Respondent Brief in Opposition — Pfeiffer Electric Co. v. Texas

Yn the Supreme Court of the Wnited States

OCTOBER TERM, 1962

No. 838

CHARTER WIRE, INC., PETITIONER

v. age

Unirep States oF AMERICA

ON PETITION FOR A WRIT OF CERTIOKARI TO THE UNITED

STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The findings of fact, discussion, and conclusions of

law of the district court (R. 147-161) * are not offici-

ally reported. The opinion of the court of appeals

(Pet. 21-27) is reported at 309 F. 2d 878.

JURISDICTION

The judgment of the court of appeals was entered

on November 28, 1962 (Pet. 28). The petition for

writ of certioran was filed on- February 16, 1963,,

The jurisdiction of this Court is invoked under 28

U.S.C. 1254(1).

14R” references are to the appendix to the petitioner's brief

in the court of appeals.

870001—63 (1)

2

QUESTION PRESENTED

Whether, on the facts of this qse, the courts below

correctly held that certain payments by the taxpayer-

corporation to its stockholders were not payments of

interest on indebtedness 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, but non-

deductible dividend distributions.

STATEMENT &

&

The taxpayer is a Wisconsin corporation 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 three iYdividuals. In

exchange for the assets of the’ partnership, each of

the partners received a portion of $66,805.74 in prom-

issory notes (representing the book value of the trans-

ferred assets)... In exchange for a total of $680, each

partner received the same percentage of the corpora-

tion’s stock as the amount of the notes that partner

received bore to the total of the notes distributed.

The former partners became directors and officers of

the new corporation and remained directors and off-

cers through the years in question. The parties main-

tained proportionate holdings of stock and notes. (R.

148-151; Pet. 22-23.)

From March 1947 to Mareh 1954 the stockholders

subordinated their notes to obligations arising from

corporate bank borrowings. Interest was paid regu-

larly on the notes, except that in 1947, in order to meet

taxpayer’s trade obligations and because of a desire to

maintain its record of discounting bills, the directors

3

voted to suspend payments of such mterest, which were

in fact suspended for a three-month period, (CR. 151-

153; Pet. 23-24.)

In 1953, taxpayer negotiated for the hiring of J.

Willard Marshall for an executive position, Mar-

shall was interested in coming with the taxpayer only

if he were allowed to buy an interest in it. He was

allowed to buy stock, and, after a suggestion that he

make a loan to the corporation, he did so and received

a note in an amount which bore the same ratio to the

total amount of all the notes outstanding as his share

of voting stock bore to the total voting stock then

issued. (R. 154-155; Pet. 24.)

In 1954, the outstanding notes, which had a matu-

rity date of January 31, 1956, were replaced by a new

issue of notes with a maturity date of January 31,

1960, and which contained new and different: terms

(R. 155-156; Pet. 24). |

During the vears 1952, 1953, 1954, and 1955, the

taxpayer paid to the shareholder-noteholders a total

of $15,489.38 and deducted the payments as interest on

its tax returns (R. 148). The Commissioner's deter-

mination that the payments represented dividend dis-

tributions rather than interest was sustained by the

distriet court (R. 158-161), and the court of appeals

affirmed ( Pet. 21-28).

ARGUMENT

The decision of the court below is correct and is

not in conflict with any other decision, It affirms

the district court's finding that certain transfers of

assets and money made to the taxpayer-corporation

4

‘by its shareholderg in exchange for corporate notes

were capital investments rather than loans, and that

purported interest payments made by the corpora-

tion to the shareholders in fact represented non-

deductible dividend distributions.

In so holding, the court below applied the prinei-

ples established by this Court in John Kelley Co.

v. Commisstoner (decided with Talbot Mills vy.

Commissoncr), 326 U.S. 521, that the question

whether an advance by a stockholder to a corpora-

tion represents a loan or a capital contribution is

essentially one of fact (326 U.S. at 526) and that

“[t}here is no one characteristic, not even exclusion

from management, wh ch can be said to be decisive

in the determination of whether the obligations are

risk investments in the corporations or debts”’ (326

U.S. at 530). See also P. M. Finance Corp. v. Com-

missioner, 302 F. 2d 786 (C.A. 3); Brake & Electric

Sales Corp. v. United States, 287 F. 426 (C.A. 1);

O. H. Kruse Grain & Milling v. Commissioner, 279

F. 2d 123, 125-120 (C.A. 9); Gilbert’ v. Com-

missioner, 248 F. 2d 399, 406-407, and 262 F. 2d 512,

513-514 (CLA. 2), certioran demed, 359 U.S. 1002;

Gregg Uo. of Delaware v. Commrssioner, 239 F. 2d

498, 501-302 (C.A. 2), certioram denied, 353 U.S.

