Yancey Bros. Co. v.
United States (1970)
Yancey Bros. Co. v. United States
of America
Civil Action No. 12150
UNITED STATES DISTRICT COURT FOR
THE NORTHERN DISTRICT OF
GEORGIA, ATLANTA DIVISION
319 F. Supp. 441; 70-2 U.S. Tax Cas.
(CCH) P9619; 26 A.F.T.R.2d (RIA) 5564
September 18, 1970
CORE TERMS: customer, installment, lender, demand
loan, collateral,
disposition, finance, collection, discounting,
discount, notes receivable, promissory, disposed, default, borrow,
conclusions of law, conditional, collected, stipulate, utilized, credited,
monthly, payable, pledge,
promissory note, discounted, lending, ratio, maker,
sell
JUDGES: Henderson, District Judge.
OPINIONBY: HENDERSON
OPINION: Statement of the Case
Yancey Bros. Co. in this action seeks to recover
amounts of taxes and interest paid to the District Director of Internal
Revenue, Atlanta, Georgia, which amounts it alleges were erroneously and
illegally assessed and collected from it. Only the issue of defendant's
liability is to be established at this point in the proceedings. As to the
actual amount of the recovery, the parties have stipulated that they:
. . . will prepare computations of the amount of taxes
and interest to be refunded, if any. Should the parties disagree as to the
correct amount of such refund, the matter will be submitted to the court
for a determination.
The case came on for trial by the court without a jury
and was submitted for decision on the pleadings supplemented by the
pre-trial order, stipulations of facts, and briefs filed by plaintiff and
defendant. The court directed the parties to submit written arguments and
proposed findings of fact and conclusions of law. The parties have
complied with that direction and the case is now ready for decision.
The taxpayer contends that it did not dispose of its
notes receivable (representing balance of purchase price under its sales
contracts with purchasers), but that it borrowed money from various banks
and finance companies, giving demand notes for the same and pledging as
security for said notes those which it held executed by its purchasers.
Section 453 of the Internal Revenue Code of 1954, n1
provides that a taxpayer who regularly sells personal property on the
installment basis may defer the reporting of realized gain until such time
as the deferred cash payments are actually received. However, if prior to
the receipt of all of the installments due under the original agreement,
the taxpayer sells or otherwise disposes of the obligation, within the
meaning of Section 453(d)(1), gain is immediately recognized. The basic
issue to be decided here is whether under the provisions of Section
453(d)(1), a sale or disposition occurred when the taxpayer pledged its
installment obligations as collateral on its own demand loans.
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n1 (d) Gain or Loss on Disposition of Installment
Obligations.
(1) General rule. -- If an installment obligation is
satisfied at other than its face value or distributed, transmitted, sold
or otherwise disposed of, gain or loss shall result to the extent of the
difference between the basis of the obligation and --
(A) the amount realized, in the case of satisfaction
at other than face value or a sale or exchange, or
(B) the fair market value of the obligation at the
time of distribution, transmission, or disposition, in the case of the
distribution, transmission, or disposition otherwise than by sale or
exchange.
Any gain or loss so resulting shall be considered as
resulting from the sale or exchange of the property in respect of which
the installment obligation was received.
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The government on the other hand contends that the
transactions come within the provisions of the above statute for the
reason that the notes receivable belonging to the taxpayer were either
"sold or otherwise disposed of".
Since this court finds in favor of the taxpayer on the
basic issue stated above, it will not be necessary to consider other
issues in the case.
Findings of Fact
(1) Taxpayer in the fiscal years 1963 and 1964 made
its federal income tax returns on the accrual basis. The Secretary of the
Treasury assessed additional tax in the amount of $239,586.21 for 1963 and
$139,484.93 for 1964. The additional tax was paid and taxpayer duly filed
a claim for refund.
(2) Taxpayer was engaged in the business of selling
tractors and other equipment, generally on the installment basis evidenced
by promissory notes with finance charges included in the total contract
price and secured by conditional sales contracts. Having been advised by
its counsel and auditors that in their opinion the installment sales
method of reporting income could be utilized in connection with demand
loans secured by pledges of installment paper, taxpayer with consent of
the financial institutions obtained a change from the method then being
followed, viz: selling its notes receivable at a discount and in lieu
thereof borrowed money on its own promissory notes payable on demand,
securing the notes with the notes and conditional sales contracts from its
customers.
(3) Portions of the Stipulation of Facts concerning
the loan operations n2 are as follows:
The operational facts relating to demand loans and
discounting are as follows:
A. When utilizing demand loans, Taxpayer pursuant to
agreement entered between it and Lenders maintains records on all customer
accounts pledged as collateral, which includes a collection policy
utilizing coupon books furnished by the Taxpayer to the customer; one
additional person was employed to handle the bookkeeping and
administrative records.
H. When demand loans are utilized, Taxpayer has the
right to grant the customer an extension of time in which to make payment.
