12 T.C. 446">*446 The respondent determined a deficiency in petitioner's income tax liability for the year 1941 in the amount of $ 26,779.90. The parties have disposed of one issue under a stipulation which will be given effect under Rule 50. Petitioner has waived one claim for depreciation deductions on certain property.

Petitioner is a member of a copartnership which carries on business under the name of "Truman Bowen Company and J. L. McLaughlin." Respondent has determined that the income of the copartnership for the year 1941 was greater than was reported; and upon the basis 12 T.C. 446">*447 of that determination he has increased the amount of petitioner's share of the partnership income and determined a deficiency in petitioner's income tax for 1941. The question raised by the pleadings relates to several contracts which were made by the partnership.

The chief question is whether payments which the partnership received during 1941 under several contracts were rents within section 22 (a) of the Internal Revenue Code, as respondent has determined, or were 1949 U.S. Tax Ct. LEXIS 241">*244 payments for property giving rise to profits, as petitioner contends.

Respondent has made claim for increase in the deficiency to $ 57,700.31, under section 272 (e) of the code.

Petitioner filed his return for 1941 with the collector for the district of Indiana, but he is now a resident of Phoenix, Arizona.

This proceeding was submitted originally under Rule 30 (a), under stipulation of the facts, but it was set for trial subsequently, when additional evidence was adduced and further facts were stipulated. The record consists of testimony, exhibits, and stipulations of certain facts.

FINDINGS OF FACT.

The facts which have been stipulated by the parties are found as facts. The stipulations are incorporated herein by this reference.

Truman Bowen & Co. & J. L. McLaughlin, a copartnership, was and still is engaged in the general contracting business throughout the United States. Petitioner is a member and one-half owner of the partnership. Since the question presented relates to the partnership, it is referred to hereinafter as the partnership.

In the spring of 1941 and thereafter the United States Government, through the War Department, made prime contracts with various contractors1949 U.S. Tax Ct. LEXIS 241">*245 for the construction of ordnance works and other plants at various places. In connection with the construction work under the prime contracts, subcontracts were made to obtain equipment, which were called "equipment rental agreements." The parties to the subcontracts were prime contractors and the Government, on the one hand, and owners of equipment, on the other hand; and the subcontract was subject to the prime contract. The subcontracts were let out after receipt of bids by the War Department. The form of the subcontract was a Government form, the terms thereof being required by the Government. The form of subcontract which is involved in this proceeding is Form 40-2111. In some instances it was described as a "rental purchase agreement." Since the prime contracts were cost plus fixed fee contracts, the prime contractors were reimbursed by the Government for all payments which they made under the equipment agreements.

12 T.C. 446">*448 On March 6, 1941, the partnership entered into a so-called equipment rental agreement with the Government and Winston Bros., prime contractors, who were constructing the Hoosier Ordnance Plant at Charlestown, Indiana. Since the equipment agreement 1949 U.S. Tax Ct. LEXIS 241">*246 was made subject to the prime contract, it had to be and was executed by the same contracting officer of the Government, or his authorized representative, who had executed the prime contract. Attached to the agreement was a schedule, another Government form, which was designated schedule A. The schedule was stated to be, on its face, "an addendum to" the agreement, "of which it forms an integral part." There were set forth in the schedule a description of each piece of equipment delivered under the schedule, the value of the item, per agreement, the amount of the monthly "rental," and the hourly rate.

During the year 1941, 62 pieces of equipment were delivered to the receiving point at the Hoosier Ordnance Plant under the agreement. All of these items were not delivered at one time; rather, certain items were delivered in each month from March to December. Upon each delivery of equipment one of the forms called schedule A was made up and made part of the agreement, so that several schedules ultimately were made part of the agreement.

The number of pieces of equipment which were delivered in each month was as follows:

1949 U.S. Tax Ct. LEXIS 241">*247 The equipment was for use in excavating, moving dirt, and general work. It consisted of cranes and draglines, air compressors, shovels, various kinds of trucks, and like equipment.

The monthly payments were on the basis of one 8-hour shift, with a 50 per cent increase in the rate for each additional shift per day.

The agreement was not for any stated period, but it would end when the prime contract was terminated, if not before. The intent of the parties was that the agreement would last for about 12 or 15 months, depending upon the date when the last piece of equipment was delivered. Since title to a piece of equipment would pass to the Government automatically when monthly payments equaled the agreed value of the item, the agreement ended, with respect to each item, when monthly payments equaled value, plus 1 per cent of value per month, as is shown hereinafter. The amount of the monthly payment was such that this would happen in from 6 to 15 months. The Government had full control over the length of time an item of equipment would be 12 T.C. 446">*449 retained at any place. If the Government wanted to have a piece of equipment used at some place other than the first place of use, 1949 U.S. Tax Ct. LEXIS 241">*248 after it had been used there, it would request a transfer.

When items were transferred to a second project, a new schedule A was made up which set forth, as in the first schedule, a description of the item, its value, the "rent" per month, and other details. In addition, the second schedule had a space which was designated "Equity," in which the total sum of the monthly rentals paid at the first location was entered, so that the monthly payments which had been paid were carried forward. The sum entered represented the Government's equity in the piece of equipment.

