The opinion
CENTRAL TERESA SUGAR CO. OF MARYLAND, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Central Teresa Sugar Co. v. Commissioner
Docket No. 14254.
United States Board of Tax Appeals
14 B.T.A. 270 ; 1928 BTA LEXIS 3002 ;
November 15, 1928 , Promulgated
*3002 1. Deduction, under the loss provision of the statute, disallowed of an amount paid out by a corporation in 1920 to a surety on certain of its trust notes to compensate him for an alleged loss of the amount of the enhancement in value, after its sale by the trustee, of certain shares of stock which the surety had pledged as collateral on the trust notes and which were sold by the trustee under the terms of the trust agreement upon default of the principal in the payment of the trust notes.
2. Invested capital for the taxable year should be reduced by the amount paid out from the date of payment.
R. Kemp Slaughter, Esq., and Hugh C. Bickford, Esq., for the petitioner.
J. E. Mather, Esq., and F. T. Jones, Esq., for the respondent.
SMITH
*270 This proceeding is for the redetermination of a deficiency in income and profits tax for the fiscal year ended July 31, 1920, in the amount of $64,577.31. The petitioner was affiliated with Central Teresa Sugar Co. of New Jersey for the fiscal year in question and with that company filed a consolidated income and profits-tax return. The deficiency determined against the petitioner arose in *3003 part from the disallowance by the Commissioner of a deduction from the gross income of the Central Teresa Sugar Co. of New Jersey of $167,425.05, which represented liquidated damages and interest thereon paid by such New Jersey Co. to Alfred W. Gieske. This amount was claimed as a deduction from gross income by the New Jersey Co. and the resulting loss of that company was claimed as a deduction from gross income on the consolidated return filed for the affiliated group. The Commissioner disallowed the deduction claimed by the New Jersey Co. and the petitioner being aggrieved by such disallowance brings this proceeding.
FINDINGS OF FACT.
The petitioner is a corporation organized and existing under the laws of Maryland. Its business is the raising of sugar cane and the manufacture and sale of sugar cane products. The New Jersey Co. was, for the fiscal year ended July 31, 1920, a subsidiary of the West India Sugar Corporation, hereinafter referred to as the West India Co., which owned all of the capital stock except qualifying shares.
Prior to June 12, 1918, the New Jersey Co. had issued 6 per cent collateral trust sinking fund gold notes of an aggregate value of $1,000,000. *3004 The notes were dated June 12, 1917, and became due June 12, 1918. On the due date $400,000 of such notes were paid *271 in cash from funds contained in a sinking fund previously created. On the same day, the New Jersey Co. executed to the Fidelity Trust Co., trustee, a new deed of trust which provided for the issuance of 6 per cent collateral trust sinking fund gold notes of the aggregate par value of $600,000, payable on the 12th day of December, 1918. The trust instrument referred to provides in part as follows:
THIS INDENTURE, dated the twelfth day of June, nineteen hundred and eighteen, between the CENTRAL TERESA SUGAR COMPANY, a corporation under the laws of the State of New Jersey (hereinafter called the "Company"), party of the first part; the WEST INDIA SUGAR CORPORATION, a corporation under the laws of the State of Virginia (hereinafter called the "Corporation"), party of the second part; ALFRED W. GIESKE, of the City of Baltimore, State of Maryland, party of the third part, and THE FIDELITY TRUST COMPANY (Baltimore, Md.,) a corporation under the laws of the State of Maryland (hereinafter called the "Trustee"), party of the fourth part.
WHEREAS, the Company, *3005 for the purpose of raising monies to refund the issue of its notes maturing on June 12th, 1918, and for other corporate purposes, has determined to issue its notes in the aggregate principal amount of six hundred thousand dollars, to be dated June 12th, 1918, and to be payable on December 12th, 1918; and
WHEREAS, to secure the payment of said notes, the performance of the covenants and agreements in this indenture contained and to pledge the property hereinafter described, this indenture is executed by the Company and to further secure the payment of said notes, the performance of said covenants and agreements and to pledge as collateral security for the payment of the same, the property hereinafter described, as well also to evidence its and his guarantee of the payment of said notes, this indenture is likewise executed by the Corporation and by the said Alfred W. Gieske; and
* * *
NOW, THEREFORE, THIS INDENTURE WITNESSETH, That, in consideration of the premises, the issue of said notes, and the purchase thereof and payment therefor, the sum of one dollar by each party hereto to the other paid and of other good and valuable considerations from each party hereto to the other, *3006 the parties hereto of the first, second and third parts do hereby covenant and agree with The Fidelity Trust Company (Baltimore, Md.), Trustee, as follows:
* * *
ARTICLE II.
