CIR v. Seaboard Finance Company

• Decision Date: 05 October 1966
• Docket Number: No. 20159-20174.,20159-20174.
• Citation: 367 F.2d 646
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. SEABOARD FINANCE COMPANY et al., Respondents. SEABOARD FINANCE COMPANY et al., Cross Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Cross Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

367 F.2d 646 (1966)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. SEABOARD FINANCE COMPANY et al., Respondents.

SEABOARD FINANCE COMPANY et al., Cross Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Cross Respondent.

Nos. 20159-20174.

United States Court of Appeals Ninth Circuit.

October 5, 1966.

Richard M. Roberts, Acting Asst. Atty. Gen., Meyer Rothwacks, David O. Walter, Ralph A. Mupip, Lee A. Jackson, Fred R. Becker, Attys., Dept. of Justice, Washington, D. C., for petitioner.

Austin H. Peck, Jr., H. Hal Visick, Latham & Watkins, Los Angeles, Cal., for respondents.

Before JOHNSEN,^* BARNES and HAMLEY, Circuit Judges.

HAMLEY, Circuit Judge:

The Commissioner of Internal Revenue filed these consolidated petitions for review of decisions of the Tax Court involving federal income taxes for fiscal years ending in 1955, 1956, 1957 and 1958. The taxpayers, Seaboard Finance Company and fourteen of its subsidiaries (Seaboard), all engaged in the small loan business, filed cross petitions.

The Tax Court had the problem of determining how much, if any, of the amount paid by Seaboard in acquiring other small loan businesses was attributable to good will or other elements of value for which depreciation deductions are not allowed. The Commissioner is not satisfied with the way the Tax Court solved that problem. Seaboard's cross petitions are protective in nature, no affirmative relief being sought if we affirm the Tax Court's decisions.

During the tax years in question, Seaboard's program of rapid growth resulted in the purchase of fifty-five small loan businesses. In connection with each purchase the company paid an amount in excess of the face value of the loans outstanding and the fixed assets acquired. Seaboard treated the excess purchase price, referred to herein as the "premium," as part of the depreciable cost of acquiring the loan accounts. Accordingly, it sought to depreciate the premium over the average useful lives of the loan accounts, namely, three years for secured loans and five years for unsecured loans.

The Commissioner disallowed the depreciation deductions, and proposed deficiencies in the aggregate amount of $621,000. He did so on the ground that the entire premium was paid for good will or other elements of value which are non-depreciable.¹ The Tax Court, however, found that only thirty percent of the total premium was attributable to good will and other non-depreciable elements of value and therefore not subject to a depreciation deduction. The court held that the remaining seventy percent of the premium was attributable to the loan accounts and was therefore depreciable over the average useful lives of those accounts. Accordingly, the Tax Court redetermined the aggregate deficiencies at about $202,000.

It is undisputed that the premium was derived by evaluating the individual loans to be acquired in connection with the purchase of each small loan business. Employees of Seaboard performed the evaluation by a procedure known in the industry as "spreading." It consisted of listing in columns the number of each loan contract, the name of the borrower, the principal balance due and a rating or classification of the individual contract. The classification symbols were A+, A, B, C, D and E.

In classifying an individual contract the person making the spread examined the contract itself and the file relating thereto, any credit check made on the borrower and any other pertinent information concerning the particular borrower. Among the items of information examined were the borrower's age, nature and length of his employment, whether his wife was employed, size of his family, and his payment record. Each contract was then classified as A+, A, B, etc., and a total of the balance in each classification was computed.

The person spreading the accounts then added to the total balance of the A+ accounts a percentage of the total balance which, in the purchases here involved, generally ranged between fifteen and thirty percent. No percentage or premium was added to the total principal balance of loan contracts classified as A. The total principal balances of loan contracts in the other classifications (B, C, D and E), were discounted by percentages ranging from twenty-five to seventy-five percent.

In determining the aggregate value of the loan contracts to be purchased, the person making the spread added to the aggregate principal balances owing on all loan contracts the premium on the A+ contracts, and subtracted the discount, if any, on the other contracts. The resulting figure was the amount which was offered for the loan contracts in bargaining with the seller for the loan business. Seaboard paid a net premium for the loan contracts of every business it purchased. The net premium on each purchase was entered on Seaboard's books in a separate account entitled "Premium Paid on Purchased Accounts," and depreciated over three- and five-year periods.

