*212 Decision will be entered for the petitioners.
X corporation possessed an ex contractu claim against Y corporation. Prior to resolution of the contract dispute, X corporation was liquidated, and its assets, including the claim against Y corporation, were distributed to its shareholders. The claim had no ascertainable fair market value on the date of its distribution. The petitioner and the other X corporation shareholders engaged an attorney to prosecute their claim against Y corporation. The attorney negotiated a settlement whereby Y corporation agreed to pay the X corporation shareholders the aggregate sum of $ 540,000 in exchange for a release of any further liability. Petitioner's share of the settlement was $ 108,000. Petitioner expended $ 6,760 for legal and bank services in connection with the collection of the aforesaid sum. Held, the amounts expended by petitioner are not in the nature of capital expenditures but are nonbusiness expenses deductible under
*647 OPINION.
The respondent determined a deficiency in income tax of $ 2,333.38 for the calendar year 1956. The only issue for decision is whether payments in 1956 for legal and bank services furnished in connection with the settlement of a contract claim were capital in nature or deductible expenses incurred in the production or collection of income.
All of*214 the facts have been stipulated and are found accordingly.
Petitioners are husband and wife and reside in Scarsdale, N.Y. They filed their income tax return for 1956 with the district director of internal revenue at New York, N.Y.
Petitioner Otto C. Doering, Jr., hereinafter referred to as petitioner, was a shareholder of Argosy Pictures Corp., hereinafter referred to as Argosy, from its date of incorporation in 1946 to its date of liquidation in January 1956. The business of Argosy was to produce motion pictures. At the time of the liquidation petitioner owned 20 percent of the outstanding stock of Argosy and had held all of such stock for more than 5 years.
In January of 1950 Argosy contracted with Republic Pictures Corp., hereinafter referred to as Republic, to produce three motion pictures *648 for distribution and exhibition by Republic. In return for producing the motion pictures, Argosy was to receive a specified portion of the respective net profits of Republic attributable to the pictures. By the end of 1952 Argosy had produced the three pictures which were entitled "Rio Grande," "The Quiet Man," and "The Sun Shines Bright." Argosy produced no further pictures for*215 Republic. Republic exhibited the three pictures in question and rendered quarterly statements to Argosy of the gross amounts received from exhibition and the expenses attributable thereto.
A dispute arose between Argosy and Republic principally as to whether Republic was entitled to charge certain of its expenses against the exhibition receipts from these three pictures and as to whether Republic was obligated to return to the United States and to pay to Argosy its share of the profits received by Republic from exhibition of these films in foreign countries and particularly countries having currency restrictions. For a period of over 3 years prior to its dissolution, Argosy, through its executives and its counsel, had conducted negotiations with Republic and its counsel looking toward a settlement of this dispute. Argosy paid its attorneys $ 54,660.34 during this period in full payment of their fees and disbursements.
Argosy retained an accounting firm to audit the accounts of Republic with respect to the contract between Republic and Argosy and was advised by them that in their opinion a substantial amount in excess of $ 1 million was due Argosy. At the same time Republic contended*216 that it had actually overpaid Argosy, a position it maintained until the dispute was settled.
Argosy was dissolved in January 1956 and its assets were distributed in liquidation to its shareholders. These assets included the claim of Argosy against Republic. On the dissolution of Argosy petitioner received $ 12,822.05 in cash, plus his pro rata interest in the claim against Republic. Argosy's claim against Republic had no ascertainable fair market value when distributed to Argosy's shareholders.
The former Argosy shareholders, including petitioner, thereafter engaged the law firm that had been employed by Argosy prior to its dissolution to attempt to recover from Republic whatever sums were allegedly due under the contract. The attorneys employed by the former shareholders of Argosy made an analysis of Republic's contentions regarding the Argosy claim. At the same time settlement negotiations with representatives of Republic were continued.
