Scotland Mills, Inc. v. Commissioner, Docket No. 90139
| Decision Date | 05 March 1965 |
| Docket Number | 90148.,Docket No. 90139 |
| Citation | 1965 TC Memo 48,24 TCM (CCH) 265 |
| Court | U.S. Tax Court |
| Parties | Scotland Mills, Inc. v. Commissioner. Edinburgh Corporation v. Commissioner. |
Richard E. Thigpen, 129 W. Trade St., Charlotte, N. C., and Richard E. Thigpen, Jr., for the petitioners. Wallace E. Whitmore, and John L. Ridenour, III, for the respondent.
Memorandum Findings of Fact and Opinion
The respondent determined deficiencies in the income taxes of the petitioners as follows:
Scotland Mills, Inc
Year Ended Income Tax
June 30, 1957............ $130,455.57
June 30, 1958............ 19,202.37
Edinburgh Corporation
Year Ended Income Tax
August 31, 1954.......... $ 4,780.52
August 31, 1957.......... 419.12
August 31, 1958.......... (37.26)
August 31, 1959.......... 122.25
The first issue for decision is whether certain net advances made by Scotland Mills, Inc., (hereinafter referred to as Scotland) to Tuftwick Corporation (hereinafter referred to as Tuftwick) created a bona fide indebtedness or amounted to a contribution to capital. Dependent upon this is the right of Scotland to bad debt deductions for its fiscal years ending June 30, 1957 and June 30, 1958, in the respective amounts of $250,876.09 and $36,927.64.
The respondent also denied treatment as an indebtedness to the net advances made by Edinburgh Corporation (hereinafter referred to as Edinburgh) to Tuftwick from September 1, 1952 to August 31, 1956. The nature of these advances will determine Edinburgh's right to a bad debt deduction for its fiscal years ending August 31, 1956 to August 31, 1959, inclusive. Edinburgh's fiscal year ending August 31, 1956, is involved only because the amount of net operating loss carry back from that year to fiscal 1954 is in controversy.
Some of the facts have been stipulated and are incorporated herein by this reference.
Petitioner, Scotland, was organized in 1939 under the laws of the State of North Carolina and operates at Laurinburg, North Carolina. The company is engaged in the business of manufacturing and selling textiles and related products such as wide sheeting for bedspreads, cotton yarns, bedspreads and carpetings. Scotland filed its Federal income tax returns for the years in question with the district director of internal revenue at Greensboro, North Carolina.
Edinburgh filed its Federal income tax returns for the years in question with the district director of internal revenue at Greensboro, North Carolina.
Petitioner, Edinburgh, was also incorporated in 1939 in North Carolina and does business at Laurinburg. The firm is engaged in the manufacturing and selling of textiles and related products.
At all times material to this case the majority of Scotland's capital stock was held by Halbert M. Jones, Edwin Morgan and corporations owned or controlled by them. The majority of the capital stock of Edinburgh was owned by Edwin Morgan.
In 1940 Jacques M. Schloss organized the Sun Spun Chenille Corporation (hereinafter referred to as Sun Spun) to manufacture chenille bedspreads. The sales of Sun Spun were handled by a selling agent, Balchman & Schloss, which firm was also used as a selling agent by Scotland. After several years of profitable operations Sun Spun was sold to Burlington Mills at a profit.
Because of his success with Sun Spun, Schloss was able to interest Morgan and Jones in the possibility of organizing a new selling agent and a new company to manufacture chenille bedspreads. The three men were instrumental in organizing Tuftwick and Morgan-Jones, Inc. (hereinafter referred to as Morgan-Jones). Morgan-Jones became the selling agent for both Scotland and Tuftwick.
Scotland was mainly interested in supplying materials to Tuftwick. Tuftwick as a chenille bedspread manufacturer was a customer for the wide sheeting produced by Scotland; and, as the manufacturer of tufted chenille bedspreads, Tuftwick broadened the line of merchandise offered through Morgan-Jones. In addition Tuftwick gave its owners a chance for an equity interest in what they hoped would be a profitable company.
Morgan-Jones was organized in 1946 with paid-in capital of $36,000. It became the selling agent for both Scotland and Tuftwick. Scotland invested $20,000 in the capital stock of Morgan-Jones. The stockholders of Morgan-Jones were Scotland, Schloss, A. B. Dennison and Morgan Cotton Mills.
Tuftwick was incorporated under the laws of the State of North Carolina on October 15, 1946, to manufacture bedspreads and other textile products. Upon incorporation Tuftwick's management was as follows: Jacques M. Schloss, director and president; A. B. Dennison, director and vice president; L. S. Woodson, director and secretary-treasurer; Edwin Morgan, director; and Halbert M. Jones, director.
Tuftwick's authorized capital was 2,000 shares of preferred stock of the par value of $100 per share and 1,000 shares of common stock without par value. At the time of incorporation one share of Tuftwick common stock was issued to each of the following: Scotland, Edwin Morgan, Halbert M. Jones, J. M. Schloss, Mary T. Schloss, L. S. Woodson, Maude K. Woodson, and A. B. Dennison. By July 31, 1947, Tuftwick had issued and outstanding 750 shares of common stock for which $75,000 was credited to capital and $75,000 was credited to paid-in surplus.
This stock was held as follows:
Scotland ...................... 298
J. M. Schloss.................. 261½
Mary T. Schloss................ 1
L. S. and Maude K. Woodson..... 112½
A. B. Dennison ................ 75
Halbert M. Jones............... 1
Edwin Morgan .................. 1
_____
750
At this time Scotland owned 40 percent of Tuftwick's common stock. In succeeding years Scotland made purchases of Tuftwick stock from individuals as follows:
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August 31, 1948
L. S. Woodson 112.5 shares common for ............. $9,000.00
January 6, 1953
A. B. Dennison 50 shares preferred for ............ 25.00
January 19, 1953
A. B. Dennison 75 shares common for ............... 37.50
January 19, 1953
J. M. Schloss 262.5 shares common for ............. 131.25
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In payment for the 298 shares of common stock issued to Scotland and the one share each issued to Jones and Morgan $60,000 was credited to the Tuftwick account on the books of Scotland on August 30, 1947. At the time this credit was made on the books of Scotland, Tuftwick had been operating for 10 months. During the first 9 months of Tuftwick's operation, Scotland advanced to it $48,088 in cash, but these cash advances were not in payment for the stock.
On March 23, 1948, 200 shares of Tuftwick's preferred stock was issued to Scotland and in payment therefor $20,000 was credited to Tuftwick's account on Scotland's books. At July 31, 1950, an additional 75 shares of such stock was issued to Scotland and $7,500 was credited therefor to the said Tuftwick account. Scotland did not advance cash to Tuftwick in connection with either purchase.
At the close of its first 9 months of operation, Tuftwick had cash, receivables, inventories, fixed assets, leasehold improvements and other assets amounting to $154,767.44. During these first 9 months Tuftwick sustained an operating loss of $85,588.41.
In 1947 Edinburgh started renting machinery to Tuftwick, but its dealings with Tuftwick were quite modest when compared with those of Scotland. The accounts receivable from Tuftwick, as shown in Edinburgh's books, cover the period from August 31, 1947 to August 31, 1959. The account is mainly concerned with Tuftwick's rental of production machinery and buildings from Edinburgh, but it also reflects that Edinburgh made cash advancements to Tuftwick, and made certain interest and principal payments on Tuftwick's bank loans.
The open account that Tuftwick maintained with Scotland follows:
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