Oregon-Washington Plywood Co. v. Commissioner

Oregon-Washington Plywood Company, an Oregon Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent Oregon-Washington Plywood Co. v. Commissioner Docket No. 39553 United States Tax Court 20 T.C. 816; 1953 U.S. Tax Ct. LEXIS 91; July 10, 1953, Promulgated *91 Decision will be entered for the respondent. Excess Profits Credit -- Borrowed Invested Capital. -- Held, that a land purchase contract and so-called note executed pursuant thereto were conditional and that the obligation under such instruments was not an outstanding indebtedness evidenced by either a note or a mortgage, within the meaning of section 719 (a) (1), Internal Revenue Code. George J. Perkins, Esq., for the petitioner. John H. Welch, Esq., for the respondent. Tietjens, Judge. TIETJENS *816 The respondent has determined an excess profits tax deficiency of $ 19,925.35 against the petitioner for the calendar year 1944. The issue presented is whether, in determining the excess profits credit based upon the invested capital method, the petitioner's obligation for the balance due under a contract for purchase and sale of timberlands and an alleged promissory note executed pursuant to that contract, constitutes an outstanding indebtedness evidenced by a note or mortgage which may be included in borrowed capital for *817 the years 1944 and 1945, within the meaning of section 719 (a) (1), Internal Revenue Code. It is stipulated that, if the Court finds*92 for the petitioner on the issue involved, the amount claimed as representing 50 per cent of the average daily borrowed capital as set forth in each of the petitioner's excess profits tax returns for 1944 and 1945, respectively, is correct and there is no deficiency in excess profits tax for 1944. It is further stipulated that if the deficiency involved herein is sustained, it will result in an overassessment of $ 9,321.80 in income tax for the year 1944. This proceeding has been submitted upon the pleadings and a stipulation of facts including numerous exhibits made a part thereof. FINDINGS OF FACT. The stipulated facts are so found and included herein by reference. The petitioner is an Oregon corporation which, during the years material herein, was qualified to transact business in the State of Washington, as a foreign corporation. The petitioner's income and excess profits tax returns for the taxable years 1944 and 1945 were filed with the collector of internal revenue for the district of Washington. At all times material to this proceeding the petitioner owned and operated a plywood manufacturing plant at Tacoma, Washington, and in that vicinity there was a scarcity of raw material, *93 namely, peeler logs. On July 30, 1941, T. A. Peterman acquired title by deed to approximately 3,500 acres of timberland in Tillamook County, Oregon, and he had not conveyed or encumbered the same prior to the execution of a contract of purchase and sale dated August 30, 1943, hereinafter mentioned. That tract of timberland was cruised in December 1940 and January 1941 and the timber cruiser's report showed an estimated total of 109,528,000 feet of merchantable timber. The tract contained a large amount of dead timber which had been killed by a forest fire and the time for using the dead timber as peeler logs was limited. During 1943 and until November 16, 1944, T. A. Peterman, Katherine Peterman, and Gladys Peterman were partners doing business under the firm name of Peterman Manufacturing Company which owned a large amount of logging equipment and maintained a logging organization in the area of the above-mentioned tract of timberland. The petitioner had no logging equipment or facilities for logging timber. On August 30, 1943, T. A. Peterman and his wife as owners and the petitioner as purchaser executed a contract of purchase and sale of the above-mentioned 3,500-acre tract*94 of timberland in Tillamook County, Oregon. The agreed purchase price was $ 500,000 payable *818 $ 25,000 on date of the contract, $ 75,000 on or before September 30, 1943, and the balance of $ 400,000 "evidenced by a note made payable" to Peterman Manufacturing Company and delivered thereto on or before September 30, 1943. Payments on the note, plus accrued interest at the rate of 3 per cent per annum on deferred balances, were due on the 15th day of each month beginning November 15, 1943, on the basis of $ 5 per thousand feet, commercial log scale, cut and removed by the purchaser during the previous month. If the purchaser defaulted in the monthly payments logging operations were to cease until the default was made good. The purchaser agreed, inter alia, that it would conduct its operations on the lands in a good and workmanlike manner in accordance with the best methods and usages practiced in the Douglas fir area and the Oregon laws and regulations; that it would pay all taxes and assessments levied upon the lands; that it would scale the logs cut and removed and keep accurate records; and that no loss or destruction of, nor injury or damage to any part or all of *95 the property from fire, wind, or other element of casualty whatsoever would give ground for the termination or rescission of the contract or relieve the purchaser of its obligations thereunder. The contract further provided that "time is of the essence of this contract and each and every portion thereof" and that in case of purchaser's default in payments or performance of other terms of the contract and after certain notice, the owners may elect to declare the contract at an end with all payments and improvements on the property forfeited as liquidated damages, or, the owners may elect to declare all unpaid sums plus accrued interest immediately due and payable and bring suit therefor. Further, the owners reserved