Before SWAIM and SCHNACKENBERG, Circuit Judges, and PLATT, District Judge.
This is a petition to review a decision of the Tax Court of the United States, 22 T.C. 1386, affirming deficiencies assessed for the fiscal years ended August 31, 1945, 1946 and 1947 in income taxes of Breece Veneer and Panel Company (hereinafter referred to as taxpayer). The question presented is whether payments made by the taxpayer to the Reconstruction Finance Corporation under a "Lease and Option to Purchase" agreement were deductible as payment of rent in the years involved under 26 U.S.C.A. § 23(a):
"(1) Trade or business expenses
"(A) In general. All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity."
The Tax Court held that the taxpayer was acquiring an equity in the property and disallowed the rental expenses.
The Tax Court under findings of fact reviewed the evidence, a part of which was admitted by stipulation. The pertinent evidence was substantially as follows:
The taxpayer is an Indiana Corporation, with its principal office at New Albany, Indiana. During the taxable periods involved it was engaged in the manufacture of hardwood plywood for the radio, television and furniture industries. Since 1937 the taxpayer had occupied about 30% of the buildings, equipment and machinery in the plant in question under a month to month lease, at a monthly rental of $700.00. The remainder of the property was leased by Gunnison Housing Corporation, a subsidiary of the United States Steel Corporation.
Prior to December 1, 1943, the R.F.C. had made efforts in numerous ways to sell the New Albany plant. In 1942 they unsuccessfully offered to sell it for $175,000.00, including machinery and equipment.
In 1941, John T. Breece, as president of taxpayer, wrote the R.F.C. that the taxpayer was "interested in the purchase of our end of the property, including the new power plant at a price of $100,000.00 paying $6,000.00 in cash, and the balance in equal monthly payments over the next seven years at 41/2% interest on the unpaid balance."
In October 1943, Breece again wrote the R.F.C., suggesting a purchase clause with a price to be decreased by excess rents. The R.F.C. submitted a leasing proposition by letter which provided in substance that the taxpayer lease the premises, machinery and equipment for a period of five years starting November 1, 1943 with an option to purchase on terms incorporated in the agreement. It was further proposed in a later letter that there be a sublease to Gunnison with a $500.00 minimum rent, plus a percentage of net sales. Breece answered the letter indicating that they wished more space but did not want to handicap Gunnison and would work out their own arrangement. Gunnison also had proposed to R.F.C. a lease arrangement for the entire plant, by which it would have paid rent ranging from $500.00 to $3,312.50 monthly.
The instant lease and option to purchase was drawn by the R.F.C. and submitted to the taxpayer. The contract was executed effective December 1, 1943. The premises included 17 buildings on 21 acres of land, with woodworking machinery and office equipment. Under the agreement the taxpayer was to pay rent monthly in advance to the R.F.C. in the sum of $20,000.00 per year, for a term of five years, renewable for three additional years. The lease also gave the taxpayer an option to purchase the premises, machinery and equipment for $50,000.00 at the end of the fifth and sixth years, $37,500.00 at the end of the seventh year, and $25,000.00 at the end of the eighth year.
Under the contract, taxpayer as lessee was to pay all taxes, assessments and insurance, and was to deposit a sufficient amount each month to provide for these payments. (The taxpayer actually paid $440.00 per month for this.) Taxpayer was not to change the nature of its occupancy of the premises, sublet to anyone other than Gunnison, assign or encumber its interest, make alterations, or alter Gunnison's sublease without the prior approval of the R.F.C. in each instance. Taxpayer had the duty to make repairs, with the right reserved by the R.F.C. to do so if the taxpayer did not. The contract also contained the usual clauses for reletting upon abandonment and for default upon nonpayment of rent, and also provided for termination upon lapse of time, reciting liquidated damages for a holdover. Upon loss or destruction by casualty, the R.F.C. could repair or rebuild, with deferment of rent during the untenable period, or terminate the lease and pay taxpayer all insurance proceeds recovered less specified sums approximating at any time, the sum of rent still due plus the purchase option price. The sublease with Gunnison provided for a term of two years with a privilege to Gunnison to renew for additional six months' periods. The minimum rental was fixed at $500.00 per month, plus a percentage of net sales over $50,000.00 and up to $200,000.00 with a maximum rental of $3,035.00 per month. Gunnison was to use the same machinery but was to occupy less space. Rentals from Gunnison in excess of $500.00 per month were to be paid to the R.F.C. to apply on the rent for the fifth and fourth years.
There were three amendments made to the lease due to the sale of certain machinery not used by the taxpayer. These amounts were to be deducted from the purchase option price, leaving a balance of $48,050.00. The R.F.C. permitted the taxpayer to terminate its sublease with Gunnison in 1945 but Gunnison remained on a month to month basis from June 1, ...