PACIFIC NORTHWEST FOOD CLUB, INC. v. Commissioner
| Decision Date | 20 January 1964 |
| Docket Number | Docket No. 93804. |
| Parties | Pacific Northwest Food Club, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Willard D. Horwich, 170 N. Robertson, Beverly Hills, Calif., for the petitioner. Douglas W. Argue, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined a deficiency in petitioner's income tax for the fiscal year ended February 28, 1958, in the amount of $48,744.22.
The issues presented for decision are as follows:1 (1) Whether the Commissioner, pursuant to section 482 of the Internal Revenue Code of 1954,2 was correct in allocating to petitioner for the fiscal years ended February 28, 1958 and 1959, the taxable income (exclusive of a net operating loss carryover deduction) reported for the fiscal year ended June 30, 1958, by Fomco, Incorporated, a corporation controlled by petitioner's sole shareholder; and (2) whether petitioner was entitled to a bad debt deduction in the amount of $21,585.66 in any year affecting its net operating loss carryover for the fiscal year ending February 28, 1958.
Petitioner did not assign error to respondent's apportionment, as between petitioner's fiscal years ended February 28, 1958 and 1959, of the income and expense reported by Fomco, Incorporated, for its fiscal year ended June 30, 1958, as set forth in Exhibit A attached to the notice of deficiency. We assume therefore that petitioner concedes the correctness of this apportionment in the event issue (1) is decided adversely to it.
Some of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.
Petitioner is a corporation organized under the laws of the State of Washington in March 1953. It filed its Federal income tax returns for the fiscal years ended February 28, 1958 and 1959, with the district director of internal revenue, Los Angeles, California. Petitioner's president and controlling shareholder is Joseph G. Shabouh (hereinafter referred to as Shabouh). Shabouh was a co-founder of the petitioner. In 1954 he acquired, and has retained at all times relevant to this proceeding, all of the outstanding stock in petitioner with the exception of two qualifying shares. From 1953 to the early part of 1955, petitioner engaged in the business of selling food freezers in the State of Washington, and in those years sustained substantial operating losses in connection with this business.
Fomco, Incorporated (hereinafter referred to as Fomco), an Oregon corporation, was similarly engaged in the business of selling food freezers in Oregon from the time of its incorporation in October 1953 through the early part of 1955. Fomco also incurred substantial operating losses in connection with this business. Shabouh has been president of Fomco since its incorporation, at which time he acquired 50 percent of its outstanding stock. In 1954 he acquired, and has retained at all times relevant to this proceeding, all of the outstanding stock in Fomco with the exception of 17.5 percent of the shares.
Shabouh, from 1953 to May 1956, conducted a produce business in Los Angeles, California, which he operated as a sole proprietorship under the name of Pacific Growers Marketing Company (hereinafter sometimes referred to as Proprietorship). The principal business activity of Proprietorship was the packing of carrots and the marketing of them throughout the country. Petitioner qualified to do business in California on May 25, 1956, and within a short time thereafter purchased the assets and business of Proprietorship. As of June 1, 1956, petitioner took over the carrot packing and marketing operations formerly conducted by Proprietorship. Petitioner's principal business address, and also the location of its packing plant, during the years involved was 4242 District Boulevard, Vernon, California.
Pursuant to an agreement dated July 31, 1956, George E. Haddad (hereinafter referred to as George), a former employee of Proprietorship, was employed by petitioner as its sales manager. As such George was in charge of sales and the carrot-packing operation. At all times relevant to this proceeding he did, in fact, supervise the packing operations.
The only assets of Fomco as of July 1, 1956, were cash in the amount of $785.06, accounts receivable of $8,770.50, a bank finance reserve in the amount of $44,737.22, and an organizational expenditure of $103.46. The accounts receivable and bank finance reserve represented the "then known uncollected balance" due from food freezer sales by Fomco during 1953 and 1954.
