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Edwin M. Clark, Jr., and Kate B. Clark v. Commissioner.Clark v. CommissionerDocket No. 60936.
United States Tax Court T.C. Memo 1958-10; 1958 Tax Ct. Memo LEXIS 223; 17 T.C.M. 39; T.C.M. (RIA) 58010;January 28, 1958 1958 Tax Ct. Memo LEXIS 223">*223 Petitioner acquired from a corporation, in 1949 and 1951, the ownership of two small-loan "brokerage" offices, including one of which he had been the office manager. In connection with such transfers, he executed and delivered to the corporation two long-term installment promissory notes, together with agreements written on the backs thereof which provided in part that it was mutually agreed between the "seller" and "buyer" that such notes constituted payment for the purchase price of the businesses of said offices, including all rights then vested in the "seller"; and that the "buyer" might sell his "equity" at any time, if the "seller" had no reasonable objection to such sale. Thereafter, petitioner operated the businesses, as sole proprietor, at the location and under the same trade name which the seller had been using. The seller, in accordance with supplemental oral arrangements, thereafter acted for the petitioner as a finder of loanable funds, and as a guarantor of borrowers' loans. Petitioner contends that the installment payments made by him during the taxable years on the above-mentioned promissory notes were for services performed for him by the corporation, and were not1958 Tax Ct. Memo LEXIS 223">*224 payments on the purchase prices of the properties; and that such payments constitute deductible business expenses, for income tax purposes.
Held, that the character of the transactions and the purpose of the promissory notes depend principally upon the intent of the parties, at the time when the agreements and notes were executed and delivered; that such intent must be determined from an examination and the weighing of all relevant facts and surrounding circumstances; and that the mutual written agreements of the parties, that the notes were delivered as the purchase price of the going businesses, are to be given greater weight in determining such intent than the contrary contentions and conclusions presented by the petitioner at the trial several years later, without substantiation by any documentary evidence of record.
Held, further, that, since the petitioner, under the terms of the agreements, acquired not only possession and use of properties but also a transferable "equity" therein, the payments under such agreements are to be regarded as deferred installments on the purchase price of the properties.
Held, further, that such installment payments made by petitioner during1958 Tax Ct. Memo LEXIS 223">*225 the taxable years involved do not qualify as deductible business expenses under section 23(a)(1)(A) of the 1939 Code.
James L. Davis, Jr., Esq., First Federal Savings Building, Jackson, Miss., for the petitioners. Homer F. Benson, Esq., for the respondent.PIERCEMemorandum Findings of Fact and Opinion
PIERCE, Judge: Respondent determined deficiencies in petitioners' income tax (and self-employment tax) for the calendar years 1951, 1952 and 1953 in the amounts of $385.74, $642.82 and $798, respectively.
Several of the adjustments set forth in the notice of deficiency were not challenged by petitioners. The sole issue for decision is whether certain installment payments made by petitioner Edwin M. Clark, Jr., during the taxable years involved, pursuant to the terms of two promissory notes which he delivered to Tower Underwriters, Inc. in 1949 and 1951 qualify as deductible business expenses, incurred during the taxable years in carrying on a small-loan "brokerage" business; or whether these payments represent nondeductible installments on the purchase price of two such brokerage businesses, which petitioner acquired from said corporation at the time of delivery1958 Tax Ct. Memo LEXIS 223">*226 of said notes.
Findings of Fact
The petitioners, Edwin M. Clark, Jr. and Kate B. Clark, are husband and wife residing in Jackson, Mississippi. For each of the taxable years involved, they filed a joint income tax return with the collector or district director of internal revenue at Jackson, Mississippi.
Prior to June 1, 1949, petitioner Edwin M. Clark, Jr. (herein called the "petitioner") was employed by Tower Underwriters, Inc., a Mississippi corporation, as office manager of one of about 15 so-called small-loan "brokerage" offices which said corporation operated in the State of Mississippi. Two of these brokerage offices were located in the city of Jackson. The one that petitioner managed, which was the largest of all the offices, was operated under the name of Tower Loan Brokers, and was located on South State Street in Jackson., and the other Jackson office was operated under the name of Dollar Brokers, and was located on South President Street. Tower Underwriters had engaged in such business since the year 1940. Its organizer, principal stockholder, president and executive manager was Wyatt Robinson. Petitioner had been employed by the corporation since the end of the year1958 Tax Ct. Memo LEXIS 223">*227 1947; and, in addition to being manager of the State Street office, was also a member of the corporation's board of directors.
