Gounares Bros. & Co. v. United States

• Citation: 292 F.2d 79
• Decision Date: 21 June 1961
• Docket Number: No. 18719.,18719.
• Parties: GOUNARES BROS. & CO., Inc., Appellant, v. UNITED STATES of America, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

292 F.2d 79 (1961)

GOUNARES BROS. & CO., Inc., Appellant, v. UNITED STATES of America, Appellee.

No. 18719.

United States Court of Appeals Fifth Circuit.

June 21, 1961.

Vincent F. Kilborn, Willis C. Darby, Jr., Mobile, Ala., for appellant.

George F. Lynch, Atty., Dept. of Justice, Washington, D. C., Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Atty., John B. Jones, Jr., Washington, D. C., Ralph Kennamer, U. S. Atty., Mobile, Ala., Louis F. Oberdorfer, Asst. Atty. Gen., A. F. Prescott, David O. Walter, Attorneys, Department of Justice, Washington, D. C., for appellee.

Before RIVES, JONES and BROWN, Circuit Judges.

JOHN R. BROWN, Circuit Judge.

This case presents primarily the question of the accrual of interest as a deduction to the payor corporation on an obligation owing to its controlling stockholder-officer-director. The Commissioner in a deficiency assessment treated the obligation as a debt for which interest would be payable and deductible. But he concluded that it was accruable during each of the four years and not, as Taxpayer treated it, in the final (fourth) year in which it was paid. Accrual to the prior years had the ostensible and momentary effect of increasing expenses for each of these years, thereby increasing losses which normally would be carried forward to extinguish the deficiency in the year of payment. But this was forbidden in view of § 24(c) (1), 26 U.S. C.A. § 24(c) (1) (1939 Code), which requires that as between controlled taxpayers having different accounting methods, the interest accrued to the payer must be paid in cash (or constructively so) to the related payee within two and one-half months in order to be deductible. This was not done in the three prior years. The result is that while the corporation is accorded the right to treat the obligation as a debt giving rise to legitimate interest charges which were finally paid in cash (and thereby subject to income tax in the payee's hands), the corporation loses three-fourths of the deduction.

After payment and claim for refund, the Taxpayer sued to recover the deficiency. The District Court did not directly decide the question whether interest was to be accrued in each of the four years. Considering the manner in which the case was presented and tried, the Judge focused on two things. The first was the belated contention of the Government that this was a "thin" corporation so that the large advances to the corporation constituted a contribution to capital and not a debt on which interest could be paid and deducted.¹ The second was the contention there primarily, here secondarily, urged by the Taxpayer that even though interest must be accrued to each of the three previous years there was a constructive receipt of income by the payee so that the timely election by payer and payee under the Technical Changes Act of 1953² made the deduction by the payor proper and consequently the carry forward of the loss was permitted. The District Court concluded that it was a debt giving rise to interest and, more or less as a matter of course, assumed it had to be accrued in each of the years. It also held that there had not been a constructive receipt by the payee so the election was ineffectual.

We do not disturb either of these conclusions.³ We do, however, hold that within the applicable clearly erroneous concept embodied in F.R.Civ.P. 52(a), 28 U.S.C.A., the District Court's implied finding is contrary to the right of this unique case and therefore may not stand. Bishop v. United States, 5 Cir., 1959, 266 F.2d 657, at page 666; Nye v. Lovelace, 5 Cir., 1956, 228 F.2d 599, at page 603; Sanders v. Leech, 5 Cir., 1946, 158 F.2d 486, at page 487. In reaching this we do not make credibility choices at variance with those made by the Trial Judge. Indeed, the record is virtually without substantial contradiction. Cf. Baldwin v. Morgan, 5 Cir., 1961, 287 F.2d 750, at page 752; Riedel v. Commissioner, 5 Cir., 1958, 261 F.2d 371, at page 372; Raymond Pearson Motor Co. v. Commissioner, 5 Cir., 1957, 246 F.2d 509, at page 513; Goldberg v. Commissioner, 5 Cir., 1955, 223 F.2d 709, at pages 711-713.