This extension is granted without consulting the lender. In such cases,
additional finance charges are collected from the customer by Taxpayer.
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n2 The stipulation provides that "terms of debt
and finance are used for descriptive purposes only and without prejudice
to the contentions of either parties."
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The parties stipulate (see Paragraph 14 of the
Stipulation) that
The actual transaction between Taxpayer and the
financial institutions is handled as follows, depending on whether demand
loans or discounting is involved:
A. When transactions involve a demand loan, the
indebtedness is evidenced by a demand promissory note, on the lender's
usual form, signed by Taxpayer on which it is the sole obligor. Interest
on said demand note, payable monthly and computed daily, is due on the
principal amount remaining unpaid. From time to time, Taxpayer, to
maintain the 105% collateral ratio, will request
consolidation of a group of notes into a single note
and borrow additional money.
E. On all customer's notes utilized as collateral to
secure a demand loan, Taxpayer continued to pay the Georgia Intangibles
Tax, and ad valorem tax. No such tax was paid by taxpayer on customer's
notes discounted.
The parties also stipulate (see Paragraph 15 of the
Stipulation) that
When a customer is unable to meet his payments, he may
arrange an extension of time to pay. Fees and late charges are collected
as follows:
A. On customer paper used for demand loans, all such
extension fees and late charges, as computed by Taxpayer, are collected by
and belong to Taxpayer. Taxpayer's practice is, thereafter, to notify the
lender of the extension terms and to forward such fees to reduce its
demand loan.
The parties stipulate (see Paragraph 17 of the
Stipulation) that
In the event a customer decides to prepay his
obligation, the procedure is as follows:
A. Under a demand loan, the customer deals directly
with Taxpayer in negotiating the amount that is required to extinguish the
indebtedness. Taxpayer takes such amount, when received from the customer,
and remits to the lender the sum necessary to equal the face amount of the
unpaid obligation.
The parties stipulate (see Paragraph 18 of the
Stipulation) that
The amount of money Taxpayer receives and the interest
it pays under the two arrangements is as follows:
D. When the interest rates have been increased,
lenders, in demand loan situations, have required the interest rate to
Taxpayer to increase
correspondingly. In discount situations, the discount
charge could not be changed during the life of the discounted contract.
(4) While stipulating the foregoing facts to be
correct the government points out the following:
(1) When the discounting procedure was followed,
plaintiff received from 94% to 95.5% of the face amount of the customer's
note. The plaintiff receives 96.5% of the face amount when the customer's
note is endorsed as security on plaintiff's demand loan.
(2) In every agreement, the bank or finance company
reserved the right to make collections on customer's promissory note. In
actual practice the plaintiff, pursuant to the bank or finance company's
discretion, collects most of the installment obligations, but the
collections are held by the plaintiff as property of the bank or finance
company. All such collections when received by the lending institutions
are credited on the note given by plaintiff.
(5) Since the taxpayer began the procedure of making
loans from the lenders and pledging its notes receivable as security
therefor, taxpayer did continue in certain instances to sell and transfer
its notes receivable to the lending institutions at a discount, and such
transactions are not involved in this case.
Conclusions of Law
(1) The court has jurisdiction of the subject matter
and the parties to the case.
(2) As supporting its contention that the transaction
here involved constituted merely a pledge and not a "sale or
disposition" of the notes receivable held by it, taxpayer cites
United Surgical Steel Company, Inc. v. Commissioner, 54 Tax Court 1215,
filed June 9, 1970. In that case the Tax Court found that there was no
"disposition" of installment obligations under the facts there
involved. In that case the petitioner and its guarantors entered into a
written agreement with the bank pursuant to which the bank agreed to
extend a line of credit up to a maximum of $850,000.00. The petitioner
executed a note payable to the bank for the full amount of its authorized
borrowings; the note was described as a draw note by lender. Pursuant to
the terms of the loan agreement, the petitioner assigned its installment
obligations to the bank and became entitled to borrow up to 88% of the
face amount of said obligation. In case of a default on any installment
obligation the petitioner was required to reduce its amount of loan with
the bank by an equal amount as the default. The bank did not realize any
income from the installment obligations but only realized interest charges
measured by the actual balance owing by the petitioner. The petitioner
continued to handle all collections and otherwise to service its
customers. All collections upon the installment notes were made by the
taxpayer and remitted to the bank and each week the amount of such
receipts were credited by the bank to the taxpayer on the taxpayer's note
(this was done in the instant case on a monthly and not weekly basis.) n3
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n3 The case just cited made reference to revenue
ruling 65-185 (Revenue Rulings p. 999) which would appear to support the
contentions of the government in this case, but pointed out material
differences in the case sub judice requiring a different result. The facts
in the instant case, however, are not materially different from the facts
before the Tax Court in the case of United Surgical Steel Company, supra.