Small-loan "brokerage" offices, such as those here involved, are more or less unique to the State of Mississippi. 1958 Tax Ct. Memo LEXIS 223">*228 to act as agents for borrowers in finding lenders, and who charged the borrowers "brokerage" fees for services in arranging the loans. Such arrangements enabled the lenders to operate outside the State of Mississippi in accepting offers for loans forwarded to them by the local "brokers," to fix their rates of interest without being restricted by the usury laws and privilege taxes applicable in Mississippi, and also to eliminate the expense of dealing directly with the borrowers.
The method of operation which Tower Underwriters employed in operating its several loan brokerage offices was substantially as follows:
Assuming, for example, that a potential borrower wished to obtain a loan of $100 for a period of from 11958 Tax Ct. Memo LEXIS 223">*229 to 6 months, and that he had insufficient credit to obtain such loan from a local bank or loan company, he might go to one of the loan brokerage offices of Tower Underwriters. The manager of such office acting as the "broker," would if satisfied with the risk involved, agree with the borrower to act as his agent in finding a lender, in consideration of the borrower's agreement to pay a brokerage fee of about $20 for such service. The "broker" would thereupon prepare and have the borrower execute a contract covering the arrangement, and also promissory notes covering the principal amount of the loan, the amount of the interest to maturity as charged by the lender, and the amount of the "brokerage" fee. In some cases, all of these items would be included in a single note, made payable to the lender; and in other cases, all or part of the "brokerage" fee would be included in a separate note made payable to the broker. Both the contract and notes were prepared on printed forms which provided for payment of the obligation by the borrower in monthly installments; which also provided for the posting of collateral or other security by the borrower that might be increased at any time upon demand1958 Tax Ct. Memo LEXIS 223">*230 of the lender, and which further provided for acceleration of the maturity of the note and the payment of additional amounts as "attorney's fees," in the event of delay or default by the borrower in making payment of any installment.
After said instruments had been executed, the broker would endorse the principal note, as primary guarantor; and would then forward the same to the lender (usually a Louisiana lending corporation) for its approval and acceptance. Such lender, in order to obtain additional protection for itself, usually required the broker, either to obtain the endorsement or guarantee of a second party, or to make a deposit in an amount equal to an agreed percentage of each loan, as a reserve against potential losses. The nature of such protective arrangements varied, depending on the particular lender, the extent of the lender's confidence in the broker, and the risks and terms of the particular loan involved.
If the lender corporation accepted the borrower's promissory note, it would forward the amount of the $100 loan to the broker, for delivery to the borrower; and it also would forward to the broker (either at the time the note was accepted or at the time the1958 Tax Ct. Memo LEXIS 223">*231 note was fully paid, depending upon the particular arrangements) any portion of the brokerage fee that was included in the principal note. Subsequent collection of the loan would usually be handled by the broker, but it might be handled directly by the lender.
The handling of loans under such arrangement involved considerable risk to the lender, to the broker, and to any secondary endorser; but, if the broker employed good judgment in his selection of borrowers, losses would be held to a minimum; and the arrangement could be very profitable to all of said parties. The short period of the loans enable the lender's funds to be reused two or three times per year; and the provisions of the notes pertaining to the acceleration of maturity in the event of delay or default by the borrower in paying any installment, might result in refinancing arrangements and a compounding of the 20 per cent brokerage fee.
An essential feature of the arrangement was that the lender, the broker and any secondary guarantor had to be legally separate from each other, if application of the Mississippi usury statutes and privilege taxes was to be avoided. Thus, the broker contracted with the borrower to act1958 Tax Ct. Memo LEXIS 223">*232 as his agent, and took the position that he was not engaged in the business of loaning money, but only in rendering personal services. The secondary guarantor took the position that it likewise was not a lender of money, but merely a guarantor of paper handled by other parties. And the lender's position was that it was not subject to Mississippi law, because its acceptance of borrower's promissory notes was effected outside the borders of said state.
