Erickson v. C. I. R.

Decision Date11 June 1979
Docket NumberNo. 77-1511,77-1511
Citation598 F.2d 525
Parties79-2 USTC P 9444 Franklin E. ERICKSON and Helen A. Erickson, Appellants-Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Appellee-Respondent.
CourtU.S. Court of Appeals — Ninth Circuit

Wallace T. Hyde, Sacramento, Cal., for appellants-petitioners.

Gilbert E. Andrews, Atty., Tax Div., U. S. Dept. of Justice, Washington, D. C., Carleton Powell, Asst. U. S. Atty., for appellee-respondent.

Appeal from Judgment of the United States Tax Court.

Before MERRILL and KENNEDY, Circuit Judges, and KING, * District Judge.

SAMUEL P. KING, District Judge.

Franklin E. and Helen A. Erickson (petitioner) 1 appeal the decision of the Tax Court sustaining the Commissioner of Internal Revenue in his determination of deficiencies in petitioner's returns for taxable years 1965 through 1968. Petitioner further contends that the Tax Court erred in excluding his testimony on the issue of whether the payment by petitioner's wholly-owned corporation of certain entertainment expenses incurred by him resulted in constructive dividends.

I

In May 1962, petitioner and two associates obtained a long-term lease of a parcel of land with a building that was being operated as a drive-in restaurant. Petitioner renovated and expanded the building and renamed it the "Wayside Inn." In 1963, petitioner took over the entire venture. On June 1, 1964, he sold his interest in the Wayside Inn to four corporations for $281,941. Petitioner was the president and sole shareholder of each of these corporations. On that same date, he entered into a leaseback agreement with the corporations whereby he continued to operate the restaurant. This agreement called for the payment of a fixed annual rent and an equal annual apportionment of net profit and loss from the restaurant operation among the petitioner and the four corporations.

About this same time, the four corporations formed a partnership ("Wayside Investment") and transferred to it the leasehold interest and improvements. The partnership maintained its books and records and reported income on a fiscal basis for federal income tax purposes, with the first taxable year beginning June 1, 1964 and ending May 31, 1965. For taxable years ending May 31, 1965 through May 31, 1967, Wayside Investment reported its allocable share of the net loss from the restaurant operation on its partnership returns. The depreciation schedules attached to the returns listed the property transferred from the petitioner.

In accordance with the June 1, 1964 agreement, petitioner reported 20 percent of the net loss for the taxable years 1965 and 1966. At some point, petitioner drafted a letter from himself, as president of the four corporations, to himself as an individual, which stated that, as of June 1, 1967, the leaseback agreement of June 1, 1964 was rescinded. There was no record of a transfer of the Wayside Inn back to petitioner in the books or records of the petitioner, the four corporations, or the partnership. In addition, as of June 1, 1967, it appeared that the four corporations had net operating losses exclusive of any loss attributable to the operation of the Wayside Inn. For the taxable years 1967 and 1968, petitioner reported 100 percent of the net loss from the restaurant operation and claimed depreciation deductions for property used in the business of the Wayside Inn. 2

The Commissioner recognized petitioner's allocation of net loss for taxable years 1965 and 1966 as fixed by the leaseback agreement; however, the Commissioner refused to recognize the purported rescission of the leaseback agreement as of June 1, 1967. Consequently, pursuant to section 482 3 of the Internal Revenue Code, the Commissioner disallowed a portion of the petitioner's loss deduction for the taxable years 1967 and 1968. The Commissioner allocated deductions pursuant to the terms of the leaseback agreement and therefore determined that petitioner was entitled to deduct only 20 percent of the net loss and disallowed in full the depreciation deduction claimed by petitioner on the Wayside Inn property.

In another unrelated transaction, petitioner purchased certain real property in Sacramento, California, in 1959. Buildings on the property were rented to Erickson Construction Company, one of petitioner's wholly-owned corporations, and to an unrelated third party. In September 1965, petitioner was notified by the State of California that this property was to be condemned. Petitioner received the condemnation proceeds in 1966 and used them to purchase various parcels of real estate. One such parcel was a lakeshore lot upon which petitioner subsequently built a house and boating facilities. Petitioner testified that he used the house on weekends for the purpose of selling nearby condominium units owned by Erickson Investment Company, another of petitioner's wholly-owned corporations. He stated that he was thus able to save his corporation real estate commissions and other selling expenses. Petitioner did not lease this lakeshore home to Erickson Investment Company nor to any other person. He also did not claim a depreciation deduction for it. The Commission determined that this parcel of real estate did not qualify as replacement property under section 1033 of the Code and consequently assessed the petitioner with a deficiency attributable to the gain recognized upon conversion of the condemned property.

