*35 Decision will be entered under Rule 50.
1. Petitioner owns and operates a department store. It acquired the business, including good will, on April 1, 1940, in a reorganization within the meaning of section 112 (g)(1) of the Internal Revenue Code. Hens & Kelly Company, one of the corporations consolidated to form the petitioner, acquired the business, including good will, on December 31, 1909, and in exchange for its common stock and a part of its preferred stock, from a predecessor corporation. Held, that the good will so acquired is includible in petitioner's equity invested capital, under section 718 (a) (2) of the Code, as its basis for determining loss upon sale or exchange; that such basis to petitioner was its loss basis to Hens & Kelly Company, which basis was its cost; and, on the facts, that the cost of the good will to Hens & Kelly Company when acquired on December 31, 1909, was $ 100,000.
2. Petitioner's predecessor, Hens & Kelly Company, on May 1, 1922, entered into leases for the various properties on which its business was located. Under the provisions of the leases, that company made certain improvements, and thereafter amortized such costs over the term*36 of the lease, plus two 20-year renewal periods, which periods extended to May 1, 1982. In order to effect the consolidation of April 1, 1940, a single lease for the properties was substituted for the 1922 leases, to extend from April 1, 1940, to May 1, 1962, with an option to renew for 20 years. The new lease eliminated a provision which had provided for an increase in minimum rentals each 5 years and substituted therefor a fixed minimum rental for the entire term, the minimum rental so fixed being less than the rental then being paid under the 1922 leases. The new lease further provided for a reappraisal of the leased property prior to the renewal date. During the process of consolidation Hens & Kelly Company, pursuant to T. D. 4957, issued December 6, 1939, filed Form 969 with the Commissioner of Internal Revenue on March 12, 1940, nineteen days before the consolidation, in which it elected to continue its amortization of the leasehold improvements over the primary lease period, plus the renewal periods to May 1, 1982. After the consolidation, petitioner continued such amortization through the years involved but now contends that it is entitled to*37 amortize such leasehold improvement costs over the term of the lease without regard to the renewal period. In the taxable years it was reasonably certain that petitioner would exercise its option to renew the lease to May 1, 1982. Held, that the proper period over which petitioner's basis for leasehold improvements should be amortized is the lease period plus the renewal period to May 1, 1982.
*305 The respondent determined deficiencies in excess profits taxes against petitioner for the fiscal years ended January 31, 1943, and January 31, 1944, in the respective amounts of $ 9,195.15 and $ 76,321.36. *306 The petitioner claims it is entitled to a refund. Issues presented are: (1) Is petitioner entitled, in determining equity invested capital for the years ended January 31, 1941, 1942, 1943, and 1944, to an inclusion of $ 400,000 representing good will? (2) Is petitioner, for the years ended January 31, 1941, 1942, 1943, and 1944, entitled to amortize the unrecovered cost of leasehold improvements under the terms of the lease executed April 1, 1940, for the lease term alone and without regard to the renewal period? The years ended January 31, 1941, and January 31, 1942, are involved by reason of an adjustment in the unused excess profits credits to be carried over to the subsequent years. Certain other issues raised by the petitioner appear to have been conceded by it.
FINDINGS OF FACT.
Some of the facts have been*39 stipulated and are found as stipulated.
Petitioner is a New York corporation, with its principal office and place of business at Buffalo, New York. It filed its income and excess profits tax returns for the years involved with the collector of internal revenue for the twenty-eighth district of New York. It kept its books and filed its returns on an accrual basis.
The petitioner owns and operates a department store. The business was started in 1892 by Matthias J. Hens and Patrick J. Kelly, who formed a partnership known as Hens & Kelly Company. Early in 1906 the business was incorporated under the name of The Hens-Kelly Company. At or as of January 1, 1910, the business was acquired by a new corporation by the name of Hens & Kelly Company. On April 1, 1940, Hens & Kelly Company was consolidated with S H Company, Inc., to form the petitioner, Hens & Kelly, Inc.
Petitioner's store is located in downtown Buffalo. It extends for an entire block, 231 feet, on West Mohawk Street, from Main Street to Pearl Street, and 90 feet on Main and Pearl Streets. The property was occupied by petitioner under leases, and was originally comprised of five separate properties, known as the Miller*40 Block; No. 8 West Mohawk Street; the Mohawk Block, consisting of Nos. 10 to 16, inclusive, on West Mohawk Street; the Snow properties, on the corner of West Mohawk and Pearl Streets; and the Manchester properties, which adjoined the Snow property and fronted on Pearl Street. Originally the store of Hens & Kelly Company occupied a part of the Miller Block. It fronted on Main Street, a short distance from the corner of Mohawk and Main Streets, and was 20 feet wide by 104 feet deep. In 1903 the partnership leased all of the Miller Block, four floors in height; all three floors of No. 8 West Mohawk Street; and the ground floors of Nos. 10, 12, and 14 in the Mohawk Block. *307 This lease ran to April 30, 1913. On January 1, 1906, the partnership leased No. 16 West Mohawk Street, four floors, and the remaining three upper floors of Nos. 10, 12, and 14 of the Mohawk Block. This lease likewise ran to April 30, 1913. A lease to the Manchester property was acquired on February 1, 1906, to end on May 1, 1913. This property had four floors. On May 1, 1906, a lease was obtained to the Snow property, consisting of four floors, from May 1, 1906, to April 30, 1913. On January 6, 1910, *41 shortly after the organization of Hens & Kelly Company, successor to The Hens-Kelly Company, new leases were obtained to the above properties. The said properties were leased by three separate leases, from three separate owners: (a) the entire Miller Block of four floors, Mohawk Block of four floors, and No. 8 West Mohawk Street, of three floors; (b) the Snow properties of four floors; and (c) the Manchester properties of four floors. The term of each lease was from May 1, 1913, to April 30, 1928. The reserved rent as set forth in the leases was as follows:
| (a) Miller and Mohawk Blocks and No. 8 West Mohawk Street | |
| May 1, 1913 -- April 30, 1918 | $ 3,583.33 per month |
| May 1, 1918 -- April 30, 1923 | $ 3,916.66 per month |
| May 1, 1923 -- April 30, 1928 | $ 4,275.00 per month |
| (b) Snow properties | |
| May 1, 1913 -- April 30, 1918 | $ 483.33 per month |
| May 1, 1918 -- April 30, 1923 | $ 533.33 per month |
| May 1, 1923 -- April 30, 1928 | $ 575.00 per month |
| (c) Manchester properties | |
| May 1, 1913 -- April 30, 1918 | $ 266.66 per month |
| May 1, 1918 -- April 30, 1923 | $ 300.00 per month |
| May 1, 1923 -- April 30, 1928 | $ 316.66 per month |
Beginning late in 1905, and ending in 1910, the buildings*42 occupied by the store were extensively remodeled. The work of remodeling was almost continuously carried on between 1908 and the beginning of 1910. The buildings had originally been tenements and small stores, and in the course of the remodeling, they were practically reduced to shells, consisting of floors and the outside walls. Partitions were taken out, walls and foundations were strengthened and the floors were leveled. New entrances and exits in the various departments were necessary, as were the opening and closing of entrances through the old walls of the different buildings. Some interference with normal business operations was occasioned by the remodeling operations.