Tower Underwriters, Inc., in operating its several brokerage offices during the first months of 1949, suffered from a shortage of operating capital; its balance sheet disclosed an unsatisfactory financial condition; and it was unable to arrange with lenders for sufficient loanable funds to meet the requests of borrowers. Also, one of its Louisiana lenders indicated an intention to increase its rate of interest on loans, which would adversely affect the corporation's business. Wyatt Robinson, as president of Tower Underwriters, was greatly concerned about this situation; and he had frequent discussions with petitioner, as to ways and means for procuring additional loanable funds. The plan which Robinson finally adopted to meet the situation, 1958 Tax Ct. Memo LEXIS 223">*233 and which he explained both to petitioner and to the board of directors of his corporation, was as follows:
Beginning on about June 1, 1949, and continuing until about 1951, Tower Underwriters sold all of its several brokerage offices to the managers thereof (including petitioner), for agreed amounts evidenced by long-term promissory notes that were made payable in monthly installments, without current interest; and, thereafter, Tower Underwriters acted solely in the capacities of being an independent finder of loanable funds, and a secondary guarantor for borrower's notes originating in such brokerage offices. The forms of the promissory notes and agreements which the several office managers executed in connection with their purchase of such offices, were all similar to those executed by petitioner, which are hereinafter set forth.
From such sales of its brokerage offices, Tower Underwriters received in 1949 approximately $120,000 face value of 10-year installment promissory notes of the purchasing office managers; and by 1951 the face amount of promissory notes which it received from such sales of its brokerage offices totaled nearly one-quarter million dollars. In 1949 it entered1958 Tax Ct. Memo LEXIS 223">*234 in its books of account, the $120,000 of office managers' notes then received, as long-term accounts receivable; and, on its 1949 income tax return, it reported the gains from the sales of its brokerage offices as long-term capital gains. Through such treatment of the office managers' notes, it improved its balance sheet, so as to show a favorable rather than a distressed financial condition; and it used such balance sheet and a prospectus which it prepared, to obtain approximately $100,000 of lendable funds for use by the brokerage offices which it had sold. All of this procedure was discussed and explained to petitioner by Robinson.
Shortly thereafter, Robinson, acting on behalf of Tower Underwriters under a plan which petitioner later learned about through entries in the corporation's records, organized several lending corporations under the laws of Louisiana; and it transferred the office managers' promissory notes to these new lending corporations, in exchange for their shares of stock. One of these new Louisiana lending corporations was Consumers Credit Corporation of Bogalusa, Louisiana, which thereafter served as the principal lender for petitioner, in his continued operation1958 Tax Ct. Memo LEXIS 223">*235 of the South State Street office, as owner thereof.
The installment promissory note and the agreement typewritten on the back thereof, which petitioner executed in connection with his purchase from Tower Underwriters of its South State Street brokerage office that was operated under the name of Tower Loan Brokers, were as follows:
"INSTALLMENT NOTE $18,000.00
HATTIESBURG, MISS., June 1, 1949 "For Value Received, the Undersigned (Promises) To Pay To The Order Of
TOWER UNDERWRITERS, INC.
At its office in the City of Hattiesburg, Mississippi the sum of Eighteen Thousand Dollars ($18,000.00 payable in 120 consecutive monthly installments of * ONE HUNDRED FIFTY * ($150.00) each, beginning July 1, 1949, and one final installment of Dollars ( $ ) payable on 19 , with interest on any overdue installment at six per cent per annum.
"In the event of default in the payment of any of said installment payments above described, the entire balance of the principal of this note then outstanding and unpaid shall, at the election of payee or the holder hereof, without demand or notice, become and shall be due and payable at once. If this note be not paid at maturity, whether by acceleration1958 Tax Ct. Memo LEXIS 223">*236 or otherwise, and it be placed in the hands of an attorney for collection, the parties hereto agree to pay twenty per cent (20%) of the amount then due hereon, as attorney's fees, but the minimum fee shall be $15.00 in any case.
