Latham Park Manor, Inc. v. Comm'r of Internal Revenue

• Decision Date: 09 November 1977
• Docket Number: Docket Nos. 2339-76,2340-76.
• Parties: LATHAM PARK MANOR, INC., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTLINDLEY PARK MANOR, INC., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

69 T.C. 199

LATHAM PARK MANOR, INC., PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENTLINDLEY PARK MANOR, INC., PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 2339-76

2340-76.

United States Tax Court

Filed November 9, 1977.

Held: Sec. 482, I.R.C. 1954, as amplified by secs. 1.482-1(d)(4) and 1.482-2(a)(1), Income Tax Regs., adopted in 1968, permits the allocation of interest income to two subsidiary corporations in respect of interest-free loans they made to their parent corporation, even though the parent corporation did not use the loan proceeds to produce income during the taxable years. To the extent inconsistent with this opinion, Smith-Bridgman & Co. v. Commissioner, 16 T.C. 287 (1951); PPG Industries, Inc. v. Commissioner, 55 T.C. 928 (1970); Kerry Investment Co. v. Commissioner, 58 T.C. 479 (1972), affd. in part and revd. in part500 F.2d 108 (9th Cir. 1974); and Kahler Corp. v. Commissioner, 58 T.C. 496 (1972), revd. 486 F.2d 1 (8th Cir. 1973), will no longer be followed. Held, further, under the facts and circumstances, petitioners are not entitled to a setoff against the interest income allocations to the subsidiary corporations for the parent's guarantee of the interest-free loans; Held, further, the amount of the fees allowable to the parent corporation for the management of the subsidiary corporations' properties is determined for the taxable years in issue; Held, further, petitioners are liable for delinquency penalties under sec. 6651(a), I.R.C. 1954, for the taxable years in issue. Marion G. Follin III, for the petitioners.

Gary F. Walker, for the respondent.

FEATHERSTON, Judge:

Respondent determined the following deficiencies in petitioners' Federal income taxes and additions to the tax pursuant to section 6651(a)(1): ¹

Due to concessions by both parties in these consolidated cases, the issues remaining for decision are as follows:

(1) Whether the Commissioner is authorized pursuant to section 482 and the regulations promulgated thereunder to allocate interest income to petitioners for interest-free loans they made to their parent corporation, Mortgage Investment Corp., irrespective of whether the proceeds of such loans generated income to the parent corporation during the taxable years in issue.

(2) Whether petitioners are entitled under section 1.482-1(d)(3), Income Tax Regs., to a setoff against the Commissioner's section 482 interest income allocations for Mortgage Investment Corp.‘s guarantee of the loans to petitioners.

(3) Whether petitioners are entitled under section 162 to deduct management fee expenses in excess of the amounts allowed by the Commissioner for the years in issue.

(4) Whether the Commissioner properly determined delinquency penalties under section 6651(a)(1) against both petitioners for the years in issue.

FINDINGS OF FACT

1. General

Petitioner Latham Park Manor, Inc. (hereinafter petitioner or Latham), is a corporation whose principal office was in Greensboro, N.C., when its petition was filed. Latham filed Federal corporate income tax returns for the fiscal years ended June 30, 1969, June 30, 1970, and June 30, 1971, with the Internal Revenue Service Center, Chamblee, Ga.; its return for the fiscal year ended June 30, 1972, was filed with the Internal Revenue Service Center, Memphis, Tenn. Latham filed its returns on an accrual basis of accounting.

Petitioner Lindley Park Manor, Inc. (hereinafter petitioner or Lindley), is a corporation whose principal office was in Greensboro, N.C., when its petition was filed. Lindley filed its Federal corporate income tax returns for 1969, 1970, and 1971 with the Internal Revenue Service Center, Chamblee, Ga.; its return for 1972 was filed with the Internal Revenue Service Center, Memphis, Tenn. Lindley filed its returns on an accrual basis of accounting.

A third corporation, Mortgage Investment Corp. (hereinafter MIC), has its principal office in Greensboro, N.C. MIC filed its Federal corporate income tax returns on an accrual basis of accounting and used the fiscal year ending April 30. All three corporations share the same business office in Greensboro.

Latham's sole asset was an apartment complex in Greensboro consisting of 140 rental units located in about 30 buildings on approximately 15 acres of land. Lindley's sole asset was a separate apartment complex in Greensboro consisting of 176 rental units located in 44 buildings on about 18 acres of land. At least subsequent to March 1971, MIC was engaged in, among other things, the management of rental properties owned by Lindley and Latham. In addition, during the period here in controversy, MIC owned and managed other rental properties.