Furthermore since prime contractors other than Winston Bros. were doing the construction work at the locations to which items were moved, located in various states, another so-called equipment rental agreement was executed, Form 40-2111, but the second form constituted a supplement to the original contract of March 6, 1941.

The standard form of agreement, Form 40-2111, contained a standard provision governing the transfer of title to items of equipment to the Government. The Government was in need of certain kinds of equipment for moving earth and making concrete in the building of plants, barracks, roads, and air fields, 1949 U.S. Tax Ct. LEXIS 241">*249 such as tractors, shovels, draglines, trucks, etc. There was an increasing scarcity of such equipment in 1941. After Pearl Harbor, certain supply lines were set up by the Government, some of which went to Europe and others to the Pacific areas. Equipment was sent overseas to be used in construction work of many kinds. Within the country, prime contractors lacked equipment required under their contracts with the Government, and it took steps to acquire needed equipment to provide to prime contractors. The procedure of acquiring equipment was called "recapture." In Washington lists were made up of equipment, according to type, model, and make, which were sent into the field with directions to "recapture" such equipment. Equipment described in other lists was to be "recaptured" if the Government contracting officer so determined. The standard clause relating to the transfer of title to equipment in Form 40-2111 was intended to provide for the "recapture" of equipment as set forth above.

The clause referred to above is as follows:

* * * When and if the total rental paid to the Lessor for any piece of equipment shall equal the value thereof, plus freight to the site of the work, 1949 U.S. Tax Ct. LEXIS 241">*250 plus one per cent per month for each month or fraction thereof such piece of equipment shall have been in use, no further rental shall be paid to the Lessor and title shall vest in the Government. At the completion of the work or upon termination of the principal contract as provided in Article VI of the principal contract, the 12 T.C. 446">*450 Government may at its option purchase any piece of such equipment by paying the Lessor the difference between the valuation of such equipment plus freight to the site of the work plus 1% per month for each month or part thereof such piece of equipment shall have been in use and the total rental therefor paid for such piece of equipment.

Under the above clause, title to an item was to pass to the Government automatically when monthly payments equaled the value per contract, plus an additional amount computed on the basis of 1 per cent of value per month. The 1 per cent amount was computed when the Government took title and was called "1 per cent Interest per Month" in the Government purchase order. Also, in the Government purchase orders the monthly accruals were called "rent paid as equity." When the purchase order was made up, the owner of the1949 U.S. Tax Ct. LEXIS 241">*251 item was reimbursed for any freight it had paid in the delivery of equipment. Thus, when monthly payments equaled value, plus 1 per cent, plus freight, if any, the Government had a right to receive a bill of sale from the owner. If title to equipment had not passed to the Government automatically, as above, before the time when work was completed or the agreement was terminated, then upon the happening of those events the Government had the right to make a final payment in return for a bill of sale. The final payment was to be in an amount which when added to the monthly payments would equal the total of value per contract, 1 per cent per month, and freight, if any. The way the final payment was computed is shown hereinafter.

The parties have stipulated as follows: The total price paid by the Government for an item of equipment was the sum of the contract value of the item, the 1 per cent increment, and freight. When the Government acquired title to the equipment in 1942, the monthly accruals were applied on the total price.

In the equipment agreement the parties were designated "lessor" and "lessee," and the monthly payments were called "rent." In the schedule attached to continuations1949 U.S. Tax Ct. LEXIS 241">*252 of an original agreement, the monthly payments which had been made, which were carried forward, were called "rent paid as equity."

The following schedule shows the number of the agreed monthly payments, without additions for overtime, the sum of which would equal value per contract. The following schedule, relating to 27 items, is typical of the agreement, as it covered the entire 62 items. 12 T.C. 446">*451

As the work progressed at the Hoosier Plant and certain pieces of equipment1949 U.S. Tax Ct. LEXIS 241">*253 were no longer needed there, the Government instructed that items of equipment be moved to other places from time to time. Before the end of 1941, 50 pieces were moved to other construction jobs, and only 12 remained at Hoosier Ordnance Plant. The pieces were moved at various times, and, in particular, on September 6, November 17, November 23, December 1, 1941, and February 25, 1942. The other jobs were located at Huntsville, Alabama; Plum Brook, Ohio; Wabash River Ordnance Works, Indiana; the Mississippi Ordnance Plant; and the Arkansas Ordnance Plant. At the end of 1941 the original agreement, as supplemented by the agreements which were made when equipment was moved, showed a considerable equity in the Government in most of the 62 items which had been delivered earlier in the year to the Hoosier job.

Monthly payments were made under the agreements in 1942 for equipment with the exception of 18 items for which the last monthly payments were accrued in December 1941. Monthly payments were accrued for 1 item for January and part of February 1942; and for part of January for 5 items.

At various times from January to July 1942 the Government forwarded purchase orders for all of1949 U.S. Tax Ct. LEXIS 241">*254 the 62 items and made final payments in return for bills of sale. The Government acquired the above mentioned 18 items as of December 31, 1941, but did not make the final payments nor forward the purchase orders until early in March 1942; and the partnership did not receive any notice about the final payments until 1942. In some instances the final payment was less than the agreed amount of a monthly payment.

