# Petition for Writ of Certiorari — Pfeiffer Electric Co. v. Texas > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385601_0843%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition for Writ of Certiorari - **Published:** January 1, 1963 - **Citation:** 372 U.S. 965 ## Text Office Supreme Court, US. RFlilsE Dp FEB 16 1963 In The SUPREME COURT OF THE UNITED STATES October Term, 1962 No. 8 3 8 CHARTER WIRE, INC., : _ Petitioner, vs. UNITED STATES OF AMERICA, p Réspondent. PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS _ FOR THE SEVENTH CIRCUIT RICKARD He LAURITZEN Counsel for Petitioner 1532 Bankers Building 2Q8 East Wisconsin Avenue Milwaukee 2, Wisconsin Of Counsel: = i. IRVING A. PUCHNER 1532 Bankers Building 208 East Wisconsin Avenue Milwaukee 2, Wisconsin 3 a ee RL ATT RAAT SEE IT HAMMERSMITH-RORTMEVER CO. MILWAUKEE Page NN sn ccc saa wees sland bcacmnvnaces =" Jurisdiction AE PORT IE ESSE TOR EN EEE CROPS ee Questions’ Presented a wen re a ee Statutes and Regulations Involved ................. hoc "2 Oe ee ee 3 Reasons for Granting Writ 20.00.02... tees “8 SS LE OR A 19 ee SE TROLL AEDS SE ace ROSEN 21 LEI OEE EE REMERON RE 28 TUITE GO ass vccsscnssnscecsnccsess Rnenssnapebbasmnadionieauaisreiauks 29 AUTHORITIES CITED Cases ° Brake & ‘Electric Sales Corp. v. United States, 287 _ SRARE Saha SER EINE RIES Byres ea tec rN 10 Byerlite Corporation v. Williams, 286 F. BO BOS oxke. 8 Comm'r. v. H. P. Hood & Sons, 141 F. 2d 467 .......... 8 Comm’. v. O. PF. Holding Corp., 76 F. 2d-11 ........ 8 Gilbert v. Comm’r., 248 F 2d 399 and 262 F. 2d 512... 12 Gloucester Ice & Cold Storage Co. v. C. I. R., 298 ie (Seen salipaeciial ..8, 9, 10, 15, 16 Gooding Amusement Co. v. Comm’r., 236. F. 2d 159.. 12 Jennings v. United States, rf vs. | a s UNITED STATES OF AMERICA. Respondent. PETITION FOR A WRIT OF CERTIORARI _ TO THE UNITED STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT Petitioner prays that a Writ of Certiorari*issue to re- ; Neg the judgment of the United States Court of Appeals for’*the Seventh Circuit dated and entered in the above entitled case on November 28, 1962. OPINIONS BELOW The opinion of the Court of Appeals for the Seventh Circuit entered November 28, 1962, is reported at 309 F. 2d 878. The Findings of Fact, Discussion and Conclusions > of Law of the District Court for the Eastern District of Wisconsin are reported unofficially at 61-2 USTC 9769 and also appear-at pages 147-161 of the printed Appendix filed in the Court of Appeals.. Copies of the opinion and judgment of the Court of Appeals are attached hereto as Supplements A and B respectively. 2 JURISDICTION The jurisdigtion of this Court is invoked under 28 USC § 1254(1). QUESTIONS PRESENTED 1. Were three instruments executed by Petitioner May |, 1946, (A. 98-102) and delivered to three partners -In partial payment of the partners’ interest in the part- nership ‘assets an indebtedness of the Petitioner within the meaning of Section 23(b) of the Internal Revenue Code of 1939 and Section 163(a) of the Internal Revenue Code of 1954. (“A.” in this petition refers to the appendix filed in the Circuit Court of Appeals and certified to this . court as part of the record. ) 2. Was an instrument executed by Petitioner Feb- ruary 15, 1954, in an arm’s length transaction with a party not@in close relationship, (A. 102-3) pursuant to an agreement-to be employed by, purchase stock in, and _ loan money to Petitioner (A. 105-10) an indebtedness within the meaning of Section 23(b) of the Intggnal Rev- | enue Code of 1939 and Section 63 ra Revenue Cote of 1954: STATUTES INVOLVED The taxable years 1952-1955 are involved, and there- fore the applicable statutory provisions involved are Section 23(b).of the Internal Revenue Code vf 1939 and Section 163(a) of the Internal Revenue Code of 1954, the pertinent parts of which are printed in Supplement C. 3 : Ps . “i STATEMENT OF CASE The District Court has jurisdiction of this action under the provisions of Title 28 USCA 1346(a) (1). A partnership, Charter Wire Company, organized in 1935 with $3,822.25 of capital, consisted of A. W. Mel- lowes, C. N. Mellowes, his son, and W. L. Scheller (A. 4+). “Ehe business of the partnership was the draw- ing of wire. (A. 10) On January 1, 1946, the market value and net worth of the partnership was $240,000.00. (A. 17) The interest.of each partner in the assets of the partnership was as follows; ee | on Dollar Value Name Percentage of Total © of $240,000.00 A.W. Mellowes HH - 8 $105,840.00 C. N.