Tyler v. Tomlinson

• Decision Date: 29 July 1969
• Docket Number: No. 25896.,25896.
• Citation: 414 F.2d 844
• Parties: Jean C. TYLER and Dolly Ann Tyler, Appellants, v. Laurie W. TOMLINSON, District Director of Internal Revenue, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

414 F.2d 844 (1969)

Jean C. TYLER and Dolly Ann Tyler, Appellants, v. Laurie W. TOMLINSON, District Director of Internal Revenue, Appellee.

No. 25896.

United States Court of Appeals Fifth Circuit.

July 29, 1969.

Samuel L. Payne, Frank C. Decker, Jacksonville, Fla., for appellants.

Johnnie M. Walters, Asst. Atty. Gen., Dept. of Justice, Washington, D. C., Richard C. Pugh, Acting Asst. Atty. Gen., Dept. of Justice, Tax Div., Washington, D. C., Lee A. Jackson, Elmer J. Kelsey, Attys., Dept. of Justice, Washington, D. C., Edward F. Boardman, U. S. Atty., Jacksonville, Fla., Mitchell Rogovin, Asst. Atty. Gen., Crombie J. D. Garrett, Marco S. Sonnenschein, Attys., Dept. of Justice, Washington, D. C., for appellee, Virginia Q. Beverly, Asst. U. S. Atty., of counsel.

Before WISDOM, THORNBERRY and GOLDBERG, Circuit Judges.

GOLDBERG, Circuit Judge:

This is another debt-equity case. We are asked once again to determine whether funds advanced to a corporation by its shareholders may be treated as Internal Revenue Code indebtedness for purposes of interest deductions, 26 U.S. C.A. § 163,¹ or whether such funds are more properly considered contributions to capital and the deductions based thereon disallowed.

We begin with the year 1959 when brothers Neal and Jean Tyler operated a partnership that distributed Schlitz beer in several northern Florida counties. In April of that year the Tyler brothers formed a corporation known as Neal Tyler & Sons, Inc., becoming and remaining for all times relevant herein its sole shareholders. They transferred to the new corporation all of the assets of their old partnership in exchange for the corporation's authorized capital stock and two promissory notes. The stock consisted of 1,000 shares of common at a par value of $10.00 per share. Each brother received 500 shares. The notes were payable on demand and bore an interest rate of five percent. One in the amount of $47,000 was payable to Jean Tyler; the other in the sum of $48,500 was payable to Neal Tyler. The stock and notes roughly approximated the brothers' proportionate partnership interests.

On June 24, 1959, the corporation executed a demand note in the amount of $59,708.67 payable to the Barnett National Bank. This created a line of credit in the corporation's favor in order to permit cash payments for beer. The note was personally guaranteed by the Tyler brothers who had subordinated their notes to the Bank shortly after incorporation.

On July 30, 1962, the corporate notes payable to Neal and Jean Tyler were released by the Bank for cancellation. New notes were then issued to the brothers in identical amounts and on identical terms except that they were specifically subordinated both as to principal and interest to the claims of all corporate creditors.²

During the first months of its operation, Neal Tyler & Sons, Inc., showed on its balance sheet a capital surplus of $14,388.21 consisting of $10,000 of capital stock and the rest of outstanding surplus. The promissory notes to the Tyler brothers in the amount of $95,500 appeared as "advances by stockholders." No interest or principal on outstanding notes had as yet been paid.

For the fiscal year ending May 31, 1960, the corporation showed on its balance sheet interest payments on its notes of $2,719.03 ($2,469.03 to Neal Tyler; $250.00 to Jean Tyler) and additional accrued interest of $2,754.15. In 1961 no interest or principal payments were made, and in 1962 the only payment was of interest to Jean Tyler in the amount of $1,315.00.

In its tax return for the fiscal year ending May 31, 1960, and in its return for the year ending May 31, 1962, the corporation claimed interest deductions in the above listed amounts. The Commissioner, however, determined that the alleged principal and interest payments to Neal and Jean Tyler constituted dividend payments rather than interest and principal payments, and disallowed the deductions. The Commissioner also assessed deficiencies in the tax returns of Jean and Neal Tyler and the returns of their wives, Dolly and Beatrice, for failure to include some of the interest payments as income on their tax returns. All parties then paid the deficiency assessments and brought suit for refund. The refund suits were consolidated and the court, after considering the stipulations of the parties and after hearing the evidence on behalf of the taxpayers, granted the government's motion for directed verdict.

On this appeal the primary issue is whether the district court should have allowed the debt-equity question to go to the jury. The government contends that the evidence was so overwhelmingly in its favor that a directed verdict was properly granted. The taxpayers argue that enough facts were in dispute to create a question for the jury. As will appear more fully, infra, we agree with the government and affirm. In reaching this result we consider first the relevant legal principles on the debt-equity controversy and verdict.

