Clark v. Commissioner

*615 This is a proceeding for the redetermination of a deficiency in income tax of $19,627.97 for 1921. The deficiency results in part from the respondent's having increased the petitioner's net income by $20,803.94 and $33,500, which he determined represented partnership income and dividends, respectively, taxable to the petitioner instead of being taxable under the provisions of section 229 of the Revenue Act of 1921 to James B. Clark Theatres, Inc., which was incorporated on March 8, 1922.

FINDINGS OF FACT.

The petitioner, who is a resident of Pittsburgh, Pa., became engaged in the distribution of moving picture films about 1906, and in 1911 entered into the exhibition branch of the moving picture business. His activities in the distribution branch of the business were concluded about 1917. However, he continued in the exhibition filed until 1926. It was not until 1922 that he became interested in the manufacture or production of moving pictures.

The petitioner's first venture in the exhibition branch of the moving picture business was the Oakland Theatre, in Pittsburgh, in 1911. Subsequently*3502 he acquired and operated other moving picture theatres in and around Pittsburgh.

In 1921, the year involved in this proceeding, the petitioner owned or leased and operated as an individual five moving picture theatres *616 in Pittsburgh and two in Erie, Pa. He owned a one-half interest in Rowland & Clark, a partnership which operated a moving picture theatre located in the East Liberty section of Pittsburgh. In this partnership the petitioner alone was active, since the other partner who was his brother-in-law resided in New York City. The petitioner was a stockholder in the following corporation: The General Amusement Enterprises, which owned and operated a moving picture theatre in the East Liberty section of Pittsburgh; the Titusville Amusement Co., which operated two moving picture theatres at Titusville, Pa.; and the Liberty Theatre Co., which operated two moving picture theatres at New Kensington, Pa. He owned 50 per cent of the stock of each of these corporations. He also owned 10 per cent of the stock of the Meadville Theatres Corporation, which operated a moving picture theatre at Meadville, Pennsylvania.

The petitioner operated all of the above theatres, *3503 except that at Meadville, in connection with which he was active only as a director. All of the theatres operated by him were operated as a group or circuit. To operate them he maintained a suite of offices consisting of seven rooms, and had an organization consisting of two bookkeepers, a man in charge of real estate rentals and insurance, a stenographer, a man to assist him in buying and booking pictures, a purchasing agent, a theatre superintendent, a maintenance crew to keep up the physical condition of the properties, and an advertising department in which there were about five employees. The petitioner received and disbursed all the money of each of the theatres; employed, directed and discharged the personnel; bought all the pictures; arranged all the attractions; bought all the supplies and equipment and looked after all the advertising. All of the theatres, whether owned individually, in partnership or by corporations, were advertised under the name of Rowland & Clark Theatres regardless of whether Rowland had any interest in them. For operating the partnership theatre the petitioner in 1921 received, in addition to his interest in the profits, a salary of $5,200. For*3504 operating the theatre owned by the General Amusement Enterprises he received from that corporation in 1921 a salary of $14,200. The petitioner received no salary from the Titusville Amusement Co. and the Liberty Theatre Co., since these corporations were just beginning operations in 1921 and had not become established. Each theatre operated by the petitioner paid its proportionate share of the expenses of maintaining the petitioner's office and paying its personnel. During 1921 the petitioner had no other occupation than looking after the theatres in which he held an interest.

In 1921 the petitioner decided to consolidate into one organization his interests in the various moving picture theatres in order to have *617 the benefit of consolidated reports which would readily show the condition of his business and also to avoid the disadvantage in Federal taxes, which arose from his operating as an individual instead of a corporation. On March 8, 1922, a corporation was incorporated to take over the business of the partnership of Rowland & Clark and for his interest in the partnership the petitioner received 50 per cent of the stock of the corporation. On the same day, the*3505 petitioner incorporated the James B. Clark Theatres, Inc. To this corporation he conveyed everything that he owned in any moving picture exhibition enterprise. There were included in this conveyance his interest in all those theatres which he owned or leased and operated as an individual in western Pennsylvania, together with the equipment, furniture and contractual rights of such theatres, his 50 per cent of the stock of the corporation which was incorporated to take over the business of the partnership of Rowland & Clark and all of his stock in the other corporations operating moving picture theatres in and around Pittsburgh, endorsed and transferred to the new corporation. There were also transferred to the new corporation all of the office equipment, supplies, stock, trucks, automobiles and scaffolding which the petitioner's operating office then had. The consideration for the foregoing assets was 6,500 shares of the par value of $100 each of the capital stock of the James B. Clark Theatres, Inc. The value at which the assets were conveyed represented the depreciated value of the assets of the different corporations as shown on their books as at December 31, 1921.