Agreement to Pay Principal, Taxes and to Carry Insurance.
The parties hereto of the first, second and third parts agree to pay the principal of said notes, when and as the same become due and payable according to their tenor, and they further covenant and agree to pay any taxes which may become due and payable on the property covered by this Indenture, and by it conveyed or pledged, and on the debt by it secured or intended to be and on the interest of the Trustee hereunder, and to keep the vessel property in this indenture described fully insured against all fire and marine risk, and against all war risk whenever the same sail between any ports other than those on the Island of Cuba and Mexican or United States ports located on the Gulf of Mexico, all such policies of insurance to be payable to owner of the property insured and the Trustee, as their respective interest may appear, and *272 to pay the premiums on such insurance as they become due, and further, to present to the Trustee, promptly *3007 upon the execution of this Indenture, a list of such policies, and to notify the Trustee promptly of any changes therein. In the event of destruction or injury to any vessel property pledged hereunder, the proceeds of the insurance thereon, paid on account of said loss or injury to the Trustee, shall be held by it as part of the sinking fund provided for by Article III, and be used only to retire notes issued and outstanding hereunder as provided in Article III hereof.
* * *
ARTICLE IV.
Property Pledged.
The parties hereto of the first, second and third parts, each according to their respective interests therein, do hereby bargain, and sell, convey, assign, transfer and deliver over unto the Trustee, its successors and assigns, forever, the following described property:
* * *
(c) 30,000 shares of the common capital stock of Cosden and Company of the par value of $5.00 per share, certificates therefor, endorsed in blank, being deposited with the Trustee simultaneously with the execution and delivery of this agreement.
* * *
ARTICLE V.
Release and Replacement of Pledged Property.
The owners of the various properties pledged hereunder shall have the right *3008 to withdraw the same and have them released from the operation and effect of this indenture by payment to the Trustee for the respective properties the following amounts, viz:
* * *
For the shares of stock of Cosden & Company --- $210,000.00
Provided, that any of the aforementioned property pledged can be redeemed or withdrawn separately, and that the stock of Cosden and Company can be redeemed as an entirety or can be redeemed in part and from time to time upon payment of seven dollars per share for each share withdrawn. * * * The Trustee shall have the right, but in its discretion, to permit the substitution for the stock of Cosden and Company or for any part of it, and from time to time, or other shares of stock, bonds or notes acceptable to it.
* * *
ARTICLE VI.
Guarantee.
The parties hereto of the second and third parts, and each of them, covenant, agree and guarantee to pay all of the notes issued hereunder as they respectively become due and payable, and each of them does further agree to make said payment on presentation of said notes, and upon demand for payment thereof, at the office of the Trustee, without requiring demand for the payment of the same *3009 upon the party hereto of the first part, and without *273 requiring that any proceedings looking to the payment of the same shall have been instituted under this indenture or otherwise, and without requiring the exhaustion of any collaterals pledged hereunder as a prerequisite to the payment of said notes by them.
* * *
ARTICLE VIII.
Possession of Property Until Default.
SECTION 1. - Until some default shall have been made in the payment of the notes issued hereunder, or any of them, or until default shall have occurred in the performance of any of the covenants or agreements of this Indenture by the parties of the first, second or third parts hereto, the party hereto of the third part shall be entitled to retain actual possession of the vessel property hereby pledged and use the same and collect the earnings thereof; there shall also be reserved to the parties of the first and third parts, until such default, the right to vote the shares of stock of the Central Car Company (subject, however, to the provisions of Article V hereof with reference to voting the said stock in favor of a sale of the tank cars of that company) and of Cosden & Company, respectively, pledged *3010 hereunder and to receive any cash dividends paid thereon.
* * *
ARTICLE IX.
Remedies in Case of Default.
Upon any default in the payment of any of the notes issued hereunder as the same become due and payable, or upon any breach of any of the covenants or conditions of this Indenture, in which case, upon the demand of the Trustee made either before or after a sale of the pledged property or part of it the notes issued hereunder shall become due and payable, and if such default or breach shall continue for fifteen days the Trustee may, in its discretion, and shall, upon the written demand of twenty-five per cent. in amount of the notes issued and outstanding hereunder sell the properties hereby conveyed and pledged, as follows, to wit:
The said stock of Cosden and Company and of the Central Car Company shall be sold upon the Baltimore Stock Exchange, or the New York Curb Market, without notice.
