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Gloucester Ice & Cold Storage Co. v. Commissioner.Gloucester Ice & Cold Storage Co. v. CommissionerDocket No. 68913.
United States Tax Court T.C. Memo 1960-196; 1960 Tax Ct. Memo LEXIS 97; 19 T.C.M. (CCH) 1015; T.C.M. (RIA) 60196;September 21, 1960 *97 Held, that debenture bonds, which were held by petitioner's stockholders or members of their families in proportion to their stockholdings and which were issued by petitioner in connection with an expansion program and simultaneously with the retirement of its preferred stock, represent a proprietary interest in the corporation rather than an indebtedness, and consequently, payments on such debenture bonds are not deductible as interest by petitioner.
Held, further, certain expenditures made by petitioner in 1955 for pump parts and a section of a chute are deductible repairs in that year.
Harry Bergson, Jr., Esq., 209 Washington Street, Boston, Mass., for the petitioner. Frank V. Moran, Jr., Esq., for the respondent.MULRONEYMemorandum Findings of Fact and Opinion
MULRONEY, Judge: The respondent determined deficiencies in petitioner's income tax as follows:
Taxable Year Deficiency 1952 $4,970.26 1953 1,123.43 1954 3,314.68 1955 4,057.38 The questions are whether petitioner is entitled to deductions of $7,000 during each of the years 1952 to 1955, inclusive, representing interest payments to the holders of its 7 per cent Debenture*98 Bonds, and whether certain expenditures in 1955 should have been capitalized or were deductible as having been made for repairs.
Findings of Fact
The stipulated facts are found accordingly.
Petitioner is a corporation organized under the laws of the State of Massachusetts in November 1938 and is located in the City of Gloucester, Massachusetts. It is engaged in the business of manufacturing and selling ice, and furnishing freezing and cold storage service particularly to fishing fleets.
Petitioner filed its income tax returns for 1952 to 1955, inclusive, with the district director of internal revenue for the district of Massachusetts.
Petitioner's authorized capital consisted of 10,000 shares of no par common stock and 1,000 shares of 7 per cent Cumulative Preferred stock par value $100. The 10,000 shares of petitioner's common stock were attributed a value of $0.10 per share.
The officers and directors of petitioner at all times material hereto were:
John Ryan President & Director James A. Ryan Treasurer & Director Harry Bergson Clerk & Director John W. Ryan Director Samuel L. Deitsch Director Sometime prior to November 1938 the United States, *99 under its W.P.A. program, the State of Massachusetts, and the City of Gloucester, in order to stimulate the fishing industry, erected a pier in Gloucester and a building situated thereon suitable for freezing and storage of fish. All of this was done pursuant to various acts of the legislature of Massachusetts and the building, situated on the State Pier, consisted of a fully-equipped freezer and storage building and 10 stores for the filleting and packaging of fish. The freezer and cold storage building was erected at a cost of $1,050,000, of which the Federal Government contributed $400,000, the State of Massachusetts $600,000, and the City of Gloucester $50,000. The building was complete and ready for the renting authority, Gloucester Community Pier Association, to lease to someone to engage in the business of manufacturing ice for the fishing fleet and for the freezing and cold storage of fish.
John Ryan procured for petitioner a lease of the freezer and cold storage building from the Gloucester Community Pier Association, and for his service in procuring said lease the 10,000 shares of petitioner's common stock were issued to him. Upon receipt of the 10,000 shares of petitioner's*100 common stock, John Ryan donated 3,000 shares to petitioner, which stock was held by petitioner as treasury stock.
The lease above mentioned was for a term of years beginning on November 1, 1938 and ending on September 30, 1949 for a rental of $30,000 a year with the right in the lessee to extend the lease for a further term of 20 years from September 30, 1949 on the same terms and conditions, except that the rent for the additional term should be mutually agreed upon, and if the parties were unable to agree, the rental would be settled by arbitration in the manner set forth in the lease.
Petitioner commenced business on January 1, 1939 and on August 22, 1939, 327 shares of petitioner's 7 per cent cumulative preferred stock were issued for $100 per share. Thereafter, from time to time between September 21, 1939 and November 14, 1940, 173 shares of petitioner's 7 per cent preferred stock were issued. One thousand five hundred shares of the common stock held by petitioner as treasury stock were given as a bonus to the subscribers of petitioner's preferred stock, the distribution being three shares of common stock for each share of preferred stock.
