Holtz v. Commissioner of Internal Revenue

• Decision Date: 12 June 1958
• Docket Number: No. 15755.,15755.
• Citation: 256 F.2d 865
• Parties: Merriman H. HOLTZ and Helene Tyroll Holtz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

256 F.2d 865 (1958)

Merriman H. HOLTZ and Helene Tyroll Holtz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15755.

United States Court of Appeals Ninth Circuit.

June 12, 1958.

Moe M. Tonkon, Portland, Or., for appellants.

Charles K. Rice, Asst. Atty. Gen., Melvin L. Lebow, Lee A. Jackson, Harry Baum, Attorneys, Department of Justice, Washington, D. C., for appellee.

Before POPE, BARNES and HAMLEY, Circuit Judges.

BARNES, Circuit Judge.

This is a petition for review of a Tax Court decision sustaining the Commissioner's determination of deficiencies in income taxes of the petitioners (husband and wife, herein referred to as petitioner) for the years 1949 and 1950. Petitioner, as guarantor of certain corporate obligations, sought to deduct as business bad debts (26 U.S.C. § 23, Internal Revenue Code of 1939 § 23(k) (1)) certain amounts he was compelled to pay upon default of corporate debt. The Commissioner determined that the losses thus sustained were non-business bad debts and deductible under the more limited provisions of § 23(k) (4), which provides short term capital loss treatment for non-business bad debts, as opposed to the ordinary losses allowed from business bad debts under § 23(k) (1).

Both the Tax Court and this Court have jurisdiction. 26 U.S.C. (I.R. C.1939) § 1141(a); (I.R.C.1954) § 7482 (a).

The sole question presented on appeal is not whether the deduction is allowable, but how. Did the Tax Court err in holding that a loss resulting from the petitioner's guaranty of loans made to a corporation was deductible by him as a non-business bad debt, rather than as a business bad debt, as claimed by the taxpayer?

I. Statutory Law

The relevant provisions of § 23(k) of the 1939 Act as applicable in 1949 and 1950 are set out in the margin.¹ This statute defines a non-business debt as "a debt * * * other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." To determine whether the loss was incurred in the taxpayer's business requires a definition of the taxpayer's business. This is a mixed question of law and fact. We must first examine the stipulated facts in this case, found by the Tax Court to be as stipulated.

II. Stipulated Facts

Petitioner for many years prior to 1949 was the ninety-percent owner of the stock of a ladies' retail apparel store in Portland, Oregon, Helene's, Inc. This operation failed in 1949, but prior to this time petitioner has been president of the firm and active in its management. During this period the corporation obtained substantial loans, which were guaranteed by petitioner.

Petitioner has been engaged since 1930 in the business of selling and distributing 16 mm. film, audio visual equipment, supplies and accessories. Petitioner organized Pictures, Inc. in 1930, but this corporation remained inactive until 1949 when petitioner advanced to it the funds necessary to commence business in the territory of Alaska, where it has since continued business. Holtz was the manager and owned ninety-nine of its one hundred shares.

In 1932 petitioner formed Screen Adettes, Inc., which has since been engaged in the sale and distribution of 16 mm. films. Petitioner is president, manager, in effect sole shareholder and has been continuously engaged in its affairs. During the period of its operation, petitioner occasionally made advances to Screen Adettes, Inc., and has personally guaranteed all bank loans to it.

In 1945 petitioner organized Screen Adettes Equipment Corporation (herein called Equipment) for the sale and distribution of motion picture equipment and accessories on the Pacific Coast. Petitioner was the owner of five hundred of five hundred and three shares of stock. Besides the original investment, Equipment obtained working capital through a loan from the U. S. National Bank of Portland, which loan was personally guaranteed by petitioner who pledged as collateral certain shares of common stocks of a value substantially in excess of the amount of the loan. In 1949 Equipment filed its petition in bankruptcy, ceased doing business and was dissolved. In early 1950 the bank sold the collateral securities for less than the amount of the loan, realizing $83,316.00 on the sale and left petitioner indebted on his guaranty in the amount of $64,119.00. The former is the amount which petitioner claims as a bad debt loss incurred in his trade or business for the year 1950 and which, if allowed, gives him a net operating loss carryback to 1949. (A refund of 1949 taxes was recovered and the Commissioner now seeks return of this amount as a refund illegally paid.)

