Comptroller of the Treasury v. Jalali

• Decision Date: 31 January 2018
• Docket Number: No. 1671, Sept. Term, 2016,1671, Sept. Term, 2016
• Citation: 235 Md.App. 369,178 A.3d 542
• Parties: COMPTROLLER OF the TREASURY v. Wais JALALI, et al.
• Court: Court of Special Appeals of Maryland

235 Md.App. 369

178 A.3d 542

COMPTROLLER OF the TREASURY

v.Wais JALALI, et al.

No. 1671, Sept. Term, 2016

Court of Special Appeals of Maryland.

January 31, 2018

Argued by: Schonette J. Walker (Brian E. Frosh, Atty. Gen., on the brief), Annapolis, MD, for Appellant.

Argued by: Adam L. Van Grack (Robb A. Longman, Theodore B. Kiviat, Longman & Van Grack, LLC, on the brief), Bethesda, MD, for Appellee.

Panel: Meredith, Shaw Geter, James A. Kenney, III, Senior Judge, Specially Assigned, JJ.

Kenney, J.

This case concerns monetary advances made by a taxpayer to businesses that he owned or in which he had an ownership interest. Appellees, Wais Jalali and Mena Jalali ("the Jalalis"), claimed that the advances were bona fide loans that were not repaid, and sought to deduct them as unreimbursed business bad debts. The Comptroller of the Treasury, appellant, rejected appellees' claim. When the Maryland Tax Court agreed with the Jalalis and reversed the Comptroller's determination, the Comptroller sought judicial review in the Circuit Court for Anne Arundel County, which affirmed the Tax Court. The Comptroller, now seeking judicial review in this Court, presents a single question, which based on the arguments in its brief, we have rephrased as two:¹

1. Did the Tax Court err in determining that the advances were bona fide loans and therefore, business bad debt, which is deductible as an unreimbursed business expense?

2. Even if the advances were debt, were they non-deductible because they were "non-business bad debt" due to Mr. Jalali being an investor, not an employee, of the companies?

For the reasons that follow, we shall affirm the judgment of the circuit court.

FACTUAL AND PROCEDURAL BACKGROUND

Mr. Jalali and the companies to which he advanced money were in the business of the sales, manufacture, and installation of large commercial heating, ventilation, and air conditioning systems ("HVAC"); the customers were businesses and government entities. The business was carried on through several affiliated companies. The three companies relevant to this case were WDJ Capital Holdings, Inc. ("WDJ"), M & I Air Systems Engineering West, Inc. ("M & I"), and Potomac Environmental Technologies, Inc. ("PEPTEC").

WDJ, which was incorporated in 2006, was a holding company for three other companies, one of which was PEPTEC.

PEPTEC was engaged in the sales of HVAC systems on the East Coast. Mr. Jalali, who was PEPTEC's CEO, owned 86% of WDJ. He began working as an engineer for PEPTEC in 1993, and around 2004 or 2005 he and two other individuals purchased the company. M & I, incorporated in 2008, manufactured HVAC units. Mr. Jalali was the sole shareholder of M & I.

Over the years, the companies did "really well." PEPTEC grew from a million-dollar-a-year company to a multi-million-dollar-a-year company. WDJ's revenue was almost $27 million and, in 2008, its net income totaled over $5 million. In October 2008, PEPTEC received a $3 million line of credit from Provident Bank,² to which it had full access until February or March 2010. M & I, in December 2009, entered into a $1 million factoring agreement with Advance Payroll Funding Ltd. to borrow on its account receivables.

In 2008, PEPTEC won three bids to provide HVAC systems to the Johns Hopkins Cancer Research Center, the National Geospatial Agency, and Aberdeen Proving Ground (the "Three Projects"). If successfully completed, those projects would generate $30 million in income. The Three Projects, however, were larger than any previous projects handled by PEPTEC, and created, in the words of the Tax Court, the "perfect storm."³

The need to manufacture and deliver on all of the projects within the same time-frame resulted in major cash flow problems for the involved companies. It was to meet those delivery demands that Mr. Jalali contends that he made eighteen monetary advances to M & I between January 2009 and December 2009 totaling $1,799,000 and one advance to WDJ in December 2009 in the amount of $2,000,000.

Each advance was documented by a written promissory note that stated a "loan amount," "loan period," "interest rate," and other repayment terms. The M & I notes stated a 30–day fixed maturity date and 5% interest rate. One of the M & I notes, in the amount of $133,000, was repaid without adherence to the interest or repayment date terms.⁴ The WDJ note was dated December 29, 2009 and provided for an 18–month term and 5% interest rate; it was not repaid. None of the notes were secured.

Mr. Jalali testified to a history of prior lending between himself and the companies during 2008 and 2009. No previously paid notes or copies were offered into evidence, but the corporate books and bank records reflected previous repaid loans from Mr. Jalali to the companies.