Petitioner's profits before Federal*101 taxes (or losses) and the amounts of dividends paid for the taxable years 1939 to 1951, inclusive, as per its books were as follows:
Profit (Loss) Dividends Before Fed- Com- Pre- Year eral Tax mon ferred 1939 ($11,598.10) 1940 4,240.11 1941 4,394.59 $3,500.00 1942 17,931.15 9,625.00 1943 27,976.58 $ 2,500 3,062.43 1944 62,952.86 7,500 1945 45,321.65 7,500 1946 69,939.29 10,000 1947 27,146.30 10,000 1948 87,180.94 20,000 1949 93,853.51 20,000 1950 41,629.24 5,000 1951 53,179.17 10,000 The Cape Pond Ice Company was a corporation organized under the laws of the State of Massachusetts in 1902 and is located in the City of Gloucester. It was engaged in the business of harvesting and selling natural ice in Gloucester, chiefly to the fishing fleet. It owned several ponds in the towns near Gloucester from which it cut natural ice and stored same in the ice houses located on the shores of the ponds. It also owned a wharf on Commercial Street situated on the water front of Gloucester Harbor and on it maintained a storage crusher plant for the purpose of furnishing crushed ice to the fishing boats operating out of*102 Gloucester. The issued and outstanding capital stock of the Cape Pond Ice Company consisted of 382 shares of common stock par value $100 per share.
In 1943 the petitioner decided to call the preferred stock and at the same time purchase the Cape Pond Ice Company. In order to effectuate this plan, petitioner issued its "7% Debenture Bonds" in the face amount of $100,000 and a holder of preferred stock (which had been called for retirement) was permitted to exchange said stock for debentures of an equal amount in face value. The plan adopted by petitioner also provided that the remaining 1,500 shares of petitioner's treasury stock would be given as a bonus to the subscribers of the $100,000 7 per cent debenture bonds who paid cash for said bonds at the rate of three shares of common stock for each $100 bond so purchased with cash. No shares of common stock were given to those who exchanged their preferred stock for debentures.
The following schedule shows the names of the holders of petitioner's securities, family relationships, the number of shares of common stock and amount of investment in preferred stock as of September 15, 1943, and the investments in debentures after the call*103 of the preferred on September 20, 1943:
Com- Pre- 7% De- Security Holder Relationship mon ferred benture John Ryan 3,790 John or Mary Ryan Husband & Wife 90 3,000 4,000 John Ryan Tr. for Constance Daughter of John 75 2,500 5,000 John W. Ryan Son of John 5,000 Mary T. Ryan Wife of John 150 5,000 10,000 Lillian (Ryan) Hodges Daughter of John 75 2,500 5,000 Irene (Ryan) Ready Daughter of John 75 2,500 7,000 James A. Ryan Brother of John 310 1,000 2,000 John Ryan Tr. for John W. Son of John 75 2,500 Ryan Vincent Coppola Tr. for 363 3,300 6,600 Vincent, Jr. Gloria Coppola Wife of Vincent 6,000 Rose Coppola Sister of Vincent 180 3,000 Harry and Augusta Bergson Husband & Wife 730 500 1,000 Harry Bergson, Jr. Son of Harry 15 500 500 Elizabeth Bergson Wife of Harry, Jr. 15 500 Samuel L. Deitsch 1,300 Frances S. Deitsch Tr. for Wife and Daughter 30 500 1,000 Frances of Samuel L. Samuel L. Deitsch, Jr. Son of Samuel L. 30 500 1,000 Frances S. Deitsch Wife of Samuel L. 464 4,900 9,800 Louis Wersba 18 300 600 Lois Wersba Daughter of Louis 363 3,300 3,300 Natalie Wersba Wife of Louis 30 500 1,000 Alice Marr 300 5,000 10,000 John D. Marr Son of Alice 500 Marr's late husband David Levine 42 700 1,400 Bernard Klawans 60 1,000 2,000 Bert Reinitz 120 2,000 2,000 John A. & Esther Cullen 60 1,000 2,000 Marista O'Connell 120 2,000 4,000 Helen M. Hurley 120 2,000 4,000 William Jacobs 2,000 Philip Jacobs 500 Mannie Kornreich 2,000 F. W. Bryce 500 *104 On October 29, 1943, petitioner purchased 366 shares of the common stock of Cape Pond Ice Company for $136,325.50 and about the same time petitioner borrowed from the First National Bank of Boston the sum of $65,000 at 4 per cent interest. Said loan was repaid in full as of October 31, 1944. Petitioner's balance sheets as of December 31, 1942 and December 31, 1943, are as follows:
