factory building to said Frank Holton & Co., its successor or assigns, free and clear of all incumbrances (except such as are created by, charged to or suffered to be created by said Frank Holton & Co., its successors, lessees and assigns or any of them) upon the terms and conditions hereinafter provided.
3. To lease said site and factory building to said Frank Holton & Co., for the term of seven (7) years, commencing the first day of May, 1918, upon the terms and conditions hereinafter provided * * *
*3913 The petitioner agreed:
1. To subscribe for two hundred shares of the capital stock of the Elkhorn Factory Company and to pay therefor the sum of ten ($10.00) dollars per share in cash on or before the first day of July, 1917. The amount so paid to be used by the Elkhorn Factory Company toward the cost of erecting said factory building.
2. To lease said factory building from the said Elkhorn Factory Company, for the term or seven (7) years commencing the first day of May, 1918, as aforesaid to be used by said Frank Holton & Co., its successors, lessees and assigns for the manufacture and carrying on of a band instrument manufacturing business and to pay therefore an annual rental equal to six (6) per cent of the amount expended by said Elkhorn Factory Company for said site and building, which rental shall be payable annually, and to remove its main offices and band instrument manufacturing business to Elkhorn, Wisconsin, on or before the first day of May, 1918.
3. During the aforesaid term of seven (7) years, to pay all taxes upon said site and building, to keep said building insured * * * all such policies of insurance to be made payable to the Elkhorn Factory Company, *3914 * * * to pay all premiums on such policy or policies of insurance; also to make all necessary repairs * * *.
* * *
5. To purchase said site and factory buildings from the said Elkhorn Factory Company at the expiration of said period of seven (7) years and to pay the Elkhorn Factory Company for the same the amount expended by it for said site and building:
Provided, however, that if said Frank Holton & Co., shall on or before May 1st, 1918, remove its main offices and bank instrument manufacturing business from the City of Chicago, State of Illinois, to the City of Elkhorn, State of Wisconsin, and shall make said city of Elkhorn its principal place of business and shall continue so to do for the said period of seven (7) years, and shall place the words, "Elkhorn, Wisconsin" upon all of the band instruments *1320 manufactured by it, and shall employ sufficient empolyees in its business and plant at said City of Elkhorn so that its payroll for employees (not including officers' salaries) shall amount to the sum of fifty thousand ($50,000.00) dollars or more for the first (1st) year and the sum of seventy-five thousand ($75,000.00) dollars or more for each succeeding year*3915 during the said period of seven (7) years, then no rent for said site and buildings other than the aforesaid taxes and insurance shall be paid by said Frank Holton & Co. in any year during which it pays its employees as aforesaid the said respective amounts;
And provided further, that if the said Frank Holton & Co. shall have paid at any time during the said period of seven (7) years an aggregate amount of five hundred thousand ($500,000.00) dollars in wages (not including officers' salaries) to its employes employed in its business and plant at the said City of Elkhorn as aforesaid, then the said purchase price shall be considered fully paid and said site and building shall be conveyed and transferred without further consideration to the said Frank Holton & Co., its successors, or assigns, free and clear of all incumbrances except such as are created by, charged to or suffered to be created by said Frank Holton & Co., and from and after the date of said conveyance, no rent shall be chargeable to said Frank Holton & Co., its successors, lessees or assigns.
And in case said Frank Holton & Co. shall not, during the said period of seven (7) years as aforesaid, have paid to its said*3916 employes employed in its business and plant at the said City of Elkhorn the sum of Five Hundred Thousand ($500,000.00) dollars as aforesaid, it shall however, upon the purchase of said site and building at the end of the said period of seven years, be credited with such portion of the purchase price thereof as the amount it shall have so paid to its employes as aforesaid bears to the sum of Five Hundred Thousand ($500,000.00) dollars.
Prior to 1917 petitioner normally had from 200 to 225 employees and a weekly pay roll of about $4,000. When it became known that petitioner was preparing to move to Elkhorn many of its employees secured other positions and petitioner was unable to fill all the places of those who left.
Petitioner moved its equipment to Elkhorn on April 15, 1918 Only 57 of its old employees accompanied it and some of them later returned to Chicago. Housing facilities were inadequate and in 1919 Holton built 27 houses. The only rail transportation at Elkhorn consisted of two branch lines, and a greater length of time was required for shipments to reach customers than was the case with shipments from Chicago.
The building erected for petitioner's use was two*3917 stories high, of so-called mill construction type, that is, cement foundations and walls of brick. In laying the ground floor a filling of cinders was put in and tamped, on that pine boards were laid, and on the pine boards 3/8" maple flooring. The second floor consisted of 2" pine boards and on that maple flooring. A large part of the ground floor warped and was replaced by the petitioner. The roof was of tar paper and gravel construction. The paper was of inferior quality *1321 and within two years petitioner was required to reroof the entire building. The brick used in the walls began to deteriorate in a short time, and petitioner was required to paint the entire exterior of the building.
Petitioner required gas for brazing and soldering and, as the town of Elkhorn was not supplied with gas, petitioner was obliged to install its own gas plant. This it did in 1918, but the plant installed proved unsatisfactory and was replaced with a different kind of plant. Petitioner also installed all of the electric wiring, put in a sprinkler system, finished the plumbing, and built benches for workmen. It was found in the fall of 1918 that the heating plant was inadequate*3918 and an additional boiler was installed. Petitioner was reimbursed by the contractor for a part of the cost of the additional boiler, and the cost of the other installations mentioned herein was charged to the Elkhorn Factory Co.
