Duncan Indus., Inc. v. Comm'r of Internal Revenue, Docket No. 6412-77.

CourtUnited States Tax Court
Writing for the CourtDRENNEN
Citation73 T.C. 266
Docket NumberDocket No. 6412-77.
Decision Date15 November 1979

73 T.C. 266


Docket No. 6412-77.

United States Tax Court

Filed November 15, 1979.

Petitioner borrowed $100,000 from Dycap, Inc., a small business investment corporation. Under the loan agreement, petitioner was to pay a variable rate of interest pegged to the prime interest rate being charged by a New York bank, $3,000 in points, and agreed to sell Dycap a 20-percent equity interest in petitioner for $500. The 20-percent equity interest involved 24,050 shares of petitioner's $1 par value stock for which Dycap paid about $0.02 per share. At about the time the agreement was executed, the book value of petitioner's stock was in excess of its $1 par value, and petitioner sold 17,500 shares of its stock to four knowledgeable individuals for $1 per share. Held: The sale of 24,050 shares of stock to Dycap for $500 was an integral part of the loan agreement without which petitioner could not have obtained the loan. The fair market value of the 24,050 shares of stock was $24,050 at the time of the sale. Petitioner is entitled to amortize the $23,550 difference between the fair market value of the stock and the amount paid therefor over the life of the loan as a cost of obtaining the loan.

[73 T.C. 267]

Andrew J. Duncan, Jr. (an officer), for the petitioner.

John W. Harris, for the respondent.


Respondent has determined the following deficiencies in petitioner's corporate income tax:

                ¦FYE Mar. 31— ¦Deficiency ¦
                ¦ ¦ ¦
                ¦1973 ¦$1,858 ¦
                ¦1974 ¦7,287 ¦

The following issues1 are presented for our resolution:

(1) Whether petitioner sold discounted stock in connection with a certain loan agreement;

(2) If the stock was in fact discounted, does section 1032, I.R.C. 1954, 2 bar a deduction under section 162;

(3) Whether petitioner must show its compliance with the terms of section 83(h) in order to claim a deduction in connection with this transaction.


Some of the facts have been stipulated and are so found. The stipulation of facts together with the exhibits attached thereto are incorporated herein by reference.

Petitioner, an Ohio corporation, maintained its principal place of business in Montecito, Calif. Petitioner filed a timely U.S. Corporation Income Tax return for the fiscal year ending March 31, 1973, with the District Director of the Internal Revenue Service at Cincinnati, Ohio. Petitioner filed its U.S. Corporation Income Tax return for the fiscal year ending March 31, 1974, on September 17, 1974. It also filed an amended return for this year on December 16, 1974. Both these returns were filed with the District Director of the Internal Revenue Service at Cincinnati, Ohio.

The petitioner's predecessor in interest, Marblcast, Inc. (Marblcast), was formed on February 18, 1969, under the laws of the State of Georgia, and began the manufacture of marble products. The authorized capital stock of the corporation was 1

[73 T.C. 268]

million shares of $1 par value stock. At that time, Andrew J. Duncan, Jr. (Duncan), was its sole shareholder and president. 3 In its first year of operation, Marblcast incurred an operating loss of approximately $40,000.

Dycap, Inc. (Dycap), is a small business investment company (SBIC). Dycap, as are all SBICs, is licensed under the Small Business Investment Act of 1958. It is a privately owned and capitalized company and engages in the business of making high-risk loans to new or financially unsettled corporations. Dycap is regulated by the Small Business Administration (SBA) and is subject to annual examination by the SBA to determine if its regulations are being properly followed.

When Dycap determines to make a loan, it typically borrows funds from the SBA. The SBA will loan Dycap $3 for every dollar of privately invested capital it raises and will charge a 73;8-percent rate of interest on the money loaned. Dycap then loans the funds to other companies at a mutually agreeable rate of interest. However, pursuant to SBA regulations, it may not lend money with an interest rate in excess of 15 percent.

Because of this interest limitation and the usually small spread between the interest paid to the SBA and the interest received from its debtor companies, Dycap usually purchased an equity interest in the companies to which it was lending money. Dycap obtained these interests in one of two ways, either by purchasing the stock outright, or by purchasing call options with the striking price set at the time of the making of the loan. Outside of the 15-percent-a-year limit on the amount charged on the outstanding principal, the SBA placed no restrictions on Dycap on the amount of consideration paid for these equity positions, nor did it limit fees charged for obtaining a loan.

During 1969, Ballinger, Inc. (Ballinger), an Ohio corporation and a competitor of Marblcast, obtained a loan from Dycap. Incident thereto, Dycap purchased 100 shares of Ballinger preferred stock. This loan was repaid with the life insurance proceeds obtained as a result of the death of Mr. Ballinger, president of Ballinger.

In December 1969, it came to Duncan's attention that Ballinger might be for sale. Ballinger was a relatively new

[73 T.C. 269]

company and had a negative net worth since its inception. Marblcast was in need of additional sales accounts. Duncan believed that a purchase of Ballinger, with its existing sales accounts, would be financially expedient and at that time contacted A. Gordon Imhoff (Imhoff), who had been running Ballinger during the period following Mr. Ballinger's death. Imhoff was also a director and general manager of Dycap. Additionally, Imhoff handled all of Dycap's portfolio investments.

