UNITED STATES of America, Appellant, v. T. W. and Evelyn B. WHEELER, Appellees, 311 F.2d 60

RIVES, Circuit Judge. This appeal involves the question whether $56,641.41 paid by appellee taxpayer in compromise and settlement of a state court action charging him with breach of a contract to sell the controlling stock interest in three corporations constituted nondeductible capital expenditures to be added to the cost basis of the stock or currently deductible expenses. The district court, sitting without a jury, found: “That the reason T. W. Wheeler made the payment of $54,-675.95 to A. G.

Ainsworth at the time of the settlement of said law suit, was to prevent the appointment of a receiver over the corporations.” The court thus concluded that the payments were an ordinary and necessary expense paid for the management, conservation or maintenance of property held for the production of income; *rather than a non-deductible capital expenditure as defined by the statutes and as more particularly distinguished in the Treasury Regulation upon which appellant relies.

Appellant contends that the subjective motive of the taxpayer in making the settlement was immaterial, but that the nature of the suit settled is the crucial test. In the alternative, appellant contends that the findings of fact are clearly erroneous. Appellee takes the position that, inasmuch as the district court found as a matter of fact that the settlement was made to prevent a receivership, the only question for review here is whether the district court’s findings of fact are clearly erroneous.

In 1953 appellee owned the controlling stock interests in three corporations and was negotiating a sale of the stock to one Cage. The sale was not consummated because one Phinney, Cage’s attorney, informed appellee that Cage was no longer interested in buying the stock. However, Phinney told appellee that one Ainsworth was interested in buying the stock. A contract for the sale of the stock to Ainsworth was executed in May 1953. The purchase price was to be one million dollars and was to include two hundred thousand dollars down payment with the balance to be paid in installments.

The two hundred thousand dollars was to be obtained by the purchaser from a bank and a deed of trust on the corporation’s property was to be given the bank as security. Ainsworth was to pledge the stock (subject to the deed of trust) to appellee as security for the eight hundred thousand dollar balance. Attorney Phinney, according to appellee, served as attorney for both parties in the transaction. The final paragraph of the note which was to evidence Ainsworth’s obligation to appellee is as follows: “No recourse shall be had for the payment of the principal or interest on this note against A. G.

Ainsworth, his heirs, executors or administrators, whether by virtue of any constitution, statute or rule of law, or by the enforcement of any assessment, or penalty or otherwise, all such liability being, by the acceptance hereof, expressly waived and released, it being understood that the holder of this note shall look solely to the security [the stock pledged] for said note for payment.” Appellee testified that, before the contract was signed, he asked the attorney if the above quoted clause would not relieve the purchaser of any personal obligation to pay the note.

He said that Phinney, acting as attorney for both parties, said it would not, assuring appellee that the purchaser would be personally responsible for the eight hundred thousand dollar balance. Appellee then signed the contract. However, upon showing the contract to friends and another attorney, appellee was advised that he had been duped. He discovered that Cage, the man originally interested in buying the stock, was still interested and had not told Attorney Phinney that he was not interested, but was ready and willing to pay one million dollars for the stock.

Appellee believed that if he performed the contract, Ainsworth would probably “bleed” the corporate assets by paying personal salaries, expenses and perhaps dividends, then turn the stock back with the corporation’s assets depleted by these withdrawals, all without any personal liability to the purchaser, Ainsworth.

Appellee refused to consummate the sale, and Ainsworth brought suit in a Texas state court, setting out the terms of the contract, complaining that appellee had breached the contract and praying that appellee be enjoined from selling the stock, that a receiver be appointed, and asking for specific performance, damages and general relief.

The district court found as facts that credit was at all times indispensable to appellee in the operation of the corporations, that appellee believed that the appointment of a receiver would cut off all credit to the corporations, and that the payment of the money in settlement was made to prevent the appointment of a receiver. The court concluded that the sums paid out were ordinary and necessary expenses paid for the management, conservation and maintenance of property (the stock) held for the production of income, and thus deductible expenses rather than capital expenditures.

Appellee taxpayer urges that the district court’s finding of fact that the reason he made the settlement was to prevent the appointment of a receiver over the corporation is not clearly erroneous, and that the taxpayer’s subjective motive for settling the suit is material in distinguishing between deductible expenses and capital outlay, and relies principally upon Levitt & Sons, Inc. v. Nunan, 2 Cir., 1944, 142 F.2d 795. The appellant insists that the subjective motive of the taxpayer is irrelevant, that the nature of the suit itself, and of the compromise agreement is dispositive.

