John Ownbey Co., Inc. v. C. I. R.

• Decision Date: 02 April 1981
• Docket Number: No. 79-1359,79-1359
• Citation: 645 F.2d 540
• Parties: 81-1 USTC P 9309 JOHN OWNBEY COMPANY, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 540

645 F.2d 540

81-1 USTC P 9309

JOHN OWNBEY COMPANY, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 79-1359.

United States Court of Appeals Sixth Circuit.

Argued Dec. 8, 1980.

Decided April 2, 1981.

Dudley W. Taylor, Ambrose, Wilson & Grimm, Knoxville, Tenn., for petitioner-appellant.

M. Carr Ferguson, Asst. Atty. Gen., Gilbert Andrews, Tax Division, U. S. Dept. of Justice, Robt. A. Bernstein, Robt. S. Pomerance, Stuart E. Seigel, Chief Counsel, Internal Revenue Service, Washington, D. C., for respondent-appellee.

Before WEICK and ENGEL, Circuit Judges, and CECIL, Senior Circuit Judge.

WEICK, Circuit Judge.

John Ownbey Company (Ownbey), a Tennessee corporation, appeals to this court from a decision of the United States Tax Court holding it liable under the transferee provisions of the 1954 Internal Revenue Code (26 U.S.C. § 6901) in the amount of $26,983.43, plus interest, for the unpaid 1968 income taxes of International Textile Products, Inc. (International), its wholly owned subsidiary. The Commissioner, by notice of deficiency dated June 13, 1974, originally determined that Ownbey was liable as a transferee in the amount of $41,046.46. This amount represented losses Ownbey had sustained in a contract with the Santone Manufacturing Company (Santone) but which International had absorbed. Ownbey petitioned the Tax Court for a redetermination of the liability assessed by the Commissioner. The Tax Court agreed with the Commissioner that Ownbey, not International was a party to the Santone contract, that International had, in effect, absorbed $41,046 of Ownbey's losses on the contract, and that the losses absorbed by International constituted transfers from International to Ownbey without fair consideration. The Tax Court held, however, that Ownbey was liable as a transferee for only $26,983.43, which represents the amount the Tax Court determined was "transferred" while International was insolvent or which left International insolvent.

In this appeal, Ownbey's principal argument is that it is not a transferee. Specifically, Ownbey contends that the Santone contract was not entered into by it but by International and that International, therefore, did not assume any of Ownbey's losses. Ownbey further contends that even if the contract with Santone was entered into by it, International was not rendered insolvent by assuming Ownbey's contract losses. We reject Ownbey's contention that the Santone contract was International's. The Tax Court's finding that the contract was Ownbey's is supported by substantial evidence. We cannot disregard this finding as being clearly erroneous, even if we believe the evidence which supports it is not, as the Tax Court believed, overwhelming. We do, however, agree with Ownbey that the evidence, when viewed against the correct legal standards, does not support the Tax Court's finding that transfers to Ownbey thereby rendered its subsidiary International insolvent. We accordingly reverse. ¹

I

Ownbey, at least originally, manufactured military field jackets for the government. Sometime during 1968 but before October 29, of that year, Herman D. Wynn, who owned all of the outstanding shares of stock in Ownbey, sold said shares to Russell Miller. Wynn and Miller were brothers-in-law and, since 1930, had maintained close personal and business relationships. Wynn was an entrepreneur, having owned, managed, or otherwise been involved with over fifty business concerns. At the time of the sale of said shares of Ownbey to Miller, Wynn was an officer of International.

In 1968, International had been manufacturing tents and tarpaulins in its LaFollette, Tennessee plant under a renegotiable government contract. This contract had proven very profitable for International during 1968. Within the first ten months of the year, International had realized in excess of $877,000 gross profits on gross sales of less than $1,900,000. Fearing this lucrative contract would be renegotiated to their disadvantage, International's shareholders decided to sell their shares for a bargain price.

International's shareholders offered Wynn their shares for $150,000. Wynn apparently was not interested, but he told Miller of the offer and advised him that the acquisition of International's stock would be a good investment for Ownbey. Miller accepted Wynn's advice and Wynn agreed to represent Ownbey during negotiations for purchase of the stock. Wynn further agreed to act as chief operating officer of International and to represent International in renegotiation of the government contract should Ownbey acquire its stock. By agreement of October 29, 1968, Ownbey acquired all outstanding shares of International stock for $105,000, plus approximately $8,000 in temporary compensation for International's officers. In addition, Ownbey agreed to hold harmless International's shareholders against any federal tax liability or any liability that might arise as a result of renegotiation of the government contract.

