*2823 Petitioner paid $50,000 to two of its stockholders in 1920, in consideration of their becoming guarantors under a renewal lease to begin May 1, 1926. Held, that this was not an allowable deduction from gross income in 1920 under the provisions of section 234(a)(1), Revenue Act of 1921.
*566 The Commissioner determined a deficiency in income and profits tax for 1920 of $23,043.31. The issue is whether an amount of $50,000 paid by the petitioner to two of its stockholders in consideration of their becoming guarantors under a renewal lease contract, such lease to begin on May 1, 1926, constitutes an allowable deduction from gross income in 1920. The facts were either stipulated or admitted in the answer.
FINDINGS OF FACT.
The petitioner is a domestic corporation, organized under the laws of the State of Michigan on or about June 22, 1910, to engage in and carry on amusement and theatrical enterprises.
May 16, 1910, a lease was made between Elmer L. White, lessor, and Benjamin Meisner and David King, as lessees, for a term of 15 years*2824 from May 1, 1911, for the premises known as 40, 42 and 44 Monroe Avenue, Detroit, Mich., to be occupied for mercantile and legitimate theatrical business. Adolph Finsterwald was guarantor upon said lease, which provided for a rental of $14,652 per annum, payable $1,221 per month. June 22, 1910, the said lessees assigned the lease to the King Amusement Co., the present petitioner.
March 7, 1911, an option to renew the lease was given the petitioner by White, the lessor, providing for a term of ten years from May 1, 1926, at a yearly rental of $25,000, payable in equal monthly installments, together with all taxes upon the land and building and to be guaranteed by Adolph Finsterwald. The said option expired by limitation on April 30, 1912.
In 1920 the petitioner had been engaged in the theatrical business and had operated a theatre in the leased premises for some years. The operations of this theatre had been very successful and had resulted in the payment of dividends over a number of years. The good will was established for the theatre in its location and it therefore *567 became imperative that a renewal lease be obtained for the same theatre at the same location.
*2825 In 1920 negotiations were begun for a renewal lease. White, the lessor, desired a guarantee upon the new lease, preferably that of Adolph Finsterwald. This guarantee Finsterwald refused to give because of the large contingent liability involved. The estimate of the rentals and charges to be paid on the new lease for a 10-year period was in excess of $300,000, and since there was a 6-year period before the expiration of the existing lease and the commencement of the new lease on May 1, 1926, made the guarantee an additional risk.
April 30, 1920, a new lease for a period of 10 years from May 1, 1926, was entered into between the petitioner and White, as lessor. The lease called for a total rental of $250,000 ($25,000 per annum) payable $2,083.34 per month. This rental was net to the lessor, the lessee to pay the taxes, insurance and other charges, which would approximate $12,000 per year, making the total risk to be assumed by the guarantors over a 10-year period of approximately $370,000.
The King Amusement Co. decided that it would pay for the guarantee of the lease if the responsible stockholders would agree, but all the responsible stockholders refused. After the refusal*2826 of the other stockholders, Finsterwald agreed that the would guarantee the new lease for a compensation of $25,000 if David King would guarantee with him. David King agreed upon the same terms. Their proposal was acceptable to the lessor. The stock of petitioner consisted of 1,000 shares of common stock which was owned during the months of March and April, 1920, as follows:
| Stockholders | Shares |
| Adolph Finsterwald | 183 |
| David King | 226 |
| Fifty-two other persons | 591 |
| Total | 1,000 |
The petitioner, by appropriate action of its board of directors, on April 30, 1920, passed a resolution by which it was provided that it (the petitioner) should pay Adolph Finsterwald $50,000 as compensation for becoming guarantor for said lease. Contemporaneously with the execution of the renewal lease on April 30, 1920, Adolph Finsterwald and David King executed a guarantee agreement with the lessor. The petitioner paid to said Finsterwald and King each the sum of $25,000 during the year 1920. Adolph Finsterwald and David King each reported the sum of $25,000, received from the petitioner upon the guarantee contract as income to them in their respective income-tax returns for the year*2827 1920.