title to the lands and timber thereon until complete performance of the contract by the purchaser but title to the logs passed to the purchaser as they were cut and removed from the land. Upon completion of the purchaser's obligations under the contract the owners agreed to execute and deliver a deed to the timberlands in fee simple with covenants of warranty and good commercial abstract or title insurance in a sum equal to the price paid for the land subject to certain*96 existing record reservations and easements. The petitioner made the cash payments totaling $ 100,000 required by the contract of August 30, 1943, and on September 30, 1943, delivered the following note as provided in that contract: Tacoma, Washington, September 30, 1943 $ 400,000.00 As provided in an agreement dated August 30, 1943, the undersigned for value received promises to pay to the order of the Peterman Manufacturing Company the sum of Four Hundred Thousand Dollars ($ 400,000.00) in lawful money of the United States of America. Payments on this note plus accrued interest at the rate of 3% per annum on deferred balances shall be made on the 15th day of each month beginning November 15, 1943. *819 The basis of such principal payments to be $ 5.00 per thousand feet commercial log scale for all logs except wood logs cut and removed by purchaser or its agents during the previous calendar month as provided in the agreement between T. A. Peterman and Ida C. Peterman, owners, and Oregon-Washington Plywood Company, purchaser, dated August 30, 1943, covering certain timber lands in Tillamook County, Oregon. OREGON-WASHINGTON PLYWOOD COMPANY By/S/Philip Garland Vice President *97 Attest/S/Mathilda M. Barrett Secretary On September 18, 1943, the Peterman Manufacturing Company executed a written agreement with the petitioner whereby for certain agreed prices to be paid by the petitioner, the former agreed, inter alia, to furnish all equipment and labor and pay all costs for logging all merchantable timber on the above mentioned 3,500-acre tract for the petitioner. The Peterman Manufacturing Company further agreed to log an annual average of from 20 to 25 million feet a year until all of the timber be logged from the tract, to commence shipping logs in October, and to be in full production by February 1944. On September 30, 1943, the Peterman Manufacturing Company executed an additional agreement with the petitioner to purchase at certain prices all logs cut other than the fir peeler logs and certain fir sawmill logs needed by the petitioner. T. A. Peterman died on November 16, 1944. Thereafter the surviving partners, the decedent's wife and executors of the decedent's estate, desired to be relieved of the agreements mentioned in the next two preceding paragraphs as to logging operations and the purchase of logs, and they were terminated by a cancellation*98 agreement dated January 4, 1946, between the interested parties and the petitioner. Also, on January 4, 1946, the same interested parties and the petitioner executed an amendment to the above mentioned contract dated August 30, 1943, whereby, inter alia, the balance of the purchase price of the said timberland of approximately $ 241,000 owing by the petitioner under the August 30, 1943, contract and September 30, 1943, note, would be paid as follows: A minimum payment of $ 5,000 on June 1, 1946, and the 1st of every succeeding month thereafter until the principal of the note was paid in full, plus additional payments "to be credited on the aforesaid note and contract" at the rate of $ 5 per thousand feet cut in excess of 7 million feet during 1946 and 12 million feet during any subsequent calendar year. Furthermore, the interest provided for in the August 30, 1943, contract and note thereunder was expressly waived and it was agreed that no interest would be charged or collected "on the balance owing on the aforesaid indebtedness or on said note." Except as so amended the August 30, 1943, contract remained in full force and effect. *820 On January 4, 1946, the petitioner*99 entered into a contract with the firm of Yunker and Wiecks for the cutting of timber on the above-mentioned 3,500-acre tract. The petitioner's records show that 90,933,000 feet of timber were logged from the land between August 30, 1943, and August 31, 1952. The petitioner's above mentioned note for $ 400,000 dated September 30, 1943, was paid in full sometime prior to December 22, 1949, on which date the petitioner acquired legal title to the 3,500-acre tract of timberland by warranty deed from the heirs of T. A. Peterman. OPINION. The issue presented is whether under the facts herein the petitioner had, during the years 1944 and 1945, an "outstanding indebtedness" which was "evidenced by" a "note" or "mortgage" within the meaning of section 719 (a) (1), Internal Revenue Code. 1 If so, there is no dispute as to the amounts to be included in the petitioner's borrowed capital for those years. *100 The petitioner contends that, during 1944 and 1945, its obligation to pay the balance due on the agreed purchase price of timberland constituted an unconditional outstanding indebtedness which was evidenced by a promissory note secured by a land purchase contract which was a form of mortgage under the laws of Oregon. The petitioner further contends that title to the land was retained by the seller only as security and that, in Oregon, the land purchase contract created a lien on the property equivalent to the common form of mortgage. The respondent contends that the transaction involved herein did not create an outstanding indebtedness evidenced by either a note or a mortgage within the meaning of section 719 (a) (1), supra. He argues that the petitioner's obligation was conditional under the terms of an executory and bilateral