The former shareholders of Argosy also engaged Bankers Trust Co. to receive and disburse any future settlement proceeds collected from Republic, and deposited with Bankers Trust Co. the cash which they had received on the dissolution of Argosy*217 in order to provide a fund to meet their anticipated legal expenses.
In December of 1956 Republic, in exchange for releases by the former Argosy shareholders of all claims under the aforementioned contract, *649 paid $ 540,000 to Bankers Trust Co. for the account of the said former Argosy shareholders, in settlement of the dispute. Petitioner's pro rata share of said settlement sum was $ 108,000, from which Bankers Trust retained $ 400 for its services and $ 6,360 for payment to the attorneys for their legal services, both of which amounts were petitioner's pro rata share of the total amounts paid to Bankers Trust and the attorneys. The law firm's fee was based on its hourly charges for legal services of its partners and legal staff, and not in relation to the amount Republic agreed to pay.
The said $ 108,000, together with the $ 12,822.05 in cash received from Argosy on May 11, 1956, as a distribution in liquidation, was reported in Schedule D of petitioners' income tax return for 1956 as the proceeds from the sale or exchange of a long-term capital asset. The said $ 6,360 and $ 400, totaling $ 6,760, were deducted by petitioners as an itemized nonbusiness expense in their*218 1956 tax return. The respondent disallowed the claimed deduction.
The instant case involves the question whether expenses incurred for legal and banking services furnished petitioner in connection with the settlement of a contract claim, which claim had no ascertainable fair market value at the time of its distribution to petitioner pursuant to a corporate liquidation, were capital in nature or were deductible under
Respondent's position stems from the pronouncement of this Court and others that if contractual rights having no ascertainable fair market value are received in liquidation of a corporation, the transaction remains open, and when some payment is realized subsequently upon that asset, said payment is treated*219 as an amount received in exchange for the stock of the liquidated corporation.
In
In the present case, petitioner upon the dissolution of Argosy in January of 1956 received an interest in Argosy's claim against Republic. As between Argosy and petitioner the exchange was complete, and petitioner was now the*221 unqualified owner of an undivided interest in the Republic claim. Subsequently, the petitioner, in concert with the other owners of the Republic claim, engaged an attorney to negotiate and, if necessary, to sue for the amounts allegedly due under the claim. Through the efforts of the attorney, petitioner received the sum of $ 108,000 from Republic. Petitioner thereafter paid legal and banking fees attributable to the Republic settlement in the amount of $ 6,760. If no other factors were present we believe the deductibility of the petitioner's expenses could be sustained under the rationale of
The instant case is complicated, however, by the fact that under the rule of
The respondent further contends that the Court should be reluctant to allow a taxpayer to be taxed on receipts at capital gain rates and at the same time to deduct expenses as ordinary deductions when both the receipts and the expenses arose out of the very same transaction. In
Decision will be entered for the petitioners.
Withey, J., concurring: While concurring in the result reached by the majority in this case, I do not agree*224 that the attorney fee is deductible by any reference whatsoever to the nature (ordinary income or capital) of the amount collected as a result of the services for which the attorney fee was paid. The attorney fee is specifically deductible under
Raum, J., dissenting: Petitioner received $ 108,000 which is regarded herein as part of the proceeds received by him in exchange for his Argosy stock, resulting in the receipt of capital gain. In order to obtain such proceeds petitioner incurred expenses in the amount of $ 6,760. The proper tax treatment of these expenses is indicated by
If, for example, the expenses herein were $ 70,000, we would have the strange result that at most only $ 54,000 would be reportable as income (one-half of the $ 108,000 proceeds, by reason of the capital gains provisions) whereas a deduction of $ 70,000 would be allowable under the Court's decision. Thus, a transaction actually producing a net profit would appear on the return as a net loss. If such is required by the statute, then, of course, that would be the end of the matter. But I think it is not required, and that Spreckels points the way to the correct answer.
Footnotes
1.
SEC. 212 . EXPENSES FOR PRODUCTION OF INCOME.In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year --
(1) for the production or collection of income;↩