Brake & Electric Sales Corporation v. United States, 5753.

• Decision Date: 09 March 1961
• Docket Number: No. 5753.,5753.
• Citation: 287 F.2d 426
• Parties: BRAKE & ELECTRIC SALES CORPORATION, Plaintiff, Appellant, v. UNITED STATES of America, Defendant, Appellee.
• Court: U.S. Court of Appeals — First Circuit

287 F.2d 426 (1961)

BRAKE & ELECTRIC SALES CORPORATION, Plaintiff, Appellant, v. UNITED STATES of America, Defendant, Appellee.

No. 5753.

United States Court of Appeals First Circuit.

Heard January 4, 1961.

Decided March 9, 1961.

George B. Lourie, Boston, Mass., with whom Arnold R. Cutler, John P. Martin and Daniel D. Levenson, Boston, Mass., were on the brief, for appellant.

Charles B. E. Freeman, Atty., Dept. of Justice, Washington, D. C., with whom Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson and Meyer Rothwacks, Attys., Dept. of Justice, Washington, D. C., Elliot L. Richardson, U. S. Atty., and James C. Heigham, Asst. U. S. Atty., Boston, Mass., were on the brief, for appellee.

Before WOODBURY, Chief Judge, and HARTIGAN and ALDRICH, Circuit Judges.

HARTIGAN, Circuit Judge.

This is an appeal from a judgment of the United States District Court for the District of Massachusetts entered July 21, 1960 dismissing plaintiff-appellant's complaint.

The Commissioner of Internal Revenue disallowed deductions taken by plaintiff for the tax years 1953, 1954 and 1955 of amounts claimed as interest paid on outstanding notes. Plaintiff paid the deficiencies determined by the Commissioner and then made claims for refunds which were disallowed. The plaintiff thereafter brought this suit to recover the alleged overpayments.

Plaintiff, Brake & Electric Sales Corporation, was organized in December 1949 to take over the business of Brake & Electric Sales Company, a distributor and wholesaler of brakes, wheels, axles, electrical systems and other parts for heavy automotive equipment. The unincorporated business was owned and operated by Murray A. Brown, as individual proprietor.

The plaintiff after its incorporation issued 200 shares of $100 par value common stock to its sole stockholder, Murray A. Brown, for $20,000 cash. At all times since the formation of the plaintiff, Brown has been sole stockholder as well as president, treasurer and a director.

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

On March 1, 1950 plaintiff gave Brown a promissory note for $90,000 due on March 1, 1955 with interest at 4% per annum in return for the property formally transferred to plaintiff. In December 1952 the $90,000 note was cancelled and replaced by three notes differing from the original note only in the amount on the face; two for $6,000 and one for $78,000. A $6,000 note was endorsed to each of Brown's two minor children, purportedly as a gift, and delivered to Brown's attorney, Mr. Davis. Davis acknowledged by letter to each of the children that he had received the note and was holding it for the child as attorney.

On March 1, 1955, when the three notes came due, they were extended for another five years by agreement between plaintiff and the holders, Brown individually and Davis as custodian of the children's notes. On March 1, 1960 the notes were similarly extended for one year.

Interest on these notes has been paid regularly when due in the amount of $3,600 annually. Plaintiff annually deducted this amount on its income tax return as interest paid on an indebtedness.

Plaintiff contended in the district court that the note transaction should be regarded as a genuine loan, as it purported to be, and that Brown had deliberately limited his risk capital investment to $20,000 and had advanced the rest of his property as a loan for his own protection, since in the event of failure of the enterprise, he would, as to the $90,000 evidenced by the note, be a creditor entitled to share in the assets on an equal footing with other creditors. The Government contended that Brown really made a capital investment of the property in the corporation, giving the transaction the form of a loan so that he might be able to receive a distribution of the profits in the form of interest which would be deductible by plaintiff, although...