In October 1956 petitioner, Fomco, an individual named Abraham Haddad (an acquaintance of, but not related to George Haddad), and a fourth party (a carrot farmer) entered into a series of contracts in connection with the growing, packing and marketing of carrots. (These contracts will hereinafter be referred to as the October 1956 contracts.) In accordance with the October 1956 contracts, the farmer shipped the carrots raised to petitioner. However, contrary to the provisions of the October 1956 contracts, the carrots were paid for by Abraham Haddad (hereinafter referred to as Abraham) and petitioner, rather than by Abraham and Fomco. Moreover, on its income tax return for the fiscal year ended June 30, 1957, Fomco listed its principal business activity as "freezer sales." It listed no item of income or expense attributable to the purchase or sale of carrots pursuant to the October 1956 contracts. Although Fomco qualified to do business in California as of November 16, 1956, it was not until July 1957 that Fomco was "reactivated" by Shabouh to take part in the produce business. Consequently, despite the fact that Fomco appeared as a principal in each of these contracts, it never performed any of its obligations, nor exercised any of its rights thereunder, such as purchasing the carrots, paying petitioner for its services, reimbursing petitioner for its expenses, or paying its share of the costs of growing the carrots.
On July 1, 1957, petitioner entered into a contract (hereinafter sometimes referred to as the July 1, 1957, packing contract) with Fomco wherein Fomco agreed to act as petitioner's packer in connection with petitioner's carrot-packing business in general. Pursuant to this contract, petitioner agreed to pay, as an agent but not as a principal, Fomco's labor costs and the costs of packing materials and supplies. The contract recited that petitioner was making these payments on behalf of Fomco because petitioner already possessed the necessary payroll identification numbers and licenses from the various governmental authorities and had established credit in the business community of Southern California and elsewhere in the United States. Fomco had not established credit in the business community. The agreement contained a schedule of the packing charges. The basic packing charge was $1.75 for a 48- 1 lb. crate.3
As of July 1, 1957, Fomco had no assets except for a bank finance reserve of $38,901.42 (representing the "then known uncollected balance" due from food freezer sales in Oregon in 1953 and 1954) and an organizational expenditure of $103.46. During the period from July 1, 1957, to June 30, 1958, Fomco listed two principal additional assets on its balance sheet, namely, accounts receivable of $85,194.63 and inventory of $37,216.56. The $85,194.63 accounts receivable represented sums due to Fomco from petitioner as of June 30, 1958, pursuant to the July 1, 1957, packing contract. Of the $37,216.56 inventory, the major portion thereof became an asset on Fomco's balance sheet by virtue of bookkeeping entries made by petitioner and Fomco on March 30, 1958. The remainder resulted from purchases of inventory items made by Fomco with funds advanced by petitioner during the period March 31, 1958, to June 30, 1958.
Carrot packing involves a continuous operation of processing, somewhat resembling assembly line production. The machinery needed is generally quite extensive, as is petitioner's. The carrot-packing operation conducted by petitioner is complex and requires the supervision of a person with experience in that line of work.
At all times relevant to this proceeding, the trade name of the carrot-packing and marketing operation was Pacific Growers Marketing Company, which name petitioner had acquired when it took over the business formerly conducted by Proprietorship.
Fomco, at all times relevant hereto, possessed no packing equipment or plant. Its address was the same as petitioner's. There was no difference between the way the packing operation was performed before and after July 1, 1957. The same carrot-packing equipment, employees and packing plant location used by petitioner prior to the July 1, 1957, packing contract continued to be used for carrot-packing operations subsequent to that date. Petitioner's income tax returns for the fiscal years ended February 28, 1958 and 1959, reflect no rental income.
The carrot-packing employees continued to be paid by petitioner until February 28, 1958. From that date until June 30, 1958, the employees used in the carrot-packing operation were paid by Fomco with funds advanced by petitioner. After July 1, 1956, all taxes due under the Federal Unemployment Taxing Act and the Federal Insurance Contributions Act on account of wages paid to these employees were collected and paid over by petitioner until February 28, 1958. During this period petitioner also filed withholding tax returns covering these wages. After February 28, 1958, some of the packing expenses were paid by both Fomco and petitioner. Petitioner advanced the funds used by Fomco for the payment of these expenses.
Petitioner's books and records consisted of the usual ledger, cash sales and purchases journals. For the period July 1, 1956, to February 28, 1958, all sales of carrots and all expenses...
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