Stinnett's Pontiac Service, Inc. v. C.I.R.

• Decision Date: 20 April 1984
• Docket Number: No. 82-6172,82-6172
• Citation: 730 F.2d 634
• Parties: 84-1 USTC P 9406, 5 Employee Benefits Ca 1474 STINNETT'S PONTIAC SERVICE, INC., Richard W. Stinnett and Gay P. Stinnett, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 634

730 F.2d 634

84-1 USTC P 9406, 5 Employee Benefits Ca 1474

STINNETT'S PONTIAC SERVICE, INC., Richard W. Stinnett and Gay P. Stinnett, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee.

No. 82-6172.

United States Court of Appeals Eleventh Circuit.

April 20, 1984.

Malcolm Lewis Kneale, Miami, Fla., for petitioners.

Kenneth W. Gideon, Chief Counsel, George M. Sellinger, Glenn L. Archer, Jr., Asst. Atty. Gen., Tax Div., Michael L. Paup, Chief, Appellate Section, Thomas A. Gick, U.S. Dept. of Justice, Washington, D.C., for respondent.

Appeals from a Decision of the United States Tax Court.

Before HILL and HATCHETT, Circuit Judges, and ALLGOOD ^*, District Judge.

HATCHETT, Circuit Judge:

In this case, we review the Tax Court's holdings regarding the tax consequences of transactions involving two corporations and their common shareholder, the taxpayer. We affirm.

Facts

Richard W. Stinnett is president of Pontiac, an automobile dealership, and he owns 74% of the stock in the company. ¹ In the early 1960's, Pontiac established a qualified profit sharing plan for its employees. Pontiac would calculate its year-end profit, and, if such profit exceeded $25,000, Pontiac would transfer 15% of the compensation paid to each employee-member to the plan. On or about January 1, 1973, Pontiac issued a demand note for $33,500 bearing 8% annual interest, to the profit-sharing plan. At the date of the note's issuance, Pontiac was financially able to contribute cash or a check to the profit-sharing plan.

On or about July 2, 1973, Stinnett, Danford L. Sawyer (Sawyer), and Albert L. Bundy (Bundy) purchased the entire stock of Cargo Construction Company, Ltd. (Cargo), a Bahamian corporation. Cargo's principal business activity was commercial fishing, and its only asset was the lobster boat, R/V Victory. Stinnett owned 43%; Sawyer owned 35%; and Bundy owned 22% of Cargo's stock. Stinnett, Sawyer, and Bundy also purchased the R/V Victory for approximately $55,000. The three shareholders realized that Cargo would need additional capital to satisfy certain unforeseen initial costs and, therefore, agreed to contribute additional capital, in proportion to each shareholder's stock ownership in Cargo, to Cargo to meet its needs.

From 1973 to 1975, Sawyer and Bundy contributed funds to Cargo as required by the shareholders' agreement. Stinnett, however, failed to contribute to Cargo pursuant to the shareholders' agreement. Pontiac, the corporation which Stinnett controlled, contributed funds and boat parts to Cargo. In 1973, Pontiac transferred $12,969.86 to Cargo, and, in return, Cargo issued interest bearing unsecured demand notes to Pontiac. During this same period, Pontiac also purchased marine parts for Cargo. Although Pontiac usually sold marine parts at 100% markup, it sold the marine parts to Cargo at only a 10% markup. Pontiac also made additional payments of $12,000 to Cargo. Cargo failed to issue any notes to Pontiac for any part of this amount.

From 1974 to 1975, Pontiac transferred an additional $45,000 to Cargo. Pontiac did not obtain any financial statements from Cargo prior to making any of the transfers, nor were the amounts of the transfers secured. After realizing that Cargo's lobster venture was unsuccessful, the shareholders decided to sell the R/V Victory and recoup their investment. On February 23, 1976, therefore, they agreed to sell the boat for $80,000 with Pontiac receiving $20,000 from the sale. That sale never materialized, but the R/V Victory was eventually sold for $42,000, and Cargo paid Richard Stinnett $6,000 for the sale of the boat.

On its 1974 federal income tax return, pursuant to 26 U.S.C.A. Sec. 166(a) (West 1978), Pontiac deducted $56,388.63 as a partially worthless debt for its advances to Cargo. ² It computed this amount by subtracting $20,000, the anticipated amount Pontiac would have received from the sale of the R/V Victory, from $76,388.63, the total amount Pontiac claimed it had advanced Cargo. The Commissioner disallowed the partially worthless debt deduction, and determined that the contributions from Pontiac to Cargo constituted constructive dividends to Stinnett in 1973 and 1974. Therefore, these dividends were taxable to Stinnett pursuant to 26 U.S.C.A. Secs. 301, 316 (West 1978 & Supp.1983). The Commissioner also disallowed Pontiac's attempt to deduct, pursuant to 26 U.S.C.A. Sec. 404(a) (West 1978 & Supp.1983), the face amount of the promissory note it had issued to its profit-sharing plan. ³ After disallowing the deductions, the Commissioner determined the respective deficiencies. The tax court affirmed the Commissioner's rulings.