In May or June of 1968, or some months before Ownbey's acquisition of International's stock, Wynn had talked to representatives of the Santone Manufacturing Company (Santone), ² apparently acting for Ownbey, concerning the production of boys' suits and sportcoats by Ownbey for Santone. In October or November of 1968, Ronald R. Monford, a Santone representative, visited Knoxville, Tennessee to meet with Wynn. Wynn, however, was not available, so Miller showed Monford Ownbey's production facilities, and discussed manufacturing boys' clothing for Santone. The two men reached an agreement, the terms of which were restated in a letter Monford sent to Miller on November 16, 1968.

The Santone contract was terminated on March 4, 1970. It resulted in a net loss of $41,046 over the life of the contract to Ownbey. Both Ownbey and International, however, operated under the assumption that the contract, and as a consequence the profits and losses under the contract, were International's. ³ Thus, contract expenses which International incurred were not charged to Ownbey, while International was charged with the contract expenses which Ownbey incurred and credited with payments Ownbey received from Santone.

It is undisputed that International paid $27,657.83 in wages and payroll taxes to employees working on the Santone contract between February 14, 1970 and the termination of the contract on March 4, 1970. It is, however, disputed as to when and how International absorbed the balance of the contract losses. To answer this question, the Tax Court relied almost exclusively on a "notes receivable" account maintained by International for Ownbey.

The first significant entries to the notes receivable account were adjusting entries totalling $14,161.76 made by International's accountants at the close of its 1969 fiscal year to reflect losses on the Santone contract during the year. These entries signified the amount the contract expenses incurred by Ownbey exceeded contract revenues. The effect of the entries was to increase International's indebtedness to Ownbey by the amount of the loss.

There were no additional entries made to the notes receivable account until after the Santone contract had been terminated. An entry was made on March 31, 1970, the end of Ownbey's fiscal year, increasing International's indebtedness to $74,352.68, though it is not clear why this entry was made other than it was unrelated to the Santone contract. On May 31 and June 30, 1970, entries were made to record the transfer of International's interest in an oil royalty valued at $71,248.13 to Wynn Inc., an Ownbey creditor. As a result of this transfer, made with the consent of Ownbey, the balance of the notes receivable account was reduced to $3,104.55 due Ownbey.

Three additional entries to the notes receivable account were made in 1970. All were adjusting entries made on November 30, 1970, the end of International's fiscal year. The first was to record the sale of equipment by International to Ownbey and served to completely eliminate International's debt to Ownbey. The final two adjusting entries were made to record previously unrecorded contract revenues of $3,422.47 and contract expenses of $2,864.80. Taken together, these final two entries reflect a profit of $773.67 earned on the Santone contract during International's 1970 fiscal year.

On its income tax return for 1968, International reported tax due of $240,476.99. The company, however, reported losses for its taxable years ending November 30, 1969 and 1970 of $143,004.64 and $170,184.00, respectively. It appears that most of these losses resulted from the operation of four "factory discount" retail clothing stores, one of which opened in November of 1968 and three of which were opened either after or about the same time the Santone contract was terminated. In June or July of 1970, International applied for a tentative refund on its 1968 income tax liability based on its losses in 1969. The application was granted, and on September 4, 1970, International received an income tax refund of $72,771.95, plus interest.

By deficiency notice dated December 23, 1971, the Commissioner notified International that it owed $165,543.59 for its 1968 taxable year. This amount included the refund it had received in 1970. International petitioned the Tax Court for a redetermination of this deficiency. Pursuant to a stipulation of the parties, the Tax Court entered judgment on April 16, 1973 in favor of the government in the amount of $163,264.46 and additions to tax under Sections 6652(a) and (b) of the Code in the amounts of $5.00 and $8,163.22 respectively. International, however, had become, and remains, insolvent. Unable to collect from International, the Commissioner thus proceeded under Section 6901 of the Internal Revenue Code of 1954 against Ownbey as a transferee.

II

Section 6901 of the Internal Revenue Code neither defines nor creates...