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Malone & Hyde, Inc., of Missouri, Petitioner v. Commissioner of Internal Revenue, RespondentMalone & Hyde, Inc. v. CommissionerDocket No. 5969-65February 29, 1968, Filed
United States Tax Court *169
Decision will be entered under Rule 50 .Petitioner was organized as a wholly owned subsidiary to take over an area of existing business of its parent. The parent furnished capital to cover a large portion of petitioner's fixed assets and advanced funds on open account initially without, but in the years involved herein with, interest to cover petitioner's inventory requirements. Petitioner's operations were highly successful.
Held , under all the circumstances, the advances represented bona fide indebtedness and the interest paid was a proper deduction.W. Stuart McCloy , for the petitioner.Charles G. Barnett , for the respondent.Tannenwald,Judge .TANNENWALD*575 Respondent determined the following deficiencies in petitioner's income tax:
Fiscal year ended Deficiency June 24, 1961 $ 3,380.00 June 30, 1962 2,255.98 June 29, 1963 13,884.00 The only issue for decision is whether certain advances to petitioner by its parent corporation constituted a bona fide debt or a contribution to capital.
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Petitioner, Malone & Hyde, Inc., of Missouri, had its principal place of*170 business in Sikeston, Mo., at the time of the filing of the petition herein. It filed its corporate income tax returns for the fiscal years ended June 24, 1961, through June 29, 1963, with the district director of internal revenue, St. Louis, Mo.
All of petitioner's issued and outstanding stock is and, since its incorporation in 1955, has been owned by Malone & Hyde, Inc., which has its principal place of business in Memphis, Tenn.
*576 Both petitioner and its parent are engaged in the wholesale distribution of foods and related products to independent retail grocers. Their sales are for the most part carried out on the basis of cash payment at the time orders are placed by their customers. A variety of other services (i.e., financing, planning of store construction and operation, and aid in setting up advertising programs) is also furnished to customers. The operations of the parent and petitioner have been highly successful.
Prior to 1955, the parent carried on a business of approximately $ 3 million in sales annually, with a substantial number of customers in Missouri, which it serviced and supplied directly from Memphis. Because of the distance of this area from the *171 Memphis warehouse, it decided that operations would be more efficient if a warehouse were established in an appropriate location in Missouri. Accordingly, in 1955, the parent organized petitioner to operate a warehouse in Sikeston and to supply and service customers in the Missouri area. Petitioner commenced business in January 1956. Except for its Memphis operation, the parent customarily carried on warehousing and sales to independent grocers through subsidiaries.
The warehouse, which was subsequently enlarged, was leased from an unrelated third party. Petitioner itself initially acquired and owned $ 89,698 *172 petitioner's issued and outstanding stock. It is also advanced approximately $ 400,000 in the form of cash and inventory in kind. The parent's decision to allocate $ 50,000 to petitioner's capital and the balance to advances was made after careful consideration of all factors anticipated in petitioner's operations. The management of the parent was experienced and regarded as highly competent. The parent continued to make advances needed, either in cash or in sales of inventory on credit. During the period from January 1956 to June 1957, the parent made additional advances and petitioner made some payments. The net amount of advances was $ 471,048 as of June 23, 1956, and $ 345,000 as of June 29, 1957.
Petitioner's business grew beyond all expectations, its net sales increasing from $ 5,199,604*175 during the fiscal year ended June 29, 1957, to $ 15,521,008 during the fiscal year ended June 29, 1963. Its inventory increased from $ 431,355 to $ 889,625 and its inventory-turnover ratio from 11.65 to 18.28 during the same period. At all times, its current assets exceeded its total liabilities, including the amount of the advances owed to the parent, except for a minor deficit in this respect *578 during the first fiscal year. *176 constituted debt or equity capital. If the advances were equity, the interest deductions claimed herein are not allowable.
Both petitioner and the parent always considered the advances as indebtedness and their books and records clearly reflected this intention. The parent and the petitioner at all times expected the advances to be repaid and this expectation was clearly reasonable under the circumstances. Respondent argues that lack of formal evidence of the indebtedness, absence of interest in the early years, lack of security, and the fact that an unrelated person would be unlikely to loan money on the same basis, *179 misdirected in the context of this case.
Footnotes
2. In fiscal 1956, current assets were $ 495,107 and the aggregate of liabilities and advances by the parent was $ 525,071.↩
3. Obviously, such a loan would have required the payment of interest. The executive vice president of the First National Bank of Memphis testified that the bank would have charged interest at one-half point above the prime rate. He also testified that the bank would have loaned the same amount either on a revolving credit or 2-year term unsecured, unsubordinated basis, and would not have required a guarantee from the parent or the maintenance of cash accounts with the bank. He indicated that "perhaps" the bank would have asked the parent to execute a repurchase agreement on the inventory, but that such an agreement would not be too important because of the ready convertibility of petitioner's inventory into cash. Such a repurchase agreement clearly would have been a meaningless and unnecessary requirement for the parent to have imposed.↩
Document Info
Docket Number: Docket No. 5969-65
Citation Numbers: 49 T.C. 575, 1968 U.S. Tax Ct. LEXIS 169
Filed Date: 2/29/1968
Precedential Status: Precedential
Modified Date: 11/14/2024