Piedmont Minerals Company v. United States, 13677.
| Decision Date | 29 July 1970 |
| Docket Number | No. 13677.,13677. |
| Citation | 429 F.2d 560 |
| Parties | PIEDMONT MINERALS COMPANY, Inc., Appellee, v. UNITED STATES of America, Appellant. |
| Court | U.S. Court of Appeals — Fourth Circuit |
Stanley L. Ruby, Atty., Dept. of Justice (Johnnie M. Walters, Asst. Atty. Gen., Lee A. Jackson, Jonathan S. Cohen, Attys., Dept. of Justice, and William H. Murdock, U. S. Atty., on brief), for appellant.
Norman Block, Greensboro, N. C. (A. L. Meyland and Harry Rockwell, and Block, Meyland & Lloyd, Greensboro, N. C., on brief), for appellee.
Before HAYNSWORTH, Chief Judge, and WINTER and BUTZNER, Circuit Judges.
In this appeal we are faced with the oft-litigated question of whether advances made to a corporation by its principal stockholders constituted capital or debt for federal income tax purposes. The district court found the advances to be debt, and we affirm.
The historical facts are undisputed.
In 1934 John A. Boren and E. M. Harvey organized a small manufacturing plant to produce refractory products. This business, incorporated in 1938 as North State Pyrophyllite Company, Inc., prospered. Since the source of ore supply owned by North State was approaching exhaustion, a search for new deposits was made in the early 1950's. New ore deposits were located by Dan E. Stephens, an employee of North State, and analyzed by Mason K. Banks, a graduate geologist specializing in minerals who later became an employee of North State. Because the new deposits contained quantities of unusable minerals not present in the deposits being utilized at the time, it was determined that an extraction process would have to be developed and a plant constructed to make the new ore suitable for North State's operations. Banks was the only person associated with North State who possessed the necessary expertise. He, and later Stephens, who was needed to operate it, demanded a proprietary interest in the extraction process as a condition to their development and operation of it. After some discussion, it was agreed that a new company would be formed in which Boren and Harvey would each own forty percent of the stock and Banks and Stephens would each own ten per cent. The company would be concerned with mining and processing the ore for sale to North State. Because neither Banks nor Stephens was able to make a financial investment of any size, it was agreed that the new company would be initially capitalized at $1,000, with Banks and Stephens each purchasing $100 worth of stock. The remaining funds necessary to start operations would be borrowed at the going rate of interest, either from a commercial bank with Boren and Harvey guaranteeing repayment or from Boren and Harvey themselves.
On May 21, 1958 articles of incorporation were issued to Piedmont Minerals Company, Inc. by the Secretary of State of North Carolina.
On five occasions beginning on June 2, 1958 and ending on January 1, 1960 Boren and Harvey made advances to Piedmont totaling $178,000.1 As each advance was made, Piedmont executed and delivered to Boren and Harvey negotiable demand notes in the face amount of each advance bearing interest at the rate of 6 per cent per annum. The notes contained no subordination provisions and did not define or restrict the source from which principal or interest was to be paid. The 1958 notes were secured by an unrecorded chattel deed of trust. On each annual financial statement of Piedmont the amount of the notes was carried as "notes payable." Interest on the notes was paid as it accrued, and two notes totaling $8,000 were repaid in full on January 1, 1964. During this time no cash dividends were paid, but in 1962 and 1964 stock dividends were declared in proportion to the original holdings. In 1964 the outstanding capital stock was $50,000.2
In 1964 Piedmont anticipated repaying a substantial amount of the principal on the remaining loans. However, on September 11, 1964 the company was notified that the Internal Revenue Service might disallow the interest payments as a deduction for federal income tax purposes. Subsequently, on the advice of its attorney, Piedmont made all payments of principal and interest into an escrow account. By June 30, 1966 the entire principal of all of the Boren and Harvey notes had been repaid, or deposited in the escrow account. At that time the company had outstanding a note payable to the North Carolina National Bank in the amount of $50,000, representing a loan made by the bank during the previous year.
By letter dated April 19, 1965 the Commissioner of Internal Revenue disallowed the deductions for interest payments and asserted deficiencies and accrued interest of $10,365.77 against Piedmont for its taxable years ending June 30, 1961, 1962, and 1963. The basis for this assessment was the Commissioner's determination that the advances made by Boren and Harvey constituted capital investments and, hence, that the interest payments were not allowable deductions, but must be treated as a return on a capital investment. Piedmont paid the deficiency under protest and brought this action in the district court to recover it. The district court found in its favor, holding the advances to be true debt rather than capital contributions and the interest payments deductible.
In Road Materials, Inc. v. C.I.R., 4 Cir., 407 F.2d 1121, we held, at the government's urging, that the rule of Commissioner v. Duberstein, 363 U.S. 278, 80 S.Ct. 1190, 4 L.Ed.2d 1218, applied to this type of situation and consequently that the classification of such advances as debt or equity is a question of fact. In this case the Government has shifted its position and now urges that we repudiate our holding in Road Materials and hold that the question is one of law.3 We decline to do so.
Where the issue is one of fact, the findings of the district court will...
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