*2533 A partnership agreement provided that 6 per cent interest should be charged as a business expense and paid to the partners on their capital used by the firm before distributing the rest of the earnings on a percentage basis. Held that the distributive share of a partner in the net income of the partnership included the amount received by him as interest on his capital.
*651 This is a proceeding for the redetermination of deficiencies in income taxes for the calendar years 1920 and 1921 in the respective amounts of $1,490.11 and $1,287.82. Two errors are alleged. One, that the Commissioner failed to allow the deduction of $125 in 1920 and $10 in 1921 as ordinary and necessary expenses of the petitioner's business, the amounts having been paid by the petitioner to *652 secure assistance in the preparation of his income-tax returns. At the trial the respondent admitted that these amounts should have been allowed as deductions. The other alleged error is that for each year the Commissioner employed an improper method for the determination*2534 of the distribution of the earnings of a partnership of which the petitioner was a member.
FINDINGS OF FACT.
The petitioner is an individual residing in Boston, Mass. Since 1900 he has been a member of a partnership known as Blake Brothers & Co., doing business in Boston and New York as bankers and brokers.
It was always necessary for the partnership to have a large amount of working capital. This capital was contributed by the members of the firm in various amounts. All partnfrs were general partners except one who was a special partner contributing $200,000. This special partner received 9 per cent on his money as his share in the profits of the firms, and was not responsible for any portion of the losses or expenses.
The copartnership agreement in effect during 1920 and 1921 provided in part as follows:
ARTICLE THIRD The other partners of the firm shall be general partners and all sums of money which may be contributed by either of the partners to the capital of the firm shall be credited upon the books of the firm to the partner so contributing the same and shall bear interest at the rate of six per centum per annum from the respective times when the same shall*2535 be so contributed which interest shall be payable semi-annually on the 30th June and 31st December in each year during said term and shall then be credited in the books of the firm to the respective parties entitled thereto Interest so credited shall be treated as an expense of the business before determining the profits thereof for division among the partners.
ARTICLE FOURTH Regular books of account shall be kept by the firm in which shall be entered daily all the receipts and payments and all the other dealings and transactions of the firm as they occur and an account of the assets of the firm and all debts payable to it or receivable by it and of the interest of each partner in its capital and of all other matters to its business or affairs relating shall be taken semi-annually on the 30th June and 31st December in each year during the continuance of said partnership and a trial balance shall then be made out and corresponding entries shall then be made in said books of account so that the true condition of said firm may then be actually known * * * and the amount of net profits actually and without contingency earned and ascertained shall from time to time be credited upon each*2536 set of books to the respective partners in the portion in which they shall severally be entitled thereto and shall bear interest at the rate aforesaid from the time of each crediting and in like manner the ascertained losses shall be charged to the respective partners in the proportion in which they shall severally be responsible therefor and shall bear interest accordingly.
* * *
ARTICLE *653 SIXTH All the net gains and profits of said firm shall be divided between the partners as follows to wit Said J. A. L. Blake shall be entitled to twenty-six one-hundredths part thereof * * * and they shall severally bear and pay the same proportion of the losses and expenses of the firm which they are severally entitled to receive of the profits * * *.
(The portions omitted in the above article include the names and shares of the other partners.)
The partnership books have always been closed on June 30 and December 31, of each year.
The following is a transcript of entries on the personal account of John A. L. Blake on the books of Blake Brothers & Co., and of the partnership totals for the corresponding items for the calendar years 1920 and 1921, respectively:
| 1920 | |||||
| J. A. L. Blake | Entire partnership | ||||
| Feb. 24 Gain Special | $16,720.00 | $59,280.00 | |||
| Gen. Part. | 24,872.55 | ||||
| June 30 Interest | 12,550.14 | Spe. Part. | 9,150.00 | ||
| June 30 Gain 12/31/19 Pro Rata | 7,235.65 | 25,653.67 | |||
| June 30 Salary | 6,500.00 | 25,000.00 | |||
| June 30 Loss---(Red) | 9,143.35 | (Red) | 35,166.74 | ||
| 33,862.44 | 108,789.48 | ||||
| Gen. Part. | 25,584.35 | ||||
| Dec. 31 Interest | 12,553.61 | Spe. Part. | 9,150.00 | ||
| Dec. 31 Gain | 1,107.13 | 4,613.05 | |||
| Dec. 31 Loss---(Red) | 1,696.33 | (Red) | 7,068.06 | ||
| Dec. 31 Loss---(Red) | 1,199.39 | (Red) | 4,613.05 | ||
| 10,765.02 | 27,666.29 | ||||
| Total for year | $44,627.46 | 136,455.77 | |||
| 1921 | |||||
| Mar. 1 Rebate Moyer & Briggs' Bill | $104.00 | $400.00 | |||
| June 30 Loss---(Red) | 1,723.52 | (Red) | 7,181.33 | ||
| June 30 Int. | 12,318.02 | Forfull year. | |||
| Gen. Part. | 46,881.34 | ||||
| Dec. 31 Int. | 12,330.47 | Spe. Part. | 18,250.00 | ||
| Dec. 31 Loss---(Red) | 141.03 | (Red) | 500.00 | ||
| Boston Seat | |||||
| Dec. 31 Gain | 5,076.93 | 18,000.00 | |||
| N.Y. Seat | |||||
| Dec. 31 Gain | 8,193.59 | 34,139.96 | |||
| Total for year | $36,158.46 | $109,989.97 |
*2537 OPINION.
