Brizard Co. v. Commissioner

Brizard Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Brizard Co. v. Commissioner Docket No. 54923 United States Tax Court 28 T.C. 1142; 1957 U.S. Tax Ct. LEXIS 97; September 10, 1957, Filed *97 Decision will be entered for the respondent. Held, amounts received by petitioner as a result of the assignment to the Bank of America of promissory notes and conditional sales contracts do not qualify as borrowed capital within the meaning of section 439, I. R. C. 1939. L. W. Wrixon, Esq., for the petitioner. Aaron S. Resnik, Esq., for the respondent. Withey, Judge. WITHEY *1142 The respondent determined a deficiency in petitioner's income and excess profits tax for 1951 of $ 8,191.35. By amended answer, respondent *1143 asserted an additional deficiency for 1951 of $ 303.74. The issue presented for our decision is the correctness of the respondent's action in determining that the proceeds received by a partnership, of which petitioner was a member, from a bank in*98 consideration of the assignment and transfer of certain conditional sales contracts and promissory notes secured by chattel mortgages do not constitute borrowed capital within the meaning of section 439 (b) (1) of the Internal Revenue Code of 1939. FINDINGS OF FACT. Some of the facts have been stipulated and are found accordingly. The petitioner is a corporation organized under the laws of the State of California, with its principal place of business located at Arcata, California. It filed its income and excess profits tax returns for 1951 with the director of internal revenue for the first district of California. The petitioner computed its excess profits tax liability for 1951 under the income credit method. During 1949, 1950, and 1951, petitioner was a partner in the Brizard-Matthews Machinery Company (sometimes hereinafter referred to as Brizard or the partnership) and owned a 50 per cent interest in the net assets and net profits of the company. The Brizard-Matthews Machinery Company was engaged in the business of purchasing, selling, repairing, and servicing tractors and other types of machinery and equipment. In the regular course of its business of selling tractors and *99 other equipment, the Brizard-Matthews Machinery Company executed conditional sales contracts with its purchasers. Such contracts specified that title to the property which was the subject of the contract should not pass to the purchaser until the amounts due thereunder were paid in full. The contracts further provided that in the event the purchaser failed to comply with any of the terms of the contract, or failed to make payment as provided, the seller, without notice to the purchaser, might declare the entire amount unpaid thereunder immediately due and payable. In addition, provision was made that the seller might, without notice to the purchaser, declare all of the purchaser's rights under the contract terminated and, without demand or legal process, might repossess the property. Brizard also received from its customers, as evidence of credit sales or services, promissory notes secured by chattel mortgages. The partnership endorsed, sold, and assigned its conditional sales contracts, promissory notes, and chattel mortgages at a discount to the Bank of America National Savings and Trust Association (sometimes hereinafter referred to as the Bank of America or bank). *1144 *100 The form of assignment used by Brizard in assigning conditional sales contracts to the Bank of America was, in part, as follows: ASSIGNMENT AND GUARANTY For value received, the undersigned does hereby sell, assign, and transfer to the his, its or their right, title and interest in and to the within contract, the property therein described and all moneys to become due thereunder. In consideration of the purchase of the within contract, the undersigned guarantees payment of the unpaid balance and agrees to pay upon demand, the unpaid balance, if the purchaser defaults in the performance of the contract or any of the warranties are found untrue. The undersigned warrants that the title of the aforesaid property rests in the undersigned, that the undersigned has the right to make this assignment and that the aforesaid property is free from any liens or encumbrances. The undersigned hereby consents that the assignee above named, or its successors or assigns, may without notice extend the time for payments under said contract, waive the performance of such terms and conditions as it, or they, may determine, and make any reasonable settlement thereunder, without affecting or limiting*101 the undersigned's liability as guarantor. For the purpose of inducing the above named assignee to purchase said contract, the undersigned submits the accompanying purchaser's statement, which the undersigned believes to be substantially true, and states that the said contract arose from the bona fide sale of the property described in said contract, and that said property has been delivered into the possession of the purchaser therein named. In further consideration of the purchase of this contract the undersigned agrees that if the property therein described is returned by or repossessed from the purchaser, the assignee, its successors or assigns, may recover from the undersigned the balance due on said contract, or may sell said property, apply the proceeds to such balance due and recover any deficiency thereof from the undersigned; in either of such events recovering also a reasonable attorney's fee and cost of suit. In the event