Sibley, Lindsay & Curr Co. v. Comm.

Decision will be entered under Rule 50.

Richard B. Barker, Esq., for the petitioner. Michael Waris, Jr., Esq., for the respondent.

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The Commissioner has determined a deficiency in petitioner's excess profits tax for the fiscal year ended January 31, 1945, of 30,957.68. The petition states that 12,873 of this amount is in dispute. The only adjustment which is contested is respondent's adjustment to net income of 16,500 which was explained in a statement attached to the deficiency notice, as follows:

(a) Legal, recapitalization expenses are held to constitute capital expenditures and excluded as a deduction from gross income for Federal income tax purposes under the provisions of the Internal Revenue Code.

By appropriate assignment of error petitioner contests this adjustment. FINDINGS OF FACT.

Petitioner is a corporation with its principal office at Rochester, New York. The return for the taxable year herein was filed with the collector for the 28th district of New York. Its books are kept and returns filed on a fiscal year basis ending January 31st.

In the spring of 1944, the board of directors of petitioner appointed a committee of the board to make a study of all phases of the capital

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structure of petitioner. This committee held several meetings and came to the conclusion that it could not make any constructive progress without the advice and guidance of outside disinterested counsel. Accordingly, early in May of 1944, the committee employed Goldman, Sachs and Company (hereinafter sometimes called Goldman), investment bankers in New York City, to study the entire capital structure of both petitioner and its subsidiary, the Erie Dry Goods Company (hereinafter called Erie), and to render petitioner a report. Petitioner did not limit Goldman in its examination but gave it a free hand to study the entire situation and to make such recommendations and proposals as it considered desirable.

Goldman thereafter studied charters, the mortgage, a plan of the properties, balance sheets, income accounts, and dividend records and made a thorough review of the whole situation. It found an unorthodox capital structure in that petitioner had 6 per cent noncallable bonds in the amount of 1,125,000 due in 1961; 10 per cent 100 par value noncallable preferred stock outstanding in the amount of 1,725,000; and 40,000 shares of 100 par value common stock. Erie had 6 per cent noncallable bonds in the approximate amount of 325,000 due in 1966; class A voting stock, 51 per cent of which was owned by the petitioner; and class B stock, owned by the management of the Erie store. The petitioner owned just under 40 per cent of both classes of Erie stock.

After several months of study, Goldman, in June 1944, submitted a report to the petitioner recommending three distinct proposals. They were: (a) A merger of Erie into petitioner.

(b) A refinancing of the 6 per cent noncallable bonds of Erie and petitioner.

(c) A recapitalization of the preferred stock and a split-up of the common stock of the petitioner. In the recapitalization of the preferred stock that stock was to be surrendered and each holder of a share of preferred was to receive seven and one-half shares of new 20 par value common stock. The old common stock, 100 par value, was to be surrendered and each shareholder was to receive three shares of new 20 par value common stock.

After the report of Goldman was submitted to the committee of petitioner's board of directors, there were numerous discussions of the three proposals by the committee and the three proposals were also discussed with the general counsel of petitioner, D. N. Beach, of the firm of Harris, Beach, Keating, Wilcox and Dale. Conferences were also held with representatives of the various families who held petitioner's various securities. Finally, on July 20, 1944, there was a final committee meeting attended by several of the other directors and the

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president of petitioner. At this meeting it was decided that petitioner, because of advice of counsel, would be compelled to abandon two of the projects recommended by Goldman, namely, the merger of petitioner with its subsidiary, Erie Dry Goods Company, and the refinancing of the 6 per cent noncallable bonds of Erie and petitioner. It was also decided at this meeting that the committee would recommend thethird proposition which was the recapitalization of Sibley, Lindsay & Curr Co.

The reason for abandoning the merger proposal was based largely on the legal advice of Beach. He advised that large blocks of both preferred and common stock of petitioner were held in trusts, which trusts had restrictive clauses in their agreements which would prevent the exchange of stock in petitioner for stock in a merged corporation. The reason for abandoning the proposal to refinance the bonds was that discussions held by the committee with various bondholders disclosed that the bondholders would not agree to the proposal.

The decision of the committee on July 20, 1944, to go ahead only with the recapitalization of the stock, was presented to the board of directors at a regular meeting thereof held on July 24, 1944. The matter was informally discussed at that time, but recognizing that it was a matter of importance, it was decided to have a special meeting of the board on the following day. At that meeting on July 25, 1944, two representatives of Goldman were present and the board went into all phases of the matter and discussed it fully. The report of the committee was approved by recommending to the stockholders the exchange of the existing preferred and common stocks for a new issue of common stock. The minutes of the meeting of the board of directors held on July 25, 1944, read in part as follows:

The committee appointed to study revision of the capital structure of the corporation reported as follows: "Having considered various plans of recapitalization as submitted by members of the committee, Goldman-Sachs and Company hereby present plan 725, which is 7-25, which they recommended to the Board of Directors for their favorable consideration." The report of the committee was received and ordered made part of these minutes. After discussing in detail the plan as submitted with Messrs. Horton and Walters of the Goldman-Sachs and Company who attended the meeting it was resolved that in the opinion of the Board the plan of recapitalization designated as plan 7-25 be and is hereby unanimously approved for submission to the stockholders provided favorable opinion of tax counsel be first discussed by the corporation attorney and the formal action looking forward. A stockholders meeting be deferred into a later meeting of the directors.