* * *
ARTICLE X.
Proceeds of Sale of Mortgaged Property.
The proceeds of any sale of the mortgaged property, together with any sums which may be then held by the Trustee or be payable to it under any of the provisions of this mortgage or indenture as part of the *3011 trust estate, shall be applied in the order following:
First: To the payment of all costs and expenses of such sale, the fees and other charges of, and a reasonable compensation to the Trustee, its agents and attorneys and to the payment of all expenses and liabilities incurred or disbursements made by the Trustee, and of all taxes, assessments or liens prior to the lien of these presents, except any taxes or other superior liens subject to which such sale shall have been made.
*274 Second: To the payment of the whole amount owing upon the notes for principal and interest, whether said notes have actually matured or not.
Third: Any surplus then remaining to the parties hereto of the first, second and third parts as their respective interests may appear.
* * *
In TESTIMONY WHEREOF the Central Teresa Sugar Company has caused these presents to be signed by its President and its corporate seal to be hereto affixed, attested by its Secretary; the West India Sugar Corporation has caused these presents to be signed by its President and its corporate seal to be hereto affixed, attested by its Secretary; and the said Alfred W. Gieske has affixed his signature and seal hereto; *3012 and the said The Fidelity Trust Company, Trustee, has caused these presents to be signed by its Vice-President and its corporate seal to be hereunto affixed, attested by its Secretary, as of the day and year first herein written.
* * *
The notes in the aggregate amount of $600,000, provided for by the above deed of trust were duly issued in denominations of $1,000 and $5,000 each and the proceeds derived therefrom were used to pay off the remainder of the previous issue of notes.
The 30,000 shares of the common capital stock of Cosden & Co. mentioned in the foregoing deed of trust were the property of Alfred W. Gieske. These shares of stock had been pledged by Gieske, originally, on December 12, 1916, to secure payment of the $1,000,000 issue of notes of the New Jersey Co. and referred to above, in accordance with a plan of financing contained in a letter from Gieske to the New Jersey Co., which reads as follows:
BALTIMORE, MD., December 6, 1916.
CENTRAL TERESA SUGAR COMPANY,
Jersey City, N.J.
GENTLEMEN: Referring to the proposed issue by your Company of $1,000,000.00 of Collateral Trust Sinking Fund Notes of date December 12th, 1916, payable June 12th, 1917, at *3013 The Fidelity Trust Company of Baltimore, Maryland, I hereby offer to purchase said notes from you upon the following terms and conditions:
(1) I will unite with your Company in the deed of trust to The Fidelity Trust Company of Baltimore, Maryland, to secure the same and pledge certain property thereunder and guarantee the payment of said notes, all as set forth in the form of the deed of trust submitted with this proposition.
(2) Upon the delivery of said notes I will pay to your Company the sum of $320,000.00.
(3) Upon the payment by your Company of all of said outstanding notes and the release of the obligation on my part for the payment thereof and the release to me of the property pledged thereunder, I will transfer and make over to you free and clear of all liens and encumbrances, and on good condition and repair, the two vessels in said deed of trust described, and until default be made in the payment of said notes or any of them, or in the discharge of any of the covenants or conditions of said deed of trust, you may have the full and complete use of said boats, - subject always to the terms and conditions of said deed of trust and without expense to me; it being of *3014 course, understood that you cannot have the use of the tank boat until the same is completed and delivered to me.
*275 (4) It is understood that the transaction is to be consummated as of December 12th, 1916, and should there by any delay in the delivery of such notes, my cash payments to you shall be adjusted in accordance therewith. It must be distinctly understood that the title to said boats shall remain in me until the release of the deed of trust as above set forth, in order to protect my guarantee of said notes.
This plan was consummated as outlined in the above letter. Gieske acquired the original notes and subsequently sold them to a firm of bankers. The shares of Cosden & Co. stock belonging to Gieske were again pledged under the renewal of January 12, 1917, and are the same shares of stock mentioned in the foregoing deed of trust dated June 12, 1918.
