# Brief for the United States in Opposition — Northeastern Consolidated Co. v. United States > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385604_0767%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Brief for the United States in Opposition - **Published:** January 1, 1969 - **Citation:** 396 U.S. 819 ## Text ee ¢ ‘CONTENTS * Opinions: below. --_.---.------, ------- ra tarda thesia seg. acgrag OE E ta PT ON ae Cqnepiios yrementid, os eee eee Statute involved_________- ~----- senha ae ovsale a a fa I ERDAS ies aE ee Ee rere EY IR 8 6, oc cee 7 CITATIONS _ American Processing & Sales Co. vy. United States, 371 F. 2d 842_..__..t 90 5,-6, 8 Berkowitz v. United States, 69-1 CCH Tax Ca 196062... ne we We ge ae Booth N ewspapers, Inc. v. United States, 303 ai re Wiener Lpad, TeRRp ee age Rien ot) Dem 10 Burr Oaks Corp. v. Commissioner, 365 F. 2d 24_ 5 Byerlite Corp, v. Williams, 286 F\ 2d 285... 5, 6, 7,8 Commissioner v. Bagley & Sewall Co., 221 F. = 2d te eS Pee” Sine a hnstgee sata siiaies 102 . \Corn Products Refining Co. v. Commissioner, ~ . 350 U.S. 46_____ Eee cna ae ten g Covey Investment Co. v. United States, 377 F, * we Set Pee Wrens com en Daily Journal Co. v. Commissioner, 135 F. 2d ~ cee OE RN OFRE ES ery SURO sa bce 11 Fin Hay Realty Co. v. United States, 398 F. - oe eee eee PRer ttre sib. Pie 1 at: Five Star Manufacturing Go. v. Com nisstoner, wee Foe oe pice atheaiscentk 10 853-460—¢9 ” B Fé Sa \ a SR a ea Le SEN SEN > * . é ‘ ” Diner Anas OOS a Ge ie ates BOGE en nN eeeeEeEeeeEeEeEeEeEeerreeee ™* II Cases-<-Continued _ Page Foresun, Inc. v. Comsnissioner, 348 F. 2d 1006- 7 Gilbert v. Commissioner, 248 F. 9d 399... ...3° 5 Higgins v.' Smith, 308 U.S. ine » # “ Knetch v. United States, 964 US. 3612 -....-- 8 : Lutz v. Commissioner, 282 F. 2d 614_-------- ae Moughon v. Commissioner, 329 F. 2d 399_---- 5, 7 Taft v. United States, 314 F. 2d 620__-----,- 5. : Tomlinson v. 1661 Corp., 377° F. 2d 291-_----- 5, 8 United Gas Improvement Co. v. Commissioner, ee ea cw ei cto as ae United States v. Estate of . Saw ‘No. you, . O.T., 1968, decided June 2, 1968__------- as. Wood Preserving Corp. of Baltimore v. United | States, 233 F. Supp. 600, affirmed, 347 F. a, 117 Hd de eciawtinekes ey , Ft Statute: : 3 Internal Revenue Code of 1954: eae a Sec. 165 (26 U.S.C. 1964 ed., Sec. 165): - 2 Sec. 165(g) (26 U. & C: 1964" ed., Sec. TCG aus eink ow daenn ee awe ss 6, 7 ' —. See. 166 (26 USC. 1964 ed., Sec. 166) __ 2 Sec. 341 (26 U.S.C. 1964 ed., Sec. 341) _- ’ See. 582 (26 U.S.C. 1964 ed., See. 582) _-~ Secs. 1242-1244 (26 USS. C. 1964 ed., Secs. 1242-1244)... Sr apstabettine rhs Miscellaneous: . , “ Bittker & Eustice, Federal Income Tdcation of © Corporations and Shareholders. (2d ed.), Sec: ee P % on January’ 6, 1969: The petition for rehearing was) | Ou the Supreme Gourt oth the Wnited —. OcTOBER Term, 1968 No. 1382 ° N ORTHEASTERN . CONSOLIDATED CoMPANy, PETITIONER yee v. Unirep States or AMERICA “oe - ON -PETITION FOR.A WRIT OF CERTIORARI TO THE UNITED. '. » STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT ° . ——— . ‘ » ——— BRIEF FOR THE UNITED STATES IN OPPOSITION ." : \ OPINIONS. BELOW * The opinion of the district court (Pet. 10a-19a) is ‘ ‘alerted at 279 F. Supp. 592. The opinion of the court of acute Niecs Ja-Oa) © is ; reported at 406 F. 2d 76. F | > Jv RISDICTION The judgment of the court of appeals was entered denied on February 17, 1969. The. petition for a writ of certiorari was filed on May 10, 1969. ‘The jurisdic-_ tion of the Court is invoked under 28 U.S.C. 12! 54(1).