The Three Projects were ultimately completed, but the companies did not survive the storm. Costly delays, mechanical problems with the systems, and a lawsuit by one of the project customers resulted in financial doom. For the tax year 2009, WDJ reported a loss of about $2.4 million and M & I reported a loss of about $2 million. M & I went out of business in December 2009. In 2010, PEPTEC ceased operations, and WDJ and its subsidiaries filed for bankruptcy.

In 2010, the Jalalis filed amended joint tax returns with the Maryland Revenue Administration Division and the Internal Revenue Service (IRS) for the tax years 2008 and 2009. Claiming the unpaid advances as unreimbursed business expenses, the amended returns sought a carried-back net operating loss (NOL) of $3,799,000 and requested refunds of $141,211 for tax year 2008 and $67,132 for tax year 2009.

When the Comptroller rejected the amended returns, the Jalalis requested a hearing under § 13–904 of the Tax—General Article⁵ prior to a final determination on their claim.

The hearing was conducted on March 13, 2014, and on June 3, 2014, the Comptroller issued a Notice of Final Determination. The refunds were denied, in part, because proof of acceptance of the 2008 return by the IRS had not been provided, and because the Comptroller concluded that the advances were not bona fide loans.

The Jalalis appealed to the Maryland Tax Court, which held a hearing on January 28, 2016.⁶ Following the hearing, the Tax Court reversed the Comptroller's determination and granted the refunds. The Comptroller filed a petition for judicial review in the Circuit Court of Anne Arundel County. The circuit court affirmed the Tax Court's decision in an Order dated September 8, 2016, and the Comptroller filed a timely notice of appeal.

STANDARD OF REVIEW

As an administrative agency, the Tax Court's final order is subject to judicial review by this Court as provided in §§ 10–222 and 10–223 of the State Government Article. Supervisor of Assessments of Anne Arundel Cty. v. Hartge Yacht Yard, Inc. , 379 Md. 452, 460–61, 842 A.2d 732 (2004). Our inquiry on review "is not whether the circuit court erred, but rather whether the administrative agency erred." Classics Chicago, Inc. v. Comptroller , 189 Md.App. 695, 705, 985 A.2d 593 (2010) (quoting Comptroller v. Clise Coal, Inc. , 173 Md.App. 689, 697, 920 A.2d 561 (2007) ).

An appeal to the Tax Court is heard de novo and conducted in a manner similar to a proceeding in a court of general jurisdiction sitting without a jury. Md. Code Ann. (1988, 2016 Repl. Vol.), Tax—General § 13–523. A taxpayer appealing the Comptroller's determination has the burden to show error in the Comptroller's determination. Tax—General § 13–411 ; see Frey v. Comptroller , 422 Md. 111, 186, 29 A.3d 475 (2011).

We review the Tax Court's findings of fact to determine whether there is substantial evidence in the record as a whole to support its findings. See, e.g. , Gore Enterprise Holdings, Inc. v. Comptroller , 437 Md. 492, 504, 87 A.3d 1263 (2014). If "a reasoning mind reasonably could have reached the factual conclusion that the [Tax Court] reached," the factual finding must be upheld. 422 Md. at 137, 29 A.3d 475. And, when the interpretation of tax law involves mixed questions of law and fact, we review the Tax Court's determination for substantial evidence. See Gore , 437 Md. at 504, 87 A.3d 1263 ; Schwartz v. Dep't of Nat. Res. , 385 Md. 534, 553, 870 A.2d 168 (2005). As we said in Comptroller v. Johns Hopkins Univ. , 186 Md.App. 169, 188–89, 973 A.2d 256 (2009), "the Tax Court is the agency charged with interpreting and applying the Maryland tax code," and therefore its decision on a "mixed question of law and fact" is given deference.

And even though we review the Tax Court's decision of pure law de novo, its "interpretation and application of the statute" it administers is often accorded "a degree of deference" and "given considerable weight." Townsend Baltimore Garage v. Supervisor of Assessments , 215 Md.App. 133, 140, 79 A.3d 960 (2013). We do not, however, extend deference to the Tax Court's "application and analysis of case law." Gore , 437 Md. at 505, 87 A.3d 1263.

DISCUSSION

I.

In administering Maryland income tax laws, "to the extent practicable, the Comptroller shall apply the administrative and judicial interpretations of the federal income tax law." Md. Code Ann., Tax—General § 10–107. Section 166(a) of the Internal Revenue Code ("IRC") allows deductions for debt that becomes worthless within the taxable year.

26 U.S.C. § 166 (1988).⁷ But only bona fide business bad debt is deductible as an ordinary loss. Id. ; Kean v. Comm'r , 91 T.C. 575, 594 (1988). A contribution to capital is not business debt under the statute. 91 T.C. at 594.

The Comptroller contends that the Tax Court erred in finding that the unpaid advances Mr. Jalali made to M & I and WDJ were bona fide loans rather than capital contributions. The Jalalis, of course, disagree.

A.

Before we can answer whether the Tax Court erred in concluding that the advances made by Mr. Jalali were bona fide loans, we must first determine whether that is a question of law, a question of fact, or a mixed question of law and fact. As the...