John W. Walter, Inc. v. Comm'r of Internal Revenue

• Decision Date: 30 December 1954
• Docket Number: Docket No. 44002.
• Citation: 23 T.C. 550
• Parties: JOHN W. WALTER, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

23 T.C. 550

JOHN W. WALTER, INC., PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 44002.

Tax Court of the United States.

Filed December 30, 1954.

Benjamin Alpert, Esq., for the petitioner.

Arthur L. Nims, Esq., for the respondent.

1. On facts, issuance of petitioner's debentures held to have been supported by consideration rendering them valid corporate obligations.

2. Interest on debentures, designated as such, payable in 10 years with fixed interest rate of 3 1/2 per cent and no accompanying rights of management, issued by petitioner corporation in exchange for valuable property without excessive relation to equity investment held, further, deductible as interest on indebtedness.

Respondent determined deficiencies in petitioner's income taxes for the years 1946, 1947, and 1948 in the amounts of $2,242.10, $2,496.29, and $1,223.72, respectively. The question to be decided is whether certain securities issued by petitioner to its sole stockholder in 1946 were valid debenture bonds and represented an an indebtedness permitting the deduction of alleged interest payments thereon under section 23(b) of the Internal Revenue Code of 1939.

FINDINGS OF FACT.

Petitioner was organized on December 19, 1945, under the laws of the State of New York. Its 1946, 1947, and 1948 corporation income tax returns were filed on an accrual basis with the collector of internal revenue for the first district of New York.

John W. Walter had been engaged in the electrical and radio appliance business for many years prior to petitioner's formation. He was district and later divisional manager in the New York area for the Apex Electrical Manufacturing Company, hereinafter called Apex, from 1936 to 1942. He was well known in the appliance business and had made many contacts in that field.

On or about June 1, 1942, Walter purchased an Apex factory branch which was engaged in the distribution of parts and performed repair service for Apex washers in the metropolitan area. He operated his business as a sole proprietorship.

Sometime in 1944, when it began to appear that the electrical appliance industry would soon resume civilian production, Walter decided to go into the radio and television business for himself. He commenced negotiations with Edward Rutledge, regional manager of the Stewart-Warner Corporation, hereinafter sometimes called Stewart-Warner, in order to obtain a distributorship for the Stewart-Warner products in the New York metropolitan area. Stewart-Warner was one of the leading manufacturers and the third oldest company in the radio and television field. Rutledge was well acquainted with Walter's abilities and contacts.

After many months of negotiation, Walter was advised by Stewart-Warner, in July 1945, that he had been appointed distributor for their radio and television products for the metropolitan area and that a formal announcement had been sent to its dealers.

In granting the franchise to Walter, Stewart-Warner considered the fact that Walter was running a distributing business in Long Island City and had been in business during the war in electrical parts and appliances; that he had been an Apex regional manager for many years, and had a thorough knowledge of the marketing of electrical and radio appliances; that he had a very good dealer-following and an excellent reputation; and that at that time he was an executive officer of the Electric and Gas Association in New York City. There were many other persons and firms desirous of acquiring a Stewart-Warner distributorship.

In 1945, there was an unlimited demand for radios, television sets, and all types of electrical appliances. The market would absorb all the radio, television, and other electrical appliances that could be produced. The public had not been able to obtain such products for many years because of World War II conditions.

Based on a projection of sales made as a result of the distributorships held by Walter from Stewart-Warner and other companies, Walter expected his minimum sales volume of radio and television products to be $2,000,000 in the first year of operations. He estimated the cost of doing business at approximately 11 per cent. The markup available to distributors of radios and television sets at the time was at least 16 per cent. This would leave a net profit of 5 per cent on radios and television sets. Walter expected a minimum net profit on these items of $100,000 per annum. He anticipated that this sales volume would be substantially increased as soon as Stewart- Warner expanded its production facilities and was able to make additional merchandise available to him. Stewart-Warner had arranged to give Walter a credit line of $250,000. This was predicated on estimated shipments to him of about $3,000,000 per annum for the first year.