On December 12, 1918, the New Jersey Co. defaulted in the payment of the aforesaid notes issued June 12, 1918. Thereafter, on the following dates, the trustees sold the shares of Cosden & Co. stock pledged by Gieske, rendering a statement of such sales to the New Jersey Co. and applying the proceeds thereof *3015 against the payment of the overdue notes, as follows: Date Shares Price Net
1918
December 16 4,300 6 7/8 $29,285.15
Do 1,000 7 6,935.50
December 18 1,000 7 6,935.60
Do 100 6 7/8 681.05
December 20 1,100 7 7,629.05
December 23 5,100 7 35,371.05
December 24 2,800 6 7/8 19,069.40
December 27 1,800 6 7/8 12,258.90
December 30 9,100 6 7/8 61,975.55
1919
January 6 4,450 6 7/8 30,306.70
Net proceeds 210,447.95
While these sales were being made Gieske called upon his attorney and complained that his stock was being thrown overboard. He was advised by his attorney, who was also the attorney for the New Jersey Co., that the stock had been loaned to the New Jersey Co. for deposit by it as collateral on its obligations and that he was entitled to recover from the New Jersey Co. the stock so loaned, or, in the event of its inability to return the stock, then the market value thereof at the time demand should be made. The attorney likewise advised him that, inasmuch as the company did not have sufficient funds at that time, he should delay making his demand until such time as the company did possess sufficient funds. At *3016 that time the West India Co. was paying some of the obligations of the New Jersey *276 Co. in connection with its trust notes and charging the same to it. Such charges were later liquidated by the New Jersey Co.
The minutes of a meeting of the board of directors of the New Jersey Co. held on June 12, 1919, read in part as follows:
At this point Mr. Gieske asked Mr. France to take the chair, and Mr. Gieske withdrew from the meeting.
Mr. France thereupon announced that Mr. Gieske had offered to assign to this Company all his liquidated claims against the West India Sugar Corporation, excepting therefrom any claim for the enhancement in value of 30,000 shares of the common capital stock of Cosden & Company, upon the delivery to him of notes of this Company in an equivalent amount, maturing eighteen months after date. He pointed out that this Company is indebted to the West India Sugar Corporation in the sum of $931,424.13, representing payments made by said West India Sugar Corporation as guarantor for this Company under certain Indentures and Agreements with The Fidelity Trust Company, and that said West India Sugar Corporation at the same time is indebted to A. W. Gieske *3017 in the sum of $549,120.28, by reason of loans and advances made from time to time, irrespective of any contingent liability by reason of enhancement in the value of 30,000 shares of common capital stock of Cosden & Company, and that the effect of such offer and the issue of such notes would be to simplify the financial relations of the parties. Thereupon, on motion duly made, seconded and carried, it was
RESOLVED that the offer of A. W. Gieske be and the same is hereby accepted, and upon the assignment by him to this Company of the liquidated indebtedness due him by West India Sugar Corporation, amounting to $549,120.28, the proper officers of this Company be and they hereby are authorized to issue to said Gieske the note of this Company dated June 12th, 1919, payable eighteen months after date, in the sum of $549,120.28.
BALTIMORE, MD., June 12, 1919.
WEST INDIA SUGAR CORPORATION
to A. W. GIESKE, Dr. To net amount due on loans and advances to and including March 31, 1919 $276,838.96
To net proceeds of sale of 30,000 shares of Common Capital Stock of Cosden and Company, pledged under indenture of West India Sugar Corporation et al to The Fidelity Trust Company, Trustee, dated December 12, 1918 210,447.95
To balance due on Salary Account to June 1, 1919 5,833.37
To loans made from April 1, 1919 to date 56,000.00
Total 549,120.28
*3018 Notes were duly issued to Gieske by the New Jersey Co. in the amount of $549,120.28 as provided for in the foregoing resolution.
On September 29, 1919, Gieske, by claim filed with the New Jersey Co., made demand for payment of the then value of the Cosden & Co. stock, which he had pledged, as follows:
September 29, 1919.
THE CENTRAL TERESA SUGAR COMPANY
In account with A. W. GIESKE,
FOR LIQUIDATED DAMAGES ON ACCOUNT OF SALE OF COSDEN AND COMPANY COMMON STOCK, SEPTEMBER 29, 1919. Value of Stock:
30,750 Shares, at $12.00 $369,000.00
Less: Commission (1/16) $1,921.88
Tax (1/5) 61.50
1,983.38
Net Value $367,016.62
Proceeds of Sales: Date Shares Price Net
1918
December 16 4,300 6 7/8 $29,285.15
December 16 1,000 7 6,935.50
December 18 1,000 7 6,935.60
December 18 100 6 7/8 681.05
December 20 1,100 7 7,629.05
December 23 5,100 7 35,371.05
December 24 2,800 6 7/8 19,069.40
December 27 1,800 6 7/8 12,258.90
December 30 9,100 6 7/8 61,975.55
1919
January 6 4,450 6 7/8 30,306.70
Net Proceeds 210,447.95
Damages 156,568.67
*277 Claim was also made for interest *3019 in the amount of $10,856.38.