- | ay ‘ey e. od 4 , Bene - 9 “ =». QUESTION PRESENTED Whether the court8 below properly: characterized advances petitioner. made to a corporation sovnseav Rp by its sole shareholder as contributions to egpital so that the resulting loss was a capital 1 loss rather than a bad debt. , e } STATUTE INVOLVED Sections 165 and 166 of the Internal Revenue Code of 1954 are set forth in the auaas ae 20a-22a). STATEMENT . oR : Pelitionar . a Delaware corporation which was or- ganized in 1949 under the name Consolidated Gas and Service Company. Its operations involved the con- struction of gas distribution facilities. John c. Don- © nelly owned all the capital stock: (Pet:10a:)° In 1954, a separate company, Northeastern Electric Construction Corporation (Necco), was organized to engage in electrical construction work for one of the petitioner’s most important customers. Donnelly ‘and — Arthur Schmidt, an officer of petitioner, were the stockholder# A separate corporate entity was used to conform to rules of the International Brotherhood of Electrical Workers,’ which would contract only with companies’ doing exclusively electrical work. . (Pet. 10a-11a.) é Necco’s initial capital was sheet $12, 000. Pron the end of 1954 to March 1956, Delaware Consolidated advanced over $300,000 to or on behalf of Necco, primarily for operating expenses such as. payrolls, materials and overhead. Although petitioner carried the advances as accounts receivable, no written-evi- dences of indebtedness. were given, no interest or - . . 7. ~ -yances up’ to the time of the merger.As part of the oe . maturity date was agreed upon, and no security was -.provided.’(Pet. Ila.) ; Pi Neceo incurred serious losses from its inception. In March 1956, it was decided to.merge the two com- © panies intu one, the present petitioner,-with a trans- ' fer of Necco’s assets to “petitioner. There is no evi-. " dence of any payments or credits against the ad- merger the value of Necco’s properties were- applied xe against the advances. The amount left unreimbursed—_ $199,791.09—was cancelled on sspieporsscal s books of cb account. (Pet. 11a.) ns EP - ‘Petitioner claimed a bad debt ies Pox the $199,791.09, for its taxable year « ending ‘March 31, 1956. The Commissioner of Internal Revenue first allowed the deduction, intluding the carry-back of petitioner’s resultant 1956 net operating loss to 1954 and 1955, but subsequently disallowed it and assessed. deficiencies.” Petitioner paid the deficiencies and filed | claims for refund. The claims were denied by the Commissioner and petitioner filed this suit in the dis- trict court. (Pet. 1la.): That court rendered judg- ment for-the -governnient (Pet. 192).°@he court of — appeals, one judge dissenting, affirmed (Pet. la-9a). 1As part of the merger effected in 1956, Necco’s own net operating loss,. whieh tofalled about $187, 000 at the time of merger, was made available to petitioner as an “offset against its taxable income. Petitioner claimed and was allow is over deductions for 1959, 1960 and 1961 ‘aggregating eon . ~— (Pet. 1la—12a.) 4 . ton rag Bie Se ee a ne NE eat ae ee Ee Saas ict crea’ _ ‘The decisiin below i 1s correct and there i is no conflict | of decision that calls for further review.: . 1. To justify a ‘business’ bad. debt. deduction under . Section 166 of the Internal Reventie Code of 1954, a taxpayer must first demonstrate that a true indebted- ness existed. Petitioner’s advaiices to Ne¢co must be— | characterized as debt or capital investment according | to the substance, rather than the form, of .what oc- curred. Higgins v, Smith, 308.U.8. 473, GP The un- derlying determinant is that an investor’s prospects of return are contingent upon the successful operation of the LOREEN venture; while the lender’ $s are not. nh ae ) evaluated in the light of. this underlying distinction. The pertinent criteria were most recently summarized thusly (Berkowitz v. United States; 69-1 CCH Tax Cases 1 9398, at p. 84, 636 (C.A. 5)): Theré are at least eleven separate determin- — ing factors generally used by the courts in de-- termining whether amounts advanced to a cor- poration constitute equity capital or indebted- — ~ ness. They are (1) ‘the names given to the certi- , ~ ficates—evidencing—the-indebtedness;— (2) -the- presence or absence of a maturity date; (3) the source of the payments; (4) the right to en- - force the ‘payment of principal and interest; (5) participation in‘management; (6) a status equal to or