°Mellowes — HEI 105,840.00 W.L.Schellers 11.8 28,320.00 ‘The three partners organized Petitioner as a corpora- tion with 680 shares-of capital stock of a par value of $1.00 per share.’ The stock was subscribed and paid for by each partner approximately in*proportion to his part- nership interest. (A. 7) The business of the partnership, having a vation of $240), 000.00, was transferred to petitioner for notes of the petitioner aggregating $66,805.74, representing ghe value of the partnership assets as carried on its books, issued to each partner in proportion to his. -partne rship interest. (A. 7) All the notes were identical in form. (A. _ 98-103) Each note bore interest at the rate of 6% per annum, payable monthly; was payable January 31, 1956, and in part or in full prior thereto at the option of pe- ‘ition and payable in the event of the death of a payee in ten équal semi-annual installments. = The excess value of the partnership over .the face of the notes was represented in the common sto¢k. To give each partner his just share of that excess value, the com- mon stock had to be subscribed for by each partner in, proportion to his partnership interest. As of January 1, 1956, the investment of ‘the three partners in the a ration was as follows: (A. 7, 17) 5 Name Common Stock ’ Notes , AW. Mellowes * . 76,713.33 29,473.12 © C. N. Mellowes . 76,713.32 29,473.12 W. L. Scheller 20,447.61 7,859.50 » 173,874.26, 66,805.74 Prior to December 31, 1953, recapitalizations oc- curred in which the stgck was divided into “B” voting and “A” non-voting *shares, and the number of shares was increased 12-3. Each partner retained, however, the same proportion of’stock and notes as he had in the partnership at the time of the organization of petitioner except that C. N. Mellowes transferred his note to Mary Mellowes in 1946 and A. W. Mellowes disposed of 9500 shares of his “A” stock, leaving him a balance of 4750 | after 1951. (A. 114) P The three partners became the officers and directors of the partnership. (A. 8) At'the time petitioner acquired the partnership busi- ness, the partnership owed the Marine National Ex- change Bank $25,000.00. (A. 7, 36) Not until 1953,- during which year the pet worth of the partnership in- creased from $195,560, to $247,173.55 (A. 113), did the petitioner borrow more and then the increase was of. short duration. Petitioner’s borrowings were generally small. (A. 11-2) _ * % Q 5 The average annual earnings of the partnership during the last five years of its existence were $62,476.29 (A. 17) and averaged neatly that much for the ten years it was g i? business. (A. 8). A. W. Mellowes and W. L. Scheller were full-time employees of National Lock Washer Company until June 30, 1951. (A.. 28) Petitioner's net worth, as per books, grew from $25,446.19 on December 34, 1946, the end of the first year-of operations, to $533,495.20 at the end of 1985 and $803,909.82 at the end of 1958. (A. 113) From January |, 1946, through 1958 petitioner had net earnings before taxes of $1,694,049.94. (A. 113) Petitioner had an excellent credit rating from the be- ginning (A. 35) and a perfect record for discounting bills. (A. 37, 54) The Trial Court stated: (A. 154) “It (Petitioner) enjoyed an excellent credit rating and could have borrowed money at a lower rate of interest than the rate provided fof in the three notes to stockholders.. However, it is not established that a lower rate would be required where the method of financing was on the basis of long-term unsecured notes such as were given