SOUTHWEST GREASE AND OIL COMPANY v. United States
| Decision Date | 26 September 1969 |
| Docket Number | Civ. A. No. W-3999. |
| Citation | 308 F. Supp. 107 |
| Court | U.S. District Court — District of Kansas |
| Parties | SOUTHWEST GREASE AND OIL COMPANY, Inc., Plaintiff, v. UNITED STATES of America, Defendant. |
Martin, Porter, Pringle, Schell & Fair, by Robert Martin, Wichita, Kan., for plaintiff.
Robert J. Roth, U. S. Atty., District of Kansas, Wichita, Kan., Darrell Hallett, Tax Division, U. S. Dept. of Justice, Washington, D. C., for defendant.
MEMORANDUM AND ORDER ON CROSS-MOTIONS FOR SUMMARY JUDGMENT
This is a civil action for refund of $81,991.50 in income taxes plus interest paid for the year 1961. Plaintiff, the Southwest Grease and Oil Company, Inc., hereafter referred to as "Southwest Grease", or "taxpayer", claims that the overpayment resulted from the wrongful disallowance of certain items of expense incurred in connection with its redemption of convertible debentures.
The case is now before the Court on cross-motions for Summary Judgment Dkt. ##13, 15. The Court has jurisdiction under 28 U.S.C.A. §§ 1340, 1346 (a) (1). The matter has been submitted upon depositions, exhibits, and stipulations of fact entered into by the parties.
The deductions claimed by taxpayer consist of two items: one, an alleged "premium" of $116,000 paid by Southwest Grease upon retirement of a 1958 debenture issue; and second, an item of $4,122.15 of unamortized issue cost of this 1958 issue. Taxpayer claims these items are deductible as ordinary and necessary business expenses under the provisions of Section 162(a) of the 1954 Internal Revenue Code, 26 U.S.C.A. § 162(a), as implemented by Treasury Regulation 1.61-12(c) (1).
After review of the evidence submitted in support of the cross-motions, the Court finds that the following facts have been established without dispute:
1. Southwest Grease is a corporation with its principal office and place of business in Wichita, Kansas. Its primary source of income is derived from the sale of lubricating oil and grease. Stipulation, Dkt. #12.
2. In February, 1958, taxpayer purchased the assets of the Battenfeld Grease and Oil Corporation of Kansas City, Missouri. This acquisition was financed by a loan from the American National Insurance Company, a new issue of 32,290 shares of common stock (par value of $7.50), and $400,000 of 15 year, 6%, convertible subordinated debentures. Stipulation, Dkt. #12, Deposition, McCabe, pp. 5-8.1 The new issue of stock was limited to a figure under $300,000 because the Company wished to avoid the costs of "long form" registration with the S.E.C. McCabe Deposition, p. 6.
3. The 6% convertible subordinate debentures mentioned above were issued as of February 15, 1958, and were sold, at par, for a total of $400,000 to the following persons and organizations. Dkt. #12, ¶ 3(b); McCabe Deposition, p. 29:
Purchaser Par Value of Debentures
Harold A. Mayor, Sr. $75,000
Harold A. Mayor, Jr. 50,000
Joe S. Johnson 75,000
Paul McIntyre 25,000
Merrill L. Carter 25,000
Charles J. Slawson 25,000
Frank E. Hedrick 25,000
F. W. Castholm 25,000
Mayco Investments, Inc. 50,000
Beech Aircraft Pension Trust 25,000
________
$400,000
4. All of the foregoing described purchasers, with the exception of the Beech Pension Trust, were shareholders of Southwest. The debentures were not offered for sale publicly, and they could not be sold or transferred to any person other than to one or more of the ten original purchasers of the issue, except in the event that the debentures were registered with, or approved by, federal and state authorities McCabe Deposition pp. 12, 13; Ex. 1. Six of the eight individual purchasers were members of the Board of Directors of Southwest Grease, and the Mayco Investment Company was a corporation controlled by the Mayor family. Mayor Deposition pp. 12-15.
5. The 1958 6% convertible debentures Dkt. #6, Ex. 1 were 15 year obligations, due February 15, 1973. Interest of 6% was cumulative, to be paid semi-annually on February 15 and August 15, but payment of this interest was subordinate to accrued payments which might be due on the "Senior Debt" of the corporation.2 The debentures were subordinate to such "Senior Debt" in all respects, although they were superior to stock rights, and no cash dividend on any shares of common or preferred stock could be paid during default of any payment of principal or interest due on the debentures. None of the provisions of the debentures could be modified without the consent of all holders of the "Senior Debt", 85% of the shareholders of the corporation, and all holders of the debentures.