The minutes of a meeting of the board of directors of the New Jersey Co., held October 2, 1919, provide in part as follows:
At this point Mr. Gieske called Mr. France to the chair and retired from the meeting. The Treasurer presented a statement received from Mr. Gieske showing the amount due him by this Company on account of 30,000 shares of the capital stock of Cosden and Company loaned to it as security under an Indenture dated June 12, 1918, to The Fidelity Trust Company, Trustee, which stock had been sold by said Trustee in accordance with the provisions of said Indenture. The Treasurer further stated that demand had been made for the payment of the amount of said account. After full discussion, it was, on motion duly made, seconded and carried.
RESOLVED that the Treasurer of this Company be and he is hereby authorized and directed to pay from the funds of this Company the account due A. W. Gieske, according to the statement presented, and hereby ordered filed with the minutes of this meeting, together with interest thereon upon such basis as may be agreed by the Treasurer and said Gieske.
Thereafter, on October 8, 1919, the company paid *3020 to Gieske by check the sum of $167,425.05, which represented liquidated damages in the amount of $156,568.67 and interest in the amount of $10,866.38 computed in accordance with the foregoing resolution.
*278 In his personal income-tax return for the calendar year 1919 Gieske reported the said amount of $167,425.05 as a part of the sales price of his shares of Cosden & Co. stock.
The said amount of $167,425.05 was entered on the books of the New Jersey Co. as a loss and was claimed as a deduction from gross income in the consolidated income and profits-tax return of the petitioner and affiliated companies for the fiscal year 1920. The Commissioner has disallowed the deduction of such amount and has reduced the invested capital of the consolidated group by a like amount as at the beginning of the fiscal year.
OPINION.
SMITH: The petitioner alleges in its petition that, (1) the Commissioner erred in disallowing Central Teresa Sugar Co., a New Jersey corporation, and a subsidiary of the petitioner, the Central Teresa Sugar Co. of Maryland, a deduction from gross income of $167,425.05 paid by Central Teresa Sugar Co. of New Jersey to Alfred W. Gieske, the endorser of *3021 and pledgor under certain of its notes, to reimburse the said Gieske for losses suffered by reason of the sale of certain collateral pledged by him; and (2) the Commissioner erred in reducing invested capital of the taxpayer by $167,425.05 on the assumption that Alfred W. Gieske withdrew the said amount, presumably as a stockholder when he was not, except for one qualifying share.
The petitioner claims in this proceeding that the New Jersey Co., a company affiliated with the petitioner, sustained a deductible loss for the fiscal year ended July 31, 1920, in the amount of $167,425.05 representing the enhancement in value of the Cosden & Co. stock from the date of sale by the Fidelity Trust Co., trustee, in December, 1918, and January, 1919, to September 29, 1919, the date upon which Gieske made demand upon the New Jersey Co. for the payment of damages and interest. The petitioner claims the benefit of the deduction by reason of the fact that it filed a consolidated return with the New Jersey Co. The deduction is claimed as a loss sustained by the New Jersey Co. in the year 1919. The deduction of the loss is resisted by the respondent upon various grounds, one being that the evidence *3022 does not prove the fair market value of the Cosden & Co. stock either at the date of sale by the trustee or on September 29, 1919, the date upon which Gieske made a demand for damages. It is not necessary, however, for us to decide the question upon the point of lack of evidence.
The petitioner contends that Gieske entered into a contract with the New Jersey Co. in support of the agreement of June 12, 1918, referred to in the findings of fact; that under this agreement the *279 New Jersey Co. was obligated to return to Gieske the collateral put up by Gieske with the Fidelity Trust Co. for the benefit of the New Jersey Co. The evidence does not, however, support the contention that Gieske under a separate contract lent his stock to the New Jersey Co. The record contains no evidence of any separate contract or agreement between Gieske and the New Jersey Co. relating to the pledging of the stock. The minutes of a meeting of the board of directors of the New Jersey Co., at which the payment of Gieske's claim was authorized, stated:
At this point Mr. Gieske called Mr. France to the chair and retired from the meeting. The Treasurer presented a statement received from Mr. *3023 Gieske showing the amount due him by this Company on account of 30,000 shares of the capital stock of Cosden and Company loaned to it as security under an Indenture dated June 12, 1918, to The Fidelity Trust Company, Trustee, which stock had been sold by said Trustee in accordance with the provisions of said Indenture. * * * (Italics ours.)
