DFSystems, Incorporated v. CIR

Case: 13-60322 Document: 00512466484 Page: 1 Date Filed: 12/10/2013
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
United States Court of Appeals
Fifth Circuit
FILED
No. 13-60322 December 10, 2013
Summary Calendar
Lyle W. Cayce
Clerk
DFSYSTEMS, INCORPORATED,
Petitioner - Appellant
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee
Appeal from a Decision
of the United States Tax Court
Case No. 17261-11
Before DAVIS, SOUTHWICK, and HIGGINSON, Circuit Judges.
PER CURIAM:*
Petitioner DF Systems appeals the decision of the United States Tax
Court that it had a deficiency in federal income tax for the taxable year 2006.
We AFFIRM.
DF Systems is an electrical contracting company owned and operated by
Larry Dorman and his wife, Gladys Dorman. In 2000, DF Systems received a
letter from one of its customers, requesting work to be performed by minority
* Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH
CIR. R. 47.5.4.
Case: 13-60322 Document: 00512466484 Page: 2 Date Filed: 12/10/2013
No. 13-60322
contractors. Lorie Dorman Schroder, the Dorman’s daughter, formed E.L.
Construction, Inc., in order to meet this request. DF Systems then convened a
special board meeting and voted “to advance money to E.L. Construction, Inc.
for the [purpose] of getting this corporation started and pursue minority work.”
The minutes of this meeting do not establish the amount of money that DF
Systems intended to advance to E.L. Construction, an interest rate for the
money advanced, a repayment schedule, or any security taken. DF Systems
did not enter into a written loan agreement with E.L. Construction, the
purported borrower, and did not take an equity interest in the company.
Unrelated to this transaction, in 2005 DF Systems wrote 19 checks to
Jose Padilla, a long-time employee of the company who was forced to stop
working due to a terminal illness, and three other checks to Reuben Padilla,
Jose Padilla’s son. DF Systems recognized these payments at a special board
meeting but did not indicate that the checks were intended to be a loan. There
was no written agreement, and the records do not establish a definite amount
to be advanced, terms of repayment, interest rate, or collateral provided as a
security interest.
On its 2006 federal income tax return, DF Systems claimed a bad-debt
deduction of $56,656 related to its payments to E.L. Construction and $25,320
related to its payments to the Padillas. After an audit, the Commissioner
disallowed the deductions, concluding that DF Systems failed to establish “that
these amounts were bad debts arising from true debtor-creditor relationships,
based upon valid and legally enforceable obligations, that these amounts
became worthless during the taxable year, or that you took all reasonable steps
to collect the debts.” Based on a disallowance of these deductions, the
Commissioner found a tax deficiency in the amount of $30,728.
DF Systems sought redetermination of the deficiency in the United
States Tax Court. Following a trial, the tax court issued its decision. The tax
2
Case: 13-60322 Document: 00512466484 Page: 3 Date Filed: 12/10/2013
No. 13-60322
court agreed with the Commissioner that neither of the monetary transfers
were bona fide loans because no objective factors indicated that DF Systems
had entered into a genuine debtor-creditor relationship with either alleged
borrower. In reaching this conclusion, the tax court found Gladys Dorman’s
and Lorie Dorman Schroder’s testimony to the contrary “unconvincing.” The
tax court held that DF Systems had an income tax deficiency for the year 2006
in the amount of $30,728.
DISCUSSION
We review the tax court’s findings of fact for clear error and conclusions
of law de novo. Green v. Commissioner, 507 F.3d 857, 866 (5th Cir. 2007).
“[W]hether payments or disbursements by a taxpayer are to be treated as debts
for tax purposes is an issue of fact.” Piggy Bank Stations, Inc. v. Commissioner,
755 F.2d 450, 452 (5th Cir. 1985); see also Saunders v. Commissioner, 720 F.2d
871, 873 (5th Cir. 1983) (“Whether a certain transaction creates a creditor-
debtor relationship is a question of fact . . . .”). 1
A taxpayer may claim a bad-debt deduction under Section 166 of the
Internal Revenue Code only for a bona fide debt. “A bona fide debt is a debt
which arises from a debtor-creditor relationship based upon a valid and
enforceable obligation to pay a fixed or determinable sum of money.” Treas.
1 The Commissioner suggests that our precedents are unclear as to whether review of
the debtor-creditor relationship is a question of law or fact, though DF Systems appears to
accede to clear-error review. See e.g., Estate of Mixon v. United States, 464 F.2d 394, 402 (5th
Cir. 1972) (stating that the evaluation of whether a monetary advance is debt or equity is a
question of law subject to de novo review); Texas Farm Bureau v. United States, 725 F.2d 307,
312 (5th Cir. 1984) (stating that the debt-capital contribution determination is a question of
law except when the court is evaluating the debtor’s subjective intent). We explained in
Saunders why the clear-error standard is the correct one here. Saunders, 720 F.2d at 873
n.3. Review here is for clear error because DF Systems relies on the subjective intent of the
parties to establish the existence of a bona fide debt. This is a question of “pure fact.” Texas
Farm Bureau, 725 F.2d at 312.