*105Gloucester Ice & Cold Storage Co. Balance Sheet December 31, 1942 Assets Current Assets Cash $ 12,174.85 Accounts Receivable 20,221.40 Ice on Hand 1,620.00 Investments - U.S. Tax Notes 5,000.00 Investments - Securities 14,724.73 Gloucester Dehydrating Process Co. 865.91 $ 54,606.89 Fixed Assets Machinery & Equipment $ 27,678.74 Furniture & Fixtures 88.28 Motor Vehicles 2,102.70 $ 29,869.72 Less - Reserve for Depreciation 5,991.93 23,877.79 Prepaid Items Insurance $ 354.75 Supplies - Ice 52.00 Supplies - Office 60.00 Cartons & Boxes 506.10 Refrigerants 117.17 Fuel Oil 28.20 Repairs - Ice 750.00 Construction Material 370.00 2,238.22 Leasehold 1,000.00 $ 81,722.90 Liabilities Current Liabilities Accounts Payable $ 13,268.69 Notes Payable - Bank $11,736.06 Less Notes Rec. Discounted 11,069.94 666.12 Notes Payable & Equipment 825.00 $ 14,759.81 Owed Officers & Directors 6,304.42 Reserves & Accruals Payroll $ 158.53 Taxes 825.49 Water 250.00 Compensation Insurance 1,050.72 Social Security 1,480.38 3,765.12 Capital Stock Preferred Stock $ 50,000.00 Common Stock 1,000.00 51,000.00 $ 75,829.35 Surplus 5,893.55 $ 81,722.90 Gloucester Ice & Cold Storage Co. Balance Sheet December 31, 1943 Assets Current Assets Cash $ 6,084.85 Accounts Receivable 19,482.60 Notes Receivable $20,000 Less Notes Rec. Discounted 20,000 Ice on Hand 5,079.00 Investments - U.S. Govt. tax 9,000.00 notes Investments - Cape Pond Ice 138,825.00 Co. Investments - Other 13,101.86 Securities Gloucester Dehydrating 976.32 $192,549.63 Process Co. Fixed Assets Building $ 2,446.85 Machinery & Equipment 32,315.53 Quickfreeze Equipment 36,963.78 Car and Tractor 2,047.30 $ 73,773.46 Less Reserve for 9,242.19 64,531.27 Depreciation Prepaid Items Insurance $ 705.39 Supplies - Ice 409.36 Supplies - Office 116.06 Supplies - Freezer 412.13 Refrigerants 107.42 Repairs - Ice 750.00 2,500.36 Leasehold 1,000.00 $260,581.26 Liabilities Current Liabilities Accounts Payable $ 22,141.42 Cape Pond Ice Co. 13,000.00 Notes Payable - Bank 45,000.00 Notes Payable - Equipment 13,700.00 Notes Payable - Others 25,000.00 $118,841.42 Owed Officers & Directors 7,375.34 Reserves & Accruals Payroll $ 699.19 Taxes 1,555.17 Water 250.00 Interest 377.21 Social Security & Payroll 2,022.37 4,903.94 taxes Debentures - 7% due 1963 100,000.00 Common Stock 1,000.00 Surplus 28,460.56 $260,581.26 *106 Petitioner paid the $7,000 interest each year on the debenture bonds and as of November 30, 1959, a sinking fund account on petitioner's books for retirement of the bonds had a balance of $68,181.40.
During each of the years in question petitioner distributed $7,000 to the holders of its debentures and took deduction therefor as interest on indebtedness. Respondent disallowed the deductions explaining that he had determined that the bond issue in the amount of $100,000 was capital rather than a loan and the $7,000 "is considered to be dividends".
Also on its return for the year 1955 petitioner took deductions for repairs in the amount of $17,045.10. Respondent, in his notice of deficiency, disallowed the following items of such expenditures on the ground that they were capital expenditures and not repairs:
Gould's Pump, Inc. - New Pump (Pipe line) $297.00 B. Peterson - New Ice Chute 198.00 Hayes Pump - Parts for new pump 398.40 The items for pumps were for replacement of the interior of two salt water pumps. Because of the corrosive action of the salt water the interior of these pumps have to be replaced at least every two years, depending somewhat on*107 how much business petitioner did. The item for the repair of the ice chute was for the replacement of the bottom section of the ice chute, which replacement has to be made frequently.
The above expenditures were for repairs and not capital expenditures.
