Dobyns-Taylor Hardware Co. v. United States

• Decision Date: 11 December 1967
• Docket Number: Civ. A. No. 2087.
• Citation: 278 F. Supp. 538
• Parties: DOBYNS-TAYLOR HARDWARE CO., Inc., Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Eastern District of Tennessee

278 F. Supp. 538

DOBYNS-TAYLOR HARDWARE CO., Inc., Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 2087.

United States District Court E. D. Tennessee, Northeastern Division.

December 11, 1967.

John Y. Merrell, Washington, D. C., T. R. Bandy, Kingsport, Tenn., for plaintiff.

Sherin V. Reynolds, U. S. Dept. of Justice, Washington, D. C., J. H. Reddy, U. S. Atty., Chattanooga, Tenn., for defendant.

MEMORANDUM OPINION

NEESE, District Judge.

This is an action by the plaintiff-taxpayer for a refund of federal income taxes, 28 U.S.C. § 1346(a), for its fiscal years ending August 31, 1961 and 1962, based on a claimed net operating loss carryback of $55,829.97 from its fiscal year ending two years after the latter date. The defendant's commissioner of internal revenue adjusted the taxpayer's taxable income for its tax year 1964 by disallowing the aforementioned loss, comprised of claims of $75,842.62 for bad debts, $4,500 for legal fees expended in connection therewith, and the allowance of $1,225.63 for additional contributions not theretofore claimed. The action was tried by the Court without a jury on August 21, 1967. Competing briefs have now been filed and considered.

The plaintiff-taxpayer Dobyns-Taylor Hardware, Inc. was organized in 1939 by George W. Taylor, his wife and children. The principal operation at all times was in Kingsport, Tennessee. From time to time, four other corporations were organized by the Taylor family. During the taxpayer's fiscal years 1961 and 1962, the Taylor family owned the stock of all these corporations, one of which was Dobyns-Taylor, Inc.,¹ located at Jonesboro, Tennessee. Mr. Taylor was the president and a director of both these corporations, as well as the controlling patriarch in all this family's corporate operations.

The local management of the Jonesboro operation was required to make daily, weekly, monthly, and annual reports of its operations to the Kingsport corporate office, where the books and records of all the family's corporate operations were kept, and whence all corporate bills were directed to be paid. No corporate official or other employee of the operation at Jonesboro was permitted to sign checks on the corporate account. Merchandise for the Jonesboro outlet was purchased by the Kingsport corporation and on its books charged out to the Jonesboro operation. On December 13, 1963, Dobyns-Taylor, Inc. at Jonesboro owed the plaintiff- taxpayer at Kingsport $83,862.50 on such account.

In anticipation of opening the Jonesboro store, Mr. Taylor arranged with the First Peoples Bank of Jonesboro for the discounting of conditional sales contracts covering merchandise sold by Dobyns-Taylor, Inc., whereunder the plaintiff-taxpayer would be responsible for the financing contracts of Dobyns-Taylor, Inc., and whereunder also the discounting institution held in a reserve account a percentage of the repayments received as a further security against prospective losses of the bank. In furtherance of this arrangement, a combined financial statement of the Kingsport, Jonesboro and a third corporation was filed with the bank, although the bank's attorney testified the bank relied on the interlocking character of the corporations, rather than on their combined financial statement as a basis of financial position.

Commencing in 1954 James C. (Jack) Taylor, a nephew of the aforenamed Mr. Taylor, was elected the vice president and was made the manager of Dobyns-Taylor, Inc. His compensation included an annual incentive bonus of 10% of the net profits of the Jonesboro corporation. He was ambitious to improve the profit picture of his store and ingratiated himself in the community through leadership in religious, civic and charitable affairs. He succeeded in becoming a valued and trusted citizen and employee, but he failed in the matter of increasing the profits of the store.

Sometime in 1958 or 1959, he undertook a circuitous criminal scheme to distort the earning and profit picture of his company. He discounted at the aforenamed bank spurious conditional sales contracts of fictitious makers and applied the proceeds to purchasing, outside of routine channels, new merchandise or to paying suppliers of merchandise, also outside of normal channels, cashier's checks of the bank. As payments became due on the initial bogus contracts, Mr. Jack Taylor obtained funds by discounting additional spurious conditional sales contracts and made payments with such proceeds.