Individually, Hens and Kelly were both active in the management and operation of the store. Hens, after looking over the mail in the morning, would proceed through the store, where he would greet and talk to department managers and employees. He would also greet and talk to customers, many of whom he knew personally. He supervised *308 the buying in the millinery department and looked after the employment of help. He had a more affable personality than Kelly. His policy was to sell at a smaller*43 margin of profit than his competitors. Kelly looked after the window trimming and store displays. He supervised the buying in the ladies' ready-to-wear department.
Seymour Knox was a director of Clawson & Wilson Company, a wholesale dry goods concern in Buffalo, which sold merchandise to The Hens-Kelly Company. He controlled S. H. Knox 5 & 10 Cent Syndicate, a predecessor of Woolworth Company. He was very wealthy and influential. John L. Clawson was president of Clawson & Wilson Company. He was fairly wealthy, although not as wealthy as Knox. He was also a director of Columbia National Bank in Buffalo.
Knox and Clawson became interested in The Hens-Kelly Company by guaranteeing a line of credit of $ 125,000 with the Columbia National Bank, to provide additional working capital for the business. The guarantee became effective on June 1, 1908. Clawson arranged to have Arthur Wesp, then general office manager at Clawson & Wilson Company, employed by The Hens-Kelly Company as office manager. As such, Wesp was placed in charge of the office and the general books of account.
In addition, Knox and Clawson decided to participate in the operation of The Hens-Kelly Company for 1 year, *44 beginning August 1, 1908 after which, if results proved satisfactory to them, they planned to put capital into the business on a permanent basis.
During the trial period changes were made in the method of operation. After 6 months, the grocery department was eliminated because of its small margin of gross profit. The grocery inventory was liquidated on the best basis which could be obtained.
Generally the store had catered to the lower class or "shawl" trade in Buffalo. Knox felt that inasmuch as that type of trade required "loss leaders," it was not profitable fundamentally. At his insistence, steps were taken, during the trial period, to upgrade the business to some extent and get into the so called "medium" class trade.
The Hens-Kelly Company had a choice location for its store in the heart of the downtown shopping district. The other department stores were all located within a radius of two blocks. In 1909, the corner where the store was located was the busiest corner, traffic-wise, in Buffalo. All principal streetcar lines went past the front door of the store, or within a block thereof. The motto "Buffalo's Fastest Growing Store" had been adopted.
By July 1909 Knox and*45 Clawson had concluded that the business had made a satisfactory showing during the trial period and decided *309 to become shareholders 1 along with Hens and Kelly in a new company to be organized to take over the business. As a condition to their participation, they insisted that new leases be acquired covering the period from 1918 to 1928. The existing leases expired in 1913. Hens negotiated the leases sought. Each lease provided for a substantial increase in rent, with provisions, as heretofore shown, and for further increases, periodically, over the term May 1, 1913, to April 30, 1928.
*46 Hens & Kelly Company was organized on December 22, 1909, under the laws of New York, to acquire, take over and buy the franchise, property, assets and good will of The Hens-Kelly Company. At the first meeting of the incorporators, held on that day, a resolution was adopted authorizing the acquisition of the franchise, property, assets and good will of The Hens-Kelly Company, including its cash, accounts and bills receivable, by the issue and delivery of 3,960 shares of common capital stock of the Hens & Kelly Company, having a par value of $ 396,000; by the issue and delivery of preferred capital stock of an amount in par value which should equal the amount in par value of the preferred capital stock of The Hens-Kelly Company then issued and outstanding; and by assuming and agreeing to pay on accounts and bills payable of The Hens-Kelly Company, as shown by its books, an amount not in excess of $ 310,000. The Hens-Kelly Company was to be required to procure and deliver a lease or leases from the owners of the premises occupied by it, covering fifteen years from the thirteenth day of May 1913. The incorporators further resolved "that the said business and property has a value to*47 the amount of the stock to be issued therefor, and that said business and property are necessary for the use and lawful purposes of this corporation."
At a meeting of the board of directors of Hens & Kelly Company, held the same day, it was directed that the offer to The Hens-Kelly Company previously authorized and directed at the first meeting of the incorporators be made and the transaction be carried out pursuant thereto.
On December 31, 1909, Hens & Kelly Company acquired the franchise and all of the property, assets, good will and leases of The Hens-Kelly Company, as authorized above. Pursuant to the terms of purchase, Hens & Kelly Company, on or about January 3, 1910, issued shares of its preferred stock having an aggregate par value of $ 102,790 *310 to The Hens-Kelly Company. On December 31, 1909, the net tangible assets of The Hens-Kelly Company had a fair market value of at least $ 102,790. Likewise, pursuant to the terms of purchase, 3,960 shares of common stock, having an aggregate par value of $ 396,000, were issued by Hens & Kelly Company to The Hens-Kelly Company. Immediately thereafter the books of Hens & Kelly Company reflected the acquisition of an asset*48 -- good will -- in the amount of $ 396,000.
At the time of incorporation, the four incorporators of Hens & Kelly Company had each subscribed for, and purchased for cash, ten shares of common stock at par, a total of $ 4,000. At a meeting of the board of directors of the Hens & Kelly Company, held on January 3, 1910, a resolution was adopted providing for the payment forthwith of $ 4,000 from the treasury to the four incorporators in an amount of $ 1,000 to each, in consideration of and in full settlement for their services in the organization of the company.
From 1910 to 1940, the books and records of Hens & Kelly Company consistently showed as an asset good will in the amount of $ 400,000, and common stock issued in the amount of $ 400,000. The same had been true also of The Hens-Kelly Company, as disclosed by its balance sheets of August 1, 1908, February 1, 1909, and August 1, 1909. Neither the time of the entry of good will on the books of The Hens-Kelly Company at $ 400,000 nor the reason or basis for the entry is disclosed.
Additional shares of 7 per cent preferred stock of the Hens & Kelly Company were sold for cash, at par, as follows:
| Date | Amount | |
| Jan. 3, 1910 | $ 64,900 | |
| Jan. 10 | 57,140 | |
| Jan. 31 | 63,090 | |
| February | 11,730 | |
| April | 3,550 | |
| May | 190 | |
| June | 1,000 | |
| July | 10,000 | |
| August | 8,000 | |
| November | 1,050 | |
| Total during Calendar 1910 | $ 220,650 | |
| January 1911 | 1,000 | |
| February | 16,110 | |
| Total during Calendar 1911 | 17,110 | |
| Total Jan. 3, 1910-Feb. 28, 1911 | $ 237,760 |
*49 The sales of preferred stock referred to above were made to one hundred fifty separate individuals. Some few of these new preferred stockholders had other stock interests in the company, but most of them did not. Many preferred stockholders did not become customers *311 until after they had purchased their preferred shares. No difficulty was encountered in selling preferred shares. Additional sales of such stock could have been made if desired. None of the common stock was offered or was available to the public.
According to its balance sheets at August 1, 1908, February 1, 1909, and August 1, 1909, the liabilities of The Hens-Kelly Company exceeded its assets by $ 29,767.48, $ 7,463.63, and $ 3,297.68, respectively. At January 31, 1910, the balance sheet of Hens & Kelly Company showed a surplus of $ 2,508.96. In 1909, and prior to the organization of Hens & Kelly Company, The Hens-Kelly Company was in need of working capital. Its credit had to be reestablished if it were to obtain the merchandise needed for profitable operations.
