Docket No. 53499.United States Tax Court.
Filed July 13, 1956.

Petitioner was the assignee of a contract to purchase a hotel executed on May 13, 1949. The closing date on which title was to be transferred and the balance of the purchase price paid was specified as June 15, 1949. The contract further provided for the retention of possession and of risk of loss by fire by the vendor until delivery of the deed and also provided for the allocation of certain expenses to the purchaser from May 1, 1949, and for the crediting to the purchaser of the net income, if any, of the property from May 1, 1949, through June 14, 1949, as a closing adjustment. The contract was closed on June 15, 1949, and the net income for the foregoing period credited on the purchase price. Held, the net income of the property from May 1, 1949, through June 14, 1949, was earned by the vendor and was not earned by nor taxable to the petitioner.

Herbert J. A. Runsdorf, Esq., for the petitioner.

Clarence P. Brazill, Esq., for the respondent.

The Commissioner determined a deficiency of $7,946.81 in the petitioner’s income tax for its fiscal year ended April 30, 1950. The only issue for decision is whether the petitioner, as purchaser of a hotel, is liable for the net income from the property for a period prior to the conveyance of title to it when the contract provided for the allocation of operating expenses to the petitioner as of an earlier date and for the crediting of the net income, if any, from the hotel between such date and the closing of the sale to the balance of the purchase price. Other issues raised by the petition appear to have been abandoned.Page 817

The petitioner is a New York corporation and has its principal place of business in New York, New York. It was organized on May 13, 1949, and filed its Federal income tax return on the accrual basis for its fiscal year ended April 30, 1950, with the collector of internal revenue for the second district of New York.

From April 1, 1941, Charles W. Schwefel was the manager of Hotel Gramercy Park for the owner, New York Life Insurance Co. (hereinafter called Insurance Company). Schwefel and Insurance Company entered into an agreement on April 1, 1948, the pertinent provisions of which, briefly summarized, were as follows:

Schwefel was engaged as managing director of the hotel for the period April 1, 1948, to December 31, 1948, the agreement to be automatically renewed from year to year unless notice was given in a specified manner; compensation was based on a sliding-scale percentage of gross revenue with fixed maximum and minimum amounts; Schwefel had complete and exclusive jurisdiction of the property and, subject to the general approval of Insurance Company, full and exclusive discretion as to policies and management methods; Schwefel also had specific authority to hire and discharge employees, make and renew leases up to 1 year without Insurance Company’s approval, purchase normal supplies and equipment, and make normal repairs; Schwefel was required to keep books of account under the supervision of a resident auditor to be appointed by Insurance Company, and to have them audited monthly and yearly by accountants designated by Insurance Company, to deposit all revenues in a depository designated by Insurance Company, to pay all expenses from such account, and to remit any excess to the owner monthly; Schwefel was not obligated to advance any funds to operate the hotel and was to be held harmless by Insurance Company for all obligations in connection with the management; Schwefel was obliged to “give entire and exclusive personal supervision to the operation and conduct of the business of the hotel,” to give the owner the benefit of any advantage obtained in any transaction for the hotel, and “to use all reasonable efforts to keep the cost of operation of said hotel to as low an amount as is consistent with its proper operation and maintenance”; the contract was not to be construed as an employment or agency agreement but as “an independent contract or agreement for the management and operation” of the hotel with Schwefel “acting in the capacity of an independent contractor.”

On May 13, 1949, Schwefel entered into a contract to purchase the Hotel Gramercy Park from Insurance Company. The agreement provided, in part, as follows:

By this agreement dated 13th day of May, 1949, CHARLES W. SCHWEFEL, residing at Hotel Gramercy Park, situate at No. 2 Lexington Avenue, in thePage 818
Borough of Manhattan City, County and State of New York, hereinafter called the purchaser, agrees to buy for one million three hundred fifty thousand ($1,350,000.00) Dollars,

[Description omitted]
and NEW YORK LIFE INSURANCE COMPANY, a domestic corporation having its principal place of business at 51 Madison Avenue, New York City, hereinafter called the seller, agrees to sell said premises and personal property at said price and to convey title to said premises to the purchaser by deed — Statutory Form CC, reciting the actual consideration subject to the following enumerated provisions which shall survive the delivery of the deed hereunder: * * *

Seller agrees to execute and deliver a bill of sale to the purchaser covering said personal property, the allocation value of which is fixed at $200,000.00.