MURDOCK: The petitioner contends that he contributed to the capital of the partnership of Blake Brothers & Co., and that all of the income which he received from Blake Brothers & Co. either by way of interest as provided in Article Third of the copartnership agreement or as a portion of the net gains and profits in accordance with Article Sixth of the copartnership agreement, constituted his distributive *654 share of the net income of the partnership for the taxable year in question, and that he should be entitled to the same fractional part of the total credits and deductions to which the partnership was entitled as this total distributive share of the net income of the partnership was of the total net income of the partnership, in short, that the so-called interest mentioned in Article Third was not in fact interest but was a part of his distributive share of the partnership net income. He contends further that the Commissioner determined that interest mentioned in Article Third was in fact interest and that the petitioner's distributive share of the net income of the partnership was .26 and, therefore, gave the petitioner only .26 of the deductions and credits*2538 to which to which the partnership was entitled.
From the facts before us, we are unable to determine what the Commissioner did. He admits that he adopted the changes made by the revenue agent but we do not know what changes the revenue agent made. However, at the trial counsel for the respondent stated that the Commissioner allowed the interest paid each of the partners on his capital contribution as an expense of the partnership before determining the distributive share of this partner, and that this distributive share as thus determined was in direct proportion to the share of the dividends, interest and other credits and deductions allowed this partner. Counsel for the respondent states the issue as being the same issue stated by counsel for the petitioner.
Various things are essential to the successful operation of a banking and brokerage business. Capital, clients and ability, are important factors. The partners may be able to supply these in varying proportions. Each contributes whatever he may have, a partnership is formed, and the partnership agreement may provide for the distribution of profits and losses among the partners in any proportion. It may be that the*2539 contribution of one partner is so essential and valuable that the others agree that his share of the profits shall be preferred. Capital may be of primary importance. If in the articles of copartnership first right to a share in the profits is given to those contributing capital and this preferred share is called interest, being equivalent to the amount of legal interest which the money might be expected to earn elsewhere, the fact remains that this so-called interest is a distribution of profits. The partnership agreement provides a method of distributing the profits which is in accordance with the wishes of the partners but it does not change profits to interest and expense. The share paid to each partner is paid for the contribution of money risked in the business as a part or all of the contribution of that partner. The latter does what he *655 can for the partnership and it may be that as a result of his contribution he will be rewarded in an amount exceeding 6 per cent on his money. How can it be said that he was not receiving partnership profits?
There would be no more reason to hold that this so-called interest was a true business expense than to hold that a*2540 share paid a partner, whose services were worth $10,000 and who contributed nothing else, was a business expense until it exceeded $10,000. In , we held that so-called salary of a partner was a part of his distributive share of the net income of the partnership.
In the case of ; , it was necessary to decide whether an amount designated "interest" paid to a special partner was income from money at interest or income from a trade or business. The complainant had contributed capital only. She received what the agreement called "interest." The court there said:
Although she is termed a special partner, her income from the capital invested is determined upon the basis of the profits and losses of the business. Her contributions of capital are at the risk of the business the same as the contributions of a general partner, except that her liability for losses is limited to the amount of capital contributed. The partnership agreements here considered provide that "interest" shall be credited*2541 on the contributions of capital of all the partners, general and special, and then that the balance shall be divided as profits. This "interest" and the profits are each charged to the profit and loss account. The interest and profits so divided are a division of profits derived from the business. The provision that "interest" shall be credited means that there is to be a division of profits equal to an amount of interest at six per cent, before the division of the remaining profits is to be made. All the money so divided, either as interest or profits, is a division of the profits which have accrued during the year from the conduct of the business. It is not interest on her contributions of capital; she is not a creditor who has lent money to the partnership. No relation of debtor and creditor exists between her and the firm. The fact that some of the income is called interest is immaterial so long as in fact it was profits derived from the business as such.
The reasoning of the Parker case is sound and applies with even more force to a case such as ours where the partner receiving the so-called interest is a general partner. The distributive share of this petitioner*2542 in the net income of this partnership included the amount to which he was entitled as interest on his capital.
Judgment will be entered on notice of 15 days, under Rule 50.
Considered by MORRIS and SIEFKIN.