The net sales of the partnership and of The Hens-Kelly Company from 1892 to December 31, 1907, were at least as much as the following amounts: *50
| Calendar year | ||
| May to Dec. | Company | Net sales |
| 1892 | Hens & Kelly Company | $ 32,915.78 |
| 1893 | Hens & Kelly Company | 43,790.70 |
| 1894 | Hens & Kelly Company | 42,691.47 |
| 1895 | Hens & Kelly Company | 62,666.61 |
| 1896 | Hens & Kelly Company | 103,267.75 |
| 1897 | Hens & Kelly Company | 115,801.66 |
| 1898 | Hens & Kelly Company | 251,723.69 |
| 1899 | Hens & Kelly Company | 313,589.17 |
| 1900 | Hens & Kelly Company | 318,295.41 |
| 1901 | Hens & Kelly Company | 444,192.95 |
| 1902 | Hens & Kelly Company | 373,881.12 |
| 1903 | Hens & Kelly Company | 391,403.51 |
| 1904 | Hens & Kelly Company | 486,520.80 |
| 1905 | Hens & Kelly Company | 514,195.60 |
| 1906 | The Hens-Kelly Company | 663,052.29 |
| 1907 | The Hens-Kelly Company | 865,903.10 |
According to the books of The Hens-Kelly Company from January 1, 1908, up to December 31, 1909, and those of Hens & Kelly Company for the month of January 1910, the net sales and earnings of the business were as follows:
| Net profit | ||
| Period | Net sales | (loss) |
| Jan. 1, 1908 -- July 31, 1908 | $ 420,689.46 | ($ 50,949.16) |
| Aug. 1, 1908 -- Jan. 31, 1909 | 410,250.72 | 21,287.90 |
| Feb. 1, 1908 -- Jan. 31, 1909 | 830,940.18 | (29,661.26) |
| Feb. 1, 1909 -- Jan. 31, 1910 | 905,934.00 | 28,628.41 |
By reason of a change in the method of*51 computing inventory, the $ 50,949.16 loss for the period from January 1 to July 31, 1908, was overstated by approximately $ 39,000. The opening inventory was computed on a basis of retail less 27 per cent, plus 10 per cent, and *312 the closing inventory was computed on the basis of cost or market, whichever was lower. Sales and profits of The Hens-Kelly Company were adversely affected by the 1907 panic.
The names of "Hens and Kelly" have been used in advertising consistently through the years, without regard to the exact legal name of the company at the time. In 1909 and 1910, there was no national advertising in department stores, nor were there national brands, as we have today. The amounts spent by The Hens-Kelly Company and the Hens & Kelly Company for advertising, for the years ended January 31, 1909, to January 31, 1912, inclusive, were as follows:
| Fiscal year ending | Amount |
| Jan. 31, 1909 | $ 31,419.85 |
| Jan. 31, 1910 | 37,790.95 |
| Jan. 31, 1911 | 42,380.57 |
| Jan. 31, 1912 | 39,979.21 |
Net sales, net profits before taxes, and the dividends paid on capital stock of Hens & Kelly Company for the 10-year period ended January 31, 1920, were as follows:
| Years ended Jan. 31 | Net sales | Net profits | Dividends | Dividends |
| (before taxes) | (common) | (preferred) | ||
| 1911 | $ 1,089,541.78 | $ 53,590.46 | * $ 14,000.00 | $ 23,661.28 |
| 1912 | 1,136,744.84 | 45,512.67 | 24,000.00 | 23,838.50 |
| 1913 | 1,186,067.43 | 40,850.45 | 23,839.25 | |
| 1914 | 1,234,678.74 | 28,915.29 | 23,842.04 | |
| 1915 | 1,168,289.84 | 5,003.82 | 23,848.30 | |
| 1916 | 1,259,076.19 | 21,338.73 | 4,000.00 | 23,664.02 |
| 1917 | 1,457,355.06 | 92,007.78 | 24,000.00 | 23,633.74 |
| 1918 | 1,685,468.69 | 139,707.90 | 44,000.00 | 23,727.20 |
| 1919 | 2,125,986.65 | 181,556.96 | 44,000.00 | 23,727.03 |
| 1920 | 2,649,859.62 | 357,235.12 | 64,000.00 | 22,870.75 |
Hens & Kelly Company filed income and excess profits tax returns for the fiscal years ending January 31, 1917 to 1921, inclusive. On each of these returns, an item of good will was shown as an asset, in the amount of $ 400,000. A similar amount was shown for issued common stock. In computing invested capital on those returns $ 400,000 was used as the amount paid in for common stock. The amount so used in determining invested capital for the purposes of World War I excess profits tax was never disallowed or adjusted by the respondent.
On May 1, 1922, Hens & Kelly Company executed three similar leases with the respective owners of the adjoining premises heretofore referred to. In each lease, the existing lease was terminated as of May 1, 1922, and a new term, running from May 1, 1922, to May 1, 1942, was fixed. In each lease, there was an option on the part of the tenant to extend the lease to May 1, 1962, and a further option in the tenant to extend the lease to May 1, 1982. Each lease recited that *313 the tenant intended to erect a modern six-story department store *53 building on the properties within ten years.
The total annual rental reserved, payable in equal monthly installments in advance, by the three leases executed on May 1, 1922, was as follows:
| Miller No. 8 | ||||
| May 1-May 1 | Mohawk | Snow | Manchester | Total |
| 1922-1923 | $ 42,334 | $ 6,396 | $ 3,380 | $ 52,000 |
| 1923-1924 | 44,010 | 6,588 | 3,402 | 54,000 |
| 1924-1928 | 42,380 | 6,344 | 3,276 | 52,000 |
| 1928-1932 | 53,625 | 7,475 | 3,900 | 65,000 |
| 1932-1937 | 57,750 | 8,050 | 4,200 | 70,000 |
| 1937-1942 | 61,875 | 8,625 | 4,500 | 75,000 |
| First Option Period | ||||
| 1942-1947 | $ 66,000 | $ 9,200 | $ 4,800 | $ 80,000 |
| 1947-1952 | 70,125 | 9,775 | 5,100 | 85,000 |
| 1952-1957 | 74,250 | 10,350 | 5,400 | 90,000 |
| 1957-1962 | 78,375 | 10,925 | 5,700 | 95,000 |
| Second Option Period | ||||
| 1962-1967 | $ 82,500 | $ 11,500 | $ 6,000 | $ 100,000 |
| 1967-1972 | 86,625 | 12,075 | 6,300 | 105,000 |
| 1972-1977 | 90,750 | 12,650 | 6,600 | 110,000 |
| 1977-1982 | 94,875 | 13,225 | 6,900 | 115,000 |
With respect to the reserved rental for each of the option periods, the leases provided for an impartial appraisal of the respective pieces of property to be made 6 months before the expiration of the then current term. The annual rental for each of the properties for both option periods*54 was to be a sum equal to 6 per cent per annum of the appraised value of the respective pieces of property; provided, however, if the amounts so determined were less than the rentals otherwise reserved, said minimum rentals as set forth above were to apply to the option periods.
Between 1922 and 1927, Hens & Kelly Company completely renovated and remodeled the store building. On completion, the store building was a modern six-story, fireproof structure, erected at a cost of $ 1,165,502.46.
The building program was financed, in part, by a loan, evidenced by demand notes, from the Marine Trust Company of Buffalo. This loan was negotiated by Clawson, who was a director of the bank and chairman of its loan committee. The indebtedness to the Marine Trust Company was increased and reduced, from time to time. Immediately prior to the April 1, 1940, reorganization, the balance due the bank amounted to $ 436,000.