agreement, that the agreement was a conditional land contract with the seller retaining title and was not a "mortgage" or even equivalent to one, and, further, that the instrument promising to pay $ 400,000 was not a "note" because there was no due date and the monthly payments called for were to be made on the basis of the quantity of timber cut and *101 removed by the petitioner. *821 The respondent argues that the situation in the instant case is almost identical to that in Consolidated Goldacres Co. v. Commissioner, 165 F. 2d 542, affirming 8 T. C. 87, certiorari denied 334 U.S. 820. Among other cited cases the respondent also relies heavily upon Bernard Realty Co. v. United States, 188 F. 2d 861, reversing 92 F. Supp. 805, and Journal Publishing Co., 3 T. C. 518, to support his position that his determination should be sustained. In each of the above cited cases the taxpayer's obligation to pay a sum of money was evidenced by a written contract. In the first two cited cases it was held that the contract did not constitute either a "mortgage" or a "note" and in the third cited case it was held that the contract did not constitute a "note" or otherwise qualify as evidence of indebtedness, within the intent of Congress in enacting section 719 (a) (1), supra. In the instant case one distinguishing circumstance not involved in the cited cases*102 is that in addition to the land purchase contract the petitioner executed an instrument purporting to be a promissory note. However, that factual distinction does not obviate the applicability of the reasons and conclusions set forth in the cited cases which we think determine the instant controversy. The concept of including in invested capital certain amounts of outstanding indebtedness as borrowed capital and the restricted character of the permissible evidence of such indebtedness which Congress has prescribed in section 719 (a) (1), has been heretofore fully discussed in the above cited cases and Flint Nortown Theatre Co., 4 T. C. 536; West Construction Co., 7 T. C. 974; Canister Co., 7 T. C. 967, affd. 164 F. 2d 579; and C. L. Downey Co., 10 T. C. 837, affd. 172 F. 2d 810. There is no need here for further discussion along that line. In the instant case the agreement of August 30, 1943, wherein the seller retained title to the land and standing timber thereon until payment in full of the agreed purchase*103 price by the petitioner, was a conditional land contract. The purchase price of $ 500,000 was payable $ 100,000 in cash and the balance during an indefinite period of time by monthly payments conditioned upon the quantity of timber cut and removed by the petitioner. In addition to the conditional monthly payments, there were numerous other conditions which the petitioner was required to meet in order to fulfill the terms of the contract. Default in any of those conditions gave the seller the option to declare the contract terminated and all payments forfeited as liquidated damages, or, declare the unpaid sums plus interest immediately due and payable and bring suit therefor. Under the contract the petitioner was obligated to pay the balance of the purchase price but that obligation was not unconditional for at any time a breach of the terms and the seller's election to terminate the contract would have relieved *822 the petitioner of any further liability. Even though the land contract may be the equivalent of a mortgage for certain remedial purposes under the laws of Oregon, as contended by the petitioner, the controlling fact here is that the contract was conditional and*104 therefore does not qualify as a "mortgage" within the meaning and for the purpose of section 719 (a) (1). A land contract or other conditional sales contract is not synonymous with and therefore may not be considered as a "mortgage" under that section. Consolidated Goldacres Co. v. Commissioner, supra, and Bernard Realty Co. v. United States, supra. The petitioner further contends that even if the contract fails to qualify as a "mortgage," the instrument executed as a note pursuant to the contract is an entirely separate instrument which qualifies as a "note" under section 719 (a) (1). In our opinion, the so-called note must be read with its interrelated contract and when so read a close analysis of both instruments discloses that there was no unconditional promise to pay a certain sum of money on demand, or at a fixed or determinable future time. Journal Publishing Co., supra. While it is true that the so-called note "promises to pay to the order of" a payee the sum of $ 400,000 in money, it is also true that it is not payable on demand nor at any designated or ascertainable future*105 time. The so-called note refers to the contract and incorporates language providing for monthly payments on the basis of the quantity of timber cut and removed by the petitioner and accordingly it is conditional. By its very terms the instrument purporting to be a note is payable in installments, the amounts of which are not fixed, and we do not agree with the petitioner's contention that the so-called note should be deemed payable in a reasonable time and if not so paid would become a demand note. We conclude that the petitioner's obligation during the years 1944 and 1945, under the instruments involved herein, was not an outstanding indebtedness evidenced by a note or mortgage within the meaning of section 719 (a) (1), supra. The respondent's determination is sustained. Decision will be entered for the respondent. Footnotes 1. SEC. 719. BORROWED INVESTED CAPITAL. (a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following: (1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus, * * * * (b) Borrowed Invested Capital. -- The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day.↩