12 T.C. 446">*452 The construction work at the Hoosier job approached completion in November and December 1941, and it was finished in January and February of 1942.

When Winston Bros. was instructed by the War Department, under its letter of November 3, 1941, to release equipment from the Hoosier Plant and transfer it to Huntsville, Alabama, it notified the partnership in part as follows:

In accordance with instructions issued relative to the transfer of equipment to other projects, we are forwarding to receiving project photostatic copies of your rental agreement Form 40-2111, dated March 6, 1941, together with schedule "A" and lien sheets in which the valuation and rental of this equipment is set forth. * * *

Further, in accordance with Government instructions set forth in War Department1949 U.S. Tax Ct. LEXIS 241">*255 letter QM480E dated November 3, 1941, relative to the transfer of this equipment, we are forwarding to the receiving post the amount of rentals paid up to the date of the Bill of Lading, which amount will be entered into the rental agreement between yourselves and the receiving post.

Winston Bros. stated, inter alia, in a letter to the Constructing Quartermaster at the Hoosier Plant relative to its transfer of equipment to Huntsville, that: "This equipment [was] leased by us from Truman Bowen Company -- J. L. McLaughlin, on Purchase Order WHMS #1278."

Kershaw, Butler Inc., the contractors at Huntsville, notified the partnership, in connection with the equipment rental agreement with Kershaw, in part as follows:

* * * We have inserted the figures as submitted to us from the Hoosier Ordnance Plant, Charlestown, Indiana, relative to the amount of equity on each piece of equipment.

The following, taken from the agreement of November 17, 1941, with Kershaw, illustrates the procedure which was followed in the execution of equipment rental agreements covering equipment which was released and transferred by Winston Bros. to other construction projects:

12 T.C. 446">*453 When the Government exercised its right to take over equipment, the War Department purchase order provided as follows for each item:

* * * ^*

1949 U.S. Tax Ct. LEXIS 241">*257 12 T.C. 446">*454 All of the equipment involved in this proceeding was acquired by the partnership at various times in 1941. In every instance the cost to the partnership was less than the value agreed upon under each original equipment agreement. In some instances, the value per agreement was the same as "cost new," and in other instances it was less. The schedules attached to the agreements set forth both "cost new" and value under the agreement. The 62 items cost the partnership the total sum of $ 315,733.21, and the total values under the agreements were $ 427,281.76.

At the end of 1941 the monthly payments on 52 items of equipment exceeded the partnership cost, or exceeded 50 per cent of the partnership cost, as follows: The monthly payments at the end of 1941 exceeded the cost to the partnership of 17 items; were close to the cost of 3 items; and were in excess of 50 per cent of the cost of 32 items. The monthly payments on 10 items amounted to less than 50 per cent of cost at the end of 1941.

The final payments which the Government made in the cases of 9 items covered only the 1 per cent increment, or the 1 per cent plus all or part of 1 monthly payment; and in 12 instances, it1949 U.S. Tax Ct. LEXIS 241">*258 covered the 1 per cent increment plus an amount which was less than 2 monthly payments.

The following schedule shows the operation of the agreements with respect to all of the equipment. The cost of each item to the partnership has been omitted as a matter of convenience. (The total cost is given elsewhere.) 12 T.C. 446">*455

1949 U.S. Tax Ct. LEXIS 241">*260 As stated previously, the various pieces of equipment were delivered to work projects at various times during 1941, after March 6, 1941. Eight items were delivered after October 27, 1941. The following schedule shows, by item, the percentage of contract value which the 1941 payments represented: 12 T.C. 446">*456

With respect to the 18 items not used after 1941, which the Government acquired in the early part of 1942, the percentages of the total monthly payments in 1941 to the values of the items were as follows:

1949 U.S. Tax Ct. LEXIS 241">*261 With respect to the above 18 pieces of equipment, the cost to the partnership, the total value per contract, the total amount paid by the Government, the total "rental" payments made in 1941, and the total of the sums paid by the Government in 1942 upon execution of the purchase orders were as follows:

12 T.C. 446">*457 The total monthly payments on the 62 items in 1941 were 43.6 per cent of the total value per contract of the items.

With respect to the equipment which the Government purchased in 1942, on which rental payments were made in 1942 as well as in 1941, the following schedule shows the total paid under the agreements, "rent" paid in 1941 and in 1942, and the total of payments made upon "recapture" in 1942:

The following schedule sets forth the total amounts, for the entire 621949 U.S. Tax Ct. LEXIS 241">*262 items of equipment, of the value per contract; of freight paid by the partnership in certain instances; of 1 per cent per month of value up to the time of execution of bills of sale; of rental payments in 1941 and 1942; and of the final payments in 1942:

The final payments in 1942, exclusive of 1 per cent interest per month and freight were about 31 per cent of the total contract value of the 62 items of equipment.

All of the equipment covered by the agreements was used by the partnership in its business.

Under all of the agreements, the value of each item of equipment represented the amount which was required for transferring title, to which was to be added 1 per cent per month plus freight.

The partnership kept its books on the accrual basis. The partnership did not return for tax purposes for 1941 any of the amounts which it had received or accrued in 1941 as rental payments1949 U.S. Tax Ct. LEXIS 241">*263 under the agreements. The partnership did not return for tax purposes for 1941 any profit from the agreements as income from installment sales.

