IN RE ST. JOHNSBURY TRUCKING CO. INC., Bankruptcy No. 93-B-43136 (FGC).

• Decision Date: 07 March 1997
• Docket Number: Bankruptcy No. 93-B-43136 (FGC).
• Citation: 206 BR 318
• Parties: In re ST. JOHNSBURY TRUCKING COMPANY, INC., Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

206 B.R. 318 (1997)

In re ST. JOHNSBURY TRUCKING COMPANY, INC., Debtor.

Bankruptcy No. 93-B-43136 (FGC).

United States Bankruptcy Court, S.D. New York.

March 7, 1997.

K.M. Lewis, Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quentel, P.C., New York City, for St. Johnsbury Trucking Co. Inc. (Debtor).

T.J. Nicholas, Office of the Attorney General of Massachusetts, Boston, MA, for Mitchell Adams, Commissioner, Massachusetts Department of Revenue (Massachusetts).

Memorandum of Decision on Motion to Reconsider Disallowance of Claim

FRANCIS G. CONRAD, Bankruptcy Judge.

In the motion to reconsider before us¹, Massachusetts asks us to reconsider our Order disallowing and expunging the tax deficiency claims of Massachusetts against Debtor. Massachusetts had filed a proof of claim to which Debtor objected by asserting that its records showed no taxes due. Massachusetts was unable to locate the documents which supported its claim and could not produce them at the claims objection hearing. We disallowed the claim, but invited Massachusetts to move for reconsideration if it found the documents. Massachusetts finally located papers supporting its deficiency claim. Accordingly, we grant Massachusetts' Motion to reconsider, and now consider the claim on its merits. The documents submitted by Massachusetts, in combination with Debtor's exhibits in opposition compel us to allow Massachusetts' deficiency claim, virtually in its entirety.

FACTS

Before Debtor's June 1993 filing of its Chapter 11 petition, Debtor was a leading regional carrier of general commodity freight. In 1986, Sun Company, Inc., acting through one of its subsidiaries, acquired Debtor. Sun Company, Inc. then sold Debtor, together with Jones Truck Lines, Inc. and Milne Truck Lines, Inc., to Sun Carriers for approximately $212 million. Approximately half of the funding for this leveraged acquisition came from Bankers Trust Company of New York under a credit agreement between Sun Carriers, Debtor, Jones Truck Lines, Milne Truck Lines and Bankers Trust. See Debtor's Objection to Motion of the Massachusetts Department of Revenue for Reconsideration, pp. 8-10 (hereinafter "Debtor's Objection").

The documents pertaining to the leveraged acquisition, according to Debtor, take up six bound volumes. Debtor's Objection, page 9. We did not receive all of the documents. Instead, Debtor submitted pieces, many unsigned, of the various credit and pledge agreements that evidence some of Debtor's obligations under the acquisition. For purposes of this Memorandum of Decision, we assume the unsigned documents to be binding. For example, Debtor was prohibited from incurring debt over certain amounts (other than Sun Carriers' debt) and from paying distributions to anyone other than Sun Carriers. Exhibit 7, Pledge Agreement, page 4 of exhibit A. Also, Debtor could not sell assets that contributed to more than 15% of Debtor's revenues unless it (a) applied the entire net proceeds to the outstanding bank debt, (b) reinvested the entire net proceeds in the trucking business or (c) used the entire net proceeds to purchase certain notes that Sun Carriers offered as part of the acquisition. Exhibit 7, Pledge Agreement, page 7 of exhibit A. All of Debtor's assets were pledged to secure the acquisition debt; Sun Carriers had few assets of its own. Debtor's Objection, page 9, citing Exhibit 9, 1989 Tax Return, page 10. Debtor also guaranteed the acquisition debt. Exhibit 8, Amended and Restated Credit Agreement, exhibit VII.

Exclusive of the agreement with Bankers Trust, Debtor also entered into an agreement with Sun Carriers and each of Sun Carriers' subsidiaries in September of 1986. See Exhibit 11, Agreement. Under this agreement, each of Sun Carriers' subsidiaries were to pay Sun Carriers a "management fee." Part of the management fee, entitled "consideration" for management services, was calculated by multiplying Sun Carriers' total operating expenses, exclusive of debt service, by a percentage of the revenue of all of the subsidiaries that each subsidiary represented. Exhibit 11, page 3. The second part of the management fee, entitled "debt allocation," was calculated by multiplying Sun Carriers' interest expense, incurred in connection with either the acquisition or operation of the subsidiaries, by each subsidiary's proportionate share of all of the subsidiaries' shareholders' equity. Exhibit 11, pp. 4-5.