Duncan was unable to secure financing from conventional lenders with which to complete the purchase of Ballinger. Since without financing there could be no purchase, he then contacted Imhoff about the possibility of obtaining a loan from Dycap. Marblcast supplied Imhoff with information regarding its financial status, history, and makeup of management; additionally, Imhoff requested and was supplied information regarding Duncan's background. Among the documents Imhoff reviewed incident to this loan request was Marblcast's unaudited balance sheet for the period ending December 31, 1969 (Exhibit 14-N), which was as follows:4

                ¦DECEMBER 31, 1969 ¦
                ¦ ¦¦ ¦
                ¦ASSETS ¦
                ¦ ¦¦ ¦
                ¦Current assets: ¦¦ ¦
                ¦Cash ¦$25 ¦
                ¦Accounts receivable—trade¦43,533¦
                ¦Employee advances ¦50 ¦
                ¦Inventories ¦19,600¦
                ¦Prepaid expenses ¦4,240 ¦
                ¦Total current assets ¦67,448¦
Fixed assets:
                Machinery and equipment $50,804
                Automobiles 3,697
                Leasehold improvements 6,704
                Office equipment 7,984
                Sales equipment 692
                Molds 11,405
                Less: accumulated depreciation 8,372 72,914
Other assets:
                Unamortized [sic] organization expense 650
                Unamortized pre-production costs 6,620
                Deposits 1,300 8,570
                Current liabilities:
                Notes payable—banks 45,000
                Installment notes payable—current 5,290
                Accounts payable 32,939
                Payroll taxes—withheld and accrued 6,829
                Overdraft—checking accounts 168
                Accrued interest 708
                Total current liabilities 90,934
Long-term liabilities:
                Installment notes 11,915
                Less: current portion above 5,290 6,625
Other liabilities:
                Loan payable—stockholder 4,265
Stockholders' equity:
                Common stock 73,500
                Net (loss)—year to date—(Exhibit B) (26,392) 47,108
                Prepared without audit

[73 T.C. 271]

Although Imhoff found problems with the treatment of certain items on the balance sheet and, therefore, believed Marblcast had a net worth substantially below the $47,108 listed therein, he nevertheless agreed to make the loan. The primary reason for granting the loan was Imhoff's confidence in Duncan's management ability and his belief that with additional working capital, Marblcast had a good chance of success. Imhoff's judgment proved correct, for, subsequent to the loan, Marblcast became a profitable company.

On March 17, 1970, Dycap entered into a financing agreement with Marblcast and Ballinger which provided, inter alia, for Dycap to agree to loan Marblcast $100,000 for the purposes of acquiring 100 percent of Ballinger's common stock and increasing its working capital. A 3-percent loan fee ($3,000) was added to the face amount of the loan. The loan bore a 10-percent variable interest rate, whereby it was adjusted semiannually to 11;2 percent over the prime rate of the First National City Bank of New York City. The loan had an 8-year term, but it provided for prepayment at the option of Marblcast.

In addition to the interest and points, and as a condition to the making of the loan, Marblcast was required to sell to Dycap 20 percent of its outstanding stock for the sum of $500. This requirement was spelled out in article 1, section 5 of the financing agreement between Marblcast, Ballinger, and Dycap which provided:

Section 5. Subject to the terms and conditions of this Agreement, MARBLCAST agrees to sell to DYCAP and DYCAP agrees to buy from MARBLCAST:

20% of the amount of outstanding and subscribed for common stock of MARBLCAST thirty (30) days from the date of this Financing Agreement at a total price of $500.00.

[73 T.C. 272]

Both parties were represented by counsel throughout the negotiations leading up to the execution of the loan agreement. These negotiations were...

To continue reading

Request your trial
63 cases
  • Partner v. Comm'r Of Internal Revenue, No. 09-60085.
    • United States
    • United States Courts of Appeals. United States Court of Appeals (5th Circuit)
    • 10 August 2010
    ...the property has no track record of earnings that provides past income data to evaluate. Id. at 153 (citing Duncan Indus., Inc. v. Comm'r, 73 T.C. 266, 280 n. 13, 1979 WL 3700 (1979); Pittsburgh Terminal Corp. v. Comm'r, 60 T.C. 80, 89, 1973 WL 2611 (1973)). Without such information, the ap......
  • Fort Howard Corp. & Subsidiaries v. Comm'r of Internal Revenue, No. 6362–92.
    • United States
    • United States Tax Court
    • 24 August 1994
    ...v. Commissioner, 75 T.C. 424, 441 (1980), affd. without published opinion 691 F.2d 490 (3d Cir.1982); Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 275 (1979); Lay v. Commissioner, 69 T.C. 421, 438 (1977); Cagle v. Commissioner, 63 T.C. 86, 97 (1974), affd. 539 F.2d 409 (5th Cir.1976); ......
  • Ward v. Comm'r of Internal Revenue, Docket No. 30068-83.
    • United States
    • United States Tax Court
    • 16 July 1986
    ...a reasonable time before or after the valuation date are the best criteria of market value. Duncan Industries, Inc. v. Commissioner, 73 T.C. 266, 276 (1979). However, the stock of J-Seven has never been publicly traded, and there have never been any sales of the stock. In the absence of arm......
  • Sommers Drug Stores Co. Employee Profit Sharing Trust v. Corrigan Enterprises, Inc., No. 85-2377
    • United States
    • United States Courts of Appeals. United States Court of Appeals (5th Circuit)
    • 14 July 1986
    ...a reasonable time before or after the basic date, are the best criterion of market value."); Duncan Industries, Inc. v. Commissioner, 73 T.C. 266, 276 (1979) (same). Nor did Hanke consider whether a discount for lack of marketability should be applied to the Trust's stock. See Estate o......
  • Request a trial to view additional results

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT