Raymond Pearson Motor Company v. Commissioner of Int. Rev.

• Decision Date: 28 June 1957
• Docket Number: No. 16306.,16306.
• Parties: RAYMOND PEARSON MOTOR COMPANY and Raymond Pearson, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Fifth Circuit

246 F.2d 509 (1957)

RAYMOND PEARSON MOTOR COMPANY and Raymond Pearson, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16306.

United States Court of Appeals Fifth Circuit.

June 28, 1957.

William O. Taylor, Houston, Tex., Butler, Binion, Rice & Cook, Houston, Tex., of counsel, for petitioners.

Meyer Rothwacks, Helen A. Buckley, I. Henry Kutz, Ellis N. Slack, Lee A. Jackson, Attys., Dept. of Justice, Washington, D. C., Charles K. Rice, Asst. Atty. Gen., Dept. of Justice, John Potts Barnes, Chief Counsel, John M. Morawski, Sp. Atty., Internal Revenue Service, Washington, D. C., for respondent.

Before HUTCHESON, Chief Judge, and TUTTLE and JONES, Circuit Judges.

JONES, Circuit Judge.

For over fifteen years prior to 1946 Raymond Pearson was an automobile dealer in Houston, Texas, handling Ford cars in one division of his business and Lincolns and Mercurys in another. This business was then wholly owned by Raymond Pearson. He handled used cars, parts and accessories, made repairs and rendered related services. In 1939 Raymond Pearson entered into a partnership with his two sons, Raymond Pearson, Jr. and Robertson Pearson under the name of Raymond Pearson and Sons. The partnership agreement recited the partnership purposes to be the handling of Ford tractors and Ferguson farm implements and the financing of the sale of automobiles, particularly those sold by Raymond Pearson. Each partner had a third interest in the business, and profits and losses were to be shared equally.

Customarily, automobile dealers dispose promptly of their time sale paper. Finance companies such as Universal C.I.T. Credit Corporation and Pacific Finance Corporation make a business of purchasing and handling such paper. It is usual for the finance companies to furnish forms for the use of the automobile dealers who do business with them. In the execution of one of these forms the automobile purchaser will generally agree to pay the price of the car less the down payment or trade-in, or both, plus a "Time Sales Charge" and sometimes other items such as insurance. The so-called time sales charge includes interest. The aggregate of these amounts is payable over an agreed period in installments by the automobile purchaser. The automobile dealer receives from the purchaser of the time sale paper that portion of the amount which represents the unpaid balance of the price of the car. The transfer from the automobile dealer is made by an assignment or endorsement in which the transferor warrants the genuineness of the instrument, the legal capacity of its maker, the delivery of the car described, the accuracy of the description, the title to the car, and the correctness of the amount stated as owing. Written agreements are made between finance companies and those from whom they purchase installment paper. These agreements provide the basis upon which the paper would be sold and handled. The transferor of the paper, usually an automobile dealer, agrees to purchase from the finance company each car which the finance company shall repossess and pay the finance company an amount equal to the balance unpaid on the time sale instrument. The agreements also contain provisions for a dealer's reserve allowance. Such provisions set forth formulae under which the finance company shares the time sales charges with those from whom it purchases secured installment paper. Under such arrangements Raymond Pearson disposed of his time sale paper prior to 1940. During some of these years Raymond Pearson suffered losses on the repossessed cars which he was required to purchase from finance companies. The partnership, Raymond Pearson and Sons, made an agreement with Raymond Pearson as of January 1, 1940, by which Raymond Pearson agreed to sell and the partnership agreed to buy, at face value, all notes and other time sale obligations received by Raymond Pearson in the sale of automobiles. Raymond Pearson agreed to handle the preparation for sale and the selling of cars which were repossessed. The partnership agreed to pay Raymond Pearson all costs of repairing and selling repossessed cars, and to pay all losses incurred in the sale of repossessed automobiles. The partnership was active in the tractor and implement business until that business became a war casualty in the latter part of 1941. At various times the partnership has invested in mineral properties and dealt in war surplus goods. The arrangement by which the partnership financed the term sales of automobiles by Raymond Pearson continued through 1945.