The petitioner*3506 had other assets which he did not convey to the new corporation. These consisted of stock in the First National Pictures of New York and The Educational Pictures of New York, which are manufacturing and distributing organizations; stock in the First National Exhibitors Exchange of Pittsburgh and The Educational Film Exchange of Pittsburgh, which were distributing organizations; stock in Loew's Incorporated, a manufacturer and distributor of moving pictures; stock in Pittsburgh, Ft. Wayne & Chicago Railway, Cleveland & Pittsburgh Railway, the Oakland Savings & Trust Co., the Skelly Oil Co., and the Republic Casualty Co. The approximate value of these assets which the petitioner did not convey to the corporation was between $360,000 and $375,000. The basic principle followed by the petitioner in conveying assets to the new corporation was that of conveying to it only his moving picture exhibition interests, that is, his interests in the theatres which he was operating from his own office, and nothing else. None of his interests in the producing branch or the distributing branch of the moving picture business or in any outside investments was transferred to the new corporation.

*3507 *618 The petitioner's distributive share of the profits of the partnership of Rowland & Clark for 1921 was $20,803.94. This amount, however, was not actually distributed by the partnership to the petitioner but remained in the partnership, thereby increasing the petitioner's interest therein. During 1921 a dividend of $30,000 was declared and paid on the stock owned by the petitioner in the General Amusement Enterprises. There was also declared and paid in 1921 a dividend of $3,500 on his stock in the Titusville Amusement Co. These dividends were received by the petitioner in 1921. Prior to incorporation by petitioner of his interests in the exhibition branch of the moving picture business, he conducted this part of his business under the name of James B. Clark Theatres. On December 31, 1921, the petitioner withdrew from his business the dividend of $30,000, which amount was carried on the books of the business as a loan from the business to the petitioner. In connection with the withdrawal of the dividend the petitioner gave his "note" for $26,000 to his business, the James B. Clark Theatres. The amount of this "note," which was subsequently paid by the petitioner, *3508 together with the dividend of $3,500, became a part of the assets conveyed to the James B. Clark Theatres, Inc., and set up on its books as of January 1, 1922.

The James B. Clark Theatres, Inc., filed a corporation return for the calendar year 1921 in which there were reported as income of the corporation in that year the above-mentioned dividends received by the petitioner in 1921 amounting to $33,500, and the petitioner's distributive share of the profits of the partnership of Rowland & Clark amounting to $20,803.94. In a field examination the foregoing amounts were eliminated as items of income of the corporation and in an audit of the petitioner's return for 1921 the respondent has determined them to be income to the petitioner.

OPINION.

TRAMMELL: The petitioner contends that under section 229 of the Revenue Act of 1921 the new corporation known as James B. Clark Theatres, Inc., organized March 8, 1922, succeeded to the business of the petitioner as owner and operator of motion picture theatres owned or leased by himself individually or owned or leased by the partnership of Rowland & Clark, of which he was a member, or owned or leased by corporations in which he was a*3509 stockholder; that such corporation properly reported the items of income in controversy; and that such items of income were erroneously included in the income of the petitioner.

The respondent contends that section 229 of the Revenue Act of 1921 was not applicable to the items of income in question, and that they were properly included in the income of the petitioner. He also *619 contends that this section does not authorize a corporation organized within four months after the passage of the Act to report the income of a trade or business for the period between January 1, 1921, and the date of organization of such corporation.

Section 229 of the Revenue Act of 1921 reads as follows:

That in the case of the organization as a corporation within four months after the passage of this act of any trade or business in which capital is a material income-producing factor, and which was previously owned by a partnership or individual, the net income of such trade or business from January 1, 1921, to the date of such organization may at the option of the individual or partnership be taxed as the net income of a corporation is taxed under Titles II and III; in which event the*3510 net income and invested capital of such trade or business shall be computed as if such corporation had been in existence on and after January 1, 1921, and the undistributed profits or earnings of such trade or business shall not be subject to the surtaxes imposed in section 211, but amounts distributed on and after January 1, 1921, from the earnings or profits of such trade or business accumulated after December 31, 1920, shall be taxed to the recipients as dividends; and all the provisions of Titles II and III relating to corporations shall so far as practicable apply to such trade or business: Provided, That this section shall not apply to any trade or business, the net income of which for the taxable year 1921 was less than 20 per centum of its invested capital for such year: Provided further, That any taxpayer who takes advantage of this section shall pay the tax imposed by section 1000 of the Revenue Act of 1918 as if such taxpayer had been a corporation on and after January 1, 1921. (Italics ours.)