The purchaser has paid to the seller as down money fifty thousand ($50,000.00) Dollars and agrees to pay on the delivery of the deed, in cash or by purchaser’s certified check drawn on a New York City Bank and payable to the order of the seller one million three hundred thousand ($1,300,000.) Dollars; the balance of the purchase price as aforesaid.

Payment of the purchase price and delivery of said deed shall be made at the office of Dudley Davis, Attorney for the seller, 51 Madison Avenue, New York City, at ten o’clock, A. M. on the 15th day of June, 1949, as of May 1, 1949.

* * * * * * *

Until delivery of the deed, the risk of loss or damage to said premises by fire is assumed by the seller.

* * * * * * *

If the purchaser defaults in the performance of this contract at the time and in the manner specified, then the down money shall be retained by the seller as liquidated damages and this contract shall be null and void. Should this title be unmarketable and be rejected by the purchaser, the down money shall be returned and the seller shall be under no further liability to be [sic] purchaser.

This contract may not be transferred without the written consent of the seller, except once to a corporation to be formed for the purpose of taking title.

* * * * * * *

Purchaser agrees to pay for beverages in unopened containers and for food in accordance with inventory thereof as of April 30, 1949.

Until delivery of the deed, seller shall remain in exclusive possession.

Until delivery of the deed, seller and purchaser agree to continue the services of the accounting firm of Harris, Kerr, Forster and Company and its resident auditor for the usual operating reports and accounts and closeout statements, which shall be binding upon both parties. The regular expense for this service will be apportioned as of May 1, 1949. Any extra expense for closeout statements required by seller shall be paid for by seller.

It is understood and agreed that from May 1, 1949, to the date of delivery of the deed the hotel manager shall deposit the income from the hotel in the account of the seller and pay ordinary operating expenses therefrom.

Upon delivery of the deed, the net income from the hotel, if any, for the period from May 1, 1949 to the delivery of the deed after payment of operating expenses as shown on the statements of said accounting firm shall be credited by the seller to the purchaser on account of closing adjustments.Page 819

The following are to be apportioned as of May 1, 1949.

1. Taxes for the fiscal year.

2. Water rates.

3. Rents.

4. Fuel. Price $13.40 per ton.

5. Insurance premiums, management fees, licenses, dues, prepaid telephone and other prepaid expenses.

6. Service contracts.

7. Salaries and wages.

8. Purchaser shall be entitled to transient room revenue accruing from twelve noon April 30, 1949 as determined by the daily transcript.

Seller shall be entitled to all other revenue received or derived from sales made up to the close of business on the night of April 30, 1949.

Seller agrees to pay seller’s proportionate share of vacations to employees in this building for the year 1949 when, as and if such vacations are received by the employees employed prior to May 1, 1949 in the building and satisfactory evidence of such vacations is presented to the seller. Seller’s proportionate share of such vacations shall be as of May 1, 1949 and shall be based upon the hotel association’s custom of giving vacations.

* * * * * * *

Purchaser agrees to make reasonable efforts to collect all accounts receivable and rents due and remaining uncollected up to twelve noon, April 30, 1949 and pay them over to seller promptly when and as collected. Seller shall have the right to audit purchaser’s records not more often than semi-monthly as [sic] a reasonable time during any business day until said accounts receivable and rents are fully liquidated. The provisions of this paragraph shall survive the delivery of the deed hereunder.

Seller’s accounts payable include goods delivered, services performed and work done through April 30, 1949. Purchaser’s accounts payable include all goods delivered, services performed and work done after April 30, 1949.

Adjustments for liquor, food, water, gas, electricity and fuel will be based on inventories taken by representatives of the purchaser and the seller on April 30, 1949.

* * * * * * *

It is understood and agreed that the agreement dated April 1, 1948 between New York Life Insurance Company and said Charles W. Schwefel, whereby the latter is employed as Managing Director of said hotel and the services of said Charles W. Schwefel thereunder shall terminate upon the delivery of the deed as herein provided, with adjustments as herein provided, and said Charles W. Schwefel accepts this provision of this contract as formal notice of termination of said agreement of employment upon delivery of said deed as herein provided, notwithstanding any provisions of said agreement of employment with regard to the manner in which such notice is to be given.