"All parties hereto, whether as makers, endorsers, guarantors, or in any other capacity, hereby waive presentment for payment, demand, protest, and notice of dishonor.
[Reverse side]
"It is mutually agreed between the SELLER AND BUYER as follows
"1. This note constitutes the full purchase price for the brokerage business now being operated as TOWER LOAN BROKERS, in Jackson, Miss., including all rights now vested in SELLER.
"2. Effective date of transfer is June 1, 1949; on and after that date seller shall bear no further expense incident to the office sold. The buyer shall comply with the rates, rules and regulations of the lender as to the business said lender accepts from the buyer's customers. The Buyer shall carry with the lender a reserve of 1% on all gross notes handled by the lender. The Seller, however, shall continue as a secondary guarantor.
"3. As such GUARANTOR the seller shall have the right to take over the business herein conveyed1958 Tax Ct. Memo LEXIS 223">*237 PROVIDED the buyer ceases to function as a broker or endangers the seller's equity as a Guarantor; in which event all previous payments on this note shall be declared rental and any balance remaining unpaid shall be cancelled. The Buyer may sell his equity at any time, provided the Seller has no reasonable objection to the sale.
"TOWER UNDERWRITERS, INC. (SELLER)
/s/ BY Wyatt Robinson President
BUYER Edwin M. Clark, Jr."
Subsequently, under date of August 1, 1951, petitioner also purchased from Tower Underwriters, its South President Street brokerage office in Jackson that was operated under the name of Dollar Brokers; and, in connection therewith, he executed another installment promissory note and written agreement. Said promissory note was identical in form with that above set forth, except that the principal amount thereof was $2,475, payable in 99 consecutive monthly installments of $25 each, beginning September 1, 1951. The agreement typewritten on the back of this note, read:
"This note is executed by E. M. Clark, Jr., in consideration of the balance due Tower Underwriters, Inc., for the business known as Dollar Brokers in Jackson, Miss.
"The terms, and condition, 1958 Tax Ct. Memo LEXIS 223">*238 governing the purchase of Tower Loan Brokers in Jackson by Clark, likewise govern the purchase of Dollar Brokers and the payment of this note."
"This being mutually understood by all parties."
Petitioner, after so purchasing the South State Street brokerage office and becoming the sole owner thereof, continued to operate it in substantially the same manner, at the same location, and under the same name of Tower Loan Brokers, which the selling corporation had employed for several years. After his similar purchase from Tower Underwriters of the second brokerage office on South President Street, he closed such office and consolidated its equipment and accounts with those of the South State Street office. He did not acquire title to any of the furniture, fixtures and physical equipment of either office; but, although such title remained in Tower Underwriters, he continued to use such furniture and equipment with said corporation's consent.
At or about the time of petitioner's acquisition of the State Street brokerage office, he and Wyatt Robinson, the president of Tower Underwriters, had certain oral agreements and understandings that were not approved by said corporation's board1958 Tax Ct. Memo LEXIS 223">*239 of directors, but which were thereafter observed. Petitioner was "assured" by Robinson "that there would be a line of credit [or lendable funds] available to make continuity of business operations," which line of credit was "to be built up to approximately $100,000"; that petitioner would not be required to deposit any reserve fund with Tower Underwriters, other than the one per cent on all gross notes of borrowers, as provided for in the written agreement on the back of petitioner's purchase note; that such reserve would gradually be built up, so that at the expiration of his purchase contract, no further reserve deposits would be required; and that Tower Underwriters would, during the period that petitioner was making the installment payments on his purchase notes, act as secondary guarantor for petitioner on borrowers' notes, "without consideration and without charge," other than as provided in the instrument. Petitioner further agreed with Robinson that he would, without charge or fee, endorse and handle the collection of approximately $70,000 outstanding borrowers' notes that had theretofore been placed with lenders through the South State Street office, and in respect of which1958 Tax Ct. Memo LEXIS 223">*240 Tower Underwriters had already collected the brokerage fees. It also was arranged that, in respect of new borrowers' loans on which Tower Underwriters was to be petitioner's secondary guarantor, petitioner would not, in most cases, be entitled to his brokerage fees until after such loans had been fully repaid.
