Jos. K., Inc. v. Comm'r of Internal Revenue , Docket No. 3961-65.

• Citation: 51 T.C. 584
• Decision Date: 13 January 1969
• Docket Number: Docket No. 3961-65.
• Parties: JOS. K., INC., PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

51 T.C. 584

JOS. K., INC., PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3961-65.

Tax Court of the United States.

Filed January 13, 1969.

William P. Shannahan, for the petitioner.

James A. Thomas, for the respondent.

Petitioner was a loan company incorporated in California, on Apr. 23, 1959, with an initial capitalization of $1,500. Ninety-nine percent of the issued and outstanding stock was owned by Joseph K. Stanley, petitioner's president, and his wife, Ernestine. At the time of petitioner's incorporation, assets (primarily in the form of notes receivable) were transferred to petitioner from another corporation controlled by Joseph K. Stanley. During 4 years of corporate life, more than 80 percent of petitioner's income in each year was interest from the notes transferred to it or from notes reflecting new loans made by it. At no time during its 4-year corporate existence did petitioner receive funds from the public or from any source other than the Stanleys or a corporation controlled by them. The Stanleys, during the first 2 years of petitioner's life, did advance substantial sums to fund petitioner's loan operations. Corporations more than 90-percent controlled by Joseph K. Stanley also advanced lesser amounts. These advances or loans from the Stanleys or Stanley-controlled corporations were evidenced by ordinary demand promissory notes, bearing interest at the rate of 6 percent per annum, ‘payable at maturity.’ Held:

1. Petitioner was a personal holding company during the taxable years ended Apr. 30, 1960, 1961, and 1962. It does not fall within the exception for loan or investment corporations found in former sec. 542(c)(8), I.R.C. 1954, during the years in issue.

2. Held, further, petitioner's liquidating distribution which occurred on Apr. 30, 1963, the end of petitioner's final fiscal year, may not be applied as a dividends-paid deduction against petitioner's undistributed personal holding company income for taxable years prior to the year of distribution. Former secs. 561(a)(1) and 562(b) are interpreted.

HOYT, Judge:

Respondent determined the following deficiencies in petitioner's income taxes for the taxable years ended April 30, 1960, 1961, and 1962:

+---------------------------+
                ¦Fiscal Year   ¦Deficiency  ¦
                +--------------+------------¦
                ¦              ¦            ¦
                +--------------+------------¦
                ¦1960          ¦$6,805.38   ¦
                +--------------+------------¦
                ¦1961          ¦14,317.24   ¦
                +--------------+------------¦
                ¦1962          ¦10,471.39   ¦
                +--------------+------------¦
                ¦              ¦31,594.01   ¦
                +---------------------------+
                

The only questions presented for our decision are whether respondent was correct in imposing the personal holding company tax of section 541, I.R.C. 1954, and if so, if petitioner is entitled to a dividends-paid deduction to be carried back and applied to prior years before liquidation under section 562. ¹

OPINION

All of the facts have been stipulated and are adopted as our findings and incorporated herein by this reference.

The petitioner is a dissolved California corporation with its former principal office at 1533 Highland Avenue, National City, Calif. During the years here involved, the petitioner's books were kept and its income reported and returned on an April 30 fiscal year basis. The cash method of accounting was employed, and Federal corporate income tax returns were filed with the district director of internal revenue at Los Angeles, Calif., for the years ended April 30, 1960, 1961, 1962, and 1963.

Joseph K. Stanley for the period 1940-58 was associated with the South Bay Savings & Loan Association at Chula Vista, Calif., in the capacity of manager and controlling stockholder. In this capacity, he was primarily engaged in the real estate loan business. In 1958 Joseph sold his stock interest in the South Bay Savings & Loan Association and severed his relationship with that organization. However, because of his long experience, he intended to remain active in the business of making or acquiring real estate loans. Prior to his retirement from the Savings & Loan Association, he had set up two corporations whose functions were complementary and which were intended to aid Joseph in his prosecution of the loan and related businesses.