War cuts a big figure in this case. It was the aftermath of World War II which brought all of this into being. It was the Korean War which produced the income now taxed. It all began in 1946. Alex Gounares, a naturalized citizen living in Alabama, had considerable savings produced out of the theater business. He was concerned about his brother Petros, a Greek citizen and a master mariner by trade. Greek shipping, as was the Greek economy, was at a very low ebb. The outlook for Petros was equally dismal. Alex conceived the idea that it would be good to acquire a vessel which Petros could command and through the shipping business find profitable and satisfying employment. Alex had thought that a small vessel costing about $25,000 could be obtained from American war surplus fleets. This turned out to be unavailing. He continued negotiations with the United States Maritime Commission under the Ship Sales Act of 1946, 61 Stat. 449. Instead of a small vessel originally hoped for, Alex became the successful bidder for a Hog Island vessel which had practically passed through two wars and two names. The vessel was certainly approaching, if she had not reached, the "twilight of her life." Ionion S.S. Co. of Athens v. United Distillers of America, Inc., 5 Cir., 1956, 236 F.2d 78, at page 81, 1956 A.M.C. 1750, at page 1753. Shortly he received the bill of sale covering the S. S. William R. Gibson (ex-West Segovia). The terms of sale permitted transfer to the Panamanian registry and flag. She cost $231,611. From the proceeds of savings bonds which he sold, and a $75,000 loan obtained on his individual credit from a local bank, Alex paid this purchase price in cash. Additional essential equipment to outfit the vessel brought the total sum to $245,031.39.

As a part of this plan, an Alabama corporation, Gounares Bros. & Co., here the Taxpayer, was formed on February 6, 1947, with a total authorized capital of $25,000.⁴ The articles of incorporation expressly provided that the subscription of Alex was to be discharged by the transfer of the vessel which by now had acquired her third name, the S.S. Ourania Gounares. By the terms of the conveyance of the ship from Alex to the corporation, Alex was to have a preferred maritime mortgage covering after crediting the stock subscription, the purchase money paid and all other expenditures. But no mortgage was then, or ever, executed.

The corporation commenced operations in February 1947. Following a common practice in the maritime industry, it appointed a local shipping company as its managing agent whose compensation came largely from commissions on freights. The corporation had no source of credit. Whatever was needed was supplied by Alex. In its first year's operations, Alex, in addition to the initial purchase money, had advanced $61,643.15. After crediting stock subscription and repayments out of gross operating receipts, the amount due Alex on February 12, 1948, was $215,254.15. On that date the directors by formal resolution authorized the officers to execute a preferred ship mortgage under the Panamanian law to secure payment of a promissory note maturing in one year in like amount at 4% interest. Those papers were prepared by the corporation's maritime counsel but were never executed. From then until 1951 the amount due Alex was never lower. Indeed, the balance increased considerably.⁵

The reason for this was not difficult to see. The managing agents could find employment for the ship scarcely 50% of the time. And when employment was found, freights were barely able to pay operating costs, and what little remained was wiped out by shore-based sales and administrative overhead expenses.⁶ Thus in four years' operations (XXXX-XX-XX-XX), the vessel, which was the corporation's sole asset, produced losses aggregating $105,377.15. This figure did not include any amount for interest on the balances (note 5, supra) due Alex. Nor did this include any amount for salaries to Alex or other shareholders. It did include, however, wages paid to the crew including that paid to Petros as master.⁷

With continuously mounting operating losses accompanied by a decline (finally to zero) in business, the impact on the corporation's general solvency was obvious.⁸ It was insolvent in every sense of the word. It avoided conduct as an insolvent only because the deficits were made up by further advances from Alex. Not surprising is it that at the close of 1950, the balance due Alex was at its peak in the sum of $251,486.39.

The venture was a complete and continuous failure. Things were not only bad, they were getting progressively worse. The year 1950 saw the vessel languish without a pound of cargo so far as the fiscal records reflect. In the meantime ordinary maintenance costs kept running on. No one has breathed even a faint suggestion that at that moment there was a single prospect that the vessel, or the corporation through her, would ever be able to break even, much less produce an operating profit. All that was left was the possibility of sale, but it is uncontradicted that all such efforts were unavailing.

It is in this setting that the accrual of interest as a deduction by the payor corporation must be judged. Several factors other than those discussed are significant and likewise uncontradicted. Alex was positive that interest (or principal) was to be paid only if the corporation had earnings. That meant only if the vessel, its sole productive asset, could operate at a profit. That meant that there was in fact no fixed, determinable amount or time of payment. Several things corroborated this. The books were carefully constructed by a certified public accountant whose competency and professional responsibility is nowhere questioned. This same accountant prepared each of the income tax returns for the corporation....