The rental payments which were received or accrued in 1941 were credited to a suspense account. When the Government acquired title to the equipment in 1942, these amounts were cleared from the suspense account and credited to the partnership's asset account. Profits 12 T.C. 446">*458 on these transactions were reported in the partnership's income tax return for 1942 as capital gains under section 117 (j) of the Internal Revenue Code, and petitioner reported his share of these profits in his 1942 income tax return.

During 1941 the partnership paid freight on moving equipment to Government jobs in the total amount of $ 3,446.71. That amount was charged in 1941 to the partnership's freight expense account, and was closed to profit and loss at the end of the year. It was reflected in the cost of labor, supplies, etc., in line 2 (c) of the 1941 partnership income tax return, Form 1065.

The partnership did not take any deductions for depreciation of any of the 62 items of equipment in its income tax return for 1941.

Prior to "recapture" of items of1949 U.S. Tax Ct. LEXIS 241">*264 equipment by the Government, the partnership paid all property taxes assessed against the equipment, and carried insurance thereon against loss and public liability, which items were charged to expense and were deducted as such in the partnership's income tax returns.

The partnership and petitioner were given extensions of time within which to file income tax returns for the year 1941, and these returns were filed on April 15, 1942.

The petitioner and the Commissioner entered into an agreement, pursuant to section 276 (b), to extend the time within which the Commissioner might assess a deficiency for the year 1941 to June 30, 1946, which time was later extended to June 30, 1947. The notice of deficiency was issued on July 23, 1946.

OPINION.

In his original determination respondent applied the provisions of I. T. 3533, C. B. 1941-1, p. 87; as amended by I. T. 3631, C. B. 1943, p. 197. That is to say, he gave recognition to the fact that the Government took title to all of the equipment in 1942 and determined that a proportionate part of the profit, $ 66,692.36, was allocable to the year 1941. The ruling set forth in I. T. 3533 is one which permits a taxpayer to allocate the profits1949 U.S. Tax Ct. LEXIS 241">*265 from a contract, such as we have before us in this proceeding, among the years during which the contract is in force. However, the partnership did not elect to follow the permissive method of reporting income which is set forth therein. In this proceeding petitioner contends that it is not required to report income from the contract in question under this ruling, and we think petitioner is correct in that view, as will be shown hereinafter.

Under his answer, the respondent made an alternative affirmative allegation. On the basis of this affirmative pleading, the respondent moved for increase in the deficiency of this petitioner from $ 26,779.90 to $ 57,700.31 under the provisions of section 272 (e) of the Internal 12 T.C. 446">*459 Revenue Code. Respondent now contends that the entire amount of the payments received under the contracts in 1941, which aggregated $ 191,248.49, constituted ordinary rental income to the partnership under section 22 (a) of the Internal Revenue Code. The question presented is whether the 1941 payments represented rents. This question is considered first. Whether or not the 1941 payments under the contract constitute rent depends upon the construction1949 U.S. Tax Ct. LEXIS 241">*266 of the contract of March 6, 1941, Government Form No. 40-2111.

The determination of the question whether an agreement is a lease or a conditional sales contract is often difficult. Union Stock Yards & Transit Co. v. Western Land & Cattle Co., 59 F. 49, 53; Beckwith Machinery Co. v. Matthews, 57 Atl. (2d) 796, 798; 47 Am. Jur., pp. 24, 25, and 26, secs. 836, 837. In In Re Rainey, 31 Fed. (2d) 197, the court stated the distinction as follows:

The distinction between an ordinary lease and a conditional sale is obvious. A lease contemplates only the use of the property for a limited time and the return of it to the lessor at the expiration of that time; whereas, a conditional sale contemplates the ultimate ownership of the property by the buyer, together with the use of it in the meantime.

See also Vermont Acceptance Corporation v. Wiltshire, 153 A. 199, 200; Hamilton v. Highlands, 56 S.E. 929.

The determination of whether an agreement is a lease or a conditional sales contract is controlled neither by the 1949 U.S. Tax Ct. LEXIS 241">*267 form nor by the use of the terms "lease" and "rent." "It is necessary to look through form to substance," In Re Rainey, supra; and the "courts will always look to its purpose, rather than to the name given to it by the parties," Hervey v. R. I. Locomotive Works, 93 U.S. 664">93 U.S. 664, 93 U.S. 664">672; Schmidt v. Boder, 130 A. 258.

Under the Uniform Conditional Sales Act, par. 1:

A lease is substantially equivalent to a conditional sale when the buyer is bound to pay rent substantially equal to the value of the goods and has the option of becoming or is to become the owner of the goods after all the rent is paid. In such a contract "rent" means the purchase price, and possession as "lessee" means the possession of a buyer under an executory contract of sale. That the buyer, in some cases, has the option of becoming the owner and thus a sale is not sure to take place, is of but small importance, for, as a practical matter, the buyer will always be willing to accept ownership when he has paid the value.