South Bay E & R Corp. was incorporated under the laws of the State of California on April 9, 1956. The main business of this corporation was to act as trustee under deeds of trust in connection with real estate transactions where the Savings & Loan Association had loaned money secured by trust deeds (of which it was the beneficiary) on various parcels of real estate. Joseph K. Stanley has owned 90 percent of the issued and outstanding stock of South Bay E & R Corp. since its inception, and upon the termination of his association with the Savings & Loan Association in 1958 it was agreed that South Bay E & R Corp. would continue to operate as trustee for the Savings & Loan Association for a period of 5 years. South Bay E & R Corp. also engaged to an undisclosed extent in the business of making real estate loans.

A second complementary corporation, South Bay Loan Service, was incorporated on May 27, 1957, under the laws of the State of California. Since its incorporation, Joseph has owned all of its stock. The primary function of South Bay Loan Service is to operate as an escrow company; however, it too also engaged in the making of real estate loans to an undisclosed extent. The funds used in the real estate loan business of South Bay Loan Service were obtained from Joseph K. Stanley and from his wife, Ernestine Stanley.

After 1958, when he served his relationship with the Savings & Loan Association, Joseph founded two further complementary corporations, J.K.S. Enterprises and petitioner, Jos. K., Inc. J.K.S. Enterprises was incorporated on July 14, 1959, under the laws of the State of California, and since its inception, over 99 percent of its stock has been owned by Joseph K. Stanley. The primary business of this corporation was to act as a collection agency for holders of trust deeds; it received trust deeds, collected monthly payments from the debtors thereunder and after deducting a small collection charge, remitted the balance to the holder of the trust deed. In connection with this collection business, J.K.S. Enterprises also initiated foreclosure proceedings on behalf of the holders of trust deeds in appropriate cases.

The petitioner, Jos. K., Inc., was incorporated on April 23, 1959, some 3 months earlier than J.K.S. Enterprises (the collection agency) and under the following circumstances: In early 1959, South Bay Loan Service (the escrow company) had been audited by the State of California, Division of Corporations, in connection with that agency's control over escrow companies doing business in the State of California. After the conclusion of the audit, South Bay Loan Service received a letter from the Division of Corporations dated April 14, 1959, the effect of which was to state the division's conclusion that South Bay Loan Service's current liabilities exceeded its current assets by the amount of $20,388.13, resulting in a deficit of working capital. Section 1740 of title 10 of the California Administrative Code provides that escrow agents must be financially solvent, and the letter closed with a request that South Bay Loan Service advise the division of the steps which would be taken to comply with the solvency provisions of the California statute. Among South Bay Loan Service's debts was $286,700 owing to Joseph, the liability being evidenced by a series of demand promissory notes bearing interest at the rate of 6 percent per annum. The notes were identical in all respects except for the dates and amounts.

It was at this juncture, on April 23, 1959, as previously indicated that petitioner was formally incorporated under the laws of the State of California, with Joseph K. and Ernestine Stanley owning 148 of the 150 original shares of issued and outstanding stock. At Joseph's direction, South Bay Loan Service discharged its indebtedness to him under the following procedure. Assets of South Bay were transferred to petitioner having a face value on petitioner's books of $286,700. Petitioner then assumed South Bay Loan Service's indebtedness to Joseph K. Stanley in the amount of $286,700. These transactions occurred on May 1, 1959, 8 days after petitioner's incorporation and 17 days after South Bay Loan Services received the warning letter from the Division of Corporations. They were recorded on petitioner's books as follows:

+-----------------------------------------------------------------------------+
                ¦                                                 ¦Debit       ¦Credit        ¦
                +-------------------------------------------------+------------+--------------¦
                ¦                                                 ¦            ¦              ¦
                +-------------------------------------------------+------------+--------------¦
                ¦Account receivable—South Bay Loan Service        ¦$86,114.36  ¦              ¦
                +-------------------------------------------------+------------+--------------¦
                ¦Real estate                                      ¦1,759.32    ¦              ¦
                +-------------------------------------------------+------------+--------------¦
                ¦Notes receivable                                 ¦194,352.50  ¦              ¦
                +-------------------------------------------------+------------+--------------¦
                ¦Accrued interest receivable                      ¦4,473.82    ¦              ¦
                +-------------------------------------------------+------------+--------------¦
                ¦Notes payable                                    ¦            ¦$286,700.00   ¦
                +-----------------------------------------------------------------------------¦
                ¦To record acquisition of real estate and notes receivable (plus accrued      ¦
                ¦interest) and assumption of notes payable (without accrued interest) from    ¦
                ¦South Bay Loan

...