946: Rowan v. United States, 219 F. 2d 51, 55

(C.A. 5); Arlington Park Jockey Club v. Sauber,

262 F. 2d 902, 905 (CLA. 7): Commissioner ¥.

Meridian & Thirteenth R. Co., 132 F. 2d 182, 185

(C.A. 7): Note, Thin Capitalization and Tar Avotd-

ance, 55 Columbia L. Rev. 1054 (1955): Goldstein,

Corporats Indebtedness to Shareholders: “Thin

ra.

+

i

Capttalization”’ and Related Problems, 16 Tax L.

Rev. 1 (1960); Hellerstein, Planning the Corpora-

tion, Seventh Annual Tulane Tax Institute 416, 429

et seq. (1958). ‘The form of the purported loan

transaction ix not determinative of the question, and

the taxpaver has the burden of proving by a pre-

ponderanee of the evidence that the advances were

not risk investments. John Kelley Co. v. Com-

misstoner, supra, 326 U.S. at 530; P. M. Finance

Corp. v. Commissioner, supra, 302 F. ial at 789; O. H.

Kruse Grain & Milling v. Commissioner, supra, 279

F. 2d at 125; Arltngion Park Jockey Club v. Sauber,

supra, 262 F. 2d at 905; Gregg Co. of Delaware v.

Commissioner, supra, 239 F. 2d at 502; Gilbert v.

Commissioner, 262 F. 2d 512, 513 (CLA. 2), certioran

denied, 359 U.S. 1002; Gooding Amusement Co. Vv.

Commissioner, 236 F. 2d 159, 166 (CLA. 6), certioran

denied, 352 U.S. 10381; Matthiessen v. Commissioner,

194 F. 2d 659, 661 (CLA. 2); NSechniteer ¥. Com

missioner, 13 T.C. 43, 60, affirmed per curtam, 183 F.

2d 70 (CLA. 9), certioran demed, 340 U.S. 911.

The evidence recited i detail by both courts below

warrants the district court’s conelusion that the

‘notes’? issued by the taxpayver-corporation to its

shareholders evidenced an equity interest rather than

a genuine creditor interest. and consequently that the

‘‘interest” paid to the stockholders represented non-

deductible returns on a capital investment. The

original notes were received by the stockholder

officers for all the physical assets of their prior part-

nership transferred to the corporation. Notes were

held proportionately to stockholdings and proportion-

' 6

ate holding of stock and notes was carefully main-

tained when I. W. Marshall was allowed to pur-

chase an equity interest in’ the -corporation. The

stockholders disregarded the terms of the notes when

their interests™?ts2 stockholders | and officers could

otherwise best) be served. Thus, interest was de-

forred in 1947 when the corporation was short of”

cash; the noteholders subordinated their notes to

bank loans: and, when the corporation was engaged

in improving and expanding its operations, the ma-

turity date was extended, a provision for automatic

maturity on the death of the holder was removed,

mb the interest rate was lowered, The dealings with

J. W. Marshall, culminating in his purchase of stock

and a note, clearly retleet that the stockholders con-

sidered the contributions represented by their notes

as part of the eqautv capital of the corporation. The

holding of the court below (Pet. 21-27) that) the

totality of the facts indieates “a risk-eapital invest-

nent is clearly correct.

Taxpacer’s arveument that certain formal eriteria

should be adopted to determine when an instrument

Isa debt obligation (Pet. 12-15) should be addressed

to Congress, not te this Court. [ndeed, as taxpaver

hetes, proposals for such legislation have been sug,

vested, but until such time as Congress sees fit: to

change the law, the decision as to whether advances

to a corporation are in stbstance capital contribu-

tions or loans depends upon all the facts im the par-

theular case, ne one of them being determinative.

Since determination of the question depends upon

wae”

7 : s

the particular record made before the trial court,

the taxpayer's suggestions of contliet: are plainly

without merit. :

ie CONCLUSION

For the foregoing reasons, the petition for a wre

of certiorari should be denied.

Respectfully submitted?

Ancuipat Cox,:

Solteitor General,

Lovis F. Onerporrer,

Assistant Atlorney General.

Davin O. WALTER,

‘ Ricnanp. J. Hema,

Tet Aflorie ys.

S

Marcu M63.

©. GOV. \MMENT PRINTING OF FicEe 1065

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