Waterman Steamship Corporation v. United States, Civ. A. No. 2284.

• Decision Date: 02 April 1962
• Docket Number: Civ. A. No. 2284.
• Citation: 203 F. Supp. 915
• Parties: WATERMAN STEAMSHIP CORPORATION, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Alabama

203 F. Supp. 915

WATERMAN STEAMSHIP CORPORATION, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 2284.

United States District Court S. D. Alabama, S. D.

April 2, 1962.

COPYRIGHT MATERIAL OMITTED

Armbrecht, Jackson, McConnell & DeMouy, Mobile, Ala., for plaintiff.

Ralph Kennamer, U. S. Atty., Mobile, Ala., Theodore D. Peyser, Jr., Atty., Dept. of Justice, Washington, D. C., for defendant.

DANIEL HOLCOMBE THOMAS, District Judge.

This action arises under the provisions of Sections 1346(a) (1) and 1402, of Title 28, of the United States Code.

Plaintiff is seeking recovery for alleged overpayment of federal income taxes for the years 1947 through 1950, in an amount of $2,811,773.29. There are five major issues raised by the plaintiff's four claims, and one major issue raised by the Government's counter-claim. Each of these issues will be discussed separately in this opinion.

This opinion does not attempt to set forth the final sum to which the parties are entitled in the various issues. Such sums are to be determined by the parties in accordance with regular accounting procedures, reflecting the views herein expressed.

I. WATERMAN BUILDING

This issue raises the questions (A) whether advances to a wholly owned subsidiary resulted in loans to or investments in the subsidiary by the parent and, if it were a loan or an indebtedness, whether or not it became worthless during the taxable year in question; and (B) whether certain stock in the subsidiary owned by plaintiff became worthless during the taxable year in question.

Prior to 1946, the personnel and operations of plaintiff and various of its subsidiary corporations were located in and carried on from several different buildings and localities in the city of Mobile, Alabama, plaintiff's home office and principal place of business. Because this arrangement was unsatisfactory and because plaintiff was unable to obtain sufficient space in an existing building to house all of its offices, plaintiff decided to construct its own office building and adjacent restaurant building.

In May of 1946, plaintiff filed an application with the Civilian Production Administration for authority to construct a sixteen-story office building and adjacent restaurant at an estimated cost of $2,600,000, exclusive of the land and architect's and engineer's fees. Shortly thereafter, plaintiff entered into a cost-plus contract with J. P. Ewin, Inc., for construction of the buildings. An architect was also employed to design the buildings.

Plaintiff determined to establish a subsidiary company to construct, own, and operate the office building. This decision was in line with its policy that any activities other than the steamship business, which was its principal business, would be carried on through subsidiary corporations. This also enabled local banking institutions to lend up to their maximum limits to each of such subsidiary corporations, which maximum would be higher than if they could lend only to plaintiff. On July 19, 1946, Waterman Building Corporation (hereinafter referred to as Building Corporation) was organized as a wholly owned subsidiary of plaintiff with authorized capital stock of $1,500,000 and paid-in capital stock of $375,000. Immediately thereafter, plaintiff assigned to Building Corporation its agreements with the architects and with the contractors for the construction of the building in question. By virtue of this assignment plaintiff was released and Building Corporation assumed all of the plaintiff's duties under the two contracts.

Construction on the new buildings commenced in 1946, with an estimated completion time of eighteen months. However, due to labor difficulties and the failure of materialmen or suppliers to meet schedules, the building was in construction for two years. The ultimate costs of the buildings, without furniture, fixtures, and equipment, came to approximately $4,250,000 — greatly in excess of the estimated costs of $2,600,000.

Plaintiff had originally planned to finance the construction of the office building by the maximum obtainable on a loan from some lending institution, which it considered to be about 50% of the estimated cost, with a pay-out of twenty-five years. The remaining 50% was to be financed by plaintiff through its initial capital contribution and by subsequent advances on open account to Building Corporation. Plaintiff planned to lease the office space from its subsidiary and, based on comparable rental figures, the rental payments under such lease would enable the subsidiary to meet the payments on the long-term loan as well as repay the open-account loans of plaintiff.

