Roth Steel Tube Co. v. C.I.R.
| Decision Date | 10 September 1986 |
| Docket Number | No. 85-1656,85-1656 |
| Citation | 800 F.2d 625 |
| Parties | -5808, 86-2 USTC P 9676 ROTH STEEL TUBE COMPANY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Bennet Kleinman (argued), Frederick N. Widen, Robert L. Merritt, Cleveland, Ohio, for petitioner-appellant.
Fred T. Goldberg, Jr., Chief Counsel, Internal Revenue Service, Michael L. Paup (Lead Counsel), Glenn L. Archer, Jr., Roger M. Olson, David E. Carmack, Gayle P. Miller (argued), Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.
Before MILBURN and BOGGS, Circuit Judges, and DeMASCIO, District Judge. *
Roth Steel Tube Company ("taxpayer") appeals from a decision of the United States Tax Court sustaining deficiencies in the amount of $1,728,802 determined by the Commissioner of Internal Revenue ("the Commissioner") with respect to taxpayer's federal income tax liability for the taxable years 1971 through 1975. The principal issue presented is whether taxpayer's unrepaid advances to a subsidiary corporation were loans deductible as bad debts under 26 U.S.C. Sec. 166 or capital contributions deductible only to the extent of capital gains under 26 U.S.C. Sec. 1221. Because the Tax Court's factual determination that the advances were capital contributions and not loans is not clearly erroneous, we affirm.
The facts are carefully set out in the opinion of the Tax Court, 79 T.C.M. (CCH) 698 (1985), and will only briefly be set forth here. Taxpayer is an Ohio corporation whose principal business activity during the years at issue was the manufacture and sale of steel tubing. In August 1972, taxpayer acquired sixty-two percent of the stock of Remco Industries, Inc. ("Remco"), a manufacturer of children's toys. Subsequent to taxpayer's acquisition of Remco. Remco's board of directors and key management personnel were replaced by taxpayer's personnel.
During the two years prior to its acquisition by taxpayer, Remco had sustained substantial losses from its operations. On January 21, 1971, Remco filed a petition for an arrangement under Chapter 11 of the Bankruptcy Act, and Remco's plan of arrangement was confirmed on April 28, 1971. Under the plan, Bankers Trust Company ("Bankers") was to advance $7,500,000 to Remco, and the advance was to be secured by a first mortgage in that amount on Remco's real estate and a security interest in all inventory owned or acquired by Remco. Remco was to use the amount borrowed from Bankers to pay existing indebtedness to Bankers of approximately $6,000,000 and to use the remainder to pay other creditors.
The plan of arrangement also provided that James Talcott, Inc. ("Talcott") would advance funds to Remco to be secured by a security interest in Remco's accounts receivable, goods and chattels, inventory, warehouse receipts, and general intangibles. Talcott was also given a third mortgage on certain real estate owned by Remco and was assigned Remco's claim for federal income tax refund for the years 1968 and 1969. Talcott would advance $2,900,000 to Remco with an agreement to advance additional sums to Remco based on seventy-five percent of Remco's eligible accounts receivable. This agreement was subsequently modified to provide that Talcott, in its discretion, would lend up to $11,000,000 on a borrowing base of seventy-five percent of eligible accounts receivable and an additional $1,000,000 on a borrowing base of fifty percent of inventory value. The plan further provided that Remco would execute a second mortgage on its real estate and provide a subordinated security interest in its machinery, equipment, and inventory to William N. Otte ("Otte"), secretary to the creditor's committee of Remco, to secure payments due Remco's general creditors in the amount of $1,186,420.
The plan provided for repayment of the Bankers and Talcott loans. Remco was to make quarterly payments of principal to Bankers in the amount of $93,750 from August 1, 1971, through May 1, 1976, when a final installment in the amount of the unpaid balance of principal and accrued interest was to be made. Remco was also required to make quarterly payments of interest to Bankers. Other payments to Talcott and Bankers were to be made from collections on accounts receivable arising prior to January 21, 1971. Additionally, Remco was required to pay Bankers a percentage of after-tax, net income over the amount of $1,000,000. Otte was to be paid on the following schedule:
January 15, 1972 $ 50,000
April 26, 1972 $284,089
October 26, 1972 $284,111
April 26, 1973 $284,110
October 26, 1973 $284,110
Talcott was authorized to collect accounts receivable and to negotiate any payment made to Remco. Any loans made by Talcott pursuant to the agreement were payable on demand.