of suit against said purchaser the undersigned also guarantees the payment of costs and a reasonable attorney's fee to said assignee, its successors and/or assigns. The form of assignment used in assigning promissory notes and chattel mortgages to the*102 Bank of America was, in part, as follows: ASSIGNMENT WITH RECOURSE For Value Received, the undersigned does hereby sell, assign, endorse and transfer with recourse to BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION his, its or their right, title and interest in and to the within Chattel Mortgage and the Note therein described and the property covered thereby, and authorizes the said BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION to do every act and thing necessary to collect and discharge the same. The undersigned warrants and agrees to defend the title of said property hereby conveyed against all lawful claims and demands except the rights of the Mortgagor, and for the purpose of inducing you to purchase the said instruments, the undersigned makes the following representations and warranties: That the said instruments are bona fide and were actually executed by the person or persons whose signature or signatures appear therein; that said *1145 person or persons were of legal age and competent to execute the instruments at the time of execution thereof; that the property which is the subject of said mortgage is truly and accurately described; that the said property*103 is in possession of said Mortgagor; that the amount owing upon said note is correctly stated therein; that there are no counterclaims or setoffs on the part of said maker or makers against the same and should any of these representations or warranties be false or should any claim or breach of warranty be made by the maker or makers, then the undersigned hereby agrees to pay to you on demand the full unpaid balance of said note. In further consideration of your purchase of the said Note and Chattel Mortgage, the undersigned guarantees payment of the full amount remaining unpaid and covenants, if default be made in the payment of any instalments, to pay the full amount then unpaid to you upon demand, and there shall be no duty on you to proceed in any way against maker, makers or mortgagor as a condition precedent to payment to you of unpaid balance. The liability of the undersigned shall not be affected by any settlement or extension of credit or variation of the terms of the said instruments effected with the purchaser or any other person interested, nor affected by any assignment hereof. The undersigned waives lack of diligence, notice of this guaranty and notices of non-payment *104 and non-performance. In addition to the foregoing, there was in effect between the Bank of America and Brizard a "Dealer's Agreement," which provided, in part, as follows: All contracts purchased by the Bank shall be without recourse, except as to any contract which may become delinquent for a period of 60 days, and as to all such contracts the Seller hereby guarantees payment of all sums of principal and interest due under the terms of said contract, and said Seller promises and agrees to pay on demand to the Bank, the balance remaining on any such contracts; said Seller also agrees that the Bank shall be under no obligation to sue or proceed against the purchasers under said delinquent contracts and hereby waives the provisions of Sections 2849 and 2850 of the Civil Code of the State of California. The agreed purchase price shall be paid to the Seller or credited to his account when the paper is purchased, and thereupon full title to the paper shall pass to the Bank. * * * Upon acquisition of a conditional sales contract or promissory note, the Bank of America notified the installment purchaser by sending him a written notice containing the following language: "Your dealer has sold*105 to us your contract or note." The Brizard-Matthews Machinery Company maintained no record in its own books of account of the amount of installment paper it had discounted to the Bank of America at any given time. Contrary to the normal accounting practice in recording items of indebtedness, the notes and sales contracts assigned to the bank were not recorded by Brizard under an "accounts payable" or "notes payable" account. The method of recording the sale of paper to the bank was to enter the cash proceeds in cash receipts and credit the customer's account with the amount of cash received. Since no interest, designated as *1146 such, was payable to the bank, no interest payable entry was made as a result of the assignment of notes or contracts. On the balance sheets of the Brizard-Matthews Machinery Company, the amount of the outstanding notes and contracts assigned to the bank was shown in a footnote as a contingent liability. However, no entry indicating any liability as a result of the assignment to the bank of a note or contract was made on the books of Brizard. The partnership books did not reflect the amount of the contracts or notes that had been in default 60 days*106 or more. However, summaries were received by Brizard from the bank indicating the accounts that were delinquent from 30 to 65 days and those delinquent beyond 65 days. In the event that it became necessary for the partnership to repurchase defaulted paper from the bank, the cash paid to the bank was charged against cash and any repossessed property was reflected by an entry to the inventory account. If, however, in the event of default, Brizard did not attempt to repossess