The stockholders of the petitioner approved the recapitalization plan adopted by the committee and the board of directors at a special meeting held on January 19, 1945.

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The minutes of the meeting of the board of directors held on November 27, 1944, read in part as follows:

Resolved that the treasurer be authorized to pay the statement of Goldman-Sachs and Company in the amount of 15,000 for the work done and submitted in the acceptable recapitalization plan. The treasurer presented a letter from the Goldman-Sachs and Company dated November 21, 1944 showing possible advantages to the corporation and individual bond holders. Should it be possible to purchase at a premium the remaining bonds from the January requirement of 875,000 of the 2,000,000 presently outstanding bonds -- after discussion was decided that no immediate action should be taken.

Goldman, in petitioner's fiscal year 1945, submitted a bill for services rendered in the amount of 15,000 and received payment of the bill in petitioner's fiscal year 1945. A fair and proper allocation of this bill to the various items of service rendered by Goldman would allot 5,000 to the services rendered in recommending a merger of the two corporations, 5,000 to the services rendered in recommending a refinancing of the bonds of petitioner and Erie, and 5,000 to the services rendered in recommending a recapitalization of petitioner's preferred and common stocks.

The law firm of Harris, Beach, Keating, Wilcox and Dale rendered legal services to petitioner in its fiscal year 1945 in studying the three proposals submitted by Goldman to the committee of the directors of petitioner. For their services they billed the petitioner in the fiscal 1945 year 1,500. A fair and proper allocation of this bill to the various items of service rendered by the law firm would allot 500 to the services rendered in studying and advising on the proposal to merge petitioner and Erie, 500 to the services rendered in studying and advising on the proposal to refinance the bonds of petitioner and Erie, and 500 to the services rendered in studying and advising on the proposal to recapitalize petitioner's preferred and common stocks.

The proposals made in fiscal year 1945 by Goldman to merge petitioner and Erie and to refinance the bonds of petitioner and Erie were abandoned by petitioner in its fiscal year 1945. The expenses incurred by petitioner in connection with the above proposals, amounting to 10,000 paid to Goldman and 1,000 to Harris, Beach, Keating, Wilcox and Dale, or a total of 11,000, were ordinary and necessary expenses to petitioner in its fiscal year 1945 and petitioner is entitled to deduct that amount in that year in computing its net income subject to tax. OPINION

The only question for decision is whether respondent erred in disallowing a deduction of 16,500 paid by petitioner for legal and investment counsel fees in connection with a revision of its capital structure. Petitioner concedes that 5,500 was properly disallowed,

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but contends that 11,000 of the fees represents payments in connection with two abandoned plans for revising its capital structure and therefore represents a deductible expense.

Respondent contends that the entire 16,500 represents a payment to increase the capital value of petitioner's property and therefore must be capitalized. Section 29.24-2, Regulations 111, the pertinent provisions of which are printed in the margin, ¹ is relied on by respondent. Petitioner does not contend that fees paid in connection with a plan for recapitalization which is effectuated are deductible. Respondent's argument is based on the contention that the fees paid by petitioner were for alternative plans for a revision of petitioner's capital structure and therefore the 16,500 must be capitalized as petitioner did select and act in accordance with one of the plans presented to it.

Petitioner contends, and we think rightly so, that the three proposals submitted to it for a revision of its capital structure were not alternative proposals, but, rather, separate and distinct suggestions for revisions of its capital structure, all of which were recommended and all or any of which petitioner might have accepted.

Goldman, Sachs and Company recommended: (1) a merger of Erie into petitioner and (2) a refinancing of the 6 per cent noncallable bonds of Erie and petitioner and (3) a recapitalization of the preferred stock and a split-up of the common stock of petitioner. Petitioner was able to adopt only the third proposal and for reasons set out in our findings of fact abandoned the first and second proposals, and the evidence shows that two-thirds of the fees paid Goldman, Sachs and Company and petitioner's attorneys was attributable to the first and second proposals.

Allocations of fees are permitted though the original payment was in a lump sum for all services. Barbara B. LeMond, 13 T. C. 670. This is also true of a lump sum fee for a proposed merger which was abandoned, and an issue of preferred stock which was issued if an allocation can be made. See Peaslee-Gaulbert Co., 14 B. T. A. 769.

In Doernbecher Manufacturing Co., 30 B. T. A. 973, we permitted a deduction for expenses incurred relative to a proposed merger which was abandoned. In the instant proceeding petitioner abandoned two of the proposed suggestions for revision of its capital structure to which 11,000 of the 16,500 in fees paid by petitioner is attributable, and therefore this amount represents a deductible expense. Doernbecher Manufacturing Co., supra. Decision will be entered under Rule 50.

Footnotes ¹ Regulations 111:

Sec. 29.24-2. Capital Expenditures. -- Amounts paid for increasing the capital value * * * of property are not deductible from gross income. * * * Expenses of the organization of a corporation, such as incorporation fees, attorneys' and accountants' charges, are capital expenditures and not deductible from gross income.