3
Case: 13-60322 Document: 00512466484 Page: 4 Date Filed: 12/10/2013
No. 13-60322
Reg. § 1.166-1(c). In order to determine the existence of bona fide debt, we
have considered the following non-exclusive factors:
(1) the names given to the certificates evidencing the indebtedness;
(2) [t]he presence or absence of a fixed maturity date; (3) [t]he
source of payments; (4) [t]he right to enforce payment of principal
and interest; (5) participation in management flowing as a result;
(6) the status of the contribution in relation to regular corporate
creditors; (7) the intent of the parties; (8) “thin” or adequate
capitalization; (9) identity of interest between creditor and
stockholder; (10) source of interest payments; (11) the ability of the
corporation to obtain loans from outside lending institutions; (12)
the extent to which the advance was used to acquire capital assets;
and (13) the failure of the debtor to repay on the due date or to seek
a postponement.
Estate of Mixon, 464 F.2d at 402.
DF Systems attempts to distinguish its situation from other cases
applying the Mixon factors. It argues that the tax court’s reliance on precedent
“addressing shareholder loans to corporations and loans between interrelated
corporations” caused that court to focus too narrowly on the form of the
transaction and disregard the evidence of the parties’ intent. See Piggy Bank
Stations, Inc., 755 F.2d at 452; Texas Farm Bureau, 725 F.2d at 311. We agree
that some of the factors may not apply to the arrangement with E.L.
Construction because its terms were so incomplete. In addition, although DF
Systems cites an unpublished decision applying the Ninth Circuit’s shorter,
slightly differently-worded list of factors, that list is almost identical in
substance to our own and is arguably a good fit here only because it condenses
the Mixon factors in a way that better meets the present circumstance. See
Todd v. Commissioner, 486 F. App’x 423, 426 (5th Cir. 2013).
Regardless of which list we use to evaluate the circumstances
surrounding the transactions between DF Systems and E.L. Construction,
nothing about the subsequent dealings between those companies indicates that
4
Case: 13-60322 Document: 00512466484 Page: 5 Date Filed: 12/10/2013
No. 13-60322
there was a debtor-creditor relationship. We agree with DF Systems that the
absence of a formal loan agreement is not determinative, but the absence of a
formal loan agreement is certainly relevant. See United States v. Williams,
395 F.2d 508, 510-11 (5th Cir. 1968). More powerful in our analysis is the
purported loan’s lack of real substance. Id. There was no initial fixed or
determinable sum to be repaid, specified interest rate, repayment schedule,
maturity date, or collateral taken as a security interest. The absence of these
objective economic indicia of genuine debt greatly weakens the argument that
a debtor-creditor relationship was intended. See Alterman Foods, Inc. v.
United States, 505 F.2d 873, 879 (5th Cir. 1974).
As for DF Systems’ evidence, a notation in the minutes of the special
board meeting that “money” would be “advanced” to E.L. Construction does not
establish the existence of bona fide debt. Moreover, the numerous debits and
credits made under an E.L. Construction account in DF Systems’ accounting
records, which vary widely over time and amount, do not prove that E.L.
Construction was making repayments on a loan. For instance, the recurring
payments made to Chase Automotive Finances and non-corresponding credits
from numerous companies, under the heading “job,” suggest that DF Systems
was paying E.L. Construction’s expenses and collecting its revenues. In any
event, these records are “little more than additional declarations of intent” and
do little to substantiate DF Systems’ argument that it had a debtor-creditor
relationship with E.L. Construction. Id. Finally, the tax court did not err in
finding Gladys Dorman’s and Lorie Dorman Schroder’s testimony regarding
the companies’ intent unconvincing based in part upon cross-examination that
revealed Schroder misunderstood the meaning of “solvent” and that E.L.
Construction had very few assets. See MacGuire v. Commissioner, 450 F.2d
1239, 1244 (5th Cir. 1971).
5
Case: 13-60322 Document: 00512466484 Page: 6 Date Filed: 12/10/2013
No. 13-60322
Similarly, DF Systems offers no objective evidence to support its
argument that it loaned the $25,320 to the Padillas. Instead, it again relies on
the minutes of a special board meeting, a number of accounting entries in its
journal, and the alleged uncontradicted testimony at trial. This evidence is
subject to the same criticism as the evidence related to its dealings with E.L.
Construction: it is subjective and there are no reliable indicia of genuine debt.
Alterman Foods, 505 F.2d at 879. Here, as with E.L. Construction, there was
no initial fixed sum of money to be repaid, repayment schedule, interest rate,
or collateral. Although Dorman’s trial testimony that Padilla intended to
repay the debt was uncontradicted in the sense that the Commissioner offered
no witnesses to rebut it, the trial court did not err by finding it unconvincing
in light of the other objective evidence. MacGuire, 450 F.2d at 1244-45.
In evaluating whether a debt is bona fide, we “look not to mere labels or
to the self-serving declarations of the parties, but to the more reliable criteria
of the circumstances surrounding the transaction.” Tyler v. Tomlinson, 414
F.2d 844, 850 (5th Cir. 1969). The tax court did not clearly err in upholding
the Commissioner’s determination that DF Systems had a tax deficiency in the
amount of $30,728 for the year 2006. We AFFIRM.
6