MERLITE INDUSTRIES, INC. v. Commissioner
| Decision Date | 15 October 1975 |
| Docket Number | Docket No. 7908-72. |
| Citation | 1975 TC Memo 312,34 TCM (CCH) 1361 |
| Parties | Merlite Industries, Inc. (and Wholly-Owned Subsidiary, Merlite Commercial Corp.) v. Commissioner. |
| Court | U.S. Tax Court |
John F. Walsh, 230 Park Ave., New York, N.Y., David A. Zack and Leonard A. Blank, for the petitioner. William K. Carr, for the respondent.
Memorandum Findings of Fact and Opinion
The respondent determined deficiencies in income taxes due from Merlite Industries, Inc., and its subsidiary, Merlite Commercial Corp., for the fiscal years ended July 31, 1966, and July 31, 1967, in the amounts of $2,097.42 and $23,948.69, respectively.
The issues for our decision are as follows:
1. Whether petitioner is entitled to bad debt deductions under section 1661 in the amounts of $115,762.04 and $41,605.20 for the fiscal years ended July 31, 1966, and July 31, 1967, respectively, on account of advances to L.M. Stylists, Inc.
2. Whether, if the advances by petitioner to L.M. Stylists, Inc. were contributions to capital, the petitioner is entitled to claim an ordinary loss pursuant to section 165 (g)(3) for the fiscal year ended July 31, 1967.
3. Whether the petitioner was affiliated with L.M. Stylists, Inc. within the purview of sections 1501 and 1504 so that the gross income and deductions of L.M. Stylists, Inc. may be included in the consolidated returns filed by petitioner for fiscal years ended July 31, 1966 and July 31, 1967.
Merlite Industries, Inc. (hereinafter referred to as the petitioner) and its wholly-owned subsidiary, Merlite Commercial Corp., are corporations organized under the laws of the State of New York. At the time of the filing of the petition in this case, the principal office of the petitioner was in New York, New York. The petitioner kept its books and records and filed its returns on the accrual basis, based on a fiscal year ended July 31.
Petitioner and its subsidiary filed consolidated U.S. corporation income tax returns for each of the fiscal years ended July 31, 1966, and July 31, 1967, with the District Director of Internal Revenue, Manhattan District, New York.
During the years 1963 to 1969, inclusive, all of the capital stock of Merlite Commercial Corp. (hereinafter referred to as Merlite Commercial) was owned by petitioner. For the same period, all of the capital stock of petitioner was owned by one Alvin B. Meyer, who was and still is the chief executive officer and president of petitioner and Merlite Commercial.
Alvin B. Meyer, together with Larry Matthews, also owned stock in All State Properties, a company which had acquired the Larry Matthews Beauty Salons. Larry Matthews was employed by All State Properties in 1963 as manager of its beauty salons and barber shop operations. Under a contract with Larry Matthews, All State Properties had the right to use his name.
About 1963, it was suggested to Meyer that All State Properties open a wig department, using the name of Larry Matthews, as a concession in Gimbels Department Store. Meyer rejected the proposal. Thereafter, Larry Matthews advised Meyer that the concession was "too good a thing to turn away" and, with the consent of All State Properties, Meyer decided that petitioner would undertake to set up the wig concession at Gimbels Department Store. Petitioner was to use the name of Larry Matthews. It was anticipated that All State Properties would benefit from the publicity which would result for its salons also doing business under the name of Larry Matthews.
Petitioner proceeded to establish a wig division in order to open the concessions in the Gimbel stores. As of July 25, 1963, petitioner had invested $121,212 in its wig division to purchase inventory and to open concessions.
L.M. Stylists, Inc. was incorporated on July 25, 1963, under the laws of the State of New York to carry on the business of the wig division. The Certificate of Incorporation of L.M. Stylists, Inc. authorized the issuance of 200 shares of common stock without par, of which 100 shares were issued to petitioner and 100 shares were issued to or in the name of Larry Matthews. Larry Matthews signed a receipt for stock certificate No. 2 for 100 shares and the stock transfer ledger of L.M. Stylists, Inc. indicates that such certificate was issued to Matthews on July 25, 1964.