Sperry & Hutchinson Company is in the business of servicing retail stores with its cash discount stamp service. It services about 25,000 *314 merchants in all lines of retail trade, in 38 to 40 states. It specializes in servicing popular priced department stores. It had*55 serviced petitioner's predecessors, off and on, for many years. The use of stamps stimulates sales and the customer is impressed with the discount he receives on cash purchases. The service was not appropriate for high-priced or luxury type stores.
Edwin J. Beinecke became associated with Sperry & Hutchinson Company as a director about 1918. On January 1, 1925, he became president of that company.
In 1939, Beinecke, as president of Sperry & Hutchinson Company, solicited Hens & Kelly Company to have it reinstall the discount stamp service. At the suggestion of an executive vice president of the Marine-Midland Trust Company of New York, which is affiliated with the Marine Trust Company of Buffalo, and with the approval of the president of Hens & Kelly Company, Beinecke surveyed the business, with a view to determining its possibilities and improving its financial structure. The survey was made in the late spring of 1939. After a thorough investigation, Beinecke reported to the Marine Trust Company that petitioner had a good name in Buffalo and a good location, but that he did not approve of the management of the company, particularly the president of the company. He pointed out*56 that the financial structure of the company was in such a deplorable situation that credit had been stopped because of adverse reports made by credit reporting agencies in New York City. It could not get any ready-to-wear or a great many other articles except on a C. O. D. basis. Beinecke informed the bank that these conditions could be remedied and that the business could be made successful again, but that it would take a drastic reorganization to do it.
At the time Beinecke made his survey, the leases executed May 1, 1922, were in effect and would not expire until May 1, 1942. New leases were deemed necessary because the May 1, 1922, leases provided for a $ 5,000 per annum increase in rent every 5 years, over the renewal periods. Participation by Sperry & Hutchinson Company in a reorganization of Hens & Kelly Company was conditioned upon obtaining new leases on more favorable terms. After complicated negotiations with the landowners, including several trustees and estates, the terms of a new lease covering the entire premises were agreed upon. Although the terms were not completely satisfactory to those acting on behalf of the new company to be formed, they were the best terms*57 obtainable under the circumstances.
S H Company, Inc., a corporation organized under the laws of New York, filed its certificate of incorporation with the Department of State of that state on February 14, 1940. It acquired $ 250,000 cash by selling to Sperry & Hutchinson Company all of its authorized capital stock, *315 42,000 shares of common stock, at one dollar par value, and 750 shares of preferred stock, no par value, for $ 75,000, and borrowing $ 50,000 from Sperry & Hutchinson Company and $ 125,000 from the Marine Trust Company of Buffalo, both of which loans were evidenced by demand notes. In March 1940 S H Company, Inc., advanced $ 35,000 in cash to Hens & Kelly Company.
On February 14, 1940, the stockholders of Hens & Kelly Company were informed, by letter, of a plan to reorganize the company, which plan was to be considered, and action taken thereon, at a special meeting of the stockholders to be held on March 16, 1940.
The petitioner resulted from a consolidation of Hens & Kelly Company and S H Company, Inc., into Hens & Kelly, Inc., pursuant to section 86 of the Stock Corporation Law of New York. The certificate of consolidation was filed with the Department of*58 State of New York on April 1, 1940.
On March 31, 1940, the authorized capital stock and the shares outstanding of the constituent corporations were as follows:
| Issued and outstanding | |||
| Authorized | |||
| Shares | Par value | ||
| Shares of common: | |||
| Hens & Kelly Company | 4,000 (par value $ 100) | 4,000 | $ 400,000 |
| S H Company, Inc | 42,000 (par value $ 1) | 42,000 | 42,000 |
| Shares of preferred: | |||
| Hens & Kelly Company | 200 (par value $ 10) | 179 | 1,790 |
| 5,980 (par value $ 100) | 5,980 | 598,000 | |
| Total | $ 599,790 | ||
| S H Company, Inc | 750 (no par) * | 750 | * $ 33,000 |
The pertinent terms and conditions of the consolidation, as set forth in the certificate, were as follows:
(a) The consolidated corporation, in addition to the general powers of corporations formed under the Stock Corporation Law, shall enjoy the rights, franchises and privileges possessed by each of the constituent corporations, subject to the restrictions, liabilities, duties and provisions contained in the Stock Corporation Law, and may prosecute or*59 carry on any kind of business which either of the constituent corporations was authorized by law to conduct.
(b) Upon the filing of this certificate of consolidation in the Department of State, all the rights, privileges, franchises and interests of each of the constituent corporations, and all the property, real, personal, and mixed, and all the debts due on whatever account to either of them, as well as all stock subscriptions and other things in action belonging to either of them, shall be taken and deemed to be transferred to and vested in the consolidated corporation, without further act or deed; and all contracts, claims, demands, property and every other interest shall be as effectually the property of the consolidated corporation *316 as they were of the constituent corporations, and the title to all real estate, taken by deed or otherwise under the laws of the State of New York, vested in either of the constituent corporations, shall not be deemed to revert or be in any way impaired by reason of the consolidation, but shall be vested in the consolidated corporation.
* * * *
(j) The consolidated corporation shall create an issue of 3% notes in the aggregate principal *60 amount of $ 175,000. Such notes shall be in such form as may be adopted by the board of directors of the consolidated corporation and shall have the following provisions:
Maturity: Fifteen years from date of issue.
Interest: 3% payable quarterly.
Sinking Fund: On or before May 1, 1944, and on or before the first day of May in each year thereafter, the consolidated corporation shall apply pro rata on the principal of the outstanding notes 50% of the net profits of the consolidated corporation for the preceding fiscal year after all charges including interest, depreciation and income taxes.
Protective Provisions: While any of the notes are outstanding, the consolidated corporation will not, without the prior written consent of the holders of all of the notes, (a) pay any dividend to the holders of its common stock except out of surplus earned after the date of issuance of the notes remaining after deducting therefrom the sinking fund requirement for the notes and the dividend requirements on the preferred stock; (b) purchase or retire any shares of its stock; or (c) create, assume or guarantee any indebtedness secured by a pledge of or a mortgage or lien on any of its*61 property.
Acceleration: Each note shall, at the option of the holder thereof, became due and payable in the event of a default in the payment of interest on any of the notes or in complying with any of the provisions of the notes. The notes shall also contain the usual provisions permitting acceleration in the event of receivership, bankruptcy, or other creditors or insolvency proceedings or proceedings for reorganization under the Bankruptcy Act or in the event a judgment against the consolidated corporation shall not be appealed or discharged within a period of sixty days.
Prepayment: The notes may be prepaid on any interest date as a whole or in part, but if in part, only on a pro rata basis, at the principal amount thereof plus accrued and unpaid interest as to the date of payment.
The consolidated corporation shall issue these 3% notes to the holders of the $ 175,000 principal amount of 3% notes of the S H Company, Inc., in lieu and in cancellation of said notes of the S H Company, Inc.
