*1201 Pursuant to a partnership agreement entered into between the three petitioners and their father, the petitioners upon their father's death succeeded to his interest in the partnership business in equal shares and in consideration therefor each executed in favor of the father's widow a promissory note for one-third of the value of the father's partnership interest. The notes were to become due and payable only upon default of interest, which was to be computed at 6 percent per annum, and were to be canceled upon the mother's death. In his will the deceased father made a provision, similar to that contained in the partnership agreement, for the succession of the petitioners to his interest in the partnership business. Held, that the notes did not represent indebtedness of the petitioners, since they were to become payable only upon a contingency within the obligors' control; held, further, that the payments which petitioners made to their mother as interest on the notes were in fact annuities and are not deductible from petitioners' gross income as interest on indebtedness; held, further, that the payments are not deductible from partnership gross income in determining*1202 the petitioners' distributable share of partnership income.
*320 These proceedings are for the redetermination of income tax deficiencies for the years 1933, 1934, and 1935, as follows:
| Deficiency | ||||
| Petitioner | Docket No. | 1933 | 1934 | 1935 |
| Paul Autenreith | 94070 | $379.18 | $322.98 | $314.90 |
| F. Julian Autenreith | 94071 | 243.76 | 196.08 | 193.38 |
| J. Harold Autenreith | 94072 | 365.11 | 288.91 | 285.08 |
It is alleged in each of the petitions that:
(a) Respondent erroneously disallowed a deduction from gross income for each of the calendar years 1933, 1934, and 1935, respectively, in the amount of $1800.00 per year, for interest paid within each such year by the petitioner upon his indebtedness.
(b) In the alternative, respondent erroneously included in, and added to, gross income, for each of the calendar years 1933, 1934, and 1935, respectively (as part of petitioner's distributive share of the income of a partnership), the sum of $1800.00 per year, which was not properly a part of such income but was, in fact, payable and distributable*1203 to a person other than the petitioner.
The proceedings were consolidated for hearing and were submitted on a written stipulation of facts filed at the hearing.
FINDINGS OF FACT.
The petitioners are brothers and are residents of Pittsburgh, Pennsylvania. Prior to March 16, 1931, they and their father, J. L. Autenreith, who died on the date mentioned, conducted a partnership business consisting of the operation of a chain of retail stores, under a partnership agreement entered into on January 10, 1929. The father, J. L. Autenreith, owned a 36/100 interest, Paul and J. Harold a 28/100 interest each, and F. Julian an 8/100 interest. The partnership agreement provided among other things that the interest of each partner was *321 to govern his interest in the profits of the partnership and his liability thereto, but was not to govern the amount of his salary for services rendered. The partnership was to be terminated only by agreement and not by the death or disability of any of the partners. The agreement further provided in paragraph 4(a) that:
(a) In the event of the death of J. L. Autenreith, his interest in the partnership is to go to and be assumed by Paul Autenreith, *1204 J. Harold Autenreith, and Frank Julian Autenreith, or the survivor of them, share and share alike. Should the said J. L. Autenreith be survived by his wife, Flora Jeannette Autenreith, then before the interest of J. L. Autenreith go to and be assumed by the surviving partners, said surviving partners shall execute and deliver to the said Flora Jeannette Autenreith notes for the value of said J. L. Autenreith's interest in the partnership. Said notes are to bear interest at six percent, and shall not be payable during the life of said Flora Jeannette Autenreith, except for nonpayment of interest. At the death of Flora Jeannette Autenreith, the notes are to become null and void.
The father, J. L. Autenreith, died testate March 16, 1931, survived by his wife, Flora Jeannette Autenreith, and the three sons named above. His will contained a provision similar to the above quoted provision of the partnership agreement that his interest in the partnership business should go to his sons or the survivors of them, upon the condition, however, that:
* * * if my wife should survive me, my three sons shall each execute notes, payable to my wife, equal to the value of the share which they*1205 receive under this will, said notes to bear six percent interest. These notes are to be given as security for the payment of interest only, for and during the life of my wife, and at her death, the notes shall become null and void.
The decedent's widow elected to take under the will.
After decedent's death it was determined by his widow and the petitioners that the value of decedent's interest in the partnership at the time of his death was $90,000. On April 18, 1932, each of the petitioners, in accordance with the partnership agreement and the decedent's will, signed, executed, and delivered to decedent's widow a judgment note in the principal amount of $30,000. On the same date and coincident with the execution of these notes separate written agreements were executed by each of the petitioners and their mother, stating that:
WHEREAS, the said [name of petitioner] has executed a judgment note, payable to the said Flora Jeannette Autenreith, dated the 18th day of April, 1932, in the amount of Thirty Thousand Dollars ($30,000), with six percent interest, payable quarterly, the receipt of said note being hereby acknowledged.