In the fiscal years ending March 1988 and March 1989, Debtor and Sun Carriers treated the management fee, for tax purposes, as a lump sum; their returns did not divide the fee into its separate components as described above. The entire management fee was labeled an expense which represented "general and administrative expenses incurred by Sun Carriers on behalf of the Debtor." Exhibit 23, Consolidated Financial Statements, page 8. Sun Carriers treated the management fee, essentially a reimbursement of expenses, as a reduction of its overall expense deduction, or a negative "allocated expense." Exhibit 26, Portions of 1989 Consolidated Tax Return, page 42.

Massachusetts, as a result of its 1993 audit of Debtor, separated for tax purposes the two components of the management fee. It disallowed as an expense the "debt allocation" component of the management fee because the interest expense was really that of Sun Carriers. See Exhibit 4, Audit Narrative, pp. 3-4. Massachusetts' research indicated that interest expense can not be pushed down to a subsidiary where that subsidiary would in effect be paying for someone to acquire it. Id. Massachusetts then reclassified Debtor's claimed interest expense as a dividend paid to its parent, Sun Carriers. This, in turn, increased Debtor's taxable income.² Id. We address Massachusetts' treatment of the "consideration" for services component of the management fee separately below.

On October 8, 1988 (fye 3/89), Sun Carriers moved from Pennsylvania to Holliston, Mass., Debtor's headquarters. The extent of Sun Carriers' continued operations after the move is disputed and is not ascertainable from the papers before us. It is undisputed, however, that the management fee ceased after this date and was not reinstated until the fiscal year ending March 1991. See Debtor's Objection, page 23. Debtor has given at least two reasons for the suspension of payments to Sun Carriers. We discovered a potential third.³ On its 1989 Consolidated Financial Statement, Debtor explained that after the move, Sun Carriers "consolidated its corporate activities with the offices of the Debtor, substantially reducing expenses. The remaining expenses will now be incurred directly by the Debtor." Exhibit 23, Consolidated Financial Statements, page 8. On the other hand, in its objection before us Debtor explains:

It is understandable that, due to the confusion of the move, the financials failed to reflect the reimbursements for the latter part of fiscal year 1989. However, this oversight was corrected in the financial statement for 1991 consistent with the terms of the Management Agreement and the fact that the cost of performance by Sun Carriers continued after its move to Pennsylvania. citations omitted.

Debtor's Objection, page 23. Massachusetts, more in tune with Debtor's first explanation, determined from inquiries it made during the audit process that the fee ceased because management services were no longer being provided by Sun Carriers after the move. Exhibit 4, Audit Narrative, page 2, ¶ 3.

Having spent nearly half of the fiscal year ending March 1989 in Massachusetts, Sun Carriers proceeded to file a Massachusetts Corporate Tax Return. Although Sun Carriers originally mistakenly attributed 100% of its 1989 income to Massachusetts, its amended return gave an apportionment percentage of 33.82%. Exhibit 14, Audit Log, page 59. The apportionment percentage, in its fractional form, represents a property factor multiplied by a payroll factor multiplied by twice a sales factor, the result of which is divided by four. Mass.G.L. Ch. 63 § 38(c). Each factor represents a fraction that compares the portion of the factor attributable to Massachusetts to the entire factor (i.e. Massachusetts sales divided by sales everywhere = sales factor). Mass.G.L. Ch. 63 § 38(d), (e) & (f). According to its audit, Massachusetts has determined that the apportionment percentage should have been 1.42%, rather than 33.82%. Exhibit 14, Audit Log, page 59. Massachusetts seeks a lower apportionment percentage because it would like Sun Carriers' "income" to be attributed away from Massachusetts. This is because, in 1989, Sun Carriers experienced a substantial loss. Debtor's Objection, pp. 18-19. Consequently, the new apportionment percentage would alter Debtor's tax liability because it would reduce Debtor's ability to offset its regular Massachusetts income with the loss of its parent, Sun Carriers.

Massachusetts found three major flaws with Sun Carriers' calculation of the apportionment percentage. Most important, Massachusetts determined that the $3,176,854 in management fees that Sun Carriers received from all of its subsidiaries for non-interest expenses, or the "consideration" for services component, should be included in the sales factor of the equation. It claims that Sun Carriers made an intercompany sale of management services to its subsidiaries and earned the management fee as a receipt. Exhibit 4, Audit Narrative, page 3, ¶ 3 and page 5. Massachusetts also placed the $3,176,854 solely in the denominator as "sales everywhere." No part of the management fee was attributed to Massachusetts because it believes that the management services ceased when Sun Carriers moved to Massachusetts. Id. By placing this large figure in the sales factor denominator without any corresponding figure in the numerator, Massachusetts drastically decreased the sales factor and hence the overall apportionment percentage.

The second flaw in the apportionment percentage, according to...