The petitioner was authorized to issue the following shares of stock:
| 2,750 (preferred par value $ 100) | $ 275,000 |
| 112,000 (common par value $ 1.00) | 112,000 |
| 114,750 | $ 387,000 |
*62 The mode of carrying the consolidation into effect and the manner of converting the shares of each of the constituent corporations into shares of the consolidated corporation as set forth in the certificate of consolidation were as follows:
(a) Shares of preferred stock of all kinds of Hens & Kelly Company outstanding of record at the time of the filing of this certificate of consolidation *317 in the Department of State shall forthwith with all rights in respect thereof, including all rights to accumulated and unpaid dividends thereon, be and hereby are converted into shares of common stock of the consolidated corporation on the basis of four shares of common stock of the consolidated corporation for each $ 100 aggregate par value of preferred stock of Hens & Kelly Company. Holders of shares of preferred stock of any kind of said constituent corporation shall be entitled on or after said filing date to surrender their stock certificates for cancellation and thereupon to receive from the consolidated corporation certificates for common stock of the consolidated corporation upon the foregoing basis. * * *
(b) The shares of common stock of Hens & Kelly Company outstanding of *63 record at the time of the filing of this certificate of consolidation in the Department of State shall forthwith be and hereby are converted into shares of common stock of the consolidated corporation on the basis of one share of common stock of the consolidated corporation for each share of common stock of Hens & Kelly Company. Holders of shares of common stock of Hens & Kelly Company shall be entitled on or after said filing date to surrender their stock certificates for cancellation and thereupon to receive from the consolidated corporation certificates for common stock of the consolidated corporation upon the foregoing basis.
(c) Shares of preferred stock of S H Company, Inc. outstanding of record at the time of the filing of this certificate of consolidation in the Department of State shall forthwith be and hereby are converted into shares of preferred stock of the consolidated corporation on the basis of one share of preferred stock of the consolidated corporation for each share of preferred stock of S H Company, Inc. Holders of shares of preferred stock of S H Company, Inc. shall be entitled on or after filing date to surrender their stock certificates for cancellation and*64 thereupon to receive from the consolidated corporation certificates for preferred stock of the consolidated corporation upon the foregoing basis.
(d) Shares of common stock of S H Company, Inc. outstanding of record at the time of the filing of this certificate of consolidation in the Department of State shall forthwith be and hereby are converted into shares of common stock of the consolidated corporation on the basis of one share of common stock of the consolidated corporation for each share of common stock of S H Company, Inc. Holders of shares of common stock of S H Company, Inc. shall be entitled on or after said filing date to surrender their stock certificates for cancellation and thereupon to receive from the consolidated corporation certificates for common stock of the consolidated corporation upon the foregoing basis.
Upon the filing of the certificate of consolidation with the Department of State of New York all the rights, privileges, franchises and interests of each of the constituent corporations; all the property, real, personal, and mixed, of either of them; all debts due to either of them; all other things in action belonging to either of them; all contracts, claims*65 demands, property and every other interest of the constituent corporations including the following specific properties, with their respective adjusted basis for determining loss in the hands of the constituent corporations, were transferred to and became vested *318 in Hens & Kelly, Inc., as effectually as they had been in the hands of the constituent corporations.
| Hens & Kelly Company | Property | S H Company, Inc. |
| $ 50,847.22 | Cash | $ 215,000 |
| 180,669.02 | Accounts receivable | |
| 294,265.48 | Inventory | |
| 19,810.42 | Investments | |
| 103,590.57 | Warehouse, store fixtures, | |
| equipment | ||
| 847,689.00 | Leasehold improvements | |
| 34,257.41 | Unexpired insurance, prepaid taxes | |
| and expense | ||
| Loan to Hens & Kelly Company | 35,000 | |
| $ 1,531,489.13 | Total | $ 250,000 |
In addition to the foregoing properties, petitioner in connection with the reorganization acquired good will from Hens & Kelly Company. It did not reflect the value of the good will on its books.
The petitioner assumed liabilities of the constituent corporations as follows:
| Hens & Kelly Company | Liability | S H Company, Inc. |
| $ 150,868.90 | Trade accounts | |
| 6,697.03 | Accrued salaries, commissions | |
| 875.30 | Due bills | |
| 5,582.63 | Taxes | |
| Notes | $ 175,000 | |
| $ 164,023.86 | Total | $ 175,000 |
*66 The notes of S H Company, Inc., in the total amount of $ 175,000, were assumed by the new company by its issuing a note in the amount of $ 50,000 to the Sperry & Hutchinson Company and the one to the Marine Trust Company of Buffalo for $ 125,000. Said notes were dated April 1, 1940, and were in the form and tenor as set forth in the certificate of consolidation. No other liabilities were assumed by petitioner.
The issued and outstanding shares of preferred stock of Hens & Kelly Company having a par value of $ 599,790 were converted into 23,991.6 shares of common stock of Hens & Kelly, Inc., on the basis of four shares of Hens & Kelly, Inc., common for each $ 100 par value of Hens & Kelly Company preferred. The 4,000 issued and outstanding common shares of Hens & Kelly Company were converted into Hens & Kelly, Inc., common on a share-for-share basis. The issued and outstanding shares of S H Company, Inc., 750 shares of preferred and 42,000 shares of common, were respectively converted into Hens & Kelly, Inc., preferred and common stock on a share-for-share basis.
As of March 31, 1940, Hens & Kelly Company was indebted to the Marine Trust Company of Buffalo on promissory notes; *67 said indebtedness *319 amounted to $ 436,000. As mentioned previously, that debt was originally incurred in connection with the building program carried on during the 1920's. In anticipation of the consolidation described above, the indebtedness was reduced to $ 400,000, by a cash payment of $ 36,000 made by Hens & Kelly Company. The individuals who effected the reorganization realized that the $ 400,000 debt was collectible. None of these persons intended an assumption thereof by the petitioner, and, accordingly, it was not assumed. Sperry & Hutchinson Company would not have participated in the reorganization if the Marine Trust note had been assumed by the petitioner. The Marine Trust Company exchanged the $ 400,000 balance of the indebtedness for 2,000 shares of new preferred and 42,000 shares of common stock of Hens & Kelly, Inc.
On April 1, 1940, the petitioner and its lessor-landowners entered into a single lease covering the entire premises. By this lease, all existing leases were terminated. The new lease was for a term beginning April 1, 1940, and running to May 1, 1962, with an option in the petitioner to extend the lease to May 1, 1982. It was provided that*68 in the event the option was not exercised, the leasehold improvements at the expiration of the present term should vest in and become the property of the lessors. The rent reserved was a minimum of $ 60,000 a year, payable in equal monthly installments, in advance, but with an additional provision for "percentage rental." Under this latter provision, the petitioner was to be required to pay an annual rental based on 4 per cent of gross sales, against which the minimum rentals were to be credited. The rent to be paid in the event the option to extend should be exercised was to be a minimum annual rental of $ 60,000, or such amount as should equal 6 per cent of the value of the premises as appraised at the end of the original term, whichever should be the greater. The percentage rental provision was to apply to the extended period, with the minimum rental payments to be credited to the amount due under the percentage rental provision. It was reasonably certain in the taxable years that petitioner would exercise its option to renew the lease for the period May 1, 1962, to May 1, 1982.
Prior to 1940, Hens & Kelly Company amortized its leasehold improvements over the term, plus the*69 option periods, of the 1922 leases. On March 12, 1940, Hens & Kelly Company, through its president and treasurer, and in conformance with Treasury Decision 4957, approved December 6, 1939, voluntarily filed with the Commissioner of Internal Revenue a consent, Form 969, designated "Election of taxpayer respecting basis of deductions for depreciation or amortization of improvements to leaseholds or capital expenditures incurred in acquiring leasehold, where the lease contained an option for renewal." The *320 election filed was to amortize the leases over the extended period. A letter, written by Wesp, the vice president, who handled tax matters of the company, accompanied the consent, with a request that the consent, though filed after the expiration of the 90-day period provided by the Treasury decision, be accepted; and it was accepted by the Commissioner. In the Wesp letter and in Wesp's affidavit thereto, the references were made to Hens & Kelly, Inc., although both were written on stationery of Hens & Kelly Company.
