W.W. Windle Co. v. Comm'r of Internal Revenue
| Decision Date | 07 January 1976 |
| Docket Number | Docket No. 9426-72. |
| Citation | 65 T.C. 694 |
| Parties | W. W. WINDLE COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Raymond T. Mahon, for the petitioner.
Petitioner, a wool processor, created Nor-West and acquired 72 percent of its stock, to manufacture woolen cloth. Petitioner's predominant motive for creating Nor-West was to have a captive customer for its processed wool. A secondary motive was to make a profitable investment. Petitioner subsequently made repeated loans and advances to Nor-West, which after 9 generally unsuccessful years went bankrupt. Held: On the facts, petitioner's stock in Nor-West was a capital asset in its hands and petitioner's losses therefrom were capital losses. The existence of a substantial investment motive precludes the applicability of the doctrine of Corn Products Co. v. Commissioner, 350 U.S. 46 (1955), even where a business motive predominates. Held, further, loans and accounts receivable due petitioner from Nor-West were debt, and not equity in Nor-West.
Respondent determined a $139,114.17 deficiency in petitioner's Federal income tax for its taxable year ended June 30, 1970. The three issues presented are:
(1) Whether the 3600 shares of capital stock of Nor-West Fabrics, Inc., owned by petitioner were capital assets in petitioner's hands when the stock became worthless during petitioner's taxable year ended June 30, 1970.
(2) Whether petitioner's loans to Nor-West Fabrics, Inc., which remained unpaid when Nor-West Fabrics, Inc., was liquidated in June 1970, constituted debt or equity in petitioner's hands.
(3) Whether petitioner's accounts receivable due from Nor-West Fabrics, Inc., for merchandise sold to Nor-West Fabrics, Inc., which became worthless during petitioner's taxable year ended June 30, 1970, constituted debt or equity in petitioner's hands.
Some of the facts have been stipulated and are found accordingly.
Petitioner was incorporated in Massachusetts in 1912 and had its principal place of business in Millbury, Mass., when it filed its petition. Petitioner filed its corporate income tax return for its taxable year ended June 30, 1970, with the Internal Revenue Service Center in Andover, Mass. Petitioner keeps its books and records on the accrual method of accounting.
Since 1912 petitioner has been engaged in the business of processing and selling raw woolen stock and other woolen materials used by manufacturers of woolen cloth. During the 1950's the woolen textile industry encountered severe economic problems, primarily due to increased competition from abroad. During this period many woolen textile mills which had been customers of petition cut back on production or went out of business because of an inability to operate profitably. Approximately 27 woolen mills which had been customers of petitioner went out of business between 1956 and 1960, and petitioner's sales declined from about $9.5 million in 1956 to $3 million in 1961.1
In 1960 Portland Woolen Mills of Portland, Oreg., one of petitioner's customers, went out of business. Petitioner's sales to Portland Woolen Mills had exceeded $218,000 in 1959. Shortly thereafter, petitioner contacted Robert Pickins, the former vice president and general manager of Portland Woolen Mills, and discussed whether petitioner could purchase some key machinery from Portland Woolen Mills to establish its own woolen mill on the West Coast. Pickins referred the matter to McMinnville Industrial Promotions, Inc., a business group in McMinnville, Oreg., interested in promoting businesses to come into the McMinnville area. After studying the matter further and discussions with the McMinnville group, petitioner agreed to organize an Oregon corporation to be known as Nor-West Fabrics, Inc. (hereinafter Nor-West), to operate a woolen textile mill in McMinnville. The McMinnville group agreed to build a factory which it would lease to Nor-West. Petitioner, which would otherwise have desired to own all the stock of Nor-West, decided that it should sell some of the stock of Nor-West to local people in order to foster local interest in the Nor-West venture.