Opinion
The principal issue in this case is whether petitioner's payments to the holders of its debenture bonds were payments of interest or dividend distributions. The issue presents the question of whether the debenture bonds are to be considered evidences of indebtedness for income tax purposes or of a proprietary stock interest in the corporation.
This problem has been present in many cases decided by this and other courts. We have held the issue presents a question of fact and in several cases we have listed some of the factors to be used as a basis for the determination. , affd. , reversing ; ; ; , affd. ; , affd. ,*108 certiorari denied ; and Gokey Properties, Inc., 34 T.C. - (Aug. 12, 1960).
The question is largely one of intent: "One must still look to see whether the socalled creditors placed their investment at the risk of the business, or whether there was an intention that the alleged loans be repaid in any event regardless of the fortunes of the enterprise." , pp. 578-579. That intent will be gleaned from the facts as a whole. The fact that the security is in the form of a debt obligation payable in any event will not be controlling. When, by virtue of stock ownership, the bondholders control the fortunes of the corporation it is obvious the money advanced on bonds, be they ever so absolute as debt instruments in form, could be intended as venture capital placed at the risk of the business. When it appears the stockholders own the bonds approximately in proportion to their shareholdings there is a strong inference that their advancements were, and were intended to be, in the nature of capital investments.
In the instant case we find approximately all of the stockholders or members*109 of their families owning debenture bonds in proportion to their shareholdings. It is admitted the debenture bonds satisfied all of the formal requirements to make the instruments effective as debt obligations. And the record establishes they were treated as debt obligations with interest payments made when due and appropriate accruals to a sinking fund to provide for their retirement at maturity. Petitioner argues the form of the instruments, along with the fact that the debentures were issued for the business purpose of buying out a competitor, establishes the debenture issue as not venture capital but true indebtedness. As we have seen the form of the instrument is only one factor to be considered and the stated purpose of the issue, to purchase the Cape Pond Ice Company, is most unfavorable to petitioner's position that the issue did not represent capital.
By purchasing all but a few shares of the Cape Pond Ice Company, petitioner acquired not only a going ice business that had existed in Gloucester since 1902, but also its assets consisting of several ponds with ice storage houses, a wharf on the water front of Gloucester Harbor, and a storage crusher plant suitable for use in*110 furnishing crushed ice to the fishing boats operating out of Gloucester. Before the purchase petitioner had fixed assets of less than $25,000. It rented its fully-equipped plant in which it carried on its business of manufacturing and selling ice in Gloucester. Certainly the acquisition of such fixed assets by petitioner, with money supplied by the stockholders in proportion to their stock interest, points most strongly to an intent to place the money at the risk of the business. The obvious effect of what was done is that the stockholders, by buying the debenture bonds in proportion to their stock interest, became pro rata owners of a complete ice business, including ponds, a plant and other buildings. The very purpose of their advancements was an investment in new assets several times the value of petitioner's existing assets, which had presumably been procured by risk capital.
In a somewhat similar situation in , where the issue was whether a stockholder's advance of funds to his corporation was to be deemed capital or loan, we said:
"Substantially all, [advances] had apparently been invested in the corporation's organization and plant, *111 a permanent asset. Advances for such a purpose are by their very nature placed at the risk of the business. * * *"
There is really no difference between the stockholders supplying all of the working capital ( , affd. ) or substantially all of such working capital ( ), and the stockholders supplying the corporation funds to invest in its fixed assets. Stockholder advancements for such purposes strongly indicate an intention to place the advancements at the risk of the business.
Nor do we think it at all material that here the debenture bonds were issued after the corporation had been in business five years and had shown increasing prosperity. Here petitioner was expanding. Petitioner so states on brief. It was acquiring new assets at a cost of about two and half times the amount of its capital represented by stock. In , we held:
"When the organizers of a new enterprise arbitrarily designate as loans the major portion of the funds they lay out in order to get the business established and under way, a strong inference arises that the entire amount*112 paid in is a contribution to the corporation's capital and is placed at risk in the business. * * *"
The same strong inference arises when the stockholders make advancements in order to expand a going business that is almost wholly without the necessary capital to finance the expansion.
Footnotes
1. See balance sheet for December 31, 1942 showing Assets of $81,722.90 and Liabilities including stock liability of $75,829.35. With the debenture issue and the simultaneous call of the preferred stock (using figures at the beginning of 1943, which is all we have) the capital at the time of the debenture issue would be less than $7,000.↩
Document Info
Docket Number： Docket No. 68913.
Filed Date： 9/21/1960
Precedential Status： Non-Precedential
Modified Date： 11/20/2020