First National Company v. CIR, 14059.

• Decision Date: 28 April 1961
• Docket Number: No. 14059.,14059.
• Citation: 289 F.2d 861
• Parties: FIRST NATIONAL COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Sixth Circuit

289 F.2d 861 (1961)

FIRST NATIONAL COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 14059.

United States Court of Appeals Sixth Circuit.

April 28, 1961.

William Waller of Waller, Davis & Lansden, Nashville, Tenn., for petitioner.

Victor A. Altman, Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Louise Foster, Attys., Dept. of Justice, Washington, D. C., on the brief), for respondent.

Before McALLISTER, Chief Judge, and MARTIN and MILLER, Circuit Judges.

SHACKELFORD MILLER, Jr., Circuit Judge.

The Commissioner of Internal Revenue determined an income tax deficiency against the petitioner, First National Company, for the taxable years 1951, 1952 and 1953 in the respective amounts of $42,381.19, $5,742.79 and $6,597.97. The deficiency was based upon the disallowance by the Commissioner of deductions taken by the petitioner as interest paid by it during the years in question on its outstanding promissory note in the principal amount of $1,838,299.10, the Commissioner holding that the note did not represent any genuine and then existing indebtedness owing by the petitioner.

The facts are stipulated and are set out in detail in First National Company v. Commissioner of Internal Revenue, 32 T.C. 798, to which reference is made. The following summary is sufficient to present the issue now before the Court.

The petitioner was originally organized as a bank and trust company in 1926, but on June 7, 1944, its corporate purposes and powers were changed to that of a mercantile establishment. Except for being involved in certain litigation the petitioner was not engaged in any active business from late in 1931 to early in 1943.

During the years 1930 and 1931 the petitioner issued promissory notes totaling $2,613,250 to several banking companies, representing borrowed money. For convenience, transactions relative to these notes are divided into two groups.

Loans by the Fourth and First Banks, Inc.

During 1930 and 1931 three demand promissory notes, totaling $688,899, were given by the petitioner to its parent company, the Fourth and First Banks, Inc., hereinafter called Fourth Banks. In 1931 the latter also made advances in the amount of $74,547.16, which were not covered by notes until 1943 and were not entered on the petitioner's books until 1937. By 1940 the total owed by the petitioner on these loans amounted to $761,140.66. No interest was paid on these loans after February 19, 1932. Prior to December 31, 1950, petitioner's indebtedness had been charged off on the books of Fourth Banks down to a value of only $2.

Prior to December 1942 all of the petitioner's outstanding capital stock, consisting of 1,000 shares of common stock with a par value of $100 per share, was owned by Fourth Banks and had been given a value on its books, sometime prior to December 31, 1940, of only $1.

Other Loans to the Petitioner.

During 1930 and 1931 petitioner borrowed $1,724,351 from, and gave promissory notes totaling that amount to, the National City Bank, the Philadelphia National Bank, the American National Bank, and the Nashville Trust Company, hereinafter referred to as "Other Banks." With minor exceptions the only payments on these notes were made with money received from the sales of collateral held by the banks as security for the notes.

By December 1942 the unpaid balance on these notes to the Other Banks amounted to $1,127,900.11. With one exception no interest on these notes was paid after February 19, 1932, the one exception being an interest payment of $125,255.32 through a sale of collateral held by one of the banks. The notes were largely charged off as worthless by the several banks.

Shortly prior to December 11, 1942, Parkes Armistead, Paul M. Davis and G. L. Comer undertook to acquire the notes, indebtedness and stock held by the Fourth Banks and the notes held by the Other Banks. Armistead was, and had been since February 1937, a member of the petitioner's Board of Directors and continued to be a Director until June 22, 1943. He was petitioner's president from December 15, 1942, until July 15, 1943. He was also executive vice-president of the American National Bank, one of the banks holding the notes. Davis was in mid-December 1942 the president of the American National Bank and at that time was made a member of the petitioner's Board of Directors. He was also a vice-president from December 15, 1942, to July 15, 1943. Comer was elected a member of the petitioner's Board of Directors on June 22, 1943, and has remained a director since then. He was also elected one of the three vice-presidents of the petitioner on July 15, 1943, and has continued as such since then.

