*1247 Where petitioner corporation had acquired assets of a partnership in consideration of assumption of its liabilities, which firm, in turn, had secured assets of an earlier partnership upon a like consideration, and petitioner had reimbursed members of the original partnership for attorney fees paid by them in defending asserted income-tax deficiency for 1917 against the original partnership, held, reimbursement was either voluntary payment of the debt of another or a capital expenditure and not an ordinary and necessary expense of doing business, deductible by petitioner corporation under section 234(a)(1) of the Revenue Act of 1926.
*791 This proceeding seeks redetermination of a deficiency of $2,970 for the calendar year 1926. The only error assigned is upon respondent's action in disallowing a deduction of $20,000 taken by petitioner in computing net income for that year as a business expense.
FINDINGS OF FACT.
Petitioner is a New York corporation, with its principal office in New York*1248 City, and is engaged in the business of freight broker, marine insurance broker and forwarding agent. Prior to May 1, 1918, the business was conducted as a partnership, consisting of three individuals, Caldwell, Rademan, and Fowler, under the firm name of Caldwell & Company. On that date the partnership was dissolved by the retirement of Caldwell, it being then agreed that the business would be continued under a new partnership composed of Rademan and Fowler under the original firm name of Caldwell & Company and that Caldwell would receive for his interest $50,000 plus $5,200 per year for three years. It was further agreed that Caldwell would assume liability for one-third of any large claims against the business growing out of transactions prior to his retirement.
In accordance with the agreement, a new partnership was created by Rademan and Fowler, which operated the business of Caldwell & Company until September 19, 1919, when all of the assets and business of the partnership were acquired by petitioner, caldwell & Company, Inc., which Rademan and Fowler had caused to be organized.
The consideration paid by petitioner for the assets and business was agreed to be $749,000, *1249 payable by the delivery of 7,490 shares of the capital stock of petitioner, of a par value of $100 per share, to Rademan and Fowler and the assumption by petitioner of all the debts, obligations and liabilities of the business as of June 30, 1919, the contract of sale providing:
The Vendors hereby give and grant to the Vendee Company its successors, legal representatives and assigns full power and authority in their name, the firm name or otherwise, but for its own use and benefit and at its own cost and expense to collect the outstanding accounts and notes receivable of the said Vendors and in their name, the firm name or otherwise to give receipt therefor and to endorse any checks, notes, drafts and any and all other instruments or orders for the payment of money made to the said Vendors, in payment thereof and to institute, prosecute, withdraw, compromise and settle any and all suits or proceedings at law or in equity relating to or arising out of the property and business hereby sold and delivered.
Following its acquisition of the property and business of Caldwell & Company, petitioner operated the business, Rademan and Fowler *792 being at all times the owners of practically*1250 all of its stock and in active control of its affairs.
On March 5, 1923, respondent mailed a deficiency letter addressed to Caldwell & Company, 50 Broad Street, New York City, this being the address at which the business in question had been carried on by petitioner and by the two predecessor partnerships. This deficiency letter asserted a deficiency of $303,387.11 additional tax for the calendar year 1917 and this proposed deficiency was assessed against Caldwell & Company on respondent's March, 1923, list.
This notice of deficiency was, on its receipt in petitioner's office, referred by Rademan and Fowler, to one Herman Goldman, who was the regularly retained attorney for petitioner and who had also represented, as attorney, both of the prior partnerships of Caldwell & Company. Rademan and Fowler also notified their former partner, Caldwell, of the determination of the deficiency and he in turn entrusted the protection of his interests to the said Goldman.
As a result of the efforts of Goldman in contesting the deficiency asserted the assessment was abated in the amount of $303,039.53 and sustained in the sum of $347.58.
Toward the close of the year 1923 a bill for*1251 $30,000 for legal services was forwarded by Herman Goldman to petitioner. This bill was returned to Goldman with the request that he make up three bills for $10,000 each to Caldwell, Rademan and Fowler, individually. This was done and these bills were paid in cash instance by the individual by his separate check dated December 31, 1923. These individuals deducted the amount of the payments made by them, respectively, in computing their individual net incomes for the calendar year 1923.
During the calendar year 1926 the treasurer of petitioner, one Robinson, in making up some statistical data for petitioner, examined the records pertaining to the acquisition of the partnership business and concluded that petitioner was liable for the attorney fees paid by Rademan and Fowler. He then called the latter's attention to this and, as a result, a directors' meeting of petitioner was held, at which the reimbursement by petitioner of these two individuals was authorized. Under this authority Rademan and Fowler were each paid by the corporation the sum of $10,000, and the total of these payments was deducted as regular and necessary business expenses upon petitioner's return for that*1252 year. Petitioner kept its books and determined its income for this year, as in prior years, upon the basis of cash receipts and disbursements.
The $10,000 received by Fowler from petitioner in 1926 was included in income by him upon his return for that year. Petitioner did not reimburse Caldwell for the $10,000 paid by him to Herman Goldman, as detailed above.
*793 OPINION.
LEECH: The tax liability in connection with which the legal fees here sought to be deducted were paid was that of the original partnership of Caldwell & Company for the year 1917, during which a partnership was a taxable entity. The evidence shows clearly that the second partnership, composed of Rademan and Fowler, assumed the liability for two-thirds of any tax liability of the prior partnership for 1917 and that petitioner assumed such liability as one existing on June 30, 1919, as a part of the consideration for its acquisition of the assets of the second partnership.
It is clear that if petitioner's liability was limited to the reimbursement of Rademan and Fowler to the extent of additional taxes the latter were required to pay for 1917, and did not extend to liability for attorney fees*1253 accruing in connection therewith, as created subsequent to June 30, 1919, then its reimbursement of the former partners for these expenditures was voluntary and accordingly not an expense ordinary and necessary in carrying on business. It would follow that it was not deductible under section 234(a)(1) of the Revenue Act of 1926. Cf. ; ; .
Conversely, if petitioner was liable to Rademan and Fowler for the $20,000 in fees paid by them, such liability was one assumed as a part of the consideration for the acquisition of the property of the second partnership and we can see no difference between this and any other item of the capital cost of any such property to petitioner. The fact that the legal fees in question accrued subsequent to the acquisition of the assets is of no significance when the obligation to assume them, if and when they accrued, was one assumed under the contract, and as a part of the consideration for the property received. If petitioner was liable to Rademan and Fowler for a deficiency in tax*1254 for 1917, recovered from them, the payment of such liability would not entitle it to a corresponding deduction as an expense of doing business. In the case of , often cited with approval by us in later cases, we said: "The liquidation of a liability of known or unknown amount assumed by a corporation as a part consideration for the purchase of assets is not an ordinary and necessary expense of doing business. It is a capital transaction. It is not a legal deduction from gross income."
It makes no difference as to petitioner, that the liability of Rademan and Fowler for attorney fees might, as to them, represent a deductible expense. As to petitioner, the reimbursement of that expense by it to Rademan and Fowler is merely the payment of something *794 it agreed to pay in part consideration for the assets acquired and, accordingly, constitutes a capital expenditure.
Judgment will be entered for the respondent.