inferior to that of regular corpo-- rate creditors; (7) the intent of the parties; — (8) “thin” or adequate capitalization; (9). identity of interest between creditor arid stock- DS tan lt OTA Hp tasers Da ete a tN Se a ich Ba bok ‘ ~~ S * FB n alte Ah ce TREE OSS Meek IAL TT Ta SG AOE ip tar aia ee Se . . ’ . = ni =) holder ; : (10) payment. of interest only out of “dividend” money; (11) the ability of the cor-. poration to obtain loans from outside lending institutions. | The circuits generally agree. See, e.g., Gilbert v. Com- missioner, 248 F. 2d 399 (C.A%2); Fin Hay Realty Co. v. United: States, 398 F. 2d 694 (C.A. 3); Wood Preserving Corp. of Baltimore v. United States, 347 F, 2d 117 (0.A. 4); Tomlinson v. 1661 Corp., 377*F. 2d 291 (C.A. 5); Moughon v. Commissioner, 329 F. * 24 399 (C.A. 6); Burr Oaks Corp. v. Commissioner, 365 FF. 2d 24, 27 (C.A.7) ; Taft v. United States, 314 F. 2d 620 (C.A. 9); Covey Investment Co. V.- United States, 37% F. 2d 408 (C.A. 10). ot As the majority opinion below recognized (Pet. App. 3a), analysis of these factors’ in this case mili- | tates against the conclusion that a bona fide debt existed. Necco was thinly capitalized, repayment was contingent on Necco’s success, Neeco and ‘petitioner ~ had ‘some identity of interest, and comparable outside lending was unavailable. Only the nomenclature the parties used to describe the transaction supports peti- tioner’s claim that a debt existed, and ‘that fact ‘alone ~—eannot-overeome the sigficant indication of a cani- ' tal contribution shown i in this record. 2... There: i is not, as petitioner argues (Pet. 12-13), a present’ conflict between thé decision hete and the position: of the Sixth Circuit evide need in Byerlite Corp. v. Williams, 286 F. 2d 285, and the Court of Claims decision in American Processing & Sales Co. v. United States, 371 F. 2d 842. There are similarities 2 & - @- ee ¥ 2 a ON il a wy a 8 Bee Grans 90 senda ad - 0 between the instant case and those cases, but the con- siderable amount of litigation in this area shows.a mul- titude of variations depending upon the facts of each -ease, The decision in each instance must rest. on a — ~ balaheing of the: relative. Weight of a mixture of facts which seldom ptesent-themselvi és again inthe. same. proportion. | The result is that square precedent: is | * Income Taxation of Corporations and Shareholders (2d ed.) See. 4.02, p. 122. Certiorari should be granted. to resolve a conflict, we suggest, only in those in- stances where thé lower courts have disagreed as to the characterization to be given virtually identical factual patterns or where a court, in disagreement with the decisions cited at pp. 4-5, supra, holds that one of the enumerated factors either should be given no weight or should be considered dispositive. Neither of these suggested criteria would -justify review of this cagé. As the Court of Claims noted in American Processing supra 371 F. 2d at 859, both =~ —~ reece, we case, the credits indicated that, in economic substance, the advances were treated as loans by the “borrower”’, _ thus suggesting the parties intended that the advances would be repaid. No such evidence appears in the in- stant case: - 2There i is no inconsistency (see Pet. 17) in the government's — _ arguments: respecting Section 165(g) (3) of the Internal Rev- enue Code of 1954. Section 165(g) (3) provides in relevant part that any ‘security of a corporation affiliated with the taxpayer shall not be treated as a capital asset. This statute fails to apply == ed vances in the form. of delivered materials. In each - rarely encountered. See Bittker & Eustice, Fedeval SS PSS Sse see 7 It is true that language in Byerlite suggests that the parties’ nomenclature and purported intent to create a debt controlled, without,zegard to the pres- : ence of other factors indicating,the existence of a ‘capital investment. But this does not provide an adequate basis for a grant of certiorari, since inter- -vening developments indicate that Byerhite no