The petitioner, on its returns for the years here involved, claimed deductions for amortization of leasehold improvements computed on the March 31, 1940, adjusted*70 basis of such improvements in the hands of Hens & Kelly Company, with appropriate adjustments for additions and reductions made by the petitioner after April 1, 1940. The term used in calculating such deductions was the period beginning April 1, 1940, and ending May 1, 1982, that is, the term of the lease, plus the 20-year option renewal period. These returns were signed by Wesp, as petitioner's president. The respondent, in adjusting the deductions for amortization, which adjustments are not contested, also adopted the April 1, 1940, to May 1, 1982, period. Petitioner's predecessor, Hens & Kelly Company, had also computed and claimed amortization deductions on leasehold improvements over the extended period.
Beginning about 1940, there was a noticeable trend toward the establishment of suburban branches by downtown department stores. The traffic in downtown Buffalo was becoming more congested and parking facilities were inadequate. Prior to 1940, Sears, Roebuck & Company had built a store in the outlying area of Buffalo, and some other Buffalo department stores also had opened surburban branches. During World War II the rent provisions of the April 1, 1940, lease did not prove*71 to be as favorable for petitioner as had been anticipated.
The good will acquired by Hens & Kelly Company on December 31, 1909, through the issuance of its capital stock to The Hens-Kelly Company, had a fair market value on the date of such exchange of $ 100,000, as did the common stock of Hens & Kelly Company issued in such exchange.
OPINION.
The first question is as to the amount to be included in equity invested capital for good will. By section 718 (a) (2) of the Internal Revenue Code, 2 it is provided that property paid in for *321 stock, or as paid-in surplus, or as a contribution to capital, shall be included in equity invested capital "in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange." The parties are in agreement that good will was acquired by petitioner in a consolidation within the meaning of section 112 (g) (1) of the Code, 3 and under section 113 (a) (7) (B), its basis for determining loss was the same as it was in the hands of the transferor, Hens & Kelly Company. The parties are also agreed that Hens & Kelly Company acquired good will on December 31, 1909, when it acquired or succeeded to the assets and business of The*72 Hens-Kelly Company. In such circumstances, the property having been acquired prior to March 1, 1913, its basis to Hens & Kelly Company for determining loss was its cost. Maltine Co., 5 T. C. 1265.
*73 The petitioner claims that $ 400,000 is the amount to be included in its equity invested capital for good will, while the respondent contends that the amount to be included does not exceed $ 68,322.10. The claim of the petitioner rests upon the proposition that Hens & Kelly Company acquired the good will of its predecessor, The Hens-Kelly Company, in exchange for its 4,000 shares of common stock; and while we are unable to find on the evidence and from the stipulated facts that the 4,000 shares of common stock were issued for good will alone, the respondent, on brief, has indicated an apparent willingness to submit the issue on that basis. The issue will accordingly be decided on the assumption that the 4,000 shares of common stock of Hens & Kelly Company were issued in exchange for the good will of The Hens-Kelly Company.
The cost to a corporation of property acquired through the issuance of its capital stock is the fair market value of such stock on the date issued. Where, however, the fair market value of the stock is not established as of the date of issue, it is proper to consider the fair market value of the property received, in arriving at the fair market value of the stock. *74 Ida L. McKinney, 32 B. T. A. 450, 456.
Among other things, the petitioner, in support of its claimed cost of $ 400,000 for good will, relies upon the established position of The Hens-Kelly Company Department Store in the city of Buffalo and its *322 physical location in that city; the individual standing of both Hens and Kelly in Buffalo and in the department store business; the fact that the directors of Hens & Kelly Company, at their first meeting, indicated in the whereas clause of a resolution that they regarded the business and property acquired as being "reasonably worth the amount of the consideration" paid therefor; the fact that Clawson and Knox, men of considerable wealth and standing in the mercantile business in Buffalo, were coming into the business as shareholders; and the fact that Hens & Kelly Company, after its organization and for a period of 10 years, did operate at a satisfactory profit, during which period it paid the dividends due on its preferred stock for all years and for most of such years very satisfactory dividends on its common stock. The respondent stresses the condition of The Hens-Kelly Company at and for some time*75 prior to the date of acquisition of its business and assets by Hens & Kelly Company and arrives at $ 68,322.10 as the amount to be included in equity invested capital for good will from the testimony of two witnesses called by him to give opinion testimony.
While we think the record does show that Hens & Kelly Company in acquiring the business and assets of The Hens-Kelly Company did acquire good will, we are nevertheless of the opinion that the record falls far short of supporting the claim that the good will acquired had a fair market value of $ 400,000 at the time of acquisition, or that its cost to petitioner was such sum. It is true that the directors of Hens & Kelly Company, at their first meeting, did in the whereas clause of a resolution state that in their judgment the business and property acquired for stock was reasonably worth the consideration paid therefor, but it is likewise true that the $ 400,000 figure for good will was a carry-over figure from the books of The Hens-Kelly Company. We have no information as to when good will was set up on the books of The Hens-Kelly Company, what the considerations were for setting it up, or how the $ 400,000 figure used was arrived*76 at. We do know, however, that prior to the organization of Hens & Kelly Company the credit of The Hens-Kelly Company was not good and had to be reestablished if it was to obtain merchandise needed for profitable operations, and, according to Knox and Clawson, who were looking the business over to see whether they would participate in it, changes in its methods of operations needed to be made and the business needed to be upgraded from the lower class or "shawl" trade into the so called "medium" class trade.
In arriving at the figure of $ 400,000, the petitioner rests its argument very heavily upon the participation of Knox and Clawson, and it is true that they did arrange for a line of bank credit for The Hens-Kelly Company about the middle of 1908 and for a trial period prior to December 31, 1909, did participate in policy determination. There is *323 no showing, however, that they acquired any proprietary interest in the business before the organization of Hens & Kelly Company and its succession to and acquisition of the assets and business of the old company. It is obvious, we think, that whatever the effect of their participation in the affairs of the business, the effect*77 was prospective and not a part of the good will acquired by Hens & Kelly Company for its common stock.
Possibly what the petitioner has in mind is that the participation of Knox and Clawson did serve to enhance the value of the common stock issued for the good will, and possibly it did prospectively enhance the value of such stock to some extent. There were no shown sales, however, of the Hens & Kelly Company common stock at any time and we have no direct evidence showing its fair market value at the time of issue. We do know that Knox and Clawson did acquire some of the common stock at some time and in some manner. Presumably they became equal holders of such stock with Hens and Kelly themselves. Except, however, for the preferred stock later sold to 150 separate individuals and the 40 shares of common stock subscribed for by the incorporators, all of the preferred stock issued and the common stock, 3,960 shares, were issued to The Hens-Kelly Company for its business and assets, and in ordinary course would thereafter have been distributed to the stockholders of that company. There is, therefore, nothing to show that either Knox or Clawson, upon the organization of Hens & Kelly*78 Company and the acquisition by it of the business and assets of The Hens-Kelly Company, put any money into the business. So far as appears of record, their acquisition of stock was through a side transaction with Hens and Kelly individually or The Hens-Kelly Company. What they paid, if, in fact, they paid anything, for the common stock acquired by them, we do not know. Where, as in such circumstances, the transaction was obviously at arm's length, evidence as to the cost to Knox and Clawson of the common stock acquired by them, which stock presumably was acquired immediately after its issue for good will, would have been much more revealing as to the fair market value of the common stock of Hens & Kelly Company at the time of issue, than the indirect evidence upon which the petitioner relies.