The manager at Jonesboro concealed his machinations from his uncle and other members of his family by reporting the spurious sales as having been genuine, but he did not seek credit for or reimbursement of the cost of merchandise thus sold. He maintained no company records of the spurious transactions, and, although the precise manner in which this Mr. Taylor misappropriated the large funds thus received was never clearly discernable, the Court finds that these funds were appropriated to this Mr. Taylor's own use in some manner known at least to him. It would appear that the decreased expenditure for purchases of merchandise, if this Mr. Taylor is to be believed, would have resulted in inflated profits at Jonesboro. Such, however, was not the statistical result on the company books. Profits at the Jonesboro store ranged from 4% to 5% before Mr. Jack Taylor became manager and remained at about 5% during his tenure.

In 1963 Mr. Guy Culbertson, who was secretary-treasurer of both the Kingsport and Jonesboro corporations, noticed that the annual payment from the aforementioned reserve account to the corporation at Jonesboro was not as great as should be anticipated from the volume of business done and made inquiry of an official of the bank. He was advised by Mr. Don C. Boyer, vice president and manager of the bank's branch at Jonesboro, that the reserve payment was low, because the credit extended on account of the Jonesboro sales amounted to $427,142.00! This prompted an investigation and a revelation that the bank held genuine conditional sales contracts of the aggregate sum of only $80,882.00, while spurious conditional sales contracts aggregated $336,260.00.²

The matter of the respective liabilities was afterward referred by the bank to its attorney, and the plaintiff-taxpayer engaged attorneys to represent and protect its interests. Demands and counterclaims were interchanged between adversary counsel, and negotiations were had through them, leading to a settlement out of court. At a meeting of the directors of the plaintiff-taxpayer on December 27, 1963, it was agreed that plaintiff taxpayer Dobyns-Taylor Hardware Co., Inc., would pay the bank $157,568.11 in exchange for its release of both corporations from all liability on account of the aforementioned net loss of $315,136.23; authority was given for officials of the plaintiff-taxpayer to borrow $150,000 from the Hamilton National Bank, Knoxville, Tennessee, under a note due and payable in 90 days; and, the aforementioned Mr. George Taylor was authorized to purchase the assets for the plaintiff-taxpayer of Dobyns-Taylor, Inc., subject to its liabilities, with its inventory, furniture and fixtures to be fixed at book value, and to apply the net amount owing the Jonesboro corporation for purchase-money as a credit on the indebtedness of Dobyns-Taylor, Inc. to the plaintiff-taxpayer, including the indebtedness created by the advancement of $157,568.11 by the plaintiff-taxpayer to Dobyns-Taylor, Inc. to settle the bank's claim.

This settlement was consummated on December 31, 1963, the plaintiff-taxpayer issuing its check for $157,568.11 to the bank in consideration of the release of Dobyns-Taylor, Inc. and charging such amount to the account of Dobyns-Taylor, Inc. At this time, and since, Mr. Jack Taylor was woefully insolvent. The stockholders and directors of Dobyns-Taylor, Inc. ratified the foregoing settlement on January 8, 1964, agreed to sell its assets, subject to its liabilities, as proposed by the plaintiff-taxpayer, and voted to dissolve the corporation. It was subsequently liquidated, and its charter of incorporation was surrendered on February 7, 1964. On the last day of that month, its net assets of $169,490.95 were transferred, at the book value as of January 31, 1964, to the plaintiff-taxpayer, which also paid its attorneys the fair and reasonable fee of $4,500 for their services as aforesaid.

The plaintiff-taxpayer argues appropriately that by reason of the aforementioned facts, it is entitled to a refund of its taxes, whether alternately, as a net operating loss, a deduction for a bad debt, or an ordinary and necessary business expense incurred in its trade or business. Bratton v. Commissioner of Internal Revenue, C.A.6th (1954), 217 F.2d 486, 489 7. Viewed from the standpoint of an intercorporate transaction, the plaintiff-taxpayer is not entitled to claim the refund as a deduction for a bad debt, because the advancement by the plaintiff-taxpayer to Dobyns-Taylor, Inc. of $157,568.11, if constituted an ordinary loan, was worthless to the extreme extent of $75,842.63 when it was made. Cf. Bratton v. Commissioner, supra, 217 F.2d at 488 1.

This Court is of the opinion, however, finds and concludes that the aforementioned items of $157,568.11 and $4,500 are deductible by the plaintiff-taxpayer as a "* * * loss sustained during the taxable year and not compensated for by insurance or otherwise. * * *" 26 U.S.C. § 165(a). "For purposes of subsection (a) of 26 U.S.C. § 165, any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss. * * *" 26 U.S.C. § 165(e). The theft of Mr. Jack Taylor was discovered by the plaintiff-taxpayer in its fiscal tax year 1964.

"* * * The word `theft' is not like `larceny', a technical word of art with a narrowly defined meaning but is, on the contrary, a word of general and broad connotation, intended to cover and covering any criminal...