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(3) In the case of Burford-Toothaker Tractor Company,
Inc. v. United States of America, 262 F.2d 891 (5th Cir. 1959), there was
involved the question (arising under another statute) whether money loaned
by a bank to a taxpayer was part of the taxpayer's "borrowed
capital" for purpose of excess profits tax even though the taxpayer
transferred its customer's conditional installment sales contracts and
promissory notes to the bank, as against the contention the customer's
conditional sales contracts were sold by the taxpayer to the bank.
In an exhaustive discussion of the matter by Chief
Judge John R. Brown it was ruled that the transaction was a loan and not a
sale, despite the fact relied upon by the government that the taxpayer did
not, with respect to this particular credit advance, execute its own note.
The court pointed out that under the [Practical] nature of the transaction
by which money was loaned, not paid by the Bank, the Taxpayer became the
Bank's debtor, not vendor, and both treated it as the lending of money,
not the sale and purchase of commercial paper. (see p. 894).
There the taxpayer had an open line of credit for
$150,000.00 which
[Was] on the Taxpayer's note bearing 4% interest.
As Taxpayer sold a machine on time, the conditional
sales contract was assigned, and the accompanying promissory note of the
customer was endorsed with recourse. The full face amount of the
customer's note which bore 6% interest was immediately credited to
Taxpayer's general checking account so that it had the full and immediate
use of this money. [That fact does not appear in the instant case].
If the customer defaulted taxpayer paid the note in
full. It was pointed out that the taxpayer likewise treated the pledge of
the notes as security. The court stated:
For here the uncontradicted facts show that neither
party considered or treated it as one of a simple negotiation by
endorsement without more. The Bank looked to Taxpayer alone for prompt and
timely payment. It was Taxpayer's obligation under the arrangement not
merely to pay in the event of the maker's default as its engagement as an
endorser implied. Its obligation was to pay when and as due and totally
without regard to whether the maker was or was not in default, technical
or substantial, or whether Taxpayer had yet received all or any part of
the current payment from the maker.
The court stated:
The transaction could have, of course, taken the
pattern of a sale of the installment contracts, . . .. But it did not, and
the result is not to be determined as though it had.
For other rulings tending to support contentions of
the petitioner see Town and Country Food Company, Inc. v. Commissioner, 51
Tax Court 1049; and Prescott v. United States, 64-2 USTC 9879 (D. Or.
1964).
[No Disposition of Customers' Obligations]
(4) Finally, three factors present in the instant case
make it apparent that taxpayer neither sold nor otherwise disposed of its
installment obligations. The first concerns the economic impact of the
Georgia Intangibles Tax, Ga. Code Ann. @ 92-110, which provides in
pertinent part that:
[Taxes] shall be charged against the owner of property
. . . . (Emphasis added.)
Accordingly, the owner of the customers' notes used as
collateral would be legally obligated to pay the required Intangibles Tax.
Ga. Code Ann. @@ 92-113, 118. As previously noted, taxpayer continued to
pay the Georgia Intangibles Tax on all customers' notes used as security
for taxpayer's demand loans. No such tax was paid by the taxpayer on
customers' notes utilized in discounting.
The second concerns the terms of the notes given by
taxpayer to lenders in demand loan situations. When effectuating a demand
loan, taxpayer executed a demand promissory note on the lender's usual
form. These demand loans were effectuated at simple interest rates,
payable monthly on the outstanding daily balance of taxpayer's note.
Manifestly, in demand loan situations, taxpayer was subject to the
vicissitudes of the "money market". For, when interest rates
increased, lenders required the interest rate to taxpayer to increase
correspondingly. This fact of economic life is to be sharply distinguished
from the economics of discounting. In the latter instance, the discount
charged could not be changed during the life of the discounted contract.
Thirdly, note should be taken of that portion of
taxpayer's loan agreements requiring it to maintain a ratio of collateral
to debt of not less than 105%. From time to time, the ratio of collateral
to debt became greater than 105%. If taxpayer needed to borrow more money,
under such circumstances, it could request consolidation of a group of
notes into a single note and would borrow additional money without putting
up additional collateral. Certainly, if taxpayer had sold or otherwise
disposed of the customers' notes, no such access to additional money would
exist. Cf. Woodsam Associates v. Commissioner, 198 F.2d 357 (2nd Cir.
1952).
(5) For the reasons set forth above, the court finds
that a taxable event does not occur when taxpayer utilizes its customers'
installment obligations as security for its demand loans.
To the extent that any findings of fact set forth in
this order are deemed to be conclusions of law or to the extent that any
of the foregoing conclusions of law are deemed to be findings of fact, the
same shall be deemed conclusions of law or findings of fact as the case
may be.
Counsel are directed to submit to the court
computations of the amount of taxes and interest to be refunded in
accordance with the foregoing findings of fact and conclusions of law and
a proposed judgment of the court within ten (10) days of the date of the
filing of this order. Upon approval thereof by the court, judgment shall
be entered accordingly.
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