We will first consider the last contention of the respondent. The provisions of section 229 are clear as to the date from which and the manner in which the net income*3511 and invested capital of a trade or business, coming within the meaning of the section, are to be computed. The section also specifically provides that all the provisions of Titles II and III of the Act relating to corporations, so far as practicable, apply to such trade or business. In view of the language of the Act we think that contention of the respondent must be denied.

The evidence shows that the business of the petitioner, in 1921, was the owning or leasing, operating and managing a chain of motion picture theatres. The operating of a chain of moving picture theatres is a business. The petitioner was experienced in this part of his business and maintained a staff of people and equipment for the purpose. His operation activity was confined to those theatres in which he had an interest either by reason of his complete ownership, his share as a partner, or as a corporate stockholder. The petitioner's opportunities to make an income as a manager and operator were secured by his investments in the various theatres. The ownership of an interest and the opportunity to operate were inseparable. It is obvious that the business conducted by the petitioner was both the owning*3512 of an interest and the operation of the theatre in which the interest was held. This was a business in which capital was a *620 material income-producing factor, and the petitioner's capital, his personal services and the personal services of others made his business. The petitioner's income was as much dependent upon his ability in selecting the right theatres in which to acquire an interest as it was upon his skill in operating them after they were acquired. The profit on ownership was dependent upon capacity in operation. Both interest in ownership and management of motion picture theatres was the petitioner's business in 1921.

The evidence shows that the petitioner's distributive share of the partnership profits was not actually distributed to him but was left in the partnership and thereby increased his interest therein. When the corporation which took over the business of the partnership was organized it gave the petitioner stock for his interest in the partnership and he transferred the stock to the James B. Clark Theatres, Inc. In this manner the petitioner's profits from the partnership, $20,803.94, were transferred to the James B. Clark Theatres, Inc., and*3513 became a part of the assets of that corporation. The evidence also shows that the dividend of $3,500 received in 1921 by the petitioner from the Titusville Amusement Co. was not withdrawn by him from his business but became a part of the assets of the James B. Clark Theatres, Inc. Since the partnership profits of $20,803.94 and the dividend of $3,500 were income of the petitioner's business and were not withdrawn therefrom during 1921 but remained and became a part of the assets transferred to the new corporation, we think the respondent erred in determining that these amounts are taxable to the petitioner.

With respect to the dividend of $30,000 received by Clark from the General Amusement Enterprises, we find that on December 31, 1921, he withdrew it from his business which he operated as an individual. At the time of the withdrawal he gave a "note" to his business for $26,000 of the amount. The evidence shows that the "note," which was subsequently paid, became a part of the assets of the James B. Clark Theatres, Inc. The respondent contends that Clark's withdrawal of the dividend, $30,000, constituted a distribution within the purview of section 229. The petitioner contends*3514 that inasmuch as he gave the business a "note" for $26,000, which was subsequently paid, that to that extent it constituted a loan from the business to him. Inasmuch as the petitioner operated his business as an individual the substance of his contention is that he loaned himself the $26,000. It is an elementary principle of law that a man can not contract with himself, and in our opinion this contention is without merit. What the tenor or nature of the "note" was the record does not show, but whatever it was we think that in so far as the petitioner is concerned, it constituted nothing more than a memorandum prior to the time it was transferred to the corporation. The *621 petitioner was unable to testify as to when or in what manner payment of the "note" was made, nor was he able to offer any explanation as to how the difference of $4,000 between the amount of the dividend and the "note" was handled. Inasmuch as the $30,000 was actually withdrawn by the petitioner from his business, we think it was such an amount distributed after January 1, 1921, as is contemplated by section 229, and, therefore, is taxable to him as a dividend as provided in that section.

Reviewed*3515 by the Board.

Judgment will be entered under Rule 50.

MURDOCK dissents.