After February 15, 1960, the debentures were subject to redemption by the corporation, upon 30 days' notice, as a whole, or in part by lot, at par and accrued interest. However, such redemption could not be made without prior written consent of all holders of the "Senior Debt".
The conversion feature of the debentures entitled a holder to convert each $1,000 principal into common stock of Southwest Grease, beginning August 15, 1959, and until August 15, 1973, in declining amounts, on the following basis: (1) Between August 15, 1959 and August 14, 1962 — 129 shares of common stock; (2) between August 15, 1962 and August 14, 1965 — 121 shares; (3) between August 15, 1965 and August 14, 1968 — 114 shares; (4) between August 15, 1968 and until February 15, 1973 — 108 shares. If called for redemption, the securities could be redeemed for stock up to the actual date of redemption.3 The right of conversion was made subject to proper registration of available common stock with federal or state agencies, and the corporation agreed that it would endeavor to obtain proper registration and approval.4
6. The Court further finds that the above described 1958 convertible debentures constituted a true indebtedness of the corporation. The terms of the debentures establish that the parties intended to create a debtor-creditor relationship, the obligations had a definite maturity date, and while they were subordinated to the "senior debt", this was because of the special nature of the problems faced by Southwest Grease in raising sufficient funds to purchase the Battenfeld operation. The debentures were superior to all stock rights. The holders had no voting rights in the corporate structure, and the debentures were not redeemable at the election of the holders. The fact that the debentures were convertible into corporate stock does not destroy the true nature of the indebtedness. In raising the funds necessary for the proposed purchase, the first priority on assets was assigned to the American National Insurance Company, and the debentures provided very little in the way of security. The convertible feature of the issue provided an added incentive to prospective purchasers. McCabe Deposition pp. 8-9.
7. The purchase of the assets of the Battenfeld company was effected, and Mr. Quentin McCabe, formerly with Battenfeld, became Secretary-Treasurer of Southwest Grease. In reviewing the corporate structure of Southwest Grease in 1960, he discovered that although there was sufficient stock authorized to cover the conversion provision of the 1958 debentures, there was no registered stock available to honor the debentures, should they be converted. It was his opinion that the expense and time element necessary for S.E.C. registration of new stock would be impractical and prohibitive, and he so advised the Board of Directors. At this time, no debenture holder had requested conversion. McCabe Deposition, pp. 14-22.
8. The fair market value of the common stock into which the 6% subordinate convertible debentures could have been converted, as of January 4, 1961, was approximately $10.00 per share. Dkt. #12, ¶ 3(1).
9. On January 4, 1961, the Board of Directors of Southwest Grease voted to redeem the 1958 debentures at a price of $1,290 for each $1,000 of debentures, to be paid by exchanging with the holders cash, and new 6% nonconvertible debentures. Dkt. #12, ¶ 3(c). The taxpayer contacted each debenture holder and advised that the securities would be redeemed. Each holder was given a choice of receiving cash or new debentures, and while no holder initiated the negotiations, there was no disagreement with taxpayer's offer after the holders learned that they would receive common stock values for their debentures. McCabe Deposition, pp. 17-19.
10. The Court further finds that the decision of the Board of Directors to redeem the debentures was based in part upon the fact that the expense and time element necessary for S.E.C. registration of new stock would be impractical and prohibitive.
11. In accordance with the decision of the Board of Directors, the 1958 debentures were redeemed as of February 15, 1961. Cash was paid and new debentures were issued to the following holders of the 1958 issue according to their elections, in the following amounts. Dkt. #12 ¶ 3(d); Deft.'s Ex. 2.
New
Convertible Debentures Cash
Bondholder Debentures Held Received Received
Harold A. Mayor, Sr. $ 90,000 $ 70,000 $ 46,100
Harold A. Mayor, Jr. 35,000 15,000 30,150
Joe S. Johnson 75,000 75,000 21,750
Paul McIntyre 25,000 20,000 12,250
Merrill L. Carter 25,000 20,000 12,250
Charles J. Slawson 25,000 20,000 12,250
Hulda C. Beckett 10,000 - - - 12,900
F. W. Castholm 25,000 8,000 24,250
Mayco Investments, Inc. 65,000 40,000 43,850
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