for the partnership assets.” On March 3, 1947, about one year after the incorpo- rat.on of petitioner, the three stockholders of petitioner, -at the request of petitioner’s bank, subordinated their notes to the’ obligation of the bank. (A. 63-4, 11) The sub- ordination agreement was. terminated March 2, 1954. (A. 11) Marshall never subordinated his note. (A. 11) Subordination was not deemed important at the time because stockholders had no question about being able ‘to pay off both bank and notes. TA. 64) No agreement existed between stockholders at any- time to maintain a fixed proportionality between peti- tioner’s capital stock and debts to stockholders. (A. 35), | § 6 The notes to stockholders were carried on the books of petitioner as debt obligations (A. 156) and interest was paid regularly except for the iast three months of 1947 when it was accrued ’and paid in January, 1948. (A. 17, 11) At that time petitioner during a steel short- age had a strike. Petitioner was unwilling to stop ship- ments, although its plant was not operating, because pe- titioner was afraid that shipments delayed would never be delivered. Petifioner up to that timé had a perfect record of discounting bills and did not want to break that record. (A. 36-7, 54) Both the Court of ‘Appeals and the District Court found that:the notes (Exhibits711- I+) (A.98-104) were paid by petitioner and cancelled. (A. 155, Supp. A. 24) The resolution of the Directors of the petitioner pro- viding for the redemption of the notes is dated February 18, 1954. The same resolution provided that new notes bearing interest at the rate of 5 per cent per annum, . payable monthly dated April 1, 1954, ,and maturing March 31, 1960, be offered to stockholders. (A. 113) De-, cision of the noteholders to take up the new notgs was not made immediately, but within two weeks’ of the cancellation of the notes, the corporate checks received by the noteholders in payment of the old notes were en- dorsed back te petitioner and new notes, dated April 1, 1954, and maturing January 31, 1960, were issued. (A, i+) The new notes reduced the interest from ‘6 per cent to 5 per cent, extended’ the maturity’ for an additional four vears and eliminated the privilege of prepayment on an interest bearing date and the provision for automatic maturity on the death of a holder. (A. 98-103, 111-112) e-, In 1953, nearly eight years after it was .organized, petitioner because it ngeded new executive talent en- ~ : 7 gaged in negotiations ‘for the hiring of Marshall, a long time friend of C. N. Mellowes, (A. 154) and before World War I1, a former employee of the partnership, Charter Wire. Company. (A. 72) Marshall agreed to. come with petitioner if he could buy an interest in it. He was willing to invest as-much as $50,000.00 in peti- tioner’s, stock. The shareholders of petitioner. were re- luetant to sell any stock to Marshall ‘but finally agreed to offer Marshall 3800 shares of common stock at book value for a price of $27,625.28: (A. 154) A. W. Mel- lowes consented to the sale of stock to Marshall only if the number of shares offered to Marshall was less than ~ 4,000 as A. W. Mellowes and Scheller ‘wanted to retain yoting control of petitioner (Ly. 33), and only if Mar- shall, in case of .the termination of his employment or his death gi to resell his shares to petitioner at book value. fA. 3 At the same aa at which he communicated to Marshall Petitioner's offer to sell 3800 shares of stock, . C. N. Mellowes suggested to Marshal! that he, loan pe- titioner $10,000.00, to create harmony among the stogk- ‘holders. (A. 154) At the time the loan was suggested petitioner could have obtained a $10,000.00 loan from a-bank. (A. 154) Marshall loaned petitioner $7,427.23. (A. 15) Macshalt was interested only in stock interest in a corporation in which he was to be part of the man- agement. The domjnant purpose of the loan was not the need of the petitioner for funds but..to assure har- monious relations among stockholders. (A. 169) With its excellent credit