Having considered all of the evidence of record and given effect thereto as best we could, we have concluded and found that the cost of the good will acquired by Hens & Kelly Company from The Hens-Kelly Company was $ 100,000.
The second issue is whether the petitioner for the years ended January 31, 1941 to 1944, inclusive, is entitled to amortize the unrecovered cost of leasehold improvements*79 over the period from April 1, 1940, to May 1, 1962, without regard to petitioner's option to extend *324 the lease to May 1, 1982. This question is governed by section 29.23 (a)-10 of Regulations 111, which reads in part as follows:
Rentals. -- * * * The cost borne by a lessee in erecting buildings or making permanent improvements of ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the lease, and such deduction shall be in lieu of a deduction for depreciation. * * *
In cases in which the lease contains an unexercised option of renewal, the matter of spreading such depreciation or amortization over the term of the original lease, together with the renewal period or periods, depends upon the facts in the particular case. As a general rule, unless the lease has been renewed or the facts show with reasonable certainty that the lease will be renewed, the cost or other basis of the lease or the cost of improvements *80 shall be spread only over the number of years the lease has to run, without taking into account any right of renewal. However, if the taxpayer for any taxable year ending prior to December 31, 1939, has been allowed such depreciation or amortization on the basis of spreading the cost or other basis of such lease or improvements over the number of years the lease has to run, including any exercised or unexercised renewal period or periods, and such taxable year has been closed on that basis and the tax for that year cannot be redetermined, then the taxpayer may for subsequent taxable years take deductions on such basis if within 90 days after the approval of Treasury Decision 4957 (approved December 6, 1939) or within such later period as may be specified by the Commissioner, he files Form 969, in duplicate, with the Commissioner of Internal Revenue, Washington, D. C., attention of the Income Tax Unit, Records Division, signifying his election to have deductions in respect of such items determined upon such basis, and expressly waives his right to claim or receive the benefits of any reduction in his tax liability which would result from the allowance of deductions for such items on*81 the basis of only the number of years the lease has to run, without taking into account any right of renewal, or on any basis other than that set forth in his election. * * *
It is the claim of the petitioner that amortization of the unrecovered cost of the leasehold improvements is to be limited to the original lease period ending May 1, 1962, and in support of that contention, it cites and relies upon Bonwit Teller & Co. v. Commissioner, 53 F. 2d 381; 719 Fifth Avenue Co. v. United States, (1934 Ct. Cl.) 5 F. Supp. 909">5 F. Supp. 909; 1620 Broadway Corporation, 36 B. T. A. 149; Estate of George B. Leonard Holding Corporation, 26 B. T. A. 46; and Bowman Hotel Corporation, 24 B. T. A. 1139. It stresses particularly the fact that, in the event of renewal of the lease for the period from May 1, 1962, to May 1, 1982, the annual rental for the extended period was to be $ 60,000, or 6 per cent of the appraised value of the property at the renewal date, whichever should be the greater, and cites Alamo Broadcasting Co., 15 T. C. 534,*82 for the proposition that where the renewal is to be based upon a reappraisal of the property, the period of amortization is limited to the original term of the lease.
*325 It is to be noted that the regulation quoted above provides that the matter of spreading amortization over the term of the original lease, together with the renewal period or periods, "depends upon the facts in the particular case," the general rule being, however, that "unless the lease has been renewed or the facts show with reasonable certainty that the lease will be renewed, the cost or other basis of the lease or the cost of improvements shall be spread only over the number of years the lease has to run, without taking into account any right of renewal." The petitioner makes no contention that the regulation is unreasonable or otherwise invalid, but, accepting the regulation, argues that on the evidence there was no reasonable certainty in the taxable years that the lease would be extended beyond May 1, 1962. The question, then, is one of fact. On its returns the petitioner computed and claimed amortization of the leasehold improvements on the basis that its lease would be extended to May 1, 1982. The*83 respondent in his determination of the deficiencies herein, accepted that computation and claim as correct. The burden is accordingly upon the petitioner to show that in the taxable years there was no reasonable certainty that its lease would be extended beyond May 1, 1962.
From 1922, when the leases to the premises occupied were renegotiated by Hens & Kelly Company and the renovating, remodeling or construction of its present store building began, up to May of 1948, when the first amended petition herein was filed, there was, in so far as shown of record, no thought whatever on the part of the petitioner or its predecessor, Hens & Kelly Company, but that the lease or leases would be renewed to May 1, 1982, the full period provided for. From 1922, until it was consolidated with S H Company, Inc., on April 1, 1940, to form the petitioner, Hens & Kelly Company amortized the leasehold improvements on the basis of the original term of the lease, plus the two renewal periods to 1982. Those leases, like the lease here, provided that in the event of renewal one of the factors in determining the rental for the extended period was to be the appraised value of the premises at the renewal*84 date. After the petitioner was formed, it likewise computed and claimed amortization of the leasehold improvements for the entire period up to 1982. It is also apparent, we think, that the claims made by the petitioner after it was organized, including the taxable years, were advisedly made. Treasury Decision 4957, later section 29.23 (a)-10 of Regulations 111, supra, was issued on December 6, 1939. Under its provisions, a taxpayer which, for any taxable period ending prior to December 31, 1939, had been allowed amortization on the basis of spreading the cost of leasehold improvements over the years the lease was to run, plus any exercised or unexercised renewal period or periods, and which desired to continue to amortize leasehold improvements in subsequent years on that basis, was required to file an election to *326 the effect within 90 days. Under date of March 12, 1940, and after the 90-day period had expired, Hens & Kelly Company transmitted to the respondent such formal election to continue to amortize its leasehold improvements over both the original lease period and the renewal period. This formal election was transmitted by a letter signed by Arthur P. Wesp, *85 vice president of Hens & Kelly Company, which letter indicated that Wesp and other officers of the company were fully informed as to the provisions of Treasury Decision 4957, and the requirements thereunder. At the time the election was filed with the respondent, it was known that Hens & Kelly Company was to be consolidated with S H Company, Inc., to form the petitioner. In the letter of transmittal it was stated that T. D. 4957 did not come to the attention of the officers of the company until March 6, 1940 "Due probably to the preoccupation of all of the interested parties in the financing program now being effected by this company." The consolidation with S H Company, Inc., was effected some eighteen or nineteen days later, and Arthur Wesp became the president of the petitioner.
At or about the time the above election was filed with the respondent by Hens & Kelly Company, a single new lease was being negotiated on behalf of the petitioner to cover the remainder of the lease period, plus the renewal period up to May 1, 1982, and the new single lease was obtained at a substantially reduced minimum rental. After its organization on April 1, 1940, the *86 petitioner, in returns signed by Wesp, as its president, continued to claim deductions for amortization of the leasehold improvements over the original lease period, plus the renewal period up to May 1, 1982, just as had been done by its predecessor, Hens & Kelly Company. On such state of facts, we think it apparent that the petitioner itself, and its predecessor, Hens & Kelly Company, regarded the renewal of the 1922 leases and after they were superseded by the single lease in 1940, the 1940 lease up to May 1, 1982, as a reasonable certainty. Such a consistent attitude on the part of the petitioner and its predecessor speaks much more loudly in favor of a reasonable certainty of renewal, than does the fact that the renewal at May 1, 1962, would be based on an appraisal of the property at that time and might, for that reason, result in a greater annual rental, speak against reasonable certainty of renewal. Not only are we of the opinion that the petitioner has failed to carry its burden of proving that during the taxable years there was no reasonable certainty that the lease to the premises occupied by it would not be renewed at May 1, 1962, for the extended period, but, to the *87 contrary, we think the evidence amply shows that there was reasonable certainty that the lease would be renewed, and we have so found as a fact.