As it turned out, however, the maximum obtainable loan was $1,000,000, repayable over a twenty-year period. This loan was obtained from Massachusetts Mutual Life Insurance Company, and a note for that amount was executed and delivered by Building Corporation to Massachusetts Mutual, secured by a mortgage on the office and restaurant buildings. At the same time, a twenty-year lease was entered into between plaintiff and Building Corporation, whereby the former agreed to pay the latter $287,039.50 annually as rental for the buildings, which lease was assigned to Massachusetts Mutual as security for the note and mortgage. The lease states that the rental was based on the estimated cost to the Building Corporation of maintaining the office building, paying all taxes and insurance on the leased premises, paying the interest at 4% on a one million dollar loan, and paying $93,102 per year to amortize the loan. If substantial error was made in these estimates, then the rent was to be adjusted accordingly. The annual rental was considered by the plaintiff to be a fair rental based on comparable facilities in the area.

Upon completion of the building and the long-term financing, plaintiff had made loans to Building Corporation in the total amount of $3,125,000. With the loan of $1,000,000 from Massachusetts, $400,000 of this amount was repaid by Building Corporation. However, during operations in 1949, plaintiff had to make further advances to its subsidiary, so that as of September 30, 1949, Building Corporation owed plaintiff, on open account, $3,110,000. Due to the greatly increased cost of the construction of the building and partially to the failure to have a lease on the restaurant building which would return some income to Building Corporation, the latter was not able, from the income derived from the lease with plaintiff, to repay the indebtedness to plaintiff after making its payments to Massachusetts Mutual. After nine months of operation, it was apparent to the officers of plaintiff that not only was the building corporation failing to show a profit, but it was not generating sufficient cash to reduce the indebtedness to plaintiff within any reasonable period, after meeting its fixed obligations and operating costs. The directors of plaintiff then determined that it would be in the best interest of and would result in material savings to plaintiff, to transfer all of the assets of Building Corporation to plaintiff, with plaintiff assuming all the obligations of Building Corporation, in reduction of the indebtedness of Building Corporation to plaintiff by the market value of those assets less the amount of its obligations assumed. This action was approved by the directors and stockholders of Building Corporation and by the Executive Committee and Directors of the plaintiff, subject to appraisal of building and land by independent real estate appraisers. An agreement between plaintiff and Building Corporation dated September 30, 1949, effectuated this plan.

A.

The first question raised is whether the advances made by plaintiff to its wholly owned subsidiary constitute loans or capital contributions. Different tax consequences attend each such classification. If those advances constitute "debts" as that term is used in Title 26 U.S.C. Sec. 23(k) plaintiff is entitled to a bad debt loss deduction. On the other hand, if those advances constitute capital contributions, reference must be made to those sections of the code concerning liquidation (Secs. 112(b) (6), 115(c)). The answer depends on the intent of the parties, which is to be ascertained from all relevant facts and circumstances. Rowan v. United States, 5th Cir. 1955, 219 F.2d 51.

When making the advances to the Building Corporation, plaintiff never requested or received any notes or other evidence of indebtedness or a mortgage as security. Nor did it request or receive any interest for the use of the funds advanced, nor was a payment date discussed or agreed upon. The government contends that such factors indicate an intention to contribute to the capital of the subsidiary. Such contention, however, fails to recognize what the testimony of plaintiff's witness clearly sets forth. Waterman Corporation dealt with all of its subsidiaries on similar open accounts without interest. Absence of these arrangements is not fatal to the creation of a creditor-debtor relationship. Moreover, the testimony shows that Building Corporation intended to repay the advances through renting to the parent and from income from the restaurant.

The burden of proof is on the corporate taxpayer to show the intention to create a loan rather than a capital contribution. Once the taxpayer has done this with supporting evidence the burden shifts to the government to refute such evidence. Where, as here, the government offers no evidence to contradict the evidence of the taxpayer, but merely arbitrarily determines the advances were capital contributions, the evidence offered by the taxpayer, if reasonable and just, when considered from all the relevant facts and circumstances, will be given effect. (See Gounares Bros. & Co. v. United States, 185 F.Supp. 794.)

The original intent and purpose of plaintiff changed only after a substantial change in circumstances over which plaintiff had no control. If...