rating, the petitioner could ,have readily borrowed money from the banks and probably at a more favorable rate than the 6 per cent rate granted” to Marshall. (A. 160) The note to Marshall, however, dated February 15, 1954, ran to Januaty 31, 1956, and oS 8 e ; , was unsecured. Marshall borrowed money to make the. loan at 334% (Supp. A. 24) but from a bank and se- cured the loaf with collateral and the endorsement of his father-in-law. (A. 78) REASONS FOR GRANTING THE WRIT A. Transaction with Partners Who Organized Petitioner. - The decision of the court below in the instant case is in direct conflict (1) with the decision of the First Cir- cuit in Gloucester Ice & Cold Storage Co. v. CI.R., 298 F. 2d 183, Comm’r. v. H. P. Hood & Sons, 141 F. 2d 467, and the dissenting opinion of Judge Magruder ‘of the First Circuit in Talbot Mills o Comm’r., 146 F. 2d 809, 812, adopted in Gloucester Ice & Cold Storage Co. v. C.I.R., supra; (2) with the decisions of the Second Cir- cuit in Kraft Foods Company v. Comm’r., 232 F. 2d 118, Comm'r. v. O. P. P. Holding Corp:, 76 F. 2d 11, and Nassau Lens Co. v. Comm’r., 308 F. 2d 39; (3) ‘with the decisions of the Sixth Circuit in United States v. _ Title-Guaranty Co., 133 F. 2d 990, and Byerlite Qorpo- . ration v. Williams, 286 F. 2d 285; and (4) with the decisions of the Ninth Circuit in Wilshire & Western Sandwiches Co.v. Comm’r., 175 F.2d 718, Miller's Estate v.-Comm’r., 239 F. 2d 729, and Washmont Corporation v. Hendricksen, 137 F. 2d 306. » | The decision of the court below is also in direct con- flict with its own decisions in Jennings v. United States, 272 F. 2d 842, (See_also Jennings v. United States, 68- -2 _ USTC §9842 which\indicates exact proportions of stock ownership.and loans) and Ortinayer v. C.1.R., 265 r. 2d 848, 853-855. : ®. 9 ; : os In all of the foregoing cases debt obligations were held valid under circumstances much less favorable to the taxpayer than in the instant case. In Gloucester Ice &® Cold Storage Co. v. C.IR., (CCA 1) 298 F. 2d 183, the taxpayer deducted $7,000.00 it paid to the holders of its debenture bonds as a payment | of interest on indebtedness. The. interest was paid on - debentures of which 84°c were issued in exchange for preferred stock and 16‘; for new money. The proceeds — from the debentures, plus a bank loan, were used to ac- quire nearly all the capital stock of an ice business. The court, in its opinion, stated (Pages 184-5) : “* * * The Commissioner disallowed the deduc- tion on the ground that the payments constituted dividends within the meaning of Par. 115 and Par. 316 (a) of the respective Codes. The Tax Court agreed with: the Commissioner. It conceded that the bonds ‘satisfied all uf the formal requirements to ‘ make the instruments effective as debt obligations’ and that 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.’ Never- theless, purporting to look through>form to sub- stance, it held that the debenture holders had placed their money at the risk of the business, and therefore in effect were stockholders so that payments to them were dividends, because (1) the bonds were held iN approximate proportion to the shares of stock, (2) the proceeds of the debentures were used to purchase a fixed asset, i. e., a majority of the stock of Cape Pond Ice Company, -(3) the bonds were issued simultaneously with the call of the preferred stock for redemption and (4) the debt-to-equity ratio was disproportionately high, being 15 to 1. We do not agree with the Tax Court. a 10 “The debenture bonds certaiply are evidence of debt in form as the Tax Court found. They are also clear evidence of debt in thear substantive provisions as well, for by their terms they impose an unqualified obligation to pay interest quarterly on fixed dates at a fixed rate, they impose an unqualified obliga- tion to pay a fixed principal amount on a day certain and within a reasonable time, and they confer upon -their holders no voting rights or voice in the man- agement of the obligor under any circumstances