In addition to the radio and television sales projected, Walter anticipated that his sales of other electrical appliances would approximate a minimum of $1,000,000 per annum. On this type of merchandise, the markup was 20 per cent and the cost of doing business was about 10 per cent.

Based on his estimate of the sales volume of radios, television sets, and other appliances, Walter anticipated that he would earn a minimum of $200,000 per annum and that this would continue for many years.

All of the negotiations and all of the transactions with the various manufacturers, particularly with Stewart-Warner, were conducted by Walter as a sole proprietor. There was no corporation in existence at that time.

After Walter, individually, received notification that he had been awarded the Stewart-Warner distributorship, and prior to the end of 1945, he had several conferences with his accountants and attorneys to discuss the type of business organization best suited for his operations. Based upon the anticipated profits indicated, Walter believed that if he were to continue to operate as a sole proprietorship, his individual income tax would absorb most of the profits earned. His advisers suggested that he conduct the operations of the business in corporate form.

Prior to November 15, 1945, Stewart-Warner sent to Walter, individually, a formal Distributor Contract for his signature. This contract was returned to Stewart-Warner on November 15, 1945, with a letter which reads in part as follows:

Attached herewith please find both copies of Distributor Agreement.

You will note that we have added Inc. to the name, the reason for same being that the incorporation papers are being processed.

Walter received the following letter from Stewart-Warner, dated November 20, 1945:

We observe from your radio contract that you evidently incorporated your business recently.

Will it be possible for you to let us have a balance sheet reflecting the corporate investment and the present financial setup?

We should have this on file as a basis for whatever credit will be extended when shipments begin.

When Stewart-Warner was apprised of the fact that Walter was to take the franchise in the name of a corporation, it was interested in ascertaining whether he would continue to be associated with the new corporation in the capacity of stockholder and director. It was also interested in ascertaining the financial structure of the corporation inasmuch as it was not then dealing with an individual. If Walter had not continued to be associated with the new corporation, Stewart-Warner would not have granted it the franchise.

Shortly after petitioner's incorporation on December 10, 1945, a stockholders' meeting was held. The minutes of that meeting read in part as follows:

Upon motion duly made, seconded and carried the aforesaid proposal was order filed in the records of this meeting, said proposal being as follows:

In consideration of the issuance of $100,000 of Ten Year 3 1/2% Debenture Bonds due January 1, 1956, John W. Walter agrees to transfer all the right, title and interest in certain franchises, as more fully set forth in the attached schedule * *

And whereas, it appears after proper investigation that it is to the best interests of the corporation that such property be acquired and that the consideration is fair and reasonable:

Now, therefore, it is resolved, that the said offer be and the same is hereby approved * * *

The schedule of franchises transferred pursuant to this resolution, as set forth in petitioner's minutes, included the Stewart-Warner, Automatic Washer Company, Peerless Manufacturing Company, and Kellogg Switchboard Company franchises originally held by Walter, individually.

Walter obtained the following additional franchises for petitioner after its organization:

+-----------------------------------------------------------------------------+
                ¦Presteel Car Corporation      ¦Electric ranges                               ¦
                +------------------------------+----------------------------------------------¦
                ¦Empire Products Company       ¦Electric ironing machines                     ¦
                +------------------------------+----------------------------------------------¦
                ¦Burtman Electric Company      ¦Vacuum cleaners, mixers, and blenders         ¦
                +------------------------------+----------------------------------------------¦
                ¦International Oil Burner      ¦Heaters                                       ¦
                ¦Company                       ¦                                              ¦
                +------------------------------+----------------------------------------------¦
                ¦General Mills, Inc            ¦Electrical irons, toasters, and iron          ¦
                ¦                              ¦attachments                                   ¦
                +-----------------------------------------------------------------------------+
                

Upon the formation of petitioner, the following tangible assets were also transferred to it:

+---------------------------------+
                ¦Cash                  ¦$10,000.00¦
                +----------------------+----------¦
                ¦Accounts receivable   ¦3,415.91  ¦
                +----------------------+----------¦
                ¦Merchandise inventory ¦9,166.80  ¦

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