See also Eager, The Law of Chattel Mortgages and Conditional Sales and Trust Receipts, 1941, pp. 388-391; 1949 U.S. Tax Ct. LEXIS 241">*268 Jefferson Gas Coal Co. v. Commissioner, 52 Fed. (2d) 120, 122, affirming 16 B. T. A. 1135; A. B. Watson, 24 B. T. A. 471, affd., 62 Fed. (2d) 35.

In this proceeding attention is drawn first to the clause in Standard Form 40-2111, the contract which is to construed, which provided that when monthly payments equaled the stated value, plus 1 per cent 12 T.C. 446">*460 per month for each month of use, plus freight (if any), title would pass to the Government; and to the fact that the amounts of the agreed monthly payments, or rental payments, were in such amounts that the payment thereof over a period of from 6 to 10 or 12 months would equal the contract value of an item. It is stated in Jones, The Law of Chattel Mortgages and Conditional Sales, 6th Ed., vol. 3, pp. 66, 67, sec. 958, that such provision in a contract "is a matter of no slight importance, and is uniformly given prominence by the courts in their consideration of the contract's controlling feature." ¹ See also Williston on Sales, 2d Ed., p. 780, sec. 336, where it is said that:

Sellers desirous of making conditional1949 U.S. Tax Ct. LEXIS 241">*269 sales of their goods, but who do not wish openly to make a bargain in that form, for one reason or another, have frequently resorted to the device of making contracts in the form of leases either with options to the buyer to purchase for a small consideration at the end of the term, provided the so-called rent has been duly paid, or with stipulations that if the rent throughout the term is paid, title shall thereupon vest in the lessee. It is obvious that such transactions are leases only in name. The so-called rent must necessarily be regarded as payment of the price in instalments since the due payment of the agreed amount results, by the terms of the bargain, in the transfer of title to the lessee. This has been clearly recognized and many of the statutes relating to conditional sales in express terms include leases within their scope. Apart from statutes courts have disregarded the form of the transaction and have held that where payment of so-called rent nearly or quite pays the price of the goods the bargain is conditional sale and subject to the rules governing that kind of transaction. [Italics added.]

1949 U.S. Tax Ct. LEXIS 241">*270 There was also the provision in Standard Form 40-2111 that upon the termination of the prime or principal contract with the Government, or upon the completion of work, the Government had the right to take title to the equipment upon payment of one final sum which, when added to the monthly payments, would equal value, if title had not passed automatically under the other provision which has been referred to above. This part of the clause relating to transfer of title must be considered in the light of the entire contract and, while it is a provision which gives the Government an "option" to acquire title, the purpose of the agreement is made clear by many facts in the record, as will be discussed hereinafter; and we are of the opinion that the dominant purpose was to enable the Government to acquire the equipment.

The record in this proceeding shows that the form of the agreement was required by the Government; that the Government was in need 12 T.C. 446">*461 of obtaining certain kinds of equipment; that the procedure for doing so was called "recapture"; that lists were made in Washington of the kinds of equipment which the Government would "recapture"; and that such lists were sent1949 U.S. Tax Ct. LEXIS 241">*271 to Government contracting officers throughout the country. The clause which provided for the Government's taking title, which is set forth in the findings of fact, enabled "recapture." In addition, the so-called rentals, which stood to increase with overtime operations, were in such amounts in relation to the agreed value as to indicate clearly that the parties had in mind that the payments were for more than just hire of goods. Since the critical clause in the agreement provided for transfer of title to the Government when "rents" equaled value, and provided for payment of 1 per cent per month from the delivery of the item, and, taking into consideration the intent of the Government to "recapture" certain equipment to meet its needs, it was the purpose of the agreement to provide for a sale and purchase in terms of a conditional sales contract. There could be no doubt about that if the critical clause had ended with the provision for transfer of title when "rents" paid equaled value. See Jones op. cit., supra; Billiter v. Ledbetter-Johnson, Contractors, Inc., 2 S. E. (2d) 677; Central Union Gas Co. v. Browning, 131 N. Y. S. 464;1949 U.S. Tax Ct. LEXIS 241">*272 modified (but affirmed on conditional sales holding), 103 N.E. 822; Holeproof Hosiery Co., 11 B. T. A. 547; and Alexander W. Smith, Jr., Executor, 20 B. T. A. 27.

Under such provision for transfer of title, the parties did not contemplate return of the equipment to the so-called lessor, in all events; and "The so-called rent must necessarily be regarded as payment of the price in installments since the due payment of the agreed amount results, by the terms of the bargain, in the transfer of title to the lessee." Williston on Sales, supra.

At the end of 1941 the monthly payments equaled agreed value for one item (No. 8), and were $ 6 short of equaling agreed value of two items (Nos. 21 and 22).

The issue in this proceeding revolves about the interpretation of the clause in its second aspect wherein the Government could acquire title by paying a final sum which, when added to the monthly "rentals" already paid, would equal value plus 1 per cent. If that provision stood alone, without the first provision for passage of title when monthly payments equaled value, there would be much more doubt1949 U.S. Tax Ct. LEXIS 241">*273 about whether the agreement was a conditional sales contract. But in the presence of the first aspect of the clause, the second one, which uses the term "option," is not to be regarded as the controlling factor. The factor is one of small importance. As is said in the Uniform Sales Act, supra:

* * * That the buyer, in some cases, has the option of becoming the owner and thus a sale is not sure to take place, is of but small importance, for as a 12 T.C. 446">*462 practical matter, the buyer will always be willing to accept ownership when he has paid the value.

