Commissioner of Internal Revenue v. Schaefer

• Decision Date: 10 January 1957
• Docket Number: No. 25,Docket 24043.,25
• Citation: 240 F.2d 381
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. George J. SCHAEFER, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

240 F.2d 381 (1957)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. George J. SCHAEFER, Respondent.

No. 25, Docket 24043.

United States Court of Appeals Second Circuit.

Argued November 13, 1956.

Decided January 10, 1957.

Joseph F. Goetten, Atty., Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., and Lee A. Jackson and Hilbert P. Zarky, Attys., Dept. of Justice, Washington, D. C., on the brief), for petitioner.

Philip Zimet, New York, N. Y. (Olvany, Eisner & Donnelly, Robert F. Welch and Alfred L. Scanlan, New York City, on the brief), for respondent.

Before CLARK, Chief Judge, and FRANK and HINCKS, Circuit Judges.

HINCKS, Circuit Judge.

The Commissioner seeks review of a Tax Court determination rejecting in part an asserted deficiency in the taxpayer's federal income tax for 1948.

The Tax Court made extensive findings which are reported at length at 24 T.C. 638. The following résumé will, we think, suffice for an understanding of the problem involved.

The taxpayer since 1914 has been connected with the motion picture industry as a corporate executive and more recently on his own account as a supervisor of film-distribution employed by independent producers. In 1946, he organized a corporation known as Romay Pictures, Inc. (Romay), for the purpose of producing a particular Photoplay, "The Return of Rin-Tin-Tin," the production of which was estimated to cost $175,000. The original capital of the corporation was $14,000 all of which was paid in by the taxpayer who became its president, dominating executive and, for the time being, its sole stockholder. He obtained from two lending institutions a primary and a secondary loan to Romay in the respective amounts of $105,000 and $65,000, on conditions which he duly fulfilled, viz.: that he should pay Romay $11,000 either as a loan or as a capital contribution (which would bring its total paid-in capital up to $25,000); should execute a personal guaranty to complete the Photoplay in the event the funds otherwise available for its production should prove to be insufficient; and that as a bonus to the lender of the secondary loan, he should donate Romay capital stock of a par value of $4200. Other personal commitments were specified and fulfilled. For the additional $11,000¹ paid to Romay and for the $53,273.65, which he later advanced to complete the Photoplay, the taxpayer received from Romay notes providing for interest at 6 per cent per annum, which in accordance with the underlying agreements he subordinated to the primary loan. The taxpayer had never before engaged in the business of producing or financing the production of a feature picture.

In his 1948 tax return the taxpayer claimed a deduction, as a "Business Loss," of the $53,273.65 advanced to Romay. The Commissioner disallowed the deduction and reflected the disallowance in an asserted deficiency. The Tax Court held that the advance of $53,273.65 by the taxpayer to Romay for the completion of the Photoplay gave rise to a debt which became worthless in 1948, and that it was a business debt wholly deductible under Section 23(k) (1) of the 1939 Code, 26 U.S.C.A. § 23(k) (1).

The sole question pressed on this review was whether the debt was a business debt, within the meaning of Section 23(k) (1) of the Code of 1939, or a nonbusiness debt under Section 23(k) (4).

We sustain the Commissioner's position and hold that the $53,273.65 advanced to complete the Photoplay constituted a "non-business" debt under Section 23(k) (4) and not one "the loss from the worthlessness of which is incurred in the taxpayer's trade or business."

As provided in Treasury Regulations 111, Sec. 29.23(k) (6), a business debt is one the loss of which through worthlessness is proximately related to a trade or business in which the taxpayer is then engaged. Hickerson v. Commissioner, 2 Cir., 229 F.2d 631, 633. We find no evidence at all to bring this debt, or its loss, into proximate relationship with any business of the taxpayer.

As the Tax Court found, the taxpayer "had never * * * been engaged in the business of financing corporations through personal advances or loans, as in Vincent C. Campbell, 11 T.C. 510." To be sure, the advances were made to enable the completion of the Photoplay: they were thus directly and proximately related to Romay's trade and business. But that is not to say that they were related to the taxpayer's business. Merely because Romay was the creature of the taxpayer, having been brought into existence to produce the Photoplay, and was under his complete and sole control, it does not follow that Romay's business was the taxpayer's business. As the Tax Court said: "In contemplation of law, a corporation is an entity separate and apart from its stockholders, and where an individual * * * seeks the benefits of the corporate form or method for the ownership and conduct of a business, he * * * may not ignore the presence or existence of the corporation, in order to avoid the disadvantages." See Burnet v. Clark, 287 U.S. 410, 53 S.Ct. 207, 77 L. Ed. 397; Dalton v. Bowers, 287 U.S. 404, 53 S.Ct. 205, 77 L.Ed. 389. It follows that having created Romay to produce the Photoplay the taxpayer may not, when it comes to determining his tax obligations, have the production or financing of the Photoplay treated as his personal business.

We also agree with the Tax Court that the record does not support a conclusion, which the taxpayer still persists in urging, that this particular venture was any...