the property involved, but instead agreed to a new arrangement with its customer, the amount of cash paid to the bank was charged back to the customer's account receivable on the partnership books. The books of Brizard did not reflect either the daily or monthly dollar amount of contracts and notes discounted and sold, or the discount charges imposed by the bank on such transactions. OPINION. Pursuant to the Excess Profits Tax Act of 1950, indebtedness qualifying as borrowed capital within the meaning of section 439 (b) (1) of the 1939 Code 1 is a factor to be utilized in the computation of the excess profits credit under both the income credit method and the invested capital method. With respect to the income*107 credit method, borrowed capital to the extent of 75 per cent is taken into account in the computation of capital additions in the base period and in the computation of the adjustment for capital additions and deductions during an excess profits tax year. *108 It is unquestioned that petitioner, a corporate taxpayer, may include in its borrowed capital its share of qualified partnership indebtedness. *1147 See Pacific Affiliate, Inc., 18 T. C. 1175, Supp. Op. 19 T. C. 245, affd. 224 F. 2d 578. The respondent has determined that the amounts received by Brizard-Matthews Machinery Company from the Bank of America in exchange for the assignment of notes and conditional sales contracts do not qualify as borrowed capital under section 439 of the 1939 Code. The petitioner contends that the cash amounts so received represent the proceeds of a loan and, therefore, that they constitute borrowed capital within the meaning of section 439 of the 1939 Code. In order to sustain its position, it is incumbent upon petitioner to demonstrate the existence of an outstanding indebtedness evidenced by one of the types of instruments specified in section 439 (b) (1) of the 1939 Code. In examining the evidence presented herein, our attention is drawn immediately to the language employed in the documents accompanying the assignment transaction. The form of assignment used*109 in connection with discounting the conditional sales contracts states that the assignor "does hereby sell, assign, and transfer * * * its * * * right, title and interest in and to the within contract." The assignment further makes at least three specific references to the "purchase" of the contract. The form of assignment used in assigning promissory notes and chattel mortgages to the bank contains the phrase, "does hereby sell, assign, endorse and transfer * * * its * * * right, title and interest in and to the within Chattel Mortgage and the Note therein described," and twice makes reference to the "purchase" of the instruments. The "Dealer's Agreement" in effect between Brizard and the bank designates Brizard as the "seller" and also speaks of the "purchase" of the contracts. Thus, the instruments governing the arrangement between the bank and Brizard-Matthews Machinery Company with respect to the assignment of notes and contracts quite obviously are drawn in terms of purchase or sale, rather than borrowing or lending. The foregoing agreements appear clearly to contemplate that the ownership of the discounted paper would be transferred to the bank. The acquisition of such *110 paper by the bank was without recourse, subject only to the obligation of Brizard to satisfy those accounts which became delinquent for 60 days or more. With respect to any assigned contract which did not become delinquent for as long as 60 days, Brizard was under no liability to the bank. We previously have held that a contingent liability does not represent an outstanding indebtedness sufficient to constitute "borrowed capital" within the meaning of section 719 of the 1939 Code. Fraser-Smith Co., 14 T. C. 892. *1148 The form of notice used by the bank in notifying the installment purchaser of the assignment of the note or contract states: "Your dealer has sold to us your contract or note," indicating that the bank regarded the assignment transaction as a sale. That Brizard likewise regarded the assignment of its installment contracts to the bank as a sale appears from the fact that it did not record the items so assigned as accounts payable or notes payable on its books. The books of Brizard contained no entry indicating any liability in favor of the bank as the result of the assignment of a note or contract. In support of its position, the *111 petitioner places considerable reliance on Brewster Shirt Corporation v. Commissioner, 159 F. 2d 227, reversing a Memorandum Opinion of this Court, and Hunt Foods, Inc., 17 T. C. 365, affd. 204 F. 2d 429. In the Brewster Shirt case, the taxpayer, pursuant to a factoring agreement, transferred its accounts receivable to the factor in exchange for an advance of 90 per cent of the face value of the accounts. The assignment agreement there involved clearly stated that the accounts assigned were assigned as collateral security for loans. The issue there presented was whether or not the assignment agreement constituted an evidence of indebtedness under section 719 of the 1939 Code. The United States Court of Appeals for the Second Circuit held that the agreement in question was the equivalent of a mortgage and therefore qualified as an evidence of indebtedness under that section. Inasmuch as the agreements here in question do not disclose that the contracts assigned by Brizard were intended as collateral security for a loan, but speak instead of a sales transaction, Brewster