During the remaining portion of 1918, after removal to Elkhorn, petitioner expended as wages the sum of $94,052.76, in 1919, the sum of $192,215.68, and in 1920, the sum of $275,029.51, exclusive. in each case, of officers' salaries.
In the latter part of 1920 petitioner, by letter, advised the Elkhorn Factory Co. that it had complied with the requirements of the contract of March, 1917, and requested a deed to the property. By resolution of December 29, 1920, the board of directors of the Elkhorn Factory Co. authorized and directed the president and secretary of the company to execute and deliver to petitioner a deed, to bear date of November 1, 1920. This resolution was complied with and the deed filed for record on December 30, 1920.
The plant thus acquired by petitioner was constructed at a cost of $40,475.82, and on April 15, 1918, it had a useful life of not more than 33 1/3 years.
For the year 1918 petitioner reported a loss of $53,635.05, *3919 of which $2,751.06 represented a loss on the sale of its Chicago real estate and building. Net income was reported for subsequent years as follows:
| 1919 | $65,192.68 |
| 1920 | 46,406.25 |
| 1921 | 23,707.28 |
| 1922 | 59,740.30 |
Petitioner claimed no depreciation on the Elkhorn building for 1918. In its return for 1919 it claimed depreciation on an amount of $19,904.74, which it designated as addition to buildings not yet owned. In 1920 the property acquired from the Elkhorn Factory Co. was appraised at $66,607.47, and that amount was listed in the return filed as an increase in invested capital in that year. Depreciation *1322 was claimed in that return at 3 per cent on the amount of $66,650.64, which was designated as buildings acquired in 1920.
The respondent added to income reported for 1920 the amount of $45,475.82 as the cost to the Elkhorn Factory Co. of the property transferred to the petitioner.
OPINION.
ARUNDELL: Among the claims advanced in this case are claims for additional depreciation for 1918 and for inclusion in invested capital for that year of the cost of the Elkhorn land and building. Inasmuch as no deficiency has been determined for 1918, *3920 we can consider the facts for that year only in so far as they may affect taxes for subsequent years and not for the purpose of determining that year's tax. Section 274(g) of the Revenue Act of 1926.
The several issues presented all arise out of the item of $45,475.82, representing the cost to the Elkhorn Factory Co. of property deeded to the petitioner in 1920. The petitioner says that that amount was not income in any year, or, in the alternative, that if it was income at all it was income in 1918 when it obtained "equitable title by possession." The petitioner must be sustained on its first contention, namely, that no income was realized in any year by the receipt of the property from the Elkhorn Factory Co. ; ; ; ; S. E. Overton Co. v. Holden, Collector, decided by the District Court of the United States for the Western District of Michigan, Southern Division, September 19, 1927.
*3921 Petitioner claims that the cost of the property to the donor should be included in invested capital of petitioner from the time petitioner took possession in 1918. We had a similar situation in , where a contract was acquired by the taxpayer from nonstockholders. We there held:
It seems clear that the petitioner secured a very favorable contract from the three organizations owning the lease, none of which were stockholders in the petitioner corporation. Such a transaction does not give rise to paid-in surplus. The contract was not paid in by the stockholders; it was not a gift from the stockholders. It was acquired from nonstockholders, and the petitioner is no more entitled to have its value included in invested capital than the value of any other advantageous contract.
That decision is accord with the principle underlying the computation of invested capital, that is, that the amount shall be restricted to sums risked in the business with the hope of realizing a gain from the investment. It is said in *3922 , that:
*1323 When speaking of the capital of a business corporation or partnership, such as the act deals with, "to invest" imports a laying out of money, or money's worth, either by an individual in acquiring an interest in the concern with a view to obtaining income or profit from the conduct of its business, or by the concern itself in acquiring something of permanent use in the business.
In the present case, while undoubtedly the contributors to the fund raised for purchasing the donated property hoped to benefit therefrom through the stimulation of business in the community, such hope is far removed from an expectation of gain through an investment in the business enterprise. As far as the record shows neither the contributors nor the donor of the property were stockholders in the petitioner; they acquired no interest of any kind in it. In these circumstances, the cost of the property to the donor does not constitute paid-in surplus and no part of it can properly go into invested capital.
The next assignment of error is the failure of respondent to allow a deduction for depreciation upon the*3923 depreciable portion of the property here involved for the full years 1918, 1919, and the first half of the year 1920. The respondent denies that he so erred. On this state of the pleadings we assume that the respondent allowed depreciation on the building for the latter half of the year 1920, and, as no issue is raised as to that allowance, except as to the amount, we do not pass on it. The evidence is that some time during 1920 the petitioner completed performance of the obligations placed upon it by the contract of March, 1917, as conditions precedent to the right to acquire title to the property. Under the contract petitioner's relation to the property was nothing more than that of a lessee with an option to oventually acquire title by fulfilling the terms laid down. It did not have title to the property, nor did it have a capital investment therein, in 1918, 1919, or the first half of 1920, and it is not entitled to deductions for depreciation for that period. .
On the question as to the depreciation rate, the petitioner has established that the useful life of the building acquired was not in excess of 33 1/3 years, and*3924 it is accordingly entitled to deductions of 3 per cent per year for the latter half of 1920 and for the subsequent years involved. Petitioner asks that this rate be applied to the cost of the building to the donor, in the amount of $40,475.82. We are satisfied from the evidence that the building had a value of at least that amount when acquired by the petitioner in 1920, and the 3 per cent rate should be applied to that figure.
Special assessment is asked by the petitioner, as an alternative in the event we find that the cost of the property involved was income *1324 to it. Having found for the petitioner on that question, we do not pass on the alternative issue.
Judgment will be entered on 15 days' notice, under Rule 50.