See Beckwith Machinery Co. v. Matthews, supra;Phelan v. Stockyards Bank, 276 P. 175, 178; In Re Rainey, supra;Judson Mills, 11 T.C. 25; Helser Machine & Marine Works, Inc., 39 B. T. A. 644, 646.

The parties to this proceeding have stipulated that the purchase price was the sum of the monthly payments, plus 1 per cent of value per month, plus freight (if any); and that when the Government acquired title to the equipment in 1942 the monthly accruals [payments] were applied1949 U.S. Tax Ct. LEXIS 241">*274 on the purchase price, as is set forth in the findings of fact. Also, the evidence shows, apart from the above stipulation of the parties, that the monthly payments, or "rentals," were carried in the agreement itself, in the supplemental schedule A, as "Equity," and that in the Government purchase orders, the "rentals," were applied to the purchase price, which was the value of the item stated in the agreement.

In this proceeding the record shows the amount of the lump sum, final payment which the Government made in 1942 when it acquired title, at various times, to each item of equipment, as well as the amount of the 1 per cent of value increment, and the amount of the monthly payment, for each item. As is stated in the findings of fact, the final payment covered only the 1 per cent of value increment (which was called interest in the purchase orders), or the 1 per cent addition and only the amount of 1 monthly payment, or less, in 9 instances; and the 1 per cent addition and an amount which was less than 2 monthly payments in 12 instances. Thus in the instances of 21 items (out of 62) the final payment was clearly a very small one compared to value. Also, at the end of 1941 the1949 U.S. Tax Ct. LEXIS 241">*275 monthly payments for 18 items, on which no further monthly payments were made prior to transfer of title, amounted to from 43 per cent to 101 per cent of the agreed value. Also, at the end of 1941 the monthly payments on 52 items exceeded cost or 50 per cent of cost; and the monthly payments on the 62 items were 43.6 per cent of the total value thereof.

It was said in In Re Munger Fish Co., 9 Fed. (2d) 54, 56, that:

The final payment, which is nominally the purchase price, is so small in comparison with the entire purchase price as to leave no real choice to the "lessee." The obvious purpose was to dispose of the machine under such conditions that when the "lessee" had paid the "rental" he could not afford to fail the relatively small final payment to obtain it. This would have been the obvious and natural, if not the inevitable, result. Evidently, it was what the parties desired and intended to accomplish.

See also Beckwith Machinery Co. v. Matthews, supra; and Watson v. Commissioner, 62 Fed. (2d) 35, 36, where it was said:

It is unthinkable that the payment of $ 47,000, which1949 U.S. Tax Ct. LEXIS 241">*276 is about 43 per cent of the entire consideration, upon property valued at $ 109,000, is an annual rental * * *

12 T.C. 446">*463 Thus, for example, the final payment for item No. 8 was $ 1,245.23. The value thereof in the contract was $ 14,000; the monthly "rent" was $ 1,350; and the "interest" at 1 per cent of value was $ 1,120. In many instances the total monthly payments amounted to from 70 per cent to 100 per cent of the value of the item, and the single payment upon acquisition of title was 30 per cent or less of the value, plus the 1 per cent of value increment. It has been found as a fact that the aggregate final payments in 1942 were about 31 per cent of the aggregate value of the 62 items, exclusive of the 1 per cent increment.

In In Re Rainey, supra, where a similar contract was involved, the court said:

In the present case the rental of the machinery for three months, the full term of the lease, amounted to 60% of its entire value. A charge so disproportionate to the term of user in relation to the value of the articles, all of which were second hand, in and of itself certainly suggests a sale.

In this proceeding, the facts show such relation 1949 U.S. Tax Ct. LEXIS 241">*277 of the so-called rental payments to value and that they represented such a substantial portion of value that they constituted more than a mere payment for hire. The testimony of petitioner, that it is likely that the equipment covered by the 1941 contract is still being used today, indicates that the monthly payments were "disproportionate to the term of the user in relation to the value of the articles"; and the evidence shows this to be a fact. The parties have stipulated the amount of the monthly "rental" of each item, and the "rental" was one-sixth to one-fifteenth of value, as a schedule in the findings of fact demonstrates. See Judson Mills, supra.

A peculiarity of the agreement under consideration is that all of the 62 pieces of equipment were not delivered thereunder at one time, but were delivered at various times after the agreement was executed on March 6, 1941, up to and including December. The Government "recaptured" items from time to time in 1942, up to and including July. In that situation, the final lump sum payments varied in amount and in the ratio of each one to the value of the equipment. In other words, the agreement operated1949 U.S. Tax Ct. LEXIS 241">*278 as to each item during varying periods of time. But regarding the entire operation of the contract as of December 31, 1941, the Government had a considerable, even though varying, equity in each of the 62 pieces of equipment, and at the end of 1941 the parties regarded the monthly payments as representing equity in each item. We must deal with this unique contract as it was intended to operate, and weigh the unusual features in accordance with what the evidence shows to have been the purpose of the entire agreement, with its supplements.