longer ° ‘expresses the position of the Sixth Circuit. In" Moughon % Commissioner, 329 F. 2d 399, and Fore- sun, Inc. v. Commissioner, 348 F.2d -1006, the Sixth Circuit had occasion to review the debt-equity issue , anew. In both cases, the court adopted the-generally 4 accepted objective criteria for resolution of the debt- equity issue. See pp. 4-5, supra. It avoided any ref- . erence to Byerlite in either opinion, which led Chief Judge Thomsen in Wood Preserving Corp. of Balti-. more v. United States, 233 F. Supp. 600 (D: Md.),\ | affirmed, 347 F, 2d 117 (C.A. 4), to observe (233 F: Supp. at 605) that the Byerlite decision “has: been considerably weakened by Moughon’*, Thefe has been no countervailing indication that at the present time Byerlite is of controlling significance in the Sixth Circuit. Rather, it appears that Byerlite is to be lim- here for two independent reasons: first, Necco does not qualify as an affiliated corporation, since (see Section 165(g) (3) (A)), peti- tioner did not own at least 95 percent of each class of Necco’s stock; and, second, because its investment in Necco did. not, in the statutory sense, become “worthless,” but was merely im- ‘paired to the extent of the loss occasioned by the subsequent merger ‘of Necco. with petitioner. Petitioner never questions either of these facts. / ‘ 4 ¢ pen ai "Eee Biel sa mc ie alte SF git pro I RAR, Ee ree Al ie ARIS i rs bid & ‘ei SESA i gis ca cts alr aa ibs he * e.g, Lomlinson v. 1661 Cor « ited to its own facts, even in‘its own circuit.’ Any. ‘thought that the Court of Claims, in its reliance on Byerlite, has ventured an approach different from or in _ , confijet with that taken in the circuits is put to rest.” by the following passage in eco cl acuie Processing (371 F. 2d at 848): - There -is no dearth of cases in this province of tax law. So large is their number and dis-. parate their facts, that for every parallel ... found, a qualifiedtion hides in the. thicket. At most they offer tentatixe clues to what i Is debt and what is equity for, tax purposes ; ‘but in'the. . . final analysis eticli:’ case “must rest and be de- ~* eided. upon its own unique faetual flavor, -dis- similar from all others, for’ the intention to create a debt is a compound. of many diverse external elements pointing in the end to what . ' * these elements “have pear such criteria as -——the |“real intention’”’ or “true intention’4 of of :.debt and. corroborated by . surrounding facts; ratio of debt to equity in the -financial structure of the debtor (i.e., the “thin incorpo- ration’? line of decisions which enjoyed a decade of popularity); reasonable expectation of repayment regardless of the success of the venture; substantial. economic reality- of: the _ transaction; and maintenance of prgportional what it thought: it was doing; or meant to do, have at most marginal relevance in posing ei ar it in fact did do. See, pra, 377 F, 2d at 299; cf. Knetsch v. United States, 364 U.S. 361, 365; United States v. Estate bed Grace, No. 574, O.T., 1968, decided June 2 ,1969,_ the parties as dine in the instrument. 2 is essentially a subjective conclusion. Elsewhere © “Wy, * Subjective intent or motivation should - -not have the sig- | _ nificance Byerlite attaches to‘ it. A’ taxpayer's allegations of: 9 , holdings by stockholders whose purported loans remain in suspicious balance with their capital contributions. ions, = i “Ss N or is there a conflict with this Court’s decision in Corn Products Refining - Co. V. Commissioner, 350 US. 46, ‘OF “any” “of the various court of appeals deci- sions cittd at pp. 14-17 of the petition. Those cases _ do not remotely suggest, as petitioner would appar- ~ | , ently. have. It, that securities owned By a corporate ‘~ | taxpayer are generally non-capital assets.. Rather the _ €ases are exceptions ‘to the general rule that. a “secu- rity’’ investment in a corporat¥ % a capital asset, * 2 v-. and rest# on special factual contexts which in no way- resemble the instant ease. © In Coin