The petitioner has always maintained its books of account on the cash receipts and disbursements basis and made its income-tax *568 return in accordance with its books. The $50,000 in question was paid out and entered upon the petitioner's books in the year 1920 as an expense disbursement and the sum was claimed as a deduction from income upon the petitioner's income-tax return for that year.
In the determination of the deficiency involved in this proceeding the Commissioner has disallowed the deduction, as a 1920 expense, of the said $50,000 paid in that year, and has added back that sum to the income as reported by the petitioner.
OPINION.
LITTLETON: The issue is whether the amount of $50,000 paid by the petitioner to Finsterwald and King in consideration for their becoming guarantors for the petitioner in the fulfillment of the terms and conditions of a certain lease constitutes an allowable deduction from gross income under the provisions of section 234(a)(1), which reads as follows:
(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
(1) All the ordinary and necessary*2828 expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity.
The facts are not in dispute. In brief they show that when in 1920 the petitioner sought to renew the lease on the premises which it was then occupying, it became necessary for the petitioner to pay $50,000 in order to secure the renewal lease. At that time the existing or old lease had six years yet to run, and the petitioner, by the renewal lease, secured no modification of the old lease. The payments in question were not made to the lessor, but were made to two individuals in consideration of their becoming guarantors for the fulfillment of the lease contract by the petitioner as lessee. As such it was not a bonus paid of the character we find which is often referred to as additional rent or a part of the rent paid in advance. It was, however, as necessary to the securing*2829 of the renewal as if it had been a bonus or price specified in the lease, since the reasonable deduction to be drawn from the facts is that the renewal could not have been obtained without making this expenditure.
The petitioner's argument in support of the deduction is directed largely to the proposition that this was an expense prudently incurred, proximate to the business and reasonably necessary and, therefore, it must be classified as a deductible expense in the nature of insurance premiums or as compensation for services rendered. What the petitioner says is a true statement of what occurred, but we can not agree with the ultimate conclusion reached, namely, that this is *569 an ordinary and necessary expense deductible under the provisions of section 234(a)(1), supra; ; . The line to be drawn between capital and expense items if often difficult to define and must be decided upon the basis of the facts in a particular case, but we fail to see where the prudence with which the expense was incurred, its proximity to the business, and its reasonable necessity assist us in making a distinction*2830 between the two classes of items. These considerations would apply equally to an outlay of money, whether it be for something which is to contribute to the income-producing activities over a period of years or whether it be for something from which the benefit is applicable only to the year in which the expenditure was made, and therefore chargeable only to such year's operations. Nor does the fact that the expenditure was for salary in the form of compensation for services rendered or for insurance, necessarily rob it of its capital nature. Certainly, where a taxpayer constructs a building with its own labor, paying salaries and wages for such work and also paying for insurance the benefits from which are applicable only to the period of construction, it could hardly be said that those expenditures are not of a capital nature. In effect, they are expenditures made in the acquisition of a building, a capital asset, for the purpose of producing income over a period of years and, therefore, would not be chargeable against income for a single year. Then, too, organization expenses in connection with the formation of a corporation may include compensation for services rendered, but*2831 they are not allowable deductions from gross income. See ; ; . As we view the situation, the expenditure was made in connection with the acquisition of a capital asset, the new lease, and was as much a part of the cost as if it had been paid to an agent in an outright acquisition of a lease. In other words it was an amount paid in order to acquire the lease, and we do not think it material that it was not paid to the party from whom the lease was obtained. The benefits from such expenditure were not confined to the year when made, but would extend to the end of the renewal lease. It may well be that some benefits from making this expenditure in 1920 accrued to the petitioner at that time and were not confined to the period of the renewal lease, since the petitioner was thus assured that it could continue its operations at that place for 16 years instead of only 6 years and, consequently, was enabled to make plans for the future in a manner which it could not have done without the renewal lease, but this is no argument for*2832 saying that this was an ordinary and necessary expense applicable only to the year 1920. On the whole, we are satisfied that this was a capital expenditure and, accordingly, the Commissioner's action is no treating it is sustained. *570 What part of it, if any, might be deductible in 1920 we have no evidence from which we can determine.
Judgment will be entered for the respondent.