NOW, THEREFORE, it is agreed by and between*1206 the parties hereto that the said Flora Jeannette Autenreith will at no time demand payment of the principal of said judgment note as long as the interest thercon is paid at interest paying periods, - and the said [name of petitioner] hereby agrees that at any time during the term of said note, or any subsequent renewal thereof, the said note *322 can be entered of record and execution had thereon for default in the payment of interest.
During each of the taxable years 1933, 1934, and 1935, the petitioners' mother was paid $5,400 by checks drawn by the partnership on the partnership bank account and each of the petitioners was charged with his proportionate part thereof in his partnership drawing account. The net income of the partnership for each of the years 1933, 1934, and 1935 was in excess of $5,400 and the distributive share of such income allocated to each of the petitioners was in excess of $1,800.
In their income tax returns for 1933, 1934, and 1935 each of the petitioners claimed the deduction of the $1,800 yearly payment to his mother as interest paid on an indebtedness. The claimed deductions were disallowed by the Commissioner in his deficiency notices*1207 and it was further ruled that the amounts paid to the mother could not be excluded from petitioners' respective shares of distributable partnership income.
OPINION.
SMITH: The petitioners' first contention is that the annual payments which were made to their mother out of partnership income are deductible from their gross income as interest paid under section 23(b) of the Revenue Act of 1934. The provision of the statute is that in computing net income there shall be allowed as a deduction from gross income "all interest paid or accrued within the taxable year on indebtedness." (Emphasis supplied.) It is quite plain that the payments which the petitioners made to their mother were not interest "on indebtedness."
It was clearly the intention of the partners that the principal amounts of the notes which the petitioners executed in favor of their mother should never be paid. They were to become payable only upon default of the payment of interest and in the absence of such default they were to be canceled upon the mother's death. Since their ultimate payment depended entirely upon the wishes and acts of the obligors themselves, they did not represent indebtedness of the*1208 petitioners. It is axiomatic that, if the notes did not evidence an indebtedness, the so-called interest paid on them was not interest "on indebtedness" within the meaning of the statute.
The payments in question were, we think, more in the nature of annuities. Looking at the decedent's will and at the preexisting partnership agreement, the terms of which in this respect are substantially the same, and at the contracts between the petitioners and their mother, each of the petitioners was obligated to pay to his mother annually an amount computed at 6 percent of the value of his one-third interest in his deceased father's interest in the partnership. *323 Unquestionably the petitioners were legally bound to amke these annual payments to their mother and it may be assumed, as the petitioners argue in their brief, that under the laws of the Commonwealth of Pennsylvania the payments were a charge upon the partnership assets, at least to the extent of the interest of the deceased father.
The facts here are similar to those in *1209 , where the court held, reversing , that the devisees who took a hotel property subject to certain annuities and operated the property under a partnership agreement were taxable on the entire partnership income without deduction of the annuity payments. The devisees were said to be personally liable for the annuities, regardless of the amount of income derived from the property, and the annuities were held to be a charge against the devised property, on which the annuitants had a lien as security for the payments due them.
Although the point is not raised by the parties to these proceedings, there is a question whether the petitioners here acquired their father's interest in the partnership by devise under his will or by purchase under the preexisting partnership agreement. See discussion in 68 Corpus Juris 619, where it is stated:
* * * it has been held by some authorities that an agreement as to the disposition of partnership assets in case of the death of a partner is of a testamentary character, and by other authorities that it is contractual only.
*1210 See also ; ; ; ; ; ; . The above cited Pennsylvania cases support the general principle that a valid contract based on adequate consideration to dispose of property after death is enforceable by the surviving contracting party.
If then, as appears to be the case, the petitioners acquired their interests in their father's share of the partnership assets by purchase under the partnership agreement of January 10, 1929, it must follow that the payments which the petitioners made to their mother pursuant to the partnership agreement were capital expenditures, constituting a part of the consideration paid for such assets. See ; ; ; *1211 .
In , a father transferred his interest in a partnership business to his three sons in consideration of their payment to him of an annuity for life and after his death a further annuity to his widow for life. The court held that the sons were taxable on their entire shares of partnership income without deduction of the annuity payments. To the same effect is There a father and son operated a business jointly under an agreement that upon the death of either the survivor should become the owner of the business and should pay a certain amount monthly to the widow of the deceased joint owner. The court held, affirming the Board, that the payments which the son made to his mother after his afther's death, pursuant to the agreement, were not deductible in computing his net income from the business.
We are of the opinion that the petitioners here are taxable on the entire amount of the income received from the partnership without either the deduction of the annuities paid to their mother as interest on indebtedness*1212 or the exclusion of the amounts from their distributable shares of partnership income.
Reviewed by the Board.
Decisions will be entered for the respondent.