In connection with petitioner's purchase of the South President Street office, he and Robinson agreed that an additional "line of credit" of approximately $30,000 would be made available to him; and that most of this would be obtained through petitioner's endorsement and collection, without charge, of approximately $20,000 outstanding borrowers' loans, and through the proceeds of such collections being made available to petitioner for use in arranging other loans. Also, in connection with the transfer of this second office, petitioner did acquire ownership of certain defaulted borrowers' accounts, which were of some value; and he also acquired certain "customers" of the office, who continued to deal with him.
Petitioner continued to operate the South State Street brokerage office, as sole owner and under the name of Tower Loan Brokers, during all the taxable years here involved; 1958 Tax Ct. Memo LEXIS 223">*241 and he was still so operating it at the time of the trial herein. Also, during each of said years, he made payment of the installments provided for in his two above-mentioned promissory notes, although said promissory notes had, as before stated, been transferred by Tower Underwriters to Consumers Credit Corporation of Bogalusa, Louisiana.
Wyatt Robinson died on some unidentified date, after purchase and sale of the offices had been completed. Beginning in August 1951, petitioner increased the amounts of the reserves which he deposited with Tower Underwriters, from one per cent on all gross notes handled by the lender, as provided for in the written agreements executed in connection with his acquisition of the brokerage offices - to two per cent of such borrowers' notes. Also, in all years involved, he paid certain guarantor's fees which he deducted on his returns apparently in respect of increased volume of borrowers' loans not covered by the original agreements.
The net profits of Tower Underwriters from its operation of the South State Street brokerage office, for its 3 fiscal years immediately preceding its sale of that office to petitioner, were (exclusive of home office expenses1958 Tax Ct. Memo LEXIS 223">*242 of said corporation):
Fiscal year ended June 30, 1947 $2,199.51 Fiscal year ended June 30, 1948 3,220.15 Fiscal period to June 1, 1949 4,639.44 The net profits derived by petitioner from his operation of said office as sole owner, for the taxable years here involved, were (as reported on his income tax returns, after adjustments made by respondent which are not disputed):
Net profit after Taxable year adjustments 1951 $ 3,918.75 1952 10,708.22 1953 17,292.06 In his income tax returns for the taxable years involved, petitioner deducted as business expenses, designated as "franchise fees," the following amounts of installment payments made on the two promissory notes which he had delivered to Tower Underwriters in 1949 and 1951 in connection with his acquisition of the two brokerage offices above mentioned:
Respondent, in his notice of deficiency, denied all of these claimed deductions.Deduction claimed as Year "franchise fees" 1951 $1,925.50 1952 2,100.00 1953 2,100.00 All of said installment payments on petitioner's above-mentioned promissory notes were nondeductible capital expenditures, representing1958 Tax Ct. Memo LEXIS 223">*243 deferred payments on petitioner's cost of purchasing in 1949 and 1951, respectively, the going brokerage office businesses operated under the names of Tower Loan Brokers and Dollar Brokers.
Opinion
Footnotes
1. Extended representations respecting the origin, the purpose, and the method of operation of such "brokerage" offices were made by petitioner in his testimony, in his briefs, and in the opening statements at the trial. See also statements of the Supreme Court of Mississippi regarding loan "brokerage" offices, in . ↩
2. Sections 36 and 37, Mississippi Code of 1942, Annotated, as amended.↩
3. Section 23(a)(1)(A) of the 1939 Code provides, in part, that in computing net income there shall be allowed as deductions: "All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *."↩
Document Info
Docket Number： Docket No. 60936.
Citation Numbers： 17 T.C.M. 39, 1958 Tax Ct. Memo LEXIS 223, 1958 T.C. Memo. 10
Filed Date： 1/28/1958
Precedential Status： Non-Precedential
Modified Date： 11/20/2020