Furthermore, because of the practical phases of the operations under the agreement, i. e., the moving of items from time to time, and the 12 T.C. 446">*464 different dates of delivery of items to the Hoosier Ordnance Plant, the agreement could not have a stated term. It is obvious, however, that it contained terminal features, because the value of each item and the amount of each monthly payment were agreed upon, and the contract would end, with respect to a single item, at the latest, when the monthly payments equaled value. The facts with respect to the value and the amounts of each monthly payment show that the parties intended that the agreement was1949 U.S. Tax Ct. LEXIS 241">*279 to extend over a short period of 6 to 15 months. The agreement resembled, therefore, the type of agreements where monthly payments are to be made for a stated period, and at the end of that period a small additional payment is to be made to acquire title. See, for example, the following cases where the period of the agreement was for a stated number of months or years, and at the end of the period, if monthly payments were not in default, the "lessee" could acquire title to property upon payment of a small additional amount: Holeproof Hosiery Co., supra; and Judson Mills, supra, where the contracts were held to be something other than an ordinary lease, the holding as to the nature of the monthly payments being that they were not rent for purposes of the income tax. See, also, Helser Machine & Marine Works, Inc., supra.

If the agreement were to be construed as a lease, and the final payments were to be regarded as the "purchase" price, the result would be that the partnership sold each one of the 62 items in 1942 at a loss, because in every instance the final payment was less than cost1949 U.S. Tax Ct. LEXIS 241">*280 to the partnership, less depreciation. The evidence shows that the partnership had need for the equipment in question and, in fact, had to go out on the market to purchase equipment. To take the view that the partnership would have entered into a contract under which it might sustain losses upon sales would be an unreasonable one. There was a demand for equipment at the time, and sales could be made at a profit.

On the other hand, construing the agreement to be a conditional sales contract, the partnership realized a gain of about $ 150,900 on the sale of the 62 items.

Section 23 (a) (1) (A) of the Internal Revenue Code defines rent as payment for the use or possession of property. It excludes from the term "rent," payments for the use or possession of property to which the taxpayer is taking title, or in which he has equity. Under the facts in this proceeding, the Government was acquiring something of value under the payments and, since it was called "equity" under the agreements, and the agreements gave the Government the right to take title, the contract payments of 1941, involved in this proceeding, do not come within the definition of "rent" in section 12 T.C. 446">*465 23 (a) (1)1949 U.S. Tax Ct. LEXIS 241">*281 (A) of the code. It is concluded that the payments were not rent, and, therefore, are not taxable as ordinary income.

While this proceeding was pending in this Court, and after the briefs were filed, Estate of Clarence B. Eaton, 10 T.C. 869, was decided. Under issue No. 2 in that proceeding (pp. 874 and 880-883), the question was whether amounts received by the taxpayer in 1942, under a fixed fee construction contract with the Government which contained a provision which was the same as the pertinent one in this proceeding, constituted ordinary income. The facts were stipulated, and a copy of the fixed fee construction contract was introduced in evidence. The contract, C. P. F. F. Form No. 1, was an entirely different form of contract than the one which is involved in this proceeding, which is Form 40-2111. However, in clause 2 of the contract was a provision for the rental of the constructor's equipment, and it contained the same kind of clause as is involved in this proceeding. In the Eaton case, the parties stipulated that certain payments made by the Government were "for the use" of items of equipment and machinery, and upon consideration1949 U.S. Tax Ct. LEXIS 241">*282 of the evidence and the contract there involved, we concluded that the "rentals" were "not an element of the purchase price" and "were not 'applied' to that price, but, on the contrary, were expressly excluded from it." Also, in the Eaton case, the respondent argued that the Government "was not interested in acquiring equipment," so that the transfer of the equipment and the payments lost "their character as elements of a sale transaction."

Comparison of the facts in this proceeding and of the contract involved, Form 40-2111, with the facts found in the Eaton case brings out several important factual differences in this case, as follows: (1) There is testimony of the head of an equipment department for the Army engineers that the Government wanted to acquire certain types of equipment (of the kind involved in this proceeding), and orders had been issued from Washington to the field to "recapture" such equipment, and, to that end, to put the "recapture" clause in all contracts; and that the Government policy was that if payments under a contract equaled the value fixed at the time equipment was furnished, the Government should own the equipment upon paying the agreed value. 1949 U.S. Tax Ct. LEXIS 241">*283 (2) The value of each piece of equipment was agreed to in the contract and in supplements to the contract when equipment was delivered, and the accrued payments under the contract were entered in the supplemental contracts as the Government's "Equity"; and in the purchase orders the payments previously made were designated "equity." (3) The parties have stipulated that the total price paid by the Government for an item of equipment was the sum of the contract value of an item, the 1 per cent increment, and freight; and that, when the Government acquired title to the equipment in 1942, the 12 T.C. 446">*466 "rent" payments were treated "as the Government's equity applied on the price paid by the Government." (4) The monthly payments agreed upon were in such amounts that the payments thereof over a period of from 6 to 10 or 12 months would equal the contract value, or purchase price, of the item. (5) The final payments by the Government for one-third of all of the items of equipment were small in amount compared to the value of the items.