2. Section 482 and Setoff Issues

During the years at issue petitioners were MIC's wholly owned subsidiaries. In 1970, Z. W. Austin (Austin) and O. L. Fryman (Fryman) were substantial stockholders of MIC. On March 20, 1970, Fryman filed a lawsuit against MIC and Austin in the General Court of Justice, Superior Court Division, Greensboro, N.C., and MIC was placed in receivership as a result of that suit.

On August 11, 1970, Austin and Fryman agreed to settle their various disputes, including the lawsuit filed against MIC. However, the agreement to this effect was not timely performed. On February 12, 1971, Austin and Fryman again agreed to resolve their differences, and they incorporated their August 11, 1970, agreement into the provisions of a second agreement. Among other things, it was agreed that Austin and MIC would secure a loan of not less than $1,800,000 to generate funds necessary to pay the balance of the cash payments required by the terms of the February 12, 1971, and August 11, 1970, agreements. In consideration for such funds, Fryman agreed to sell his MIC stock to Austin and to dismiss his suit against MIC and Austin. As a result of these agreements, Austin became MIC's controlling shareholder.

Rather than borrow the $1,800,000 in funds directly, MIC caused petitioners to secure the funds from Sackman-Gilliland Corp. (hereinafter Sackman), and, in turn, petitioners loaned the funds interest-free to MIC.

Specifically, on or about March 29, 1971, Latham secured a 10-year loan from Sackman in the amount of $925,000, with interest payable at the rate of 10 percent per annum, secured by a first deed of trust on Latham's 140-unit apartment complex and an assignment of the rents. After loan acquisition costs of $24,750 were paid, a portion of the borrowed money was used to pay certain existing obligations of Latham to enable Sackman to secure the first deed of trust on Latham's apartment complex. The obligations which were paid off bore interest at the rate of 4 1/2 percent per annum. The amount of $265,444.49 was disbursed on behalf of MIC. Latham and MIC treated the $265,444.49 disbursement as a loan from Latham to MIC. Thus, after allocation of loan costs and other expenses in connection with the $925,000 loan, Sackman disbursed $865,568.91: $600,124.42, or 69.33 percent, was disbursed with respect to Latham, and $265,444.49, or 30.67 percent, was disbursed for MIC.

On or about March 29, 1971, Lindley secured a 10-year loan from Sackman in the amount of $1,175,000 with interest payable at the rate of 10 percent per annum, secured by a first deed of trust on Lindley's 176-unit apartment complex and an assignment of the rents. After loan acquisition costs of $29,400 were paid, a portion of the borrowed money was used to pay certain of Lindley's existing obligations to enable Sackman to secure the first deed of trust on Lindley's apartment complex. The obligations which were paid off bore interest at the rate of 4 1/2 percent per annum. The amount of $360,538.15 was disbursed on behalf of MIC. Lindley and MIC treated the $360,538.15 disbursement from Sackman as a loan from Lindley to MIC. Thus, after allocation of loan costs and other expenses for the $1,175,000 loan, Sackman disbursed $1,121,480.13: $760,942.68, or 67.85 percent, was disbursed with respect to Lindley, and $360,538.15, or 32.15 percent, was disbursed for MIC.

The obligations of Lindley and Latham to Sackman, undertaken on March 29, 1971, were further secured by a guarantee agreement executed by MIC. The guarantee agreement was secured by first deeds of trust on an office building located at 1808 Spring Garden Street, Greensboro, and an apartment building located at 301 McIver Street, Greensboro, both owned by MIC, and by a second deed of trust on an apartment complex located on Mosby Drive, Greensboro, also owned by MIC. The guarantee agreement and deeds of trust were executed simultaneously with Lindley's and Latham's procurement of the loans from Sackman. MIC's deed of trust securing the guarantee agreement was released by Sackman on August 13, 1973.

With respect to its $925,000 loan, Latham paid interest costs to Sackman totaling $34,681.09 during the fiscal year ended June 30, 1971, and $91,901.29 during the fiscal year ended June 30, 1972. With regard to the $1,175,000 loan, Lindley paid interest costs to Sackman totaling $102,580.16 during the taxable year 1971 and $116,101.37 during the taxable year 1972. Neither petitioner charged MIC interest nor did MIC pay any interest on the loans it received from petitioners totaling $625,982.64.

No fee was charged or accrued by MIC to Lindley or Latham for the execution of the guarantee agreement and deed of trust nor was any sum deducted by Lindley or Latham on its Federal corporate income tax returns for the years in issue for any such fee.

Thus, on or about March 29, 1971, MIC received interest-free loans from Latham and Lindley totaling $625,982.64. Of that amount, $618,618.71 was utilized by MIC to resolve the legal suit filed by Fryman through funding of Austin's personal obligation to Fryman and to pay the legal and accounting fees stemming from that action. No portion of that amount was expended for MIC's operations in carrying on its trade or business and no...