On December 11, 1942, Armistead, Davis and Comer acquired all of petitioner's capital stock from Fourth Banks, together with petitioner's notes payable and accounts payable to the Fourth Banks in the amount of $761,140.66. The consideration given was $1,000. New stock certificates were issued to them and their nominees.

At or about the same time Armistead also acquired from the Other Banks the notes of petitioner which they held for a payment by him of 4½% of the unpaid balance of each note, which payment, totaling $50,741.67, was made by his personal checks or cashier checks purchased for that purpose. The value of petitioner's total assets at that time was $51,531.20. The assets were immediately converted into cash and the $50,741.67 that Armistead had paid out in obtaining the notes from the Other Banks was repaid to him almost simultaneously by the petitioner. The excess cash derived from the liquidation of the petitioner's assets was expended in its entirety in defraying the costs of liquidation and in the purchase of transfer stamps for the transfer of its stock on its books to Armistead, Davis and Comer.

On July 1, 1943, petitioner issued its unsecured, demand promissory note to Davis, Armistead, and Comer in the amount of $74,547.16, which was in lieu of the account payable in a like amount carried on petitioner's books as being due Fourth Banks. Petitioner's minute books contained no authorization for issuance of this note.

On or about January 12, 1945, Comer purchased the respective interests of Armistead and Davis in petitioner for $30,000 to each of them. A new certificate for 1,000 shares of common stock was issued to Comer by petitioner on January 12, 1945, making him the sole owner of petitioner's outstanding voting common stock, with a total investment therein of $60,333.

On May 31, 1946, Comer for the sum of $60,333 transferred the 1,000 shares of stock to Washington Manufacturing Company, which on October 26, 1946, transferred it to the Washington Overall Manufacturing Company. Both of these companies were controlled by Comer and his brother.

On or about July 23, 1951, all of the old notes payable of petitioner were given by Comer to the Church of Christ Foundation, Inc., hereinafter referred to as the Foundation. The Foundation was incorporated under the laws of Tennessee August 28, 1946. It had five incorporators, two of whom were Comer and his brother. Comer was elected vice-president and a member of the Board of Trustees on December 20, 1946. His brother was elected president and a member of the Board of Trustees on December 20, 1946, and served in such capacities until his death on June 26, 1953. The Foundation was ruled a tax exempt organization by the Internal Revenue Service on January 5, 1948.

The old notes as given to the Foundation by Comer had outstanding balances thereon of $1,838,299.10. On August 1, 1951, petitioner issued its unsecured, demand promissory note to the Foundation in that amount. This action was authorized by the "entire outstanding voting stock" and Board of Directors of petitioner on July 23, 1951. The Foundation surrendered to the petitioner all the old notes at that time. On December 27, 1951, the Washington Overall Manufacturing Company transferred the 1,000 shares of the outstanding common voting stock of the petitioner to the Foundation.

By November 24, 1954, petitioner had paid the principal amount due on its single note to the Foundation. In addition to the payments of principal, petitioner paid to the Foundation in the years 1951, 1952 and 1953 certain sums as interest on the note which it took as interest deductions in its income tax returns for those years. These are the deductions which the Commissioner disallowed, resulting in the deficiency assessment herein involved.

The petitioner contended, and now contends, that the promissory note was an outstanding valid indebtedness on its part, and that the interest payments paid by it on the note were properly deductible under Section 23(b), Internal Revenue Code, 26 U.S.C.A. § 23(b). That section provides that in computing net income there shall be allowed as deductions "all interest paid or accrued within the taxable year on indebtedness," with certain exceptions not applicable here. The Commissioner contended, and the Tax Court held, that the payments made by the petitioner were not allowable as interest deductions because the liability under the note to the Foundation was not a bona fide liability of the corporation, and that the amounts claimed as interest were to be treated as contributions subject to the statutory limitations.

In support of his position the Commissioner argues that in order to be deductible "interest" must be paid on "indebtedness," which as used in Section 23(b) means an existing, unconditional and legally enforceable obligation for the payment of money. Autenreith v. Commissioner of Internal Revenue, 3 Cir., 115 F.2d 856; United States v. Virgin, 5 Cir., 230 F.2d 880. We agree with this statement of the applicable law.

The Commissioner and the Tax Court are not entirely in accord in their reasons for the conclusion that the note was not such a valid indebtedness, but if the conclusion is correct upon any legal ground, it...