Products, the Court was asked. to decide whether the taxpayer, a. manufacturer of corn by- products,. was entitled to capital gains~treatment on -its profit from dealing in corn futures. The deejsion * ‘that the profits were Ordinary i income’ proceeded from the fact that the taxpayer’s “long position’’ in corn. futures was established “ ‘as a part of its coin buying * Although it is unquestioned that the definition of a capital asset must he narrowly construed, a corporate security is gen- erally a capital asset because it represents investment in a cor- _’ porate venture placed at the risk of the enterprise’ over an indefinitey future, except in certain very special situations. Sec- - tion 166 of the Code, among others, supports this premise, since i it is ofly by express exception (Section 165(g)(3)) that a . worthless ‘security is given ordinary loss treatment. See, also, Section 341 ( collapsible corporations), Section 582 (securities ‘held by a dealer), and Sections 1242 through’ 1944 (relating to small business investme companies and stock of. small .busi- nesses). In contrast, no -section affirmatively defines a sds type.of security to be a capital asset. 2. a. 77 10» » program’ and ‘as the most economical method ef obtain-. ing an adequate supply of raw corn’ ” (350 U.S. at 48) ‘and that. it therefore constituted an intégral part of its manufacturing business (350 U.S. at 51). In con- trast, the operation of Necgo, in the instant case,’ was _ not an intégral part of petitioner’s business, but was ee + a separate and distinct field of endeavor which Don- nelly decided to enter. 3 7 ‘In each of the court of appeals ‘decisions which . petitioner* cites, the expenditures either were under-— taken to alleviate temporarily sorie-impediment to the operation of the business, or were an integral part of a non-capital item, such as the acquisition of raw materials. In Booth Newspapers, Inc, v. United States, 303 F. 2d 916, 921 (St. Cl.), the ma bah purchased stock in a paper manufacturing company, but dnly to insure a short term source of newsprint, In Lutz v. Com- missioner, 282 F. 2d 614, 619 (C.A. 5), payments to cred- itors of the taxpayer’s wholly owned corporation were negessary to retain an agricultural commodity ‘bro- . kerage license. In United Gas Improvement: Co. v. Commissioner, 240. F. 24 312 (C.A. 3), the taxpayer made short-term advances to a. controlled subsidi- ary corporation to enable the subsidiary to meet its ~ current dividend obli ations. In Five Star Manufgctur- ing Co. V. Commissior 7, 805. 2d 724, 727 (C.A.5), the holding of one shareholder was purchased-in order to free the oe ae from “unwarranted fetters’’. In Commissioner v. Bagley & Sewall Co., 221 F. 2d 944, 947 €C.A. 2), the taxpayer had purchased government bonds 11 to guarantee performance of its purchase, contract with a foreign corporation ; and in substance the bonds served Weg the function of a performance bond.’ — . -Petitioner’s’ sole ‘shareholder, Donnelly, ‘desired to." aaa the electrical contracting business. While this. * new -venture in part permitted it. to service an exist- : ing customer- (Pet. lla), the activity was an attempt - to expand its operations permanently. Petitioner’s ad- ; te ‘vances representeé ‘capital placed at the risk of Nec- “i co’s operations over’ an indefinite time in the future, and there is no precedent for allowing an er . loss ‘deduction upon the. unprofitable termination of. -® Wee ecco’s ere CONCLUSION ce rete : “ é oes $ “The petitio for’a writ of certiorari should be. ee sae ERWIN- N. GRISWOLD, Soticitor General. sistant t attorae General. ONATHAN S.. CoHEN, ‘Rosert I: Waxman, Attorneys. a UNE 2 1969. 5In Daily Jourbat Co. v. (C.A. 9), the only question payer’s president was _) performed. ommissioner, 135 F. $a 687, 688: s whether salary paid to the tax- | nable in. relation to the services. U.S. GOVERNMENT PRINTING OFFICE: 1969 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385604_0767%3A2. Public record. Not legal advice.