Stinnett's Pontiac Service, Stinnett, and Gay P. Stinnett appeal the United States Tax Court's decision determining a $4,047.52 deficiency in Pontiac's corporate income tax for 1972, and determining deficiencies of $16,012.81 and $36,321.46 in Stinnett's personal income taxes for 1973 and 1974.

Pontiac and Stinnett urge us to reverse the tax court's holding, claiming that Pontiac's advances to Cargo were worthless debts and, therefore, were deductible under 26 U.S.C.A. Sec. 166; and, the advances failed to constitute constructive dividends to Stinnett. Pontiac and Stinnett also contend that the amount of the promissory note it had paid to its profit-sharing plan was deductible under 26 U.S.C.A. Sec. 404(a).

A. Were the Advances From Pontiac to Cargo Deductible as a Worthless Debt, Or Were They a Contribution to Capital?

Title 26 U.S.C.A. Sec. 166(a)(1) (West 1978) provides that a deduction shall be allowed for "any debt which becomes worthless within the taxable year." 26 U.S.C.A. Sec. 166(a)(1). The right to a deduction for a bad debt is limited to a bona fide debt. 26 C.F.R. Sec. 1.166-1(c) (1983). "A gift or contribution to capital shall not be considered a debt for purposes of section 166." 26 C.F.R. Sec. 1.166-1(c) (1983). The tax court determined that the advances from Pontiac to Cargo were contributions to capital and, therefore, not a bona fide debt for the purposes of 26 U.S.C.A. Sec. 166. The tax court also held that even if the advances constituted bona fide debts, they did not become worthless in 1974; and therefore, Stinnett could not deduct them in 1974.

The question of whether the advances from Pontiac to Cargo constitute a loan or a contribution to capital depends on whether the advances are debt (loans) or equity (contributions to capital). In Estate of Mixon v. United States, 464 F.2d 394 (5th Cir.1972), the Fifth Circuit detailed the thirteen factors which merit consideration in determining whether advances constitute debt or equity: (1) the names given to the certificates evidencing the indebtedness; (2) the presence or absence of a fixed maturity date; (3) the source of payments; (4) the right to enforce payment of principal and interest; (5) participation in management flowing as a result; (6) the status of the contribution in relation to regular corporate creditors; (7) the intent of the parties; (8) "thin" or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) source of interest payments; (11) the ability of the corporation to obtain loans from outside lending institutions; (12) the extent to which the advance was used to acquire capital assets; and (13) the failure of the debtor to repay on the due date or to seek a postponement. Id. at 402. See also In re Indian Lake Estates, Inc., 448 F.2d 574, 578-79 (5th Cir.1971); Tyler v. Tomlinson, 414 F.2d 844, 848 (5th Cir.1969). "The approach of this court has been to consider all the factors and weigh the evidence favoring characterization of the advance as debt or equity, while realizing that the various factors are not of equal significance and that no one factor is controlling." Estate of Mixon, 464 F.2d at 402.

1. Name Given to the Certificate

"The issuance of a stock certificate indicates an equity contribution; the issuance of a bond, debenture, or note is indicative of a bona fide indebtedness." Estate of Mixon, 464 F.2d at 403. In this case, notes represented only $12,969.86 of the $76,388.63 Pontiac advanced Cargo. The notes were payable on demand and required interest; however, no fixed or final maturity date existed and Cargo never paid interest on the notes. The notes were also unsecured. While the issuance of a note may evidence a bona fide indebtedness, an unsecured note due on demand with no specific maturity date, and no payments is insufficient to evidence a genuine debt. Tyler v. Tomlinson, 414 F.2d 844, 849 (5th Cir.1969).

The remaining $63,418.77 was advanced without any indicia of indebtedness. Moreover, Pontiac never attempted to collect this amount despite the fact that a distribution was made to Cargo's shareholders upon liquidation. The lack of any certificate evidencing indebtedness for the majority of the advances and the unsecured note with no specific maturity date tend to show that the advances were equity and not a bona fide debt.

2. The Presence or Absence of a Fixed Maturity Date

The Fifth Circuit has held that the presence of a definite maturity date and a definite obligation to repay is, "[a] highly significant feature of a debtor-creditor relationship." Dillin v. United States, 433 F.2d 1097, 1101 (5th Cir.1970). Indeed, the Fifth Circuit has held that the absence of a fixed maturity date is indicative of an equity advance. Estate of Mixon, 464 F.2d at 404. In this case, no fixed date for repayment existed for any of the advances, including the amounts the notes represented. This factor, therefore, strongly indicates that the advances were contribution to capital, and not loans.

3. Source of the Payments

The importance of the source of the payments, "is that if repayment is possible only out of corporate earnings, the transaction has the appearance of a contribution of equity capital, but if repayment is not dependent upon earnings, the...