There is no testimony or other evidence that there was any agreement involved other than the deed of trust executed June 12, 1918.
The evidence does not show the cost of the Cosden & Co. stock to Gieske. It does show, however, that the trustee sold this stock in December, 1918, and January, 1919, and that the net proceeds therefrom were $210,447.95. This amount was credited to the New Jersey Co. in respect of its indebtedness on the notes. Gieske knew of the sales of this stock at the time they were being made. There is no evidence that the shares of stock were not sold by the trustee at market price. Gieske consulted his own attorney, who was likewise the attorney of the New Jersey Co., at the time that the sales were being made as to his rights in the matter. He was advised that inasmuch as the company did not have sufficient funds *3024 at that time he should delay making his demand until such time as the company did possess sufficient funds. Gieske, accordingly, delayed making his demand until September 29, 1919.
What is the measure of the damages which may be claimed by bailor or surety in respect of pledged property which has been sold by the bailee or principal in accordance with the terms of the contract under which the property was pledged? It is stated in 32 Cyc. 272 that:
Prima facie the amount due from the principal to the surety is the face value of the claim of the creditor; but the surety is not allowed to speculate on his principal, and can not collect any more than the amount actually paid by him, although he may have taken an assignment of the claim. The same rule governs between a supplemental surety and a surety. The surety can not recover for remote and indirect losses suffered by him which could have been avoided by payment of the debt.
See .
*280 In ; *3025 , it was stated:
The general rule is, undoubtedly, that a surety can recover of the principal only the amount or value which the surety has actually paid. If he has paid in depreciated bank-notes taken at par, he can recover only actual value of the bank-notes so paid and received. If he has paid in property, he can recover only the value of the property. If he has compromised, he can recover only what the compromise has cost him. The rule is that he shall not be allowed to "speculate out of his principal." * * *
Upon the conversion of chattels the measure of the pledgor's damages is the market value of the chattels at the time of conversion. ; ; Kilpatrick v. Dean, 3 N.J.Supp. 60. In the case of a sale of stocks the pledgor is ordinarily entitled to receive the highest value reached by the stocks between the date of sale and a reasonable time after he has received notice of it so as to enable him to replace the stocks. *3026 ; . In Maryland, however, the rule is that the measure of damages is the value of the stock at the time of its conversion and this is the rule whether the action is an action in tort or one in assumpsit. ; ; . Gieske clearly had notice of the sale of his Cosden & Co. stock at the time it was sold and the evidence indicates that it would not have been difficult for him to replace the stock at the market price in December, 1918, or January, 1919. The measure of the damages to which he was entitled was therefore not in excess of the price at which the stock was sold was sold by the trustee. That price was $210,447.95 and the petitioner is making no claim with respect to any loss upon that amount. Nor could such claim be made, because the New Jersey Co. was credited with that amount upon the books of the trustee. Nor is there any claim for interest in respect of the amount realized by the trustee upon the sale of the Cosden & Co. stock. Any claim *3027 for interest that Gieske might have made against that company was settled by the agreement of June 12, 1919, whereby Gieske received notes of the West India Co. in the amount of $549,120.28. We can not find that there is any merit in the petitioner's claim for the deduction of the $167,425.05. The amount was not a liability of the New Jersey Co. Why the company paid the amount to Gieske is not clear from the evidence. The relationship of Gieske to the petitioner and the West India Co. is not shown by the record. Gieske was president of both the West India Co. and the New Jersey Co., and during the year 1919 received a salary from each. The record indicates that the transaction between Gieske and the several corporations which he controlled were not arm's-length transactions. The payment by the New Jersey Co. to Gieske of $167,425.05 may have been nothing more than a distribution to Gieske of a portion of the profits of that company for the taxable year involved, the distribution *281 being made directly to Gieske rather than through the West India Co. The action of the respondent in disallowing the deduction of $167,425.05 from the gross income of the New Jersey Co. *3028 for the fiscal year ended July 31, 1920, is sustained.
The Commissioner has reduced the consolidated invested capital of the petitioner and affiliated companies for the taxable year ended July 31, 1920, by the amount paid to Gieske in October of that year by the New Jersey Co. from the beginning of the fiscal year. This was error, since, as we found, there existed no liability on the part of the New Jersey Co. at the beginning of the year in respect of the amount later paid to Gieske. The invested capital of the consolidated group should be reduced from the date the payment was made.
Reviewed by the Board.
Judgment will be entered under Rule 50.