Erickson Construction Company maintained its books and records and reported for federal income tax purposes on a fiscal year beginning June 1 and ending May 31 of each year. For fiscal years ending May 31, 1965 through May 31, 1968, the Commissioner disallowed certain travel and entertainment expenses that petitioner had individually charged at clubs, restaurants and various other places but had been paid for by the corporation. Neither the books and records of the corporation nor the petitioner provided substantiating information other than payment to the named payees. The Commissioner determined that these payments, less the dividend exclusion, 4 constituted constructive dividends to the petitioner. At all material times, the corporation had earnings and profits in excess of the amount determined to be dividend income.

During the trial, petitioner attempted to testify as to the business nature of these expenses. The Tax Court refused to permit petitioner's testimony on the grounds that the admission of petitioner's unsubstantiated testimony was improper without corroborating evidence.

II

Petitioner contends that the conduct of the Commissioner pursuant to section 482 in reallocating the loss and depreciation deductions on account of the operation of the Wayside Inn was "unreasonable, arbitrary and capricious." To support his contention, petitioner argues that there was a transfer of the Wayside Inn from the corporations back to himself at the time of his letter rescinding the leaseback agreement. As proof of such transfer, he points to records indicating that the corporations were indebted to him for over a million dollars and to his testimony that his tax service and company accountants had not been making proper bookkeeping entries. Presumably, petitioner believes that had such a transfer occurred, the full loss and depreciation deductions would have been allocable to him. We find it unnecessary at this time to decide what effect, if any, such a transfer would have had.

Petitioner's contention accurately suggests the appropriate rule of law to be applied in reviewing allocations made pursuant to section 482. The Commissioner has broad discretion under section 482, and neither we nor the Tax Court will countermand his decision unless the taxpayer shows it to be unreasonable, arbitrary or capricious. Charles Town, Inc. v. Commissioner, 372 F.2d 415, 422 (4th Cir. 1967).

The Tax Court stressed the timing of the various transactions between the petitioner and his four corporations. When petitioner was faced with losses in June 1964, he sold the Wayside Inn to the corporations and entered into the leaseback agreement; when the corporations were generating losses in 1967 independent of the Wayside operation, he claims that the restaurant property was sold back to him. The Tax Court noted that the earlier June 1, 1964 transfer from the petitioner to the corporation was documented in the books and records of the petitioner and the corporations, but the alleged June 1, 1967 transfer was not reflected in those same records. The Tax Court held that petitioner had failed to prove the June 1, 1967 transfer and thus found as a question of fact that the alleged transfer had never occurred. Unless the Tax Court's finding was "clearly erroneous," we will not disturb its determination. Wien Consolidated Airlines v. Commissioner, 528 F.2d 735 (9th Cir. 1976); Allen v. Commissioner, 514 F.2d 908 (5th Cir. 1975); See I.R.C. § 7482(a).

Weighing the evidence offered by petitioner against the lack of confirmation in the records of the parties to the alleged transfer, we are not convinced that a mistake has been made so as to render the Tax Court's findings "clearly erroneous." United States v. United States Gypsum Co.,333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1947). Because the Tax Court found that the Wayside Inn had not been transferred back to the petitioner on June 1, 1967, the restaurant operation continued substantially as before. Thus, the action of the Commissioner in reallocating the losses in accordance with the agreement and in disallowing petitioner's depreciation deduction was not arbitrary or capricious. We therefore affirm the decision of the Tax Court sustaining the Commissioner's disallowance of petitioner's loss and depreciation deduction from the operation of the Wayside Inn for taxable years 1967 and 1968.

Petitioner next contends that the lakeshore lot that he purchased with a portion of the proceeds resulting from the condemnation of certain rental property...

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