On May 24, 1949, Schwefel assigned the contract for the purchase of the Hotel Gramercy Park to the petitioner. The closing was held June 15, 1949, and the transactions which occurred and the adjustments which were made at that time are shown by the following closing statements prepared by the attorney for the Insurance Company:Page 820

Charge Purchaser

Sales price ……………………………… $1,350,000.00
Second half 1949-50 general tax
total $49,005.00 ……………………… 8,167.50
Insurance as per attached schedule …………. 4,196.95
Fuel in bin on April 30 — 3 tons
at $13.40 ……………………………. $40.20
Delivered May 2 — 108 tons at $11.90 …….. 1,285.20
Food on hand April 30 …………………….. 2,821.44
Beverages on hand April 30 (unopened
bottles) ………………………………. 29,683.73 32,505.17
Trade dues ………………………………. 348.65
Gramercy Park dues ……………………….. 228.00 576.65
Refund on liquor license ………………….. 1,833.34
House funds ……………………………… 11,000.00
Telephone prepaid expense May 1-May 11 ……… 229.02
Telephone commissions …………………….. 169.49
Service contracts ………………………… 118.11
taxes — S. U. I. T … .027} May 1-June 14
{1,741.40 F. U. I. T … .03 } {
178.55 F. O. A. B … .01 } { 595.18 2,515.13
——— ————-
Credit Purchaser

Cash on contract …………………………. $50,000.00
Guest ledger in advance …………………… $738.37
City ledger in advance ……………………. 3,192.77
Rents in advance …………………………. 3,691.24 7,622.38
Water Feb. 23, 1949-Apr. 30, 1949 ………….. 1,711.55
Gas Apr. 13-30, 1949 ……………………… 429.69
Electricity Apr. 13-30, 1949 ………………. 804.03 2,945.27
Telephone ……………………………….. 1,345.63
Employees insurance ………………………. 720.45
Salaries Apr. 26-30, 1949 …………………. 6,426.02
Safe deposit keys ………………………. 209.50
Telephone listings ……………………… 20.00 229.50
State utility tax ………………………… 51.32
May net …………………………………. 49,624.18
June net to June 14 ………………………. 8,465.56 58,089.74
Accounting fee (April paid in June) ………… 165.00
Allowance items #3 — 9— 10 as per contract …. 496.00
Transient revenue Apr. 30, 1949 ……………. 82.00
Balance due the New York Life Insurance Company at closing
of title …………………………….. $1,284,463.45

Page 821

The item of $58,089.74 reflected above as a credit to purchaser and recorded on the petitioner’s books was the excess of cash receipts over cash disbursements of the hotel for the period May 1, 1949, through June 14, 1949, which, upon conversion to the accrual basis, resulted in the net income for the period in question of $34,646.14.

Insurance Company paid a real estate broker’s commission on the sale of $20,475 to Ivor B. Clark, Inc., by check dated June 13, 1949. On June 8, 1949, the general counsel for Insurance Company requested a warrant for the issuance of a check for $1,265 for the purchase of United States revenue stamps to be affixed to the deed of the Hotel Gramercy Park to the petitioner.

Schwefel held an interest in approximately 25 per cent of the nonvoting preferred stock and approximately 21 per cent of the common stock of the petitioner. There were 14 other stockholders, 1 of whom owned approximately 25 per cent each of the preferred and the common stock. Schwefel was president of the petitioner during the year in issue.

The report of the internal revenue agent who examined the petitioner’s return for its fiscal year ended April 30, 1950, is dated November 19, 1952. At that time respondent was aware of the retroactive provisions of the contract for the purchase and sale of the hotel and of the treatment of the proceeds by Insurance Company and of the purchase price by petitioner.

The Commissioner determined that the net income from the operation of the Hotel Gramercy Park for the period May 1, 1949, through June 14, 1949, in the adjusted amount of $34,646.14, was taxable to the petitioner.

The stipulation of facts and the exhibits annexed thereto are incorporated herein by this reference.

