Brake & Electric Sales Corporation v. United States

• Decision Date: 18 July 1960
• Docket Number: Civ. A. No. 59-522.
• Citation: 185 F. Supp. 1
• Court: U.S. District Court — District of Massachusetts
• Parties: BRAKE & ELECTRIC SALES CORPORATION v. UNITED STATES of America.

185 F. Supp. 1

BRAKE & ELECTRIC SALES CORPORATION v. UNITED STATES of America.

Civ. A. No. 59-522.

United States District Court D. Massachusetts.

July 18, 1960.

Irvin M. Davis, Boston, Mass., for plaintiff.

Elliot L. Richardson, U. S. Atty., Andrew A. Caffrey, Asst. U. S. Atty., Boston, Mass., for defendant.

FRANCIS J. W. FORD, District Judge.

For a number of years prior to 1950 Murray A. Brown was engaged as an individual proprietor in the distribution and wholesale selling of brakes, wheels, axles, bearings, electrical systems and other parts for heavy automotive equipment and in the servicing of such parts. In December of 1949 Brake & Electric Sales Corporation, plaintiff here, was formed to take over this business. Brown advanced $20,000 in cash to the new corporation in payment for 200 shares of its common stock, representing all the shares issued. At all times since the formation of the corporation Brown has been the sole stockholder of the corporation, its president and treasurer and a director. His wife has been clerk and a director, and the third director has been one Rockwell, an accountant who works one day a week for the corporation.

On January 3, 1950, the corporation took over the business of the original proprietorship. It took over all the tangible and intangible assets of the proprietorship except for some of the cash and the real estate, which it has continued to occupy under a lease from Brown who has retained ownership. Formal transfer of these assets from Brown to the corporation was made on March 1, 1950, after closing of the proprietorship books and completion of an inventory. Brown transferred to the corporation assets having a book value of $116,955.20 and the corporation assumed liabilities of $26,955.20, leaving a net worth of $90,000 for the assets transferred. Brown also transferred to the corporation the good will and franchises of the proprietorship, which were not carried as assets on the books. Brown testified that the fair value of these franchises was $157,000 and that the going-concern value of the whole business with its assets as turned over to the corporation was $300,000. During 1949 the business had sales totaling $250,908.37 and profits before taxes of $53,000. Since 1950 the business of the plaintiff corporation has been increasingly successful, with sales generally increasing from year to year. Sales in 1959 amounted to $862,490.89. It has met all its obligations without borrowing and has discounted all its bills.

On March 1, 1950, the corporation, in return for the property formally transferred to it on that date, issued a negotiable promissory note payable to Brown in the amount of $90,000, due March 1, 1955, and bearing interest at 4 per cent per annum. In December, 1952, this note was canceled and replaced by three notes identical in all respects with the original note except for the amount, two of them being for $6,000 and the third for $78,000. One of the $6,000 notes was endorsed to each of Brown's two minor children, purportedly as a gift, and delivered to Davis, Brown's attorney, who by letter to each of the children acknowledged that he had received the note and was holding it for the child as attorney.¹ On March 1, 1955, when these notes came due, they were extended for five years by agreement between the corporation and the holders, Brown individually and Davis as custodian of the children's notes. On March 1, 1960, they were similarly extended for one year.

Interest on these notes has been regularly paid when due by the corporation in the amount of $3,600 annually. The corporation has annually deducted this amount on its income tax return as interest paid on an indebtedness. For the tax years involved here, the Commissioner of Internal Revenue disallowed the deduction, deficiency assessments were made and paid by the corporation, claims for refund were made and disallowed and plaintiff now brings this action to recover a claimed overpayment. The issue is whether the property turned over to the corporation in the transaction described above represented a loan to the corporation giving rise to interest payments deductible under Section 23(b) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(b) and Section 163(a) of the Internal Revenue Code of 1954, 26 U.S.C.A. § 163(a), or whether it represented a capital investment in the corporation, so that the annual payments by the corporation are in the nature of dividends and hence not deductible by the corporation.

It is plaintiff's contention that the transaction should be regarded as a genuine loan, as on its face it purports to be, and that...