JS Biritz Construction Co. v. CIR

• Decision Date: 12 December 1967
• Docket Number: No. 18816,18817.,18816
• Citation: 387 F.2d 451
• Parties: J. S. BIRITZ CONSTRUCTION CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Joseph S. BIRITZ and Dorothy Biritz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

387 F.2d 451 (1967)

J. S. BIRITZ CONSTRUCTION CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Joseph S. BIRITZ and Dorothy Biritz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 18816, 18817.

United States Court of Appeals Eighth Circuit.

December 12, 1967.

Oliver W. Schneider, Clayton, Mo., for petitioners; Donald H. Whaley, Clayton, Mo., on the brief.

Robert J. Campbell, Atty., Dept. of Justice, Washington, D. C., Mitchell Rogovin, Asst. Atty. Gen., Dept. of Justice, Lee A. Jackson, Harry Baum, Robert H. Solomon, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before VAN OOSTERHOUT, GIBSON and HEANEY, Circuit Judges.

FLOYD R. GIBSON, Circuit Judge.

This is a petition to review two decisions of the Tax Court, holding that a note taken by a sole stockholder from his corporation in exchange for some land represented a contribution to capital rather than a debt. The decisions concern a single issue and were consolidated for purpose of trial and for review.

The Tax Court in an opinion by Scott, J., sustained the determination of the Commissioner of Internal Revenue increasing the taxable income of petitioners, Joseph and Dorothy Biritz, for the calendar year 1960 by $15,290, as additional dividend income resulting from the payment of a $20,653 demand note given by the corporation to Biritz in 1954. The total amount paid could not be treated as a dividend distribution as there was only available for dividend distribution (out of earnings and profits for the period of the corporation's existence) the amount assessed. Likewise, the Tax Court sustained the Commissioner's disallowance of interest deductions of $1239 claimed by the petitioner corporation for its fiscal years 1959 and 1960, and treated these payments as non-deductible dividend distributions.¹

A determination of whether an advance made by a stockholder to a closed corporation creates a true debtor-creditor relationship or actually represents a contribution to capital depends upon the particular facts of each case. John Kelley Co. v. Commissioner of Internal Revenue, 326 U.S. 521, 66 S.Ct. 299, 90 L. Ed. 278 (1946); Gooding Amusement Co. v. Commissioner of Internal Revenue, 236 F.2d 159 (6 Cir. 1956), cert. denied 352 U.S. 1031, 77 S.Ct. 595, 1 L.Ed.2d 599. It is, therefore, necessary to set out in some detail the factual situation and background of the transaction under review.

Joseph Biritz began working in the building trades as a carpenter in 1934. From 1938 until 1949, except for time spent in the Armed Forces, Biritz built homes in partnership with another person for various real estate companies. The homes were financed by the real estate companies that contracted for them. In 1949 Biritz began to conduct his business as a sole proprietor, which business consisted principally of carpentry work in connection with building homes, repair work, room additions and millwright work. Financing of the homes built was supplied by the buyers who made partial payments as the work progressed. However, on minor repairs or small jobs Biritz would finance the work and render his bill on completion. It was his policy to pay subcontractors and suppliers within thirty days and take advantage of discounts offered.

On November 21, 1952 Biritz and his wife acquired a tract of land containing 10.847 acres for $21,386. From the date of acquisition until the incorporation of J. S. Biritz Construction Co., $5,924 was expended improving the property. A friend of Biritz suggested that he incorporate in order to limit his personal liability. Upon discussing this matter with his lawyer, who also approved of incorporating, the corporation was organized under the laws of the State of Missouri. The assets and liabilities of the Joseph Biritz sole proprietorship were transferred to the corporation along with the real estate mentioned in exchange for capital stock and the promissory note in question. The assets transferred where valued at $30,765, the principal asset being the tract of improved land valued at $27,310 (which was apparently the cost basis). Minor liabilities were assumed and no cash was paid into the corporation. The corporation issued 996 shares of its $10 par value common stock to Biritz, and two qualifying shares, necessary under Missouri law, were issued to Dorothy Biritz and to her father. As part of the same corporate financing the corporation issued a demand negotiable promissory note to Joseph Biritz dated March 6, 1954 in the amount of $20,653 bearing interest at the annual rate of 6 per cent. This note was not secured. The note was set up on the corporate records as a note payable and interest thereon was paid annually at the rate of 6 per cent in cash or by the issuance of another promissory note, which in turn was later paid. The corporation deducted the annual interest paid on the note on its tax return as interest paid under § 163 (a) of the Internal Revenue Code (26 U.S.C. § 163(a)).²