Such facts, as above referred to, were not found in the Eaton case and, lacking them, it was reasonable to conclude that it was the intent of the1949 U.S. Tax Ct. LEXIS 241">*284 parties to the contract in that case that machinery and equipment were being rented. The petitioner in that case stipulated that the payments involved were "for the use" of equipment, which signifies that the parties intended that the payments were rent, and this stipulation was regarded by this Court as highly determinative of the question presented. See p. 880. In this case, we have a different form of contract, in which monthly payments were entered as the Government's "equity," and a stipulation that the payments were applied to the total price. In view of the differences in the contracts, the intent of the parties, the facts as shown by the records, the exhibits, and the stipulations in the two proceedings, this proceeding is distinguishable from the Eaton case.

In the consideration of the issue presented, review has been made of practically all of the decisions by this Court in cases where the general question was whether payments constituted rent or payments of purchase price under some form of sale agreement, and attention has been given, in particular to the following: Goldfields of America, Ltd., 44 B. T. A. 200; Rotorite Corporation, 40 B. T. A. 1304;1949 U.S. Tax Ct. LEXIS 241">*285 reversed, 117 Fed. (2d) 245; Gilken Corporation, 10 T.C. 445; Indian Creek Coal & Coke Co., 23 B. T. A. 950. The holdings in such cases are not apposite to the facts and the contract involved in this proceeding.

Petitioner relies chiefly upon the rationale of Virginia Iron Coal & Coke Co., 37 B. T. A. 195; affd., 99 Fed. (2d) 919. In our opinion, it is unnecessary to consider the applicability of the reasoning of that case to the question presented, in view of the character of the contract we have here, and the facts.

It is concluded that the agreement in this proceeding was in the nature of a conditional sales contract, upon the record before us, and under the authorities which are cited above. It is held that the payments under the contract which the partnership accrued in 1941 were not rents, but were payments on purchase price. Respondent's alternative contention is rejected.

A further question remains which is disposed of briefly. Respondent originally determined that the partnership realized in 1941 a proportionate part of1949 U.S. Tax Ct. LEXIS 241">*286 the entire profit from the disposition of the 12 T.C. 446">*467 equipment under bills of sale in 1942, and increased the partnership income by $ 66,692.36. He made this determination by applying to the partnership a ruling in I. T. 3533, C. B. 1942-1, p. 87. He determined that $ 66,692.36 represented "the percentage of profit realized under the contract with respect to the payments received in the year 1941."

We have considered the above ruling, as amended by I. T. 3631, C. B. 1943, p. 197. The method set forth in I. T. 3533, supra, permits a taxpayer to treat a contract of the kind involved as a contract to sell property on the installment plan, and appears to approve interpretation of the contract as one where title is to remain in the vendor until the purchaser has performed his part of the transaction. The ruling is permissive. It appears that it allows a taxpayer to have the benefits of section 44 (b) of the Internal Revenue Code, which applies to casual sales of personalty. But the ruling does not deal with the alternative method or methods of reporting income under such type of contract where the taxpayer does not elect to use the permitted method.

The partnership did not1949 U.S. Tax Ct. LEXIS 241">*287 elect to accept the "privilege" of reporting income from the contract under I. T. 3533. The Commissioner can not compel the partnership to make an election which it does not choose to make. The installment method of accounting is optional. Indeed, the binding effect of making an election, and the problems inherent in changing from the installment basis to the accrual basis under the Commissioner's regulations, suggest that the taxpayer must be free to chart his own course. See also Regulations 111, section 29.44-1, p. 270, where it is said:

If the vendor chooses as a matter of consistent practice to return income from installment sales on the straight accrual or cash receipts and disbursements basis, such course is permissible.

Respondent erred in increasing the partnership income for 1941 with respect to the payments under the agreements in question, and in increasing petitioner's share of the partnership income.

Decision will be entered under Rule 50.

Murdock, J., dissenting: I do not think this case is distinguishable from Estate of Clarence B. Eaton, 10 T.C. 869.

Johnson, J., dissenting: In holding that payments 1949 U.S. Tax Ct. LEXIS 241">*288 received from the Government on account of equipment constituted selling price under a conditional sale agreement and not rent as recited in the contract, the majority imputes to the Government a fixed intention to buy 12 T.C. 446">*468 the equipment when the contract was made and relies on decisions in which similar contracts between individuals and corporations have been so construed. In my opinion the motives of financial caution which might influence private parties to incorporate lease terms or "recapture" clauses in contracts really intended to effect sales can not be rationally imputed to the United States Government. It requires no "easy payment plans," no credit extensions, no safeguards against future financial straits. If it had harbored a fixed intention of purchasing the equipment when the contract was made, it would have bought it then for cash. Since it did not do so, the conclusion seems inescapable that it had no fixed intention to buy at that time and meant to rent, as it purported to do. In Estate of Clarence B. Eaton, 10 T.C. 869, this Court treated similar payments as rent under a Government contract that, as the majority here expressly1949 U.S. Tax Ct. LEXIS 241">*289 states, "contained a provision which is the same as the pertinent one in this proceeding." I perceive no material respect in which the facts here shown differ from those considered there, and the majority's conclusion in this case seems to me in direct conflict with the Court's prior holding.