At the end of Remco's 1971 calendar year, Remco's balance sheet disclosed an excess of current assets over current liabilities of $1,106,263, but its total liabilities exceeded total assets by $3,046,072. Remco's statement of operations for 1971 reported a loss in the amount of $4,443,483. During 1972, Remco continued to experience financial difficulties, and, at the end of Remco's 1972 calendar year, Remco's balance sheet disclosed an excess of current liabilities over current assets in the amount of $2,698,762 and an excess of total liabilities over total assets in the amount of $5,925,175. Remco's statement of operations for 1972 reported a loss in the amount of $3,274,155. Assuming the sale of Remco's Harrison facility, Remco had total debts in the amount of $8,794,372 and total equity in the amount of $28,063.
In 1973, Remco introduced its new product line at the annual Toy Fair. Remco projected that it would have gross sales for 1973 of at least $22,000,000 and that net sales for 1973 would be approximately $19,000,000. Remco also projected that for 1973 it would have a total pre-tax net income of $550,000. Additionally, a cash availability analysis was prepared for 1973 which indicated that, after repayment of current loan obligations, cash receipts would exceed cash disbursements by $305,000. These projections were reviewed by taxpayer's management.
In 1972 and early 1973, Remco reached agreements with Bankers, Otte, and Talcott which permitted Remco to defer payments due each respective creditor. Bankers permitted Remco to pay the amount of $251,544.38 due on May 1, 1972, in monthly installments of $10,000 through December 29, 1972, when the balance of the amount due, together with interest, was to be paid. Bankers also agreed to an extension of the time for payment of approximately $360,000 of interest due for the period ending December 31, 1972. Otte permitted Remco to defer its final three payments of approximately $283,500 each, due on October 26, 1972, April 26, 1973, and October 26, 1973, under the plan of arrangement, to January 26, 1973, April 26, 1974, and October 26, 1974, respectively. Talcott permitted Remco to pay the $400,000 promissory note due on May 1, 1972, in monthly installments of $50,000, commencing on October 1, 1972 with the balance payable on December 31, 1972.
From November 3, 1972, through October 15, 1973, taxpayer made unsecured cash advances to Remco in the amount of $3,420,000. The advances, which were made to provide working capital needed for Remco's operations, included $587,850 from Roth Properties, Inc. ("Properties"), a subsidiary of taxpayer. With the exception of the $10,000 advance made on September 7, 1973, all the advances made by taxpayer to Remco were recorded on taxpayer's general ledger as receivables from Remco. On September 10, 1973, Remco repaid the $10,000 advance, and, in addition, Properties discharged the liability for payment of the advance made by taxpayer on its behalf in the amount of $587,850 as part of the purchase price for Remco's Harrison facility.
No interest was paid on any of these advances. Remco, however, reflected accrued interest expenses on its accounting records, and taxpayer recorded "Interest Income--Remco" and "Interest Receivable--Remco" on its general ledger. Taxpayer reported some of the interest from Remco on its federal income tax returns for the years ending April 30, 1973, and April 30, 1974.
Although resolutions of Remco's board of directors directed its officers to execute notes evidencing the indebtedness, the advances were not evidenced by notes or other instruments of indebtedness. One resolution of taxpayer's board of directors authorized loans to Remco, and resolutions of Remco's board of directors approved receipt of advances from taxpayer in the aggregate amount of $2,997,150. Only the resolution of November 3, 1972, by Remco's board of directors approving receipts in the amount of $175,000 stated the period of the advance or the rate of interest payable. The resolution also provided, in pertinent part, that: "The directors deem it to be in the best interest of Remco to effect such borrowing from [taxpayer], which borrowing can be made on terms and at a rate of interest substantially more favorable and beneficial to Remco than are obtainable elsewhere."
Taxpayer's source of funds for the advances to Remco was its own capital sources, including loans from Society National Bank and Talcott. Society National Bank financed the initial advance to Remco in the amount of $175,000 but was unwilling to finance subsequent advances. Talcott agreed to make loans to taxpayer and its subsidiary corporations. The Talcott loans were secured by accounts receivable, inventory, equipment, real estate, guaranties, and other collateral. The loan agreement required that taxpayer and the subsidiary corporations advance $1,650,000 to Remco and required Remco to sell its Harrison facility to Properties. Properties and Remco executed an agreement for the sale of the real estate on May 16, 1973. A purchase price of $7,500,000 was to be...
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