It seems to us that the finding by the district court and the argument of counsel place undue emphasis upon the reason or subjective motive of the taxpayer, and that the real question is what was the substance as distinguished from the legal form of the transaction. As said in Interstate Transit Lines v.

Commissioner, 1943, 319 U.S. 590, 594, 63 S.Ct. 1279, 1282, 87 L.Ed. 1607: “The origin and nature, and not the legal form, of the expense sought to be deducted determines the applicability of the words of § 23 (a).” Conceding that the taxpayer’s reason or motive may be considered in determining the real substance of the transaction, it certainly cannot be so considered to the exclusion of the objective facts. Those facts leave us in no doubt that the suit which was settled was a suit for specific performance and directly involved title to the stock in question.

It was based on a written contract signed by the taxpayer. The district court made no finding that Ainsworth’s claim for specific performance had no foundation. No attorney so testified. The only evidence tending to that conclusion was the taxpayer’s testimony that, “the attorney told me that I could win that specific performance thing hands down.” To conclude from a client’s understanding of his attorney’s optimistic prediction of victory that the attack on title lacked substance would indeed be farfetched.

The first intimation of such an impression is in the taxpayer’s testimony upon the trial of this tax refund suit. Actually the taxpayer was already committed to the fact that he settled the case to prevent the possibility of losing the case and being required to specifically perform his contract.

Attached to his formal claim for refund was a statement of “Grounds for Claim,” which included the following: “Taxpayer made such settlement to prevent: “(1) the possibility of losing the case which would force him to complete the contract and cause a tremendous reduction in the value of his property held for the production of income. Taxpayer before the contract was entered into had property held for the production of in- ' come (capital stock) amounting in value to $1,000,000.00.

Should taxpayer have been forced to fulfill the contract of sale his property held for the production of income would have been converted into property (promissory notes) which he feared would have a value much less than their face value due to the anticipated action of the purchaser.

Taxpayer wanted to protect his property held for the production of income (capital stock) and to conserve it. “(2) the possibility of placing the corporation in receivership which would damage the corporations heavily, financially and their goodwill, and cause taxpayer’s property held for the production of income (capital stock) to decrease in value accordingly. “Section 212 of the Internal Revenue Code allows as expenses all ordinary and necessary expenses paid for the management, conservation or maintenance of property held for the production of income.

Taxpayer’s sole reason for payment of such settlement was to protect and conserve such capital stock, his property held for the production of income.” Likewise, taxpayer’s complaint instituting the present action alleged: “IX “Taxpayers made such settlement to prevent the possibility of losing the case which would force them to complete the contract and cause a tremendous reduction in the value of their property held for the production of income, and to prevent the possibility of placing the corporation in receivership which would damage the corporations heavily, financially, and their good will, and cause taxpayers’ property held for production of income to decrease in value accordingly.” In the face of these record commitments, it cannot now be successfully urged that taxpayer’s reason for making the settlement was substantially or solely to prevent the appointment of a receiver.

That does not accord with the objective facts or with the taxpayer’s own statements. We conclude that the payments in question were made by the taxpayer in defense or protection of his title to the stock that was the subject of the suit for specific performance, and were therefore capital expenditures. The judgment is therefore reversed and the cause remanded. Reversed and remanded. . Including $1,965.46 paid as attorneys’ fees in defending the suit and effectuating the compromise. . Evelyn B. Wheeler is a party to this action only because she and her husband filed a joint income tax return.

Therefore, in this opinion “appellee” refers only to T. W. Wheeler. . The complaint prayed for appointment of a receiver, temporary restraining orders and injunction, general relief as for damages and specific performance. . Deductible from net income under 26 U.S.O.A. § 212(2) 1954 Code: “In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year— * * * * * “(2) for the management, conservation, or maintenance of property held for the production of income.” [§ 23(a)

(2) I.R.C.1939.) . 26 U.S.C.A. § 263(a) (1): “(

a) General rule. No deduction shall be allowed for— “

(1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. * * * ” (§ 24(a)

(2) I.R.C.1939.) . Treasury Regulation 1.212(1) (k): “ÍExpenses paid or incurred in defending or perfecting title to property, in recovering property * * *, or in developing or improving property, constitute a part of the cost of the property and are not deductible expenses. * * * ” . Citing Lewis v. Commissioner, 2 Cir., 1958, 253 F.2d 821, 824, 825, 826, n. 5; United States v. General Geophysical Co., 5 Cir., 1961, 296 F.2d 86. 90; Brown v. Commissioner, 5 Cir., 1954, 215 F.2d 697, 700; Arcadia Refining Co. v. Commissioner, 5 Cir., 1941, 118 F.2d 1010.