whatever. Neither is there any evidence, or indeed any suggestion, of some sotto voce understanding that interest would be paid on the bonds only out of income or that the principal amoynt would not or would not likely be paid at maturity as in Brake & ' Electric Sales Corp. V. United States, 287 F. 2d 426 (C.A. 1, 1961). Moreover, there is no evidence that the petitioner was in such a shaky financial con- dition or that\its business prospects were so dark that in reason the parties to transaction could hot have expected the petitioner to meet its obligations on its bonds as they fell due * * *” * * * * & ‘“* * * Tn both form and substance the debentures aré out and out evidence of the petitioner's in- debtedness. Nor is there anything to suggest that the bonds4vere a sham in that they did not embody the true intention of the parties, or that they did not or in reason could not have been understood to ob- ligate the petitioner directly according to their terms. Compare Brake & Electric Sales Corp. v. United States, supra. * * * ” | .+—_)_}_@—_*@ “There being no element of subterfuge or artifice to escape tax consequences, the bonds speak for them- selves. And they speak in clear and unmistakable terms of indebtedness. Therefore there are no dis- puted questions of fact relevant to the issue to be decided. Inferences cannot avail against patent facts.” | In Wilshire €& Western Sandwiches v. Comm'r., (CCA 9) 175 F. 2d 718, four persons formed a corpo- ® ration to go into the restaurant business. The purpose of incorporating was to participate with general creditors for part of their investment in the event that business was unsuccessful. The incorporators also regarded loans as a better investment than stock to obtain returns on and repayment of their capital outlay. The incorporators decided against borrowing from a bank because they considered the receipt of interest desirable. Other per- tinent factors were as follows: Stock and notes were issued in equal proportion; one incorporator testified he expected to be repaid the loan only if taxpayer Serr ae for the purpose; another testified he expected to b€ pard—————— out of current earnings and would not have insisted on payment to the detriment of the corporation; interest was not paid when duc; final payment of principal was late; and initial book entries did not treaf’Rotes as loans. The court reversed the tax court and held that the notes were valid debt obligations. Neither the district court nor the Court of Appeals in the instant case refer to Jennings v. United States, (CCA 7) 272 F. 2d 842, which is an appeal from Jen- nings v. United States, 58-2 USTC 9842. In that case the facts that (a) practically all the stock was held in nearly equal proportions by husband and wife, (b) loans were made to the corporation by the stockholders in pro- portion to stock holdings, (¢) no interest was paid from 1935 to 1948, (d), accrued interest Was Waived on three occasions, (e) indebtedness to stockholders was payable only when directors deemed it advisable, and (f) by transferring by agreement the liability entry “netes pay- able” on the books of the corporation to a “net worth” 12 entry “contributed.or paid in surplus” subordinated the stockholder indebtedness to claims of general creditors and delayed payment indefinitely did‘not deter the Sev- enth Circuit Court of Appeals from holding the advances by stockholders valid debt obligations. The facts in the instant case are more favorable to Petitionér than they were to the taxpayer iff the Jennings case. In “Corporate Indebtedness to Shareholders: Thin Capitalization and Related Problems” by William M. Goldstein, 16 Tax Law Review |, it is stated: ~“* * * The fact that there is no special treatment of many aspects of corporate indebtedness to stock- holders has given rise to an inordinate amount of litigation resulting in a plethora of conflicting judi- cial opinions, a vast amount of legal literature and several proposals for legislative action.” * 33) It is important that