Shirt Corporation v. Commissioner, supra,*112 appears clearly to be factually distinguishable from the situation here presented. Hunt Foods, Inc., supra, is likewise distinguishable. The taxpayer there drew sight drafts with attached bills of lading on its customers for merchandise sold and endorsed the drafts to its bank which in turn credited the taxpayer's account for the amount of each draft. In the event such drafts were not honored by the drawee, the bank charged the amount thereof against the account of the taxpayer. We there held that the foregoing method of financing constituted borrowing by the taxpayer and that the amount of the drafts outstanding represented an outstanding indebtedness within the meaning of section 719 of the 1939 Code. Contrary to the situation here presented, there was no intention on the part of the parties there involved to sell the drafts to the bank. Further, since the Bank of America acquired title to the contracts and notes assigned to it by Brizard, the provisions of the California*1149 Civil Code 2 creating a banker's lien "upon all property in his [banker's] hands belonging to a customer, for the balance due to him from such customer in the *113 course of the business" have no application here. (Emphasis added.) A situation analogous to the facts here involved was presented in East Coast Equipment Co., 21 T. C. 112, affd. 222 F. 2d 676. The taxpayer there sold equipment under lease and purchase option agreements. The agreements subsequently were transferred by the taxpayer to a financial institution under an "Assignment and Recourse Agreement," in exchange for an amount less than the face value of the contracts. The issue there presented was whether or not the agreements were sold by the taxpayer to the financial institution within the meaning of section 44 (d) of the 1939 Code, or were merely pledged as security for loans. We there held*114 that the transaction constituted a sale rather than a pledge, stating as follows, at pages 120-121: Each of the 26 agreements involved in this proceeding was transferred by the petitioner immediately upon acquisition to the Contractors Acceptance Corporation. To effect the transfer the petitioner signed in each case the "Assignment and Recourse Agreement" set forth in our Findings of Fact. As the terms of that agreement indicate, the petitioner sold and transferred the installment obligation to Contractors Acceptance Corporation and received in turn a cash equivalent. Elmer v. Commissioner, 65 F. 2d 568. The petitioner contends that in doing so it did not dispose of the installment obligations but simply pledged them with the finance company as collateral security for loans. However, the evidence fails to bear this out. There is nothing in the agreements between the petitioner and the Contractors Acceptance Corporation to indicate that the parties thereto intended that the installment obligations should simply be pledged as security for loans. On the contrary, the conduct of Contractors Acceptance Corporation indicates otherwise for the record*115 reveals that it was the habit of Contractors Acceptance Corporation to deal with the installment obligations as it would its own property. In many instances Contractors Acceptance Corporation in turn transferred the installment obligations to a bank to secure moneys needed in its business. Further, Contractors Acceptance Corporation was compensated for its efforts not by the petitioner but by the equipment purchasers who bore the tariff in the guise of interest-bearing notes transferred by the petitioner to Contractors Acceptance Corporation along with the other contracts. Further, the books of Contractors Acceptance indicate that that corporation considered the transaction one of purchase and of sale. We do not deem the fact that the petitioner guaranteed the installment paper significant. * * * In view of the explicit language contained in the three agreements in effect between Brizard and the bank during the year in issue and the fact that both parties to the assignment transaction apparently regarded *1150 the transfer of notes and contracts to the bank as an outright sale of the paper involved, we are of the opinion that no "outstanding indebtedness" resulted from such*116 assignment within the meaning of section 439 (b) (1) of the 1939 Code. We accordingly hold that the proceeds received by Brizard from the assignment of its promissory notes and conditional sales contracts to the Bank of America during 1951 do not qualify as borrowed capital within the meaning of section 439 (b) (1) of the 1939 Code. Decision will be entered for the respondent. Footnotes 1. SEC. 439. BORROWED CAPITAL. (b) Daily Borrowed Capital. -- For the purposes of this subchapter, the daily 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, incurred in good faith for the purposes of the business, which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, deed of trust, bank loan agreement, or conditional sales contract. In the case of property of the taxpayer subject to a mortgage or other lien, the amount of indebtedness secured by such mortgage or lien shall be considered as an indebtedness of the taxpayer whether or not the taxpayer assumed or agreed to pay such indebtedness, * * *↩ 2. Cal. Civ. Code Ann. (West 1954): SEC. 3054. Banker's lien. Banker's lien. A banker has a general lien dependent on possession, upon all property in his hands belonging to a customer, for the balance due to him from such customer in the course of the business.↩