Dillin v. United States

• Decision Date: 13 November 1970
• Docket Number: No. 28108.,28108.
• Parties: John W. and Marie B. DILLIN, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

433 F.2d 1097 (1970)

John W. and Marie B. DILLIN, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 28108.

United States Court of Appeals, Fifth Circuit.

October 14, 1970.

Rehearing Denied November 13, 1970.

Michael L. Kinney, Sherwin P. Simmons, Albert C. O'Neill, Jr., Fowler, White, Collins, Gillen, Humkey & Trenam, Tampa, Fla., Daniel Mungall, Jr., Stradley, Ronon, Stevens & Young, Philadelphia, Pa., for plaintiffs-appellants.

John L. Briggs, U. S. Atty., Tampa, Fla., Rodger M. Moore, Atty., Johnnie M. Walters, Asst. Atty. Gen., Lee A. Jackson, Janet R. Spragens, Harry Baum, Attys., Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Before PHILLIPS^*, BELL and SIMPSON, Circuit Judges.

SIMPSON, Circuit Judge:

The Dillins appeal from a judgment entered on a jury verdict, which held that $99,250 received by Mrs. Dillin in 1961 was not a loan repayment and was properly taxed as a dividend.¹ The husband is a party by reason only of signing a joint return. Hereinafter, "appellant" or "taxpayer" refer to Mrs. Dillin or to the couple jointly, as the context requires.

Appellant is one of four children born to Emma and Phillip Baur. Phillip was co-founder of the Tasty Baking Company (TBC), and his family owned 50% of the stock. When he died in 1951 a management impasse arose between the Baur family and the Morris family, owner of the other half of TBC. In 1953, Herbert Morris offered to sell 800 shares of TBC to the Baur family at $1,000 a share. Phillip Baur's testamentary trust agreed to buy 400 shares, and the four Baur children plus Paul Kaiser, husband of Louise Baur Kaiser, agreed to buy the remaining 400 shares.

Tasty Holding Company (THC) was formed to hold the children's 400 shares, Kaiser and the family lawyer having decided that this provided the best means for retaining control of TBC. THC issued 400 shares to the four Baur children for the aggregate consideration of $500.

THC, on June 2, 1953, bought the 400 shares of TBC from Herbert Morris, using $400,000 borrowed from the Fidelity Bank at 3½% interest and payable on demand. Fidelity apparently made the loan in anticipation of handling more of TBC's business. As TBC had other banking ties, Kaiser decided to pay off the loan to Fidelity immediately.

On June 19, 1953, Emma Baur loaned THC $200,000 on open account. THC used the $200,000 plus four promissory notes to discharge its obligations to Fidelity. The same day, Kaiser and the four Baur children paid the bank $200,661.11, and were assigned the notes obligating THC. Each child, including the taxpayer, held one of the four equal notes.

From 1954 to 1961, Emma Baur assigned parts of the $200,000 THC obligation, in $3,000 parcels for gift tax reasons, to the children and Kaiser. Appellant was assigned $49,250 of the open account indebtedness, and was thus owed a total of $99,250 by THC.

THC, with its only income from dividends and its only assets TBC stock, was characterized for tax purposes as a personal holding company. It distributed all the dividend income to the five (including Kaiser) stockholders to avoid the heavy tax levied on undistributed personal holding company income. (I.R. C., Sec. 541)

By 1961, through two stock splits and a reorganization the 400 shares had become 72,000 shares of non-voting stock and 8,000 shares of voting stock. In late 1961, THC made a public offering of 40,000 non-voting shares. THC then used $400,000 of the $529,048 net sales proceeds to pay off the obligations held by the Baur children and Kaiser. No interest on indebtedness was paid. The appellant recovered $99,250, claiming that it represented a tax free repayment of debt, rather than a taxable dividend. The government contends that this event resulted in the acquisition by the taxpayer of taxable dividend income.

The problem of determining, in the context of the Internal Revenue Code and modern business relations, what constitutes an equity interest and what constitutes a debt interest has been a matter of continuing concern for the courts.² This case is no exception.