The assets and liabilities of the wig division of petitioner were transferred to L.M. Stylists, Inc. The amounts previously invested by petitioner in its wig division were recorded as a loan payable to petitioner on the books of L.M. Stylists, Inc. and as a loan receivable on the books of petitioner, except for the amount of $1,000 which was recorded as capital stock on the books of L.M. Stylists, Inc. and an investment in L.M. Stylists, Inc. stock on the books of petitioner.
As a concessionaire in the Gimbel stores, L.M. Stylists, Inc. was required to comply with the sale policies of Gimbels. Pursuant to such policies, the customer was permitted to return merchandise for credit. L.M. Stylists, Inc. found that it was accepting for return approximately 25 percent of the wigs sold. Health regulations prohibited the resale of those wigs. The operation of wig concessions by L.M. Stylists, Inc., resulted in substantial losses on that account.
In addition to the original investment of $121,212 in the wig division, carried over as a loan to L.M. Stylists, Inc., the loan account of petitioner with L.M. Stylists, Inc., during the fiscal years ended July 31, 1964, to July 31, 1967, reflected the following:
Repayments
Taxable Year Ended Advances
July 31, 1964 ............... $23,000 $13,212
July 31, 1965 ............... None 21,000
July 31, 1966 ............... None 5,000
July 31, 1967 ............... None None
________ _______
Totals ................... $23,000 $39,212
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Additional advances were made by Merlite Commercial to L.M. Stylists, Inc., during the fiscal years ended July 31, 1963, to July 31, 1967, as follows:
Taxable Year Ended Advances
July 31, 1963 ............... $18,000
July 31, 1964 ............... None
July 31, 1965 ............... 35,000
July 31, 1966 ............... 5,000
July 31, 1967 ............... 3,000
_______
Totals .................. $61,000
=======
The assets and liabilities of L.M. Stylists, Inc. as reflected in its U.S. corporation income tax returns filed for the fiscal years ended July 31, 1964 to July 31, 1967, inclusive, were as follows:
______________________________________________________________________________________________
Assets 1964 1965 1966 1967
______________________________________________________________________________________________
Cash ................................... $ 17,883 $ 17,171 $ 318 $ 6,151
Notes and Accounts Receivable .......... 58,007 61,155 66,042 2,642
Inventories ............................ 74,937 106,382 65,680 0
Other Current Assets ................... 12,240 14,639 7,484 2,049
Other Investments ...................... 0 100 772 0
Buildings & Other Depreciable Assets ... 811 2,159 3,782 0
________ ________ ________ ________
Total assets ....................... $163,878 $201,606 $144,078 $ 10,842
Liabilities and Capital
Accounts Payable ....................... $ 5,413 $ 27,920 $ 27,945 $ 3,192
Other Current Liabilities2 ........ 165,574 190,095 195,048 161,734
Capital Stock — Common ........... 2,000 2,000 2,000 2,000
Earned Surplus ......................... (9,109) (18,409) (80,915) (156,084)
________ ________ ________ ________
Total Liabilities and Capital ...... $163,878 $201,606 $144,078 $ 10,842
______________________________________________________________________________________________
The funds transferred by petitioner and Merlite Commercial to L.M. Stylists, Inc. were recorded as "Loans Payable", classified as current liabilities on the books, financial statements and Federal income tax returns of L.M. Stylists, Inc. for the fiscal years ended July 31, 1963 to July 31, 1967, inclusive, and as "Loans Receivable" on the books, financial statements and Federal income tax returns of petitioner and Merlite Commercial for the same period.
Neither petitioner nor Merlite Commercial received any other evidence of indebtedness from L.M. Stylists, Inc. for the amounts transferred. If petitioner was required to borrow funds for transfer to L.M. Stylists, Inc. it would charge L.M. Stylists, Inc. whatever interest it was charged. Most of the transfers, however, came from the petitioner's own funds.
On the consolidated U.S. corporation income tax returns for the fiscal years ended July 31, 1966, and July 31, 1967, petitioner and Merlite Commercial deducted as bad debts the amounts of $115,762.04 and $41,605.20, respectively on account of the advances to L.M. Stylists, Inc.3
In his notice of deficiency the respondent disallowed the bad debt deductions and determined that the amounts advanced by petitioner and Merlite Commercial to L.M. Stylists, Inc. constituted contributions to capital. As a result of this determination, respondent also made adjustments in regard to the petitioner's allowable contributions and net operating loss...
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