During a part of 1950 petitioner was engaged as a sole proprietor in the sale and distribution of audio visual equipment. He was also employed part-time as a salesman for an audio film firm.

Apparently petitioner participated, either as lender or guarantor, in approximately two hundred and fifty loans to the four corporations which he owned, controlled, and managed.

Petitioner makes two basic contentions of error:

1. That the legislative history makes it clear that Congress intended to prohibit full bad debt deductions only in the case of loans to relatives or friends made without prospect of repayment or which would give the taxpayer a dependency credit to which he was not otherwise entitled. Therefore, the section is improperly applied to good faith business transactions, such as those here, revealing a long history of continued similar activity by the taxpayer.

2. Alternatively, if the law applied was correct, the finding of fact by the Tax Court is clearly erroneous in that petitioner's activities fall within that line of cases holding that one who is engaged in the financing, organizing, promoting, and managing of corporations is entitled to a business bad debt deduction for losses incurred in loans to such corporations.

We conclude neither of petitioner's contentions is sound.

As to the first, his entire argument is based on a short statement in the summary explanation of the provisions of the Revenue Act of 1942, contained in the House Report of the bill (1942-2 Cum. Bull. 372, 408). This very short summary notes that the bad debt provisions have been the subject of abuses and gives as an example of a non-business bad debt, an unrepaid loan to a relative or friend, while an example of a business bad debt is one incurred in the trade or business of the taxpayer.

In the detailed technical explanations of the provisions of the bill, no such example is given; a business bad debt is defined as one incurred in the trade or business as defined for the purposes of § 23(e) (losses incurred in the trade or business), and the proximity of relationship required is stated. Petitioner ignores the latter committee statements and argues that the interpretation of the statute must be determined from the congressional intent expressed in the summary (see 1942-2 Cum.Bull. at 431 (House Report), 572 (Senate Report)).

Congress has expressly established the standard for determining whether a transaction was within the trade or business of the taxpayer, i.e., the standard used for business losses under § 23(e), and thereby indicated that because abuses have revealed need for revision of the statute that revision was comprehensive and sweeping, and was not merely limited to the particular abuses giving rise to the revision, or those used as examples.

Further, the Supreme Court has recently expressly rejected any such interpretation of the committee reports by pointing out that the summary noted above merely cites as an example loans made to relatives or friends and stating that not even this segment of the committee reports supports such a contention as made both before that Court and in the instant case. Putnam v. Commissioner, 1956, 352 U.S. 82, 91, note 17, 77 S.Ct. 175, 1 L.Ed.2d 144.

Further, regulations, using the language of the committee report, have been issued on the subject:

"The character of the debt * * * is to be determined * * * by the relation which the loss resulting from the debts becoming worthless bears to the trade or business of the taxpayer. If that relation is a proximate one in the trade or business in which the taxpayer is engaged at the time the debt becomes worthless, the debt is not a non-business debt for the purposes of this section." § 29.23(k)-6 of Treasury Regulation III promulgated under the Internal Revenue Code of 1939.

Once it is established that the correct legal standard was applied by the Tax Court, the issue of whether petitioner was engaged in a trade or business is one of fact and subject to the clearly erroneous rule of F.Rules Civ.P. 52(a), 28 U.S.C. Higgins v. Commissioner, 1941, 312 U.S. 212, 217, 61 S.Ct. 475, 85 L.Ed. 783; Towers v. C. I. R., 2 Cir., 1957, 247 F.2d 233; Omaha Nat. Bank v. C. I. R., 8 Cir., 1950, 183 F.2d 899, 25 A.L.R.2d 628; Maloney v. Spencer, 9 Cir., 1949, 172 F.2d 638, 640.

Petitioner relies on the line of cases which hold that a stockholder's loan to one of his corporations may qualify as a business bad debt if the stockholder was engaged in promoting, organizing, financing and managing business enterprises, or in other words, was engaged in the business of being a promoter. Petitioner unsuccessfully seeks to bring himself within the facts of certain of the promoter cases. Each of those cases is distinguishable.

In Maloney v. Spencer, supra, the taxpayer organized three corporations to engage in the food packaging business. He retained ownership of the equipment needed and rented it to the corporations under leases which contained express clauses requiring the lessor to obtain financing for the corporate activities. This Court held that the activities were "extensive, varied, continuous and regular," that there was continuity and frequency, and that taxpayer was engaged in two businesses, i.e., the food business through his corporations and the business of leasing equipment...