In Montclair, Inc. v. Commissioner of Internal Revenue, 5 Cir. 1963, 318 F.2d 38, at page 40, we attempted to list some of the guiding considerations in deciding debt-equity cases:

"(1) the names given to the certificates evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the source of the payments; (4) the right to enforce the payment of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) `thin\' or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of `dividend\' money; (11) the ability of the corporation to obtain loans from outside lending institutions."³

In applying these factors, each case must be decided on its own unique fact situation and no single test is controlling. Berkowitz v. United States, 5 Cir. 1969, 411 F.2d 818; Harlan, et al. v. United States, 5 Cir. 1969, 409 F.2d 904; Tomlinson v. 1661 Corporation, 5 Cir. 1967, 377 F.2d 291. Judge Goldberg has said for us that the Court rejects the thought that these tests are "talismans of magical power," and the most that can be said is that they prove a source of helpful guidance. Tyler v. Tomlinson, 5 Cir. 1969, 414 F.2d 844, 848.

A question preliminary to a consideration of the merits is whether this case was properly submitted to a jury. The appellant contends that the district court erred in sending the case to a jury since the operative facts are undisputed; she asserts that in this posture the case should have been decided by the court as a matter of law. Berkowitz, supra. While some dispute exists over the matters of the intent of the parties at the time these transactions occurred and the proper determination of the actual operating debt-equity ratio of the corporation, the facts are otherwise totally stipulated. As we said in United States v. Snyder Brothers Company, 5 Cir. 1966, 367 F.2d 980, 982-983, cert. denied 386 U.S. 956, 87 S.Ct. 1021, 18 L.Ed.2d 104:

"* * * the problem is not one of ascertaining intent since the parties have objectively manifested their `intent.\' It is a problem of whether the intent and acts of these parties should be disregarded in characterizing the transaction for federal tax purposes."

Thus in these debt-equity cases, if the other operative facts are undisputed, the existence of disagreement over the intent of the parties is not a barrier to determination of the issue as a matter of law. With regard to the debt-equity ratio question, the amounts attributable to each category as reflected on the corporate books ($400,000 debt — $500 equity) were undisputed. The controversy arose over whether for purposes of this litigation the debt-equity ratio should be computed by considering the equity amount as listed on the corporate books or by reference to the actual market value of the assets. In this situation we are of the opinion that establishing the standard and thus the proper debt-equity ratio was a matter of law. However, it is arguable that the case should have been submitted to the jury on the limited issue of establishing the proper value of the assets, and in view of the fact that the trial judge instructed the jury that they should look to actual market value in order to establish the debt-equity ratio, for purposes of this appeal we have given the appellant the benefit of the doubt and have assumed that appellant's estimation of the debt-equity ratio is correct. With that reservation, we are generally of the opinion that the district court improperly submitted the case to the jury. Berkowitz, supra.

The appellant also contends with great vigor that this is not a typical debt-equity case for two major reasons: (1) the initial transaction with Fidelity Bank was a bona fide transaction, and it retained that characterization when the promissory notes were later transferred for consideration to the stockholders of THC, and (2) this case involves a personal holding company, and because a holding company is uniquely designed to hold other property and not primarily to conduct profit-making operations, the traditional rules for evaluating and characterizing the advance of funds cannot properly be applied to such a company. We agree that these unusual circumstances may alter the emphasis placed on certain criteria which are traditionally involved in such decision-making. We fail to see, however, why these guidelines, imperfect as they may be, will not suffice in this case.

We turn to the merits. There was testimony at the trial by a bank officer and Kaiser that the initial loan made by the bank was a bona fide business deal and not part of some larger plan to convert the notes into the hands of the stockholders. Apparently the bank anticipated future business from the Baur family when it made the loan. It seems that the family was not equally enamored with the bank and upon learning of the bank's design they decided to pay off the loan. Therefore some seventeen days after the initial bank loan Mrs. Emma Baur advanced $200,000 to the corporation on open account, and the stockholders of THC obtained the additional $200,000 needed to pay off the bank and to take possession of the four THC promissory notes. Although it strains coincidence that the four notes held by the bank and obtained by the THC stockholders precisely matched the stockholders' pro rata holdings in THC (a factor which might indicate that the Baurs intended to put their money at the "risk of the business." Tyler v. Tomlinson, supra), at this point the dealings admittedly resemble a bona fide loan transaction. In saying this we do not mean to imply that a transaction which initially takes on the appearance of a legitimate loan may never later become an equity interest because of subsequent developments. Such a...