Nor-West was incorporated in Oregon on February 15, 1961, and engaged in the business of manufacturing and selling woolen cloth. The authorized capital stock of Nor-West was 10,000 shares of common stock with a par value of $100 per share. Only 5,000 shares were issued and outstanding. Of these, petitioner acquired 3,600 shares on June 5, 1961, for $360,000 (consisting of $210,000 cash, and textile machinery and equipment valued at $150,000 which petitioner had purchased from the defunct Portland Woolen Mills on November 30, 1960, for $150,000). The remaining 1,400 shares of the common stock of Nor-West were purchased between March 9, 1961, and June 5, 1961, for $140,000 cash by approximately 594 different individuals and businesses located in the McMinnville area.
Before the petitioner purchased stock in Nor-West, it had investigated the feasibility of conducting a profitable woolen mill in the Pacific Northwest and had concluded that it could be done. Petitioner's president, Winfred W. Windle, had contacted Charles Carter, former president of Portland Woolen Mills, who had assured him that there was a place on the West Coast for such a mill. Carter felt that a relatively small mill could be operated at a profit whereas Portland Woolen Mills, which had been a large woolen mill, could not. In addition, before petitioner purchased stock in Nor-West, it conducted studies and prepared forecasts concerning Nor-West's expected sales, materials requirements, expenses, and profit for the period October 1961 through September 1963.2 Research indicated that Nor-West could reasonably be expected to operate profitably. However, petitioner was aware that in view of the general decline in the woolen industry, a new woolen cloth mill was not justifiable as an investment on its own merits without reference to the acquisition of a captive customer, and that there was substantial risk that Nor-West might not in fact prove profitable.
At the time petitioner acquired its stock in Nor-West it expected to supply all of Nor-West's raw materials requirements. Petitioner, as owner of the controlling interest in Nor-West, had complete control of the buying policies of Nor-West. Petitioner viewed Nor-West as a captive customer for its raw woolen stock. Petitioner expected that Nor-West would need about $900,000 of raw woolen stock annually in order to conduct its manufacturing operations. Petitioner was aware that as long as Nor-West continued operating, petitioner would be able to make profitable sales to Nor-West, even if Nor-West itself did not prove very profitable or just broke even.
When petitioner acquired its stock interest in Nor-West, it did not expect that dividends would be paid on the Nor-West stock. At that time, companies engaged in the woolen textile business were having difficulties remaining solvent and in general were not paying dividends. In fact, Nor-West never paid any dividends. Petitioner did, however, expect the value of its equity interest in Nor-West to increase over time, and expected Nor-West to remain in business at a profit and to continue to buy its raw woolen stock from petitioner.
Petitioner's sales of raw woolen stock and other woolen materials to Nor-West were as follows:
+-------------------------------------------------+
¦Years or periods ¦Amounts of sales ¦
+------------------------------+------------------¦
¦ ¦ ¦
+------------------------------+------------------¦
¦November and December 1961 ¦$28,309.47 ¦
+------------------------------+------------------¦
¦Year ended Dec. 31, 1962 ¦151,931.23 ¦
+------------------------------+------------------¦
¦Jan. 1, 1963, to June 30, 1963¦64,844.95 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1964 ¦126,681.03 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1965 ¦170,700.53 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1966 ¦369,773.70 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1967 ¦275,480.63 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1968 ¦335,876.06 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1969 ¦451,086.90 ¦
+------------------------------+------------------¦
¦Year ended June 30, 1970 ¦328,055.08 ¦
+------------------------------+------------------¦
¦Total ¦2,302,739.58 ¦
+-------------------------------------------------+
These sales by the petitioner to Nor-West fulfilled about 99 percent of Nor-West's materials requirements.
Petitioner's profit on the sales to Nor-West varied on each shipment because inventory costs varied from day to day, depending upon the price for raw wool on the open market. The gross profit in each year (which varied between 8.4 percent and 20.7 percent) was substantially equal to petitioner's net profit on sales to Nor-West.3 This was because little of the petitioner's annual selling and administrative costs were allocable to its business with Nor-West, a captive customer. Petitioner recorded a profit on all of its sales to Nor-West, including those made during the years when Nor-West was losing money in its operations.
Although petitioner had expected Nor-West to operate profitably, Nor-West suffered operating losses in all of its years except its taxable years ended November 30, 1965, and November 30, 1966. Nor-West's actual sales were far below projected levels. Nor-West's sales and profits or losses for its years of operation were as follows:
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