Universal Castings Corporation v. CIR
| Citation | 303 F.2d 620 |
| Decision Date | 22 May 1962 |
| Docket Number | No. 13619.,13619. |
| Parties | UNIVERSAL CASTINGS CORPORATION, an Illinois corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Marshall G. Sampsell, Robert A. Helman, Chicago, Ill., Isham, Lincoln & Beale, Chicago, Ill., of counsel, for petitioner.
Louis F. Oberdorfer, Asst. Atty. Gen., Ralph A. Muoio, Atty., Tax Division, Lee A. Jackson, Harry Baum, Attys., Dept. of Justice, Washington, D. C., for respondent.
Before DUFFY, SCHNACKENBERG and SWYGERT, Circuit Judges.
By its petition, Universal Castings Corporation, an Illinois corporation, asks us to review a decision of the Tax Court of the United States that there were deficiencies in its income tax payments for the taxable years 1953, 1954 and 1955.
There appears little conflict in the evidentiary facts, some of which were stipulated. The contested issue is whether the Tax Court erred in finding as not deductible for federal income tax purposes the amounts paid as interest by petitioner on its "Income Notes" during those years.
Petitioner contends that the Tax Court's determination that the income notes represent equity rather than debt was clearly erroneous and was contrary to the substantial weight of the evidence.
The following facts appear in excerpts from petitioner's brief:
Prior to July 31, 1946, and up to May 18, 1950, petitioner had issued and outstanding capital stock consisting of 1,566 shares of common stock, without par value, and 1,142 shares of class A stock, par value $66 per share. The class A stock differed from the common stock only in that it had preference in the event of liquidation.
Petitioner's stock was owned during that period of time as follows:
Class A Common Total
Stock Stock Stock
Locomotive Firebox
Company ........... 1,142 shs. 570 shs. 1,712 shs
Louise Carr Hodgkins
Trust ............. 696 " 696 "
Walter S. Carr ...... 300 " 300 "
__________ __________ __________
1,142 shs. 1,566 shs. 2,708 shs
Locomotive Firebox Company ("Locomotive") was a publicly-owned corporation with about 700 stockholders. Walter S. Carr was its president. He was also chairman of the board of petitioner until May 18, 1950. The beneficiary of the Trust was Carr's niece.
In the summer of 1946, petitioner had an earned surplus deficit of $340,329.64 and was losing money. The three stockholders employed Lester B. Knight, president of Lester B. Knight & Associates, Inc., a firm of management and engineering consultants ("Knight Associates"), to make a review of its business.
Knight did so and reported to Carr that if certain changes were made in the management and operations of petitioner, the business could be made profitable. Carr asked Knight to take over the management of petitioner.
On or about September 20, 1946, petitioner entered into a contract with Knight Associates and W. G. Wilkins under which Knight became consultant-manager, and Wilkins became vice-president and general manager of petitioner. Both were elected to its board of directors. Under this contract, Knight Associates received as a management fee 25%, and Wilkins received as a bonus 2½%, of petitioner's net income before federal income taxes.
On August 21, 1946, petitioner borrowed $250,000 for five years from Central National Bank (the "Bank"). The loan was evidenced by petitioner's note dated August 21, 1946 and due July 21, 1951, bearing interest at the rate of 4% per year, and was secured by a chattel mortgage which covered all of petitioner's fixed assets. The repayment of 75% of the principal amount of the loan was guaranteed by Reconstruction Finance Corporation.
On the same day, petitioner's three stockholders loaned it $150,000 in the following principal amounts:
Locomotive ................ $102,298.50
Louise Carr Hodgkins Trust. 33,333.00
Carr ...................... 14,368.50
___________
$150,000.00
The loans were evidenced by petitioner's five year notes, dated August 21, 1946, which bore interest at the rate of 5% per year and which were subordinated to the Bank's loan. Each of these notes contained a confession of judgment clause.
In October and November, 1946, petitioner's three stockholders loaned it an additional $50,000 in these amounts:
Locomotive .................. $34,099.50
Louise Carr Hodgkins Trust .. 11,111.00
Carr ........................ 4,789.50
__________
$50,000.00
For these loans petitioner gave demand notes bearing interest at the rate of 5% per year and containing confession of judgment clauses. These loans were not subordinated to the Bank's loan.
The loans made to petitioner by its stockholders were duly recorded and carried on its books of account as "Notes Payable". The loan transactions were duly authorized by its board of directors.
The three stockholders made their loans to petitioner in proportion to their respective holdings of its stock. The loan allocations were made by assigning the $200,000 principal amount of the loans 50% to the class A stock and 50% to the common stock. The loans were then prorated among the holders of each class of stock as shown by the following table:1
Percentage
of
Stock Stock and Total
Owned of Notes Notes
Locomotive
All class A stock .. 1,142 shs. 50.0 %
_________
Common stock ....... 570 " 18.199
_______
68.199 $136,398
Louise Carr
Hodgkins Trust
Common stock ....... 696 " 22.222 44,444
Carr
Common stock ....... 300 " 9.579 19,158
__________ ______ ________
Total common .... 1,566 shs. 100. % $200,000
__________
Total stock ..... 2,708 "
Within sixty days in 1946 after Knight and Wilkins took over the management, petitioner began to show a profit, and it has shown a profit for every year since then.
In the spring of 1949, because of a general business recession, petitioner requested permission from the Bank and RFC to reduce the principal payments on the Bank's loan. The Bank and RFC granted the request on these conditions, which were accepted by petitioner and its stockholders:
(1) The three stockholders accept new notes aggregating $50,000 maturing August 21, 1951, and bearing interest at the rate of 5% per year in exchange for their demand notes of like amount;
(2) Petitioner, Locomotive and Carr agree with respect to all of petitioner's notes owned by these two stockholders (aggregating $155,556) that:
Notes issued by petitioner to its three stockholders in the principal amount of $50,000 (replacing the demand notes in the same principal amount), were dated June 15, 1949, were due August 21, 1951, bore interest at the rate of 5% per year, and contained confession of judgment clauses.
Petitioner paid when due all of the interest on all of its notes owned by its stockholders from the dates of issuance through the dates of cancellation of the notes.
In May of 1950, petitioner's credit position with respect to operating expenses was good; it was discounting all of its bills for operating expenses.
Chrysler Corporation was a major customer of petitioner. In the spring of 1950, Chrysler asked petitioner to make a proposal under which it would furnish about half of the torque converter casting requirements for all of Chrysler's automobile lines. This business would have represented a large increase over any volume of business which petitioner had been doing or was capable of financing at that time.
Petitioner estimated that, to handle the business, it would require new equipment costing $150,000 to $200,000, plus a substantial amount of additional working capital. Knight concluded, however, and told Carr, that petitioner had to make the requested proposal to Chrysler and had to be prepared to make the necessary additional expenditures.
Carr informed Knight that, because of the pending liquidation of Locomotive and of Carr's desire to withdraw from active business participation, petitioner's stockholders could not make available the money needed for the Chrysler expansion.
Knight responded by offering to purchase for about $90,000 the stock and notes of petitioner then owned by Locomotive and to allow Carr and his niece's Trust to maintain their respective equity interests in petitioner if they would exchange their notes for common stock of petitioner. Locomotive, Carr and the Trust rejected Knight's offer, but offered to sell to Knight for $150,000 all of petitioner's stock and all of petitioner's notes, except for the note owned by the Bank. Knight accepted.
Knight was not in a position to make the purchase alone. He therefore invited several persons to participate with him.
On or about May 18, 1950, Locomotive, Carr and the Trust sold to the group represented by Knight (the "Knight Group") for...
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