The facts reviewed above indicate that Seaboard paid the premium as a part of the cost of acquiring the loan accounts. The fact that the premium was part of such cost, however, does not resolve the question of whether the premium, or any part of it, represented payment for good will. Notwithstanding that it was a cost of acquisition, the premium constituted payment for good will if, and to the extent that, it represented elements of value usually associated with good will.

This court has recognized that "* * the essence of goodwill is the expectancy of continued patronage, for whatever reason." Boe v. Commissioner, 9 Cir., 307 F.2d 339, 343. The Tax Court recently defined good will as "the probability that old customers will resort to the old place" without contractual compulsion. Brooks v. C.I.R., 36 T.C. 1128, 1133. This definition has also been used in the Fifth and Seventh Circuits. See Commissioner v. Killian, 5 Cir., 314 F.2d 852, 855; Karan v. Commissioner, 7 Cir., 319 F.2d 303, 306. In Meeker v. Stuart, D.C.D.C., 188 F.Supp. 272, 275, aff'd 110 U.S.App.D.C. 161, 289 F.2d 902, the district court stated that good will may be defined as "* * * the habit of customers to return to the concern with which they have been previously dealing." See District of Columbia v. ACF Industries, Incorp., 122 U.S.App.D.C. 12, 350 F.2d 795, 799.

In the Tax Court the Commissioner contended that the premium was attributable primarily to the good prospects for loan renewal, an element of good will. This contention was based upon the fact that the main source of a small loan company's new business is its present customers. According to undisputed evidence, a customer of a small loan company will usually refinance his loan two or three times before finally paying it off.

The experience of Seaboard was cited as typical. In the taxable year ended September 30, 1957, Seaboard made sixty percent of its loans to present customers who refinanced their accounts. This same percentage held true for 1958. Another ten percent of the loans made by Seaboard in those years represented new business from former borrowers who had previously paid off their loans.

The Commissioner further contended in the Tax Court that part of the premium was paid for the benefit of continuity enjoyed by the purchaser of a going business, this element of value also representing a non-depreciable asset.² He argued that one who purchases an existing small loan business avoids the start-up costs necessary to put a newly-established small loan office on a paying basis.³ The undisputed evidence shows that a small loan office which is started from "scratch," will generally have to operate for about two and a half years before it begins to make a profit.

The Commissioner argued to the Tax Court that the acquisition of a customer structure which could be solicited for allied services was a third element of good will which was paid for by the premium. For example, customers acquired by Seaboard were sold or solicited for credit life insurance and for Seaboard's "ever-ready chek" program. Seaboard also offered its customers an "all-in-one" package loan. Letters were sent to newly acquired customers encouraging them to drop into one of Seaboard's offices and borrow more money.

In view of all of these asserted elements of good will associated with the purchase of the small loan businesses, the Commissioner urged the Tax Court to accept his determination that the entire amount of the net premium was attributable to good will or other unamortizable elements of value.

As noted above, the Tax Court did not agree that the entire amount of the net premium was attributable to good will or other non-depreciable elements, allocating only thirty percent of the premium to good will and other non-depreciable elements of value.

In its opening brief to this court, the Commissioner did not specify as error any of the Tax Court's findings of fact. See Rule 18(2) (d), Rules of the United States Court of Appeals for the Ninth Circuit. He has also told us in his reply brief that neither the facts nor the inferences to be drawn from those facts are in dispute, and that we therefore are not called upon to determine whether any of the findings of fact are clearly erroneous. See Rule 52(a), Federal Rules of Civil Procedure.⁴ The Commissioner contends that the only question involved in this case is a legal one, namely:

"* * * whether this Ninth Circuit Court was correct in holding that a payment for the `expectancy of continued patronage\' is non-amortizable goodwill (Boe v. Commissioner, 9 Cir. 307 F.2d 339, 343), or whether the Tax Court was correct in permitting taxpayers in this case to amortize the portion of the premium paid for `expectancy of continued patronage.\'"⁵

In so formulating the issues presented on this review the Commissioner has misconceived the Tax Court decisions. The Tax Court agreed with the Commissioner's contention that the elements of value referred to above — good prospects of loan renewal,...