Gregg Co. of Delaware v. Commissioner of Int. Rev.

• Decision Date: 17 December 1956
• Docket Number: No. 2,Docket 23621.,2
• Citation: 239 F.2d 498
• Parties: The GREGG COMPANY OF DELAWARE, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

239 F.2d 498 (1956)

The GREGG COMPANY OF DELAWARE, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 2, Docket 23621.

United States Court of Appeals Second Circuit.

Argued November 7, 1956.

Decided December 17, 1956.

Kenneth W. Moroney, New York City, for petitioner.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Harry Baum, I. Henry Kutz, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before MEDINA, LUMBARD and WATERMAN, Circuit Judges.

WATERMAN, Circuit Judge.

The petitioner, The Gregg Company of Delaware, appeals from a decision of the Tax Court, 23 T.C. 170, 1954, that the amounts paid by petitioner to its parent corporation on its so-called "Fifty-Year 4% Income Notes" were not deductible "interest * * * on indebtedness" within the meaning of Section 23(b) of the Revenue Acts of 1934, 1936, and 1938, 26 U.S.C.A. (I.R.C.1939) § 23(b). Petitioner asserts that these Notes were evidence of a valid indebtedness and therefore it was entitled to a tax deduction for the payment of interest thereon.

We believe the Tax Court was so clearly correct in its disposition of this case that we would affirm on the opinion of Judge Murdock, 23 T.C. 170, were it not that subsequent to his opinion we decided an appeal from that court in Kraft Foods Co. v. Commissioner, 2 Cir., 1956, 232 F.2d 118, and the petitioner here relies upon our opinion in that case to support its contention that the Tax Court erred.

The involved facts in the present appeal are set forth in detail in the Tax Court opinion. Many of these facts were stipulated by taxpayer and Commissioner. The Fifty-Year 4% Income Notes, as will hereinafter appear, have some of the characteristics of a conventional debt issue and some of the characteristics of a conventional equity issue. When such "hybrid" securities are involved, the problem of characterization is one of considering each case on all of its facts. See John Kelley Co. v. Commissioner (Talbot Mills v. Commissioner), 1946, 326 U.S. 521, 66 S.Ct. 299, 90 L.Ed. 278. Therefore, despite the detailed statement of facts in the Tax Court opinion, we must summarize the history behind the issuance of the taxpayer's Fifty-Year 4% Income Notes; and, in the light of that history, examine the nature of the transaction evidenced by them in order to realistically understand the meaning and purpose of the actual provisions contained therein.

Taxpayer is a Delaware corporation, incorporated in 1933. Prior to its incorporation the Gregg family had been actively engaged in the business of building and selling railway cars and equipment in various parts of the world, primarily in Latin America. In 1903 the Gregg Company, Ltd., a New York corporation, hereinafter called "New York," was organized as the original corporate entity engaged in this business. During the period from 1929 to 1932 all the manufacturing operations of New York were transferred to a wholly-owned subsidiary, Societé Gregg d'Europe, a Belgian corporation, organized in 1927. New York, however, continued to conduct all the selling operations; to own the patents and inventions, the inventories, work in process, and finished goods; and to exercise entire control over the merchandise and the operations of the Belgian corporation. In 1933, since all of the business of the enterprise, as well as the manufacturing, was conducted outside the United States, it was decided to organize a foreign corporation to carry on the operations of New York. The Tax Court found that this was done to avoid United States income taxes assessed against New York upon profits made elsewhere. The taxpayer, The Gregg Company of Delaware, petitioner here, was organized on October 18, 1933 as the first step in the execution of this intention. On October 31, 1933, New York transferred substantially all of its assets, including its foreign assets, to taxpayer in exchange for taxpayer's entire authorized capital stock consisting of 2,000 shares of capital stock without par value and for $1,000,000 face value of taxpayer's Fifty-Year 4% Income Notes. Thereupon, New York distributed these Income Notes to the stockholders of New York in the same proportions in which they held New York common stock. The assets so acquired by taxpayer from New York had an actual value of at least $1,318,000, New York retaining some assets of an undisclosed value. After taxpayer was organized, and before the transaction with New York of October 31, 1933, a corporation was organized on October 24, 1933 under the laws of the Republic of Panama. On November 1, 1933, the day after the transaction between New York and taxpayer, taxpayer transferred to the Panama corporation, Gregg Car Company, Ltd., all of the assets so acquired from New York, except $2,000 in cash, being assets having an actual value of at least $1,316,000, — and received in exchange therefor the entire authorized issue of 4% non-cumulative voting preferred stock of the Panama corporation, having an aggregate par value of $1,000,000. Therefore, if all went well, taxpayer would receive income of $40,000 annually by its receipt of dividends from Panama, and would pay out $40,000 annually to the stockholders of New York by the payment proportionately to each of them each year of a 4% return on $1,000,000.

The "Fifty-Year 4% Income Notes" issued by taxpayer were to mature February 1, 1984. They bore interest from January 1, 1934, at a rate not to exceed 4%, payable on February 1 of each succeeding year. The interest was payable "out of the surplus net earnings and income for the preceding calendar year but only if and to the extent that the surplus net earnings and income of the Company shall suffice for such payment; such interest shall not be cumulative and no part of the interest hereon for the payment of which the surplus net earnings and income for any interest year shall be insufficient shall be a charge upon or shall be paid from the income of any other year." Current expenses of the business, taxes, insurance charges, other interest charges, and such sums as the board of directors in their discretion might set aside as a reserve for any purpose or contingency were to be deducted from the gross earnings for the interest period in determining the...