*327 In reaching the above conclusion, we have not overlooked the arguments advanced by the petitioner on the basis of testimony appearing of record and relied upon as raising doubts as to the reasonable certainty that the lease would be renewed. The fact that traffic in downtown Buffalo was becoming more congested and parking facilities were inadequate and that there was a noticeable trend toward the establishment of suburban branches by downtown department stores, is not, in our opinion, an indication that the petitioner had any thought or intention of giving up its downtown location, but merely that it might seek to further expand its business by the establishment of suburban branches. By the time of the trial, one such branch had been established and another was in the planning stage, but they were specifically referred to as "branches" and there was still nothing to indicate the presence of any thought or intention of abandoning the main store or of changing its location. It is interesting to note that on this point the evidence*88 relied upon by the petitioner is the testimony of Wesp, who had played such a part in the claims by Hens & Kelly Company, and later the petitioner, for extending amortization of the leasehold improvements to 1982, and the testimony of Beinecke, who had represented Sperry & Hutchinson Company in the 1940 consolidation and substantially dominated the management of the petitioner thereafter, and who, although he had insisted that more favorable leases be negotiated, had based his recommendation favoring participation by Sperry & Hutchinson Company in the 1940 reorganization on the good name of the store in Buffalo and its "good location." Because of his participation in the reorganization and his part thereafter in determining policy for the petitioner, it is not at all unlikely that Beinecke was aware of T. D. 4957, the election of Hens & Kelly Company thereunder, and the basis of petitioner's claims as to the amortization of leasehold improvements over the entire period to 1982. The testimony of these witnesses was, we think, largely hindsight in character. We have found the facts as they existed at the time here involved and the action then taken thereon*89 much more convincing. In that connection, see and compare 1620 Broadway Corporation, supra.
The respondent's regulation applicable to the years involved in Bonwit Teller & Co. v. Commissioner, supra, provided for an annual deduction to cover amortization of the cost of leasehold improvements in "an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease." There was no provision, such as we have here, permitting the spreading of depreciation or amortization over the term of the original lease, together with the renewal period or periods. Accordingly, the court had no occasion to consider the reasonableness of a regulation which *328 does permit the spreading of amortization over the original lease period, plus the renewal period, where, as here, "the facts show with reasonable certainty that the lease will be renewed." See Morris Nachman, 1204">12 T. C. 1204, 1209. Furthermore, the petitioner here does not claim that the present regulation is unreasonable or invalid, but seemingly accepts the regulation and argues that there was*90 no reasonable certainty that the lease would be renewed. We have already noted our finding of fact to the contrary. For cases where there was reasonable certainty of renewal, see Standard Tube Co., 6 T. C. 950, and Alamo Broadcasting Co., supra.It is true that in the latter case the situation where renewal of a lease is based upon a reappraisal of the property is referred to as an exception to the proposition stated by Mertens in his Law of Federal Income Taxation, that where "the lessee has an option to renew on the same terms, the exhaustion should be spread over the combined period named in the lease and the renewal period or the life of the property, whichever is shorter." Alamo Broadcasting Co., however, was a case where the option was an option to renew on the same terms and is not authority for the proposition that leasehold improvements may not be spread over the term of the original lease, plus the renewal period, even though the renewal is based on reappraisal, if the facts of the particular case support the conclusion that there is reasonable certainty of renewal. It is manifest, of course, that the statement*91 appearing in Mertens is merely that of a digester's views as to what certain decided cases hold. It may not properly be regarded as controlling authority for the decision of this or any other case and it was not so cited in Alamo Broadcasting Co. Futhermore, all of the cases shown in the footnote in support of the proposition stated involved years, and were decided prior to the promulgation of the regulation applicable in the instant case.
A short time before the trial herein the petitioner, in a third amended petition, made a vague and general allegation to the effect that the respondent "erred in failing to compute properly the amount paid in for stock of the petitioner, or as paid-in surplus, or as a contribution to capital of the petitioner in connection with the organization of the petitioner." There were, however, no supporting allegations of fact. When the proceeding was called for trial, counsel for the petitioner made no reference to or statement of such an issue, unless the words "In connection with fiscal 1943 and fiscal 1944 there is another issue raised, which is simply a matter of Rule 50" was with reference thereto. On brief, however, the petitioner has entered*92 into some rather extended discussion as to the applicability of section 760 of the Internal Revenue Code. The argument is not clear, and there again, the assertion is made that the "issue will not become material *329 until computation is made under Rule 50 of the Tax Court's Rules of Practice." On such state of the record, we think it apparent that no issue, whatever petitioner's counsel may have had in mind, was properly raised and presented for decision by this Court, and as to any such issue, we leave the parties where we found them.
Decision will be entered under Rule 50.
Arundell, J., dissenting: The general rule, as I understand it, permits a lessee to amortize the cost of improvements he has placed on property over the original term of the lease even though there may be an option of renewal if, incident to renewal of the lease, the property is to be valued as of the time of renewal and the rent thereafter fixed upon the new value. Cf. Alamo Broadcasting Co., 15 T.C. 534">15 T. C. 534. In the latter circumstance the inclusion of the value of the lessee's improvements in the basis upon which the new rent is computed results in his loss*93 of the benefit of the improvements at that time equally as effectively as though he had lost possession of the property through failure to renew the lease or for any other cause. It requires that in order to recover his cost the lessee must then be permitted to amortize over the shorter term. I think the majority have erred in denying to petitioner the right to amortize his costs over the term of the original lease.
Footnotes
1. The manner in which Knox and Clawson became shareholders in Hens & Kelly Company, or what they paid for the stock they received, if they paid anything, is not shown. All of the common and preferred shares of the company, except 40 shares of common stock issued to the four incorporators and the preferred shares sold, as hereinafter shown, to 150 separate individuals, were issued to The Hens-Kelly Company for the department store business and assets. There is no showing that Knox and Clawson actually put any capital into Hens & Kelly Company at the time of its organization or upon the acquisition by it of the assets and business of The Hens-Kelly Company, although there is a statement in the testimony of one witness that by 1922, when the leases were renegotiated, Clawson had "some $ 200,000 invested in Hens & Kelly Company."↩
*. $ 6,000 declared and paid on February 10, 1910, and $ 8,000 declared and paid on August 18, 1910.↩
*. These items are shown as stipulated by the parties. Possibly the $ 33,000 was intended as the stated value of the preferred stock rather than par value.↩
2. SEC. 718. EQUITY INVESTED CAPITAL.
(a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) --
* * * *
(2) Property Paid In. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined under the law applicable to the year of disposition, but without regard to the value of the property as of March 1, 1913. * * *↩
3. SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(g) Definition of Reorganization. -- As used in this section (other than subsection (b) (10) and subsection (1)) and in section 113 (other than subsection (a) 22)) --
(1) The term "reorganization" means (A) a statutory merger or consolidation, * * *↩