KERN, Judge:

The sole issue for decision herein is whether petitioner is taxable on the net income of the Hotel Gramercy Park, as adjusted by conversion to the accrual basis, for the period May 1, 1949, through June 14, 1949.

The petitioner’s position is that the income for this period is that of Insurance Company, the vendor, which retained the risk of loss, possession of the premises, and possession of the receipts until the closing on June 15, 1949. Respondent, on the other hand, contends that such income is taxable to the petitioner on the ground that under the contract of sale the benefits and burdens of the ownership of the property passed to the petitioner as of May 1, 1949, and that the income received thereafter was, in reality, the income of petitionerPage 822
which derived economic benefit and satisfaction therefrom by the application of the net amount to the balance of the purchase price due on the closing. Respondent bases his argument on the proposition that the refinements of the passage of title do not govern the taxation of sales of property and that a closed transaction for Federal income tax consequences is deemed to occur regardless of the time title passes, when the benefits and burdens of ownership from a practical standpoint have previously been transferred to the buyer, citing Commissioner v. Union Pacific Railroad Co., (C. A. 2, 1936) 86 F.2d 637, affirming 32 B. T. A. 383; and NorthCarolina Lumber Co., 19 T.C. 587, reversed on other grounds (C. A. 4, 1954) 211 F.2d 543.

We are unable to accept respondent’s position and agree with the petitioner that the income from the hotel during the period in question was earned by and taxable as such to the vendor and not to the purchaser. The fact that respondent may have allowed the statute of limitations to run with respect to Insurance Company or that the tax is otherwise not collectible from the vendor does not justify a shift of the tax on this income to the petitioner. See Pratt-Mallory Co. v. United States, (Ct. Cl., 1936) 12 F. Supp. 1020.

The Union Pacific and North Carolina Lumber cases, cited by respondent in support of his basic premise, are clearly distinguishable from the instant case. The first involves the time of taxation of the gain realized upon the sale of property on the basis of installment payments, where the deed is delivered upon the completion of the payments. The purchaser therein took immediate possession, assumed the expenses of management, and applied the rentals received to the purchase price, whereas in the instant case exclusive possession was retained by Insurance Company. The vendor in that case had the unqualified right under the contract to recover the consideration whereas in the instant case the inability of Insurance Company to deliver a marketable title on the closing date would have released the petitioner from its obligations under the agreement and would have entitled it to a refund of its downpayment. This distinction was specifically noted by the Court of Appeals for the Second Circuit where at page 639 of its opinion it stated:

In the instant case there was a contractual obligation to pay even though no notes or other evidence of debt were given. It was not an executory contract, as where the transfer of title and full payment are made conditions to the completion of the transaction. Lucas v. North Texas Lumber Co., 281 U.S. 11,50 S.Ct. 184, 74 L.Ed. 668. The respondent granted a period of payment and retained title for his own protection. The obligation imposed upon the purchaser of the Seattle Tide Lands, such as preserving and insuring the property, were intended to fulfill the same purpose of security.

This Court in its opinion in the same case in32 B. T. A. 383, at pages 391 and 392, similarly had pointed out that while the purchaser’s rightPage 823
to and possession of the property prior to the transfer of the title might be qualified, there was no qualification of the vendor’s right to the price and that it made little difference to a seller on the accrual basis whether a deed was delivered in escrow or withheld by the vendor as security for the purchaser’s full performance.

In the North Carolina Lumber case, supra, which relied upon the Union Pacific case, the documents in question were held to amount to a present conveyance of title subject to a vendor’s lien rather than a contract to sell and the taxpayer-seller had the unqualified right to receive the agreed sales price.

Respondent has also cited us to Moore v. Commissioner, (C. A. 7, 1941) 124 F.2d 991, as an example of the taxation of income to the beneficial owner of property. Therein, pursuant to a contract the seller of certain stock had endorsed the stock certificates in blank and deposited them with an escrow agent who affixed the certificates to notes of the buyer. The contract also provided that dividends were to be credited upon the principal and interest of the notes, and when a note was paid up the certificates attached to it were to be released to the buyer. If the buyer defaulted on the payment of the principal and interest of a note, it was to be returned to him and the attached stock certificate returned to the seller. The buyer was thus not personally liable for payment of the notes which represented the balance of the purchase price, the buyer having previously made a very substantial downpayment. The Court of Appeals for the Seventh Circuit held that title to the stock had passed to the buyer and out of the control of the seller who had nothing further to do in a transaction tantamount to a conditional sale and, alternatively, that even if title remained in the seller, it was only for the purpose of securing payment, the beneficial ownership of the stock having passed to the buyer. Thus, the purchaser rather than the seller, who was the taxpayer in the case, was chargeable with the income tax on dividends received during the period the certificates were held in escrow.