I.

The problem of whether advances by stockholders to closely held corporations are to be considered as debts or contributions to capital has often been considered by this court. Berkowitz & Kolbert, etc. v. United States, 5 Cir. 1969, 411 F.2d 818 May 13, 1969; Curry, et al. v. United States, 5 Cir. 1968, 396 F.2d 630, cert. denied, 393 U.S. 967, 89 S.Ct. 401, 21 L.Ed.2d 375 (U. S. Nov. 26, 1968); Harlan, et al. v. United States, 5 Cir. 1969, 409 F.2d 904 April 4, 1969; Tomlinson v. The 1661 Corporation, 5 Cir. 1967, 377 F.2d 291; United States v. Snyder Brothers Co., 5 Cir. 1966, 367 F.2d 980, cert. denied, 386 U.S. 956, 87 S.Ct. 1021, 18 L.Ed.2d 104; Aronov Construction Co. v. United States, M.D.Ala.1963, 223 F.Supp. 175, aff'd per curiam, 5 Cir. 1964, 338 F.2d 337; Montclair, Inc. v. Commissioner of Internal Revenue, 5 Cir. 1963, 318 F.2d 38; Campbell v. Carter Foundation Production Co., 5 Cir. 1963, 322 F.2d 827; Rowan v. United States, 5 Cir. 1955, 219 F.2d 51. It has not, however, proved susceptible to easy resolution. While some legal problems are endowed with a case by case uniqueness calling for ad hoc determinations, the debt-equity problem has exhibited a special kind of uniquity. The oft-cited principle that each case "must be judged on its own unique fact situation," see Tomlinson v. The 1661 Corporation, supra; Curry, et al. v. United States, supra, has resulted in a lack of decisional uniformity even in cases where the individual creditor-debtor relationships exhibit ostensible similitude. See Stone, Debt-Equity Distinction in the Tax Treatment of the Corporation and its Shareholders, 42 Tulane Law Review 251, 254-255 (1968). We thus face the undesirable but perhaps unavoidable consequence that this field of the law continues to defy symmetry. Decisions must be based on a wide variety of considerations, including the financial viability of the corporation, the manner in which corporate debts are created and shareholder equities distributed, the financial source from which corporate repayment is to be anticipated, the identity of interest between shareholder and creditor, and whatever else appears relevant. This diversity helps explain why no simple test for the resolution of debt-equity questions has ever emerged. Instead there have evolved "at least eleven separate determining factors generally used by the courts in determining whether amounts advanced to a corporation constitute equity capital or indebtedness." Montclair, Inc. v. Commissioner, supra, 318 F.2d at 40. These factors have been enumerated with some specificity as follows:

"(1) the names given to the certificates evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the source of the payments; (4) the right to enforce the payment of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) `thin\' or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of `dividend\' money; (11) the ability of the corporation to obtain loans from outside lending institutions." Montclair, Inc. v. Commissioner, supra, at 40.

To this already comprehensive list other courts have added such criteria as: 1) the extent to which the initial advances were used to acquire capital assets, Janeway v. Commissioner of Internal Revenue, 2 Cir. 1945, 147 F.2d 602, and 2) the failure of the debtor to pay on the due date or to seek a postponement, Commissioner of Internal Revenue v. Meridian & Thirteenth Realty Co., 7 Cir. 1942, 132 F.2d 182. Undoubtedly a further search of the cases would reveal yet other considerations that would add additional inquiries to this baker's dozen, but such a search would be a labor of supererogation. The object of the inquiry is not to count factors, but to evaluate them. No single factor can be controlling. John Kelley Co. v. Commissioner of Internal Revenue, 1946, 326 U. S. 521, 530, 66 S.Ct. 299, 90 L.Ed. 278, 284. As we have said elsewhere in situations requiring the quest for a solution among myriad criteria: "We think that the tests are, at most, helpful factors to be considered, and not fiats to be bound by. We disapprove of rubricating such `tests' into talismans of magical power." Georgia Southern & F. Ry. Co. v. Atlantic Coast Line R. Co., 5 Cir. 1967, 373 F.2d 493, 498, cert. denied, 389 U.S. 851, 88 S.Ct. 69, 19 L.Ed.2d 120.

Application of the above principles to the case sub judice leaves no doubt that the advances to the Tyler corporation were nothing more than contributions to capital. In the first place the corporation was inadequately financed. While the concept of inadequate capitalization is today more coolly and modestly applied than in former years, see Rowan v. United States, 5 Cir. 1955, 219 F.2d 51, 55, it has not been completely spurned. United States v. Henderson, 5 Cir. 1967, 375 F.2d 36, 40, cert. denied 389...