OH Kruse Grain & Milling v. CIR

• Decision Date: 27 May 1960
• Docket Number: No. 16663.,16663.
• Citation: 279 F.2d 123
• Parties: O. H. KRUSE GRAIN & MILLING, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

279 F.2d 123 (1960)

O. H. KRUSE GRAIN & MILLING, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16663.

United States Court of Appeals Ninth Circuit.

May 27, 1960.

Enger & Yardum, LeVone A. Yardum, Beverly Hills, Cal., for petitioner.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Meyer Rothwacks, Lloyd J. Keno, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before BARNES and MERRILL, Circuit Judges, and BOWEN, District Judge.

BARNES, Circuit Judge.

The Commissioner of Internal Revenue determined a deficiency in petitioner grain company's returns for the years 1952 and 1953. Petitioner filed a petition for redetermination of the deficiency with the Tax Court under Title 26 U.S.C. § 6213. The Tax Court sustained the deficiency in part and disallowed it in part. From that decision petitioner seeks review under Title 26 U.S.C. § 7482.

Petitioner corporation claimed deductions from net income for the years 1952 and 1953 for certain items of interest and rent owing to its sole proprietor. The Commissioner determined (a) that the interest was not due on a bona fide debt, nor (b) was it paid within two and one-half months of the next tax year, as required by § 24(c) of the Internal Revenue Code of 1939. The Tax Court found that the interest was not due on a bona fide debt, and did not reach the § 24 (c) problem. The Commissioner determined that the rents were not paid within the requisite two and one-half months as required by § 24(c), and disallowed the rental deductions on that basis alone. The Tax Court determined that the amounts deducted for rentals had been constructively received by the corporation's sole owner during the taxable years, hence § 24(c) was not applicable, and the deficiences as to the rentals were disallowed.

O. H. Kruse had been in business for fourteen years when he formed the petitioner corporation in 1950. The corporation has an authorized capital stock of $300,000; 3,000 shares of $100 par value. In April 1950 Kruse transferred to petitioner, in exchange for 800 shares of stock, certain office equipment, trucks, machinery and current assets, of a value of $9,000. In June 1950, Kruse transferred to the corporation the following assets:

                  Accounts receivable    $139,506.62
                  Merchandise inventory    37,724.59
                  Cash                     41,348.08
                                         ___________
                                         $218,579.29
                

Kruse accepted in payment therefor a promissory note of the corporation in the principal amount of $200,000, and a drawing account was opened in his favor for the balance.

The note was payable "On or before December 31, 1950, or thereafter on Demand" and bore interest at the rate of six per cent "from January 1, 1951 until paid, interest payable semi-annually." No interest was actually paid until September 1953 when $2,000 was paid. Payments on principal were made as follows:

                  November 1, 1955      $100,000
                  April 12, 1957          20,000
                  October 22, 1958        80,000
                                        ________
                                        $200,000
                

No payments on principal were made until a revenue agent questioned the transaction. The corporation deducted the following amounts for interest:

                  1950     $ 9,000
                  1951     $12,000
                  1952     $12,000
                  1953     $12,000
                

O. H. Kruse reported the following amounts in his personal return as income from interest from the corporation during the same years:

                  1950  None
                  1951  None    (petitioner reported
                                 $21,000 rent received
                                 although but
                                 $12,000 rent was
                                 due that year)
                  1952  $ 6,000  (no interest actually
                                 paid)
                  1953  $12,000  ($2,000 actually
                                 paid)
                

The corporation was to receive credit for any amounts paid to Kruse, first on accrued interest, then accrued rent, and then on the drawing account.

In November of 1951, Kruse signed an agreement subordinating the "debt" to any amounts owing on a $100,000 line of credit which was established with the Bank of America. We note the debt was not subordinated at the time it was made, and that it was not subsequently subordinated to the debt of a general creditor.

At the trial the only testimony offered by appellant was that of the accountant who had made out the returns of both the corporation and Kruse. The accountant was assistant secretary of the corporation and spent three days a month on the books of the corporation. Kruse himself, though available, did not testify. The essence of the Tax Court's opinion was that petitioner had failed to sustain the burden of showing that the Commissioner's determination was erroneous. He found there was no showing that the debt was one which was intended to be repaid. The court laid stress on the fact that the best evidence as to this would have been the testimony of Kruse to the effect that this was the intent with which the transaction had been entered into. Since Kruse did not testify, the court drew the inference that his testimony would have been unfavorable to the petitioner's position. Besides holding that the petitioner failed to sustain his burden of proof, the Tax Court relied on the following factors to buttress its conclusion:

1. The note was in essence a demand note without fixed maturity date.

2. The note was subordinated to another major creditor after it was made.

3. There were accounting "mistakes," which could give rise to the inference that the note was not regarded as a debt. This was given added weight by the fact that no attempt was made to explain the erroneous entries except to characterize them as "mistakes."

4. No payments were in fact made on the principal until the revenue agent questioned the transaction.

At the outset it must be recognized that the finding that the note in fact constituted a capital investment was one of fact, and not subject to overthrow by us unless the finding was clearly erroneous. E. g. Earle v. W. J. Jones & Son, 9 Cir., 1952, 200 F.2d 846, 847.

Petitioner specifies no error, but cites as the "issue to be decided" whether the note was intended to...