In De Guire v. Higgins, (C. A. 2, 1947) 159 F.2d 921, which involved the income tax liability of the purchaser in the same transaction, a similar result was reached on the ground that while the ultimate ownership of the income, as between the buyer and the seller, was temporarily suspended by the escrow arrangement, when the buyer picked up his option and paid off the notes, the stock certificates attached thereto and the dividend income related to such certificates were released from their uncertain ownership status and became the income of the buyer. Judge Clark, in a concurring opinion, agreed with the result on the basis of the opinion in the Moore case which he took to involve a comparative weighing of the respectivePage 824
bundles of rights or attributes of ownership, such as beneficial rights, powers, and privileges, held by the buyer and seller.

Even if cases involving the taxation of income during the period when corporate stock certificates are held in escrow pending payment are pertinent to the consideration of a case involving the taxation of the income earned by actively managed real property, we are of the opinion that the Moore and DeGuire cases are sufficiently distinguished by pointing out that in the instant case Insurance Company not only did not convey title to the petitioner until June 15, 1949, but did not convey title in escrow prior to that date; that until June 15, 1949, it was the vendor’s responsibility to operate the property and on the closing date to offer a marketable title to the purchaser and to execute the deed and bill of sale. The contract in the instant case was executory on the part of the vendor when the income was earned and the vendor’s retention of title during the period of May 1 through June 14 was not for the sole purpose of securing payment of the agreed price but undoubtedly was also for the purpose of affording a reasonable time to the purchaser to search the title and to arrange financing.

In our opinion, the vendor retained and did not transfer, even conditionally, the important attributes of ownership with regard to the property during the interim period in question together with the corresponding burdens of ownership. Under the terms of the contract, the vendor retained title and exclusive possession until the delivery of the deed, and also retained for the same period the risk of loss or damage to the premises by fire. Under the Uniform Vendor and Purchaser Risk Act, in effect in New York in 1949, the vendor bore the risk of loss if all or a material part of the property were destroyed in any manner, whether or not by fire, without the fault of the petitioner, or if the property were taken by eminent domain. In such event, the Insurance Company would have been unable to enforce the contract and would have been required to return the downpayment. N.Y. Real Property Law, sec. 240-a (1) (a). Although the contract provided for the allocation to the petitioner, as of May 1, 1949, of what appear to be the normal operating expenses of a hotel so that the petitioner was to be responsible for such costs if the transaction were completed and was to receive the rental income for the same period, no provision of the contract made the petitioner liable for any net operating loss. It was obviously the intention of the parties that the costs would be paid out of gross income.

Regardless of the manner in which Insurance Company and the petitioner may have respectively treated the proceeds of the sale and the payment of the purchase price on their books of account, in view of the substantial risks and burdens of ownership retained by the vendor and the conditional status of both the conveyance of the title and thePage 825
benefits of the property between May 13 and June 15, 1949, we read the agreement as a contract to sell and to purchase the physical assets of the hotel, as specified, together with the net income, if any, earned by the property between May 1, 1949, and June 15, 1949, for the flat sum of $1,350,000, subject to the adjustments customary upon the sale of real property. Respondent’s argument to the contrary would require the taxation to the petitioner of income to which it might never have been entitled as the earnings from property to which it might never have acquired title. Under the circumstances present in this case we cannot hold, as respondent urges, that the right to receive the income during this interim period had become fixed and hence accruable by the petitioner. Spring CityFoundry Co. v. Commissioner, 292 U.S. 182.