After incorporation additional amounts were spent in developing the land, which amounts were advanced by Biritz and carried on the corporation's books as "J. S. Biritz Account." At the close of the corporation's fiscal year ending February 28, 1955 the corporation owed Biritz $35,680 on this account. Of this amount $31,114 represented expenditures made by Biritz personally to improve the land, which was platted as "Biritz Drive." By the end of fiscal year 1956 the "J. S. Biritz Account" had been reduced to $7,821 and the account continued to reduce in amount until the end of fiscal year 1960 when only $1,132 was shown as owing Biritz.

From the time of incorporation until February 1960 the corporation completed construction of and sold 11 residences on Biritz Drive, 7 of these residences were constructed under contract after the lots were sold, 3 were fully constructed prior to sale, and 1 was partially constructed prior to sale. The corporation did not obtain construction loans on any of these houses. The majority of the homes built were financed by means of earnest money and progress payments made by the purchasers. Some costs of construction were defrayed by notes given by Biritz as well as advances made to the corporation on open account.

In addition to the development of Biritz Drive, the corporation continued to do repair work, room additions and millwright work along the same general lines as had been done by Biritz as a sole proprietor. The volume of business of the corporation averaged about $130,000 per year from 1954 through fiscal 1960. The sales of homes and lots averaged about $80,000 per year while income resulting from remodeling and repairing averaged about $50,000 per year, although in fiscal 1955 and 1959 income from remodeling and repairing totaled more than from the sale of homes and lots.

The corporation's books for the period 1954 through 1960 showed notes (not at issue here) were issued to J. S. Biritz and Dorothy Biritz for such purposes as office rent, officers' salaries, etc., which notes generally were paid off in the year issued. The corporation continued the policy instituted by Biritz of paying all trade accounts within thirty days.

On February 10, 1960, the promissory note issued by the corporation in 1954 to Joseph Biritz in the amount of $20,653 was paid to him upon demand in order that he might embark on another business venture. The Tax Court concluded that the payment of the note to Biritz was a dividend distribution to the extent of available corporate earnings, finding that the note did not represent a true indebtedness but was rather an equity investment by Biritz in the corporation.

The rationale of the Tax Court opinion was that Biritz intended to place all of the assets transferred to the corporation at the date of its incorporation at the risk of the corporate business and that Biritz intended that the note was to be paid "only if and when the corporation had sufficient profits to make the payment without handicapping the corporate operation." The Tax Court pointed out that the corporation had no working capital and could only obtain working capital from Biritz or from mortgaging the land transferred to it, and found significant the fact that Biritz did not take back a mortgage on the land. The Tax Court found that the corporation could operate on its limited initial assets only because of Biritz's assistance and concluded that Biritz "intended that the corporation make payment of interest or principal on this note only if the business were successful and able to pay such amounts without curtailing its business activities"; that the successful development of the land by the corporation was the only circumstance under which Biritz "could reasonably anticipate payment of his note", and that "The land which petitioner transferred to the corporation was needed to get the corporation into operation as it in fact did operate. This fact indicates that the note given petitioner for the land represented money at the risk of the corporate business." And then the Tax Court concluded "that under the circumstances here shown the entire properties transferred to the corporation were in the nature of a contribution to the corporate equity capital at the risk of the corporate business", and decided the note represented an equity investment and not an indebtedness for federal tax purposes.

The Commissioner contends that whether the note represents a true indebtedness for federal income tax purposes is essentially a factual question upon which the taxpayer has the burden of proof, citing John Kelley Co. v. Commissioner of Internal Revenue, supra; Crown Iron Works v. Commissioner of Internal Revenue, 245 F.2d 357 (8 Cir. 1957); Arlington Park Jockey Club v. Sauber, 262 F.2d 902, 905 (7 Cir. 1959); and submits that the findings of the Tax Court on a factual issue should not be disturbed unless clearly erroneous. Commissioner of Internal Revenue v. Dubenstein, 363 U.S. 278, 291...