In January, 1946, two corporations were organized, Raymond Pearson Motor Company which took over Raymond Pearson's Mercury and Lincoln business, and Raymond Pearson, Inc. which acquired the Ford dealership. Both corporations deal in used cars, parts and accessories and render repair and other related services. Raymond Pearson owned sixty per cent. and each of his sons owned twenty per cent. of the stock of each corporation. On January 14, 1946, each of the corporations entered into a contract with the partnership having identical provisions as the 1940 agreement between Raymond Pearson and the partnership. On January 1, 1949, each corporation made a supplemental agreement with the partnership. By these agreements the partnership appointed the corporations as agents to endorse and deliver notes and other automobile paper which were the subject of the 1946 agreements, to Universal C.I.T. Credit Corporation, or to Pacific Finance Corporation, or to any other person or corporation with whom the parties might choose to do business. These agreements confirmed an established practice under which the corporation selling cars and taking the time sale paper would transfer the paper direct to Universal C.I.T. or to Pacific Finance, or occasionally, to some other finance company. These transfers were made for the account of the partnership pursuant to the 1946 agreement. One of the purposes of making direct transfers of the paper from the Pearson corporations to the finance companies, perhaps the dominant purpose, was to avoid taxes which would otherwise be payable to the State of Texas.

Both Universal C.I.T. and Pacific Finance knew of the agreements between the corporations and the partnership, and agreed to look to the partnership, but not to the corporations, to discharge all of the obligations arising under the warranties contained in the assignments or endorsements of the time sale paper. These finance companies recognized the obligation of the partnership under the agreements to purchase repossessed cars, and they recognized that the partnership was entitled to receive the payments from the dealers' reserve accounts. On the books of Pacific Finance the dealers' reserve accounts were carried in the name of the partnership and checks in payment of dealers' reserve income were made by Pacific Finance to the partnership. Universal C.I.T. carried the dealers' reserve accounts in the names of the two corporations. Most of its checks were made to the partnership. Occasionally the payee in a check from Universal C.I.T. would be one of the corporations or Raymond Pearson individually. Occasionally, some time sale paper would be sold to a finance company other than Universal C.I.T. or Pacific Finance. Remittances from these other companies generally came to one of the corporations or to Raymond Pearson. All dealers' finance reserve funds received by Raymond Pearson or the corporations were turned over to the partnership. The dealers' reserve income received by the partnership and arising out of time sale instruments originating with Raymond Pearson Motor Co. during its fiscal year ending September 30, 1949, was $8,877.90. The amount received arising out of time sale instruments originating with Raymond Pearson, Inc. during the same period was $16,375.26. This income was included as taxable income by the partnership in its Federal tax return. The Commissioner determined that these items were taxable income to the corporations. The Tax Court, in a Memorandum Opinion, held that for tax purposes the partnership was a mere sham and device, that the corporations performed all of the business transactions incident to earning the dealers' reserve income although ostensibly acting as agents for the partnership, that the partnership functioned only to receive and report the dealers' reserve income, that economic conditions were such that repossessions of automobiles would be unlikely, and that no business purpose was served by the arrangements between the corporations and the partnership. In the Tax Court's opinion, there was no question but that all of the dealers' reserve income flowed from the efforts of the corporations. The Commissioner's determinations were approved and the Tax Court entered its decisions against the corporations. Those decisions are before us for review.

The definition of "gross income" is extremely broad. It reads:

"(a) General definition. `Gross income\' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever." 26 U.S.C.A., I.R.C.1939, § 22(a).

The determination that the dealers' reserve income was taxable to the corporations was made pursuant to the following provision of the Internal Revenue Code:

"In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized

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