It is clear from the contract that during the period in question it was the vendor and not the purchaser who was obligated to render the service that was to earn the income to be derived by the property. See Hyde Park Realty Inc. v.Commissioner, (C. A. 2, 1954) 211 F.2d 462, affirming 20 T.C. 43;J. Ungar, Inc., 26 T.C. 331 (1956). The operation of the hotel and the rendition of this service were to be under the management of Schwefel as an independent contractor under an agreement with the vendor. This agreement charged him with a duty to use his best efforts to operate the hotel efficiently for the vendor and, regardless of the conveyance of title, his compensation depended in part upon the gross revenue. The notice of termination of his engagement given to Schwefel in the May 13 contract with Insurance Company was effective only upon the delivery of the deed, and he remained responsible to the vendor for the performance of his duties.

Thus, the income in question was earned at a time when the greater bundle of rights or attributes of ownership, including title, possession, management, and the substantial burdens and possibly the benefits of the ownership of the property, were all still possessed by Insurance Company, and hence Insurance Company and not the petitioner was liable for the tax thereon.Helvering v. Horst, 311 U.S. 112; see also Cold Metal ProcessCo., 25 T.C. 1333 (1956); Clarence W. Miller, 26 T.C. 151
(1956). We are unable to comprehend respondent’s contention that “it is not inconceivable that under the accrual method both buyer and seller had a right to receive this income which became fixed at different times and such income, under that method, would be reportable by each.” The income for the period in question belonged either to Insurance Company or to the petitioner, not to both. De Guire v. Higgins, supra.

We are aware that the petitioner ultimately benefited from the application of the net income between May 1, 1949, and June 15, 1949, to the purchase price. However, the disposition of income alreadyPage 826
earned by Insurance Company would not save it from taxation, nor could the transfer of such income to the petitioner result in the imposition of the tax on the latter. Hulbert v.Commissioner, (C. A. 7, 1955) 227 F.2d 399, affirming a Memorandum Opinion of this Court filed December 30, 1953. In this case, the authority nearest in point to the instant case, a partnership entered into a contract on March 26, 1946, for the sale of its business. The sale was made upon the basis of the January 26, 1946, balance sheet of the partnership, and the contract further provided that the vendor partnership would operate the business for the benefit of the buyer from January 26, 1946, to the date of the consummation of the agreement which was fixed by the contract as on or before June 26, 1946, which period was designated as the Buyer’s Business Period. It was also provided that one-half of the net profits of the business from January 26, 1946, to the date of consummation, after the deduction of taxes, would belong to the buyer. The other half of the net profits would constitute a part of the purchase price, and would be paid by the buyer to the partnership. The agreement also recited the buyer’s intention to finance the purchase through a stock issue contingent upon qualification under Securities and Exchange Commission rules and the Blue Sky laws of the various States. If such financing were not effected in 90 days, the partnership was to retain $7,500 downpayment as liquidated damages. Various provisions of the agreement referred to the business as that of the sellers. If the sale was not consummated, the buyer was not to be responsible for any losses, and the partnership was to retain any profits during the period January 26, 1946, to June 26, 1946. Although the stock issue was not approved by the Securities and Exchange Commission, the sale was consummated on June 26, 1946, and the Court of Appeals for the Seventh Circuit held that the vendors were liable for the tax upon the net income earned between March 26 and June 26, stating, in part, as follows:

The business operated by the sellers during the Buyer’s Business Period and the net profits accruing therefrom were the business and the profits of the sellers. The fact that their agreement required them to deliver that business and those profits to Kungsholm does not detract from the fact that, by use of their own property, the sellers as a firm made profits and that as a matter of law the partners became liable for income taxes on such profits in the year when they accrued.

* * * * * * *

By their contract, the Century partners undertook to dispose of the income of the partnership during the Buyer’s Business Period. The power to dispose of income is the equivalent of ownership of it and the exercise of the power to procure its payment to another is within the reach of the statute taxing income “derived from any source whatever.” * * *

In our opinion the rationale of the Hulbert case is in accord with our analysis of the transaction herein and is controlling. See alsoPage 827Rouss v. Bowers, (C. A. 2, 1929) 30 F.2d 628, certiorari denied279 U.S. 853, affirming 4 B. T. A. 516. The amount of $58,089.74 credited to the petitioner in the instant case in connection with the closing adjustments on June 15, 1949, did not represent income earned by the petitioner and taxable to it.

Decision will be entered under Rule 50.