the confusion that exists in the acea of defiaing debt obligations be not enlarged by per- mitting courts to give a meaning to arm's length trans- actions other than®that which appears upon the face of the instruments giving the transaction effect. > S ; af or 4 & 20 CONCLUSION For che foregoing reasons, this petition for a ‘Writ of Certiorari should be granted. Respectfully submitted, RICKARD H. LAURITZEN Counsel for Petitioner ' 1532 Bankers Building ., 208 East Wisconsin Avenue Milwaukee 2, Wisconsin ¢ Of Counsel: « IRVING A. PUCHNER 1532 Bankers Building «% © 208 East Wisconsin Avenue Milwaukee 2, Wisconsin ‘ &. ‘ae ne ee “ Me, a! sate Eek ah ; ee SUPPLEMENT A IN THE - U pas ltED STATES COU RT OF APPEALS FOR THE SEVENTH CIRCUIT nee ers — Nos. 13695, 13696 SEPTEMBER TERM, 1962 SEPTEMBER SESSION, 1962 CHARTER WIRE, INC., On Appeg! from the Plaintiff-Appellant, judgments of the : | {United States Dis- ™ ; trict Court for the \ stern District of UNITED STATES OF AMERICA, Ww) Isconsin. ‘i Defendant-A ppellee. ' November 28, 1962. Before SCHNACKENBERG, CASTLE and SWYGERT, Circutt Judges. SWYGERT, Circuit Judge. This is an appeal from a judg- ment dismissing two consolidated actions by taxpayer, Charter Wire, Inc., for refunds of income tax for the years 1952 through 1955. During this period taxpayer paid to néteholders, who were also its sole shareholders, a total of $15,489.38 and deducted the payments as in- terest on its tax returns. The Commissioner of Internal Revenue determined that the payments represented div- idend distributions rather than interest on “indebtedness” as contemplated by Section 23(b) of the Internal Rev- enue Code of. 1939' and. Section 163(a) of the Internal Revenue Code of:1954. The District Court, in dismiss- ing the actions sustained the determination. Taxpayer, a Wisconsin corporation, is engaged in the business of drawing and rolling wire. It was formed in 1946 to take over the assets and business of a partnership composed of Alfred W. Mellowes, Charles N. Mellowes, and William L. Scheller. At the time of incorporation, the partnership had a book value net worth of $66,805.74, and a going concern value of $240,000. The original cap- ital of the partnership was $3,822.65. The average an- nual earnings of the partnership during the last five years of its existence were $62,476.29. The partnership assets were transferred to the corpora- tion.in exchange for six per cent promissory notes in the amount of $66,805.74. The notes were issued to the former partners in the following proportions: - ; | . Percentage Amount of Note Total Alfred W. Mellowes 5.-0-$29473.12000 4G Charles N. Mellowes .......... 29,473.12 44.1% W liam" L. Scheller _......... 7,859.50 11.8¢% _ “ee woe. 66,805.74 100.0; ' Internal Revenue Code of 1939: SEC. 23. DEDUCTIONS FROM GROSS INCO In computing net income there shall be allowed 2s uctions : * * * * * (b) Interest.—All interest paid or accrued within the taxable year on indebtedness, * * *. * * - 8 * + (26 U. S. C. 1952 ed., Sec. 23.) Section 163(a), Internal Revenue Code of 1954 (26 U.S. C. 1958 ed., Sec. 163), is substantially the same as the section set out above. cy Ai) oe 23 | - In exchange for $680, one dollar par value stock was issued to the former partners in the following proportions: Number of Amount .— Shares Percentage Contributed Issued — of Total 300 44.1 Alfred W. Mellowes ....4300.00 Charles N. Mellowes .... 300.00 300 44.1; William L, Scheller 31 1954 INTERNAL REVENUE CODE “S163. Interest (a) General rule——There shall be allowed as a de- duction all interest paid or accrued within the taxable year on indebtedness. Code of Federal Regulations an rans Title 26 Internal Revenue 1954 $1. 163-1(a) Exegpt as otherwise provided in’ sections 4. 267, inclusive, interest paid or aceried within the taxable year on indebtedness shall be allowed as a de- duction in computing taxable.income.” --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385601_0843%3A2. 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