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Parties Involved:
Cerand & Company, Incorporated
Appellant
Commissioner of Internal Revenue Service
Appellee

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 4, 2000 Decided July 6, 2001

No. 99-1252

Cerand & Company, Incorporated,

Appellant

v.

Commissioner of Internal Revenue Service,

Appellee

Appeal from the United States Tax Court

(No. TAX-2767-97)

Michael S. Fried argued the cause and filed the brief for

appellant.

Joel McElvain, Attorney, U.S. Department of Justice, argued the cause for appellee. With him on the brief was

Kenneth L. Greene, Attorney. David E. Carmack, Attorney,

entered an appearance.

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Before: Williams, Ginsburg and Garland, Circuit Judges.

Ginsburg, Circuit Judge: Cerand & Co., Inc. (Cerand)

appeals from a judgment of the tax court predicated upon

that court's conclusion that payments Cerand made to three

of its sister corporations were intended to be capital contributions rather than loans. We hold that the tax court erred in

failing to consider the fact seemingly most probative of the

proper classification of the payments -- that the taxpayer

over several years treated as taxable interest income more

than $175,000 it received from its sister corporations. Accordingly, we remand this matter to the tax court for further

consideration.

Background

Gerard Cerand is the president and sole shareholder of

Cerand, which provides consulting services to owners and

operators of airport parking lots. Many of the airports at

which Cerand provides services are small and are not served

by regularly scheduled flights. In order to facilitate travel to

those airports, Gerard Cerand in 1984 formed three new

corporations: Cerand Aviation (CAI), which provided charter

flights both to Cerand and to unaffiliated clients; Airport

Service Corporation (ASC), which provided aviation support

services to CAI; and First World Corporation (FWC), which

provided administrative services both to CAI and to ASC.

Between 1984 and 1991 Cerand transferred $1,413,374 to

its three sister corporations through an "open account receivable" it maintained for each one. Cerand did not draw up a

formal document describing the nature and terms of the

transfer. Over the years 1984 to 1990 the three corporations

made occasional payments to Cerand, totaling $414,220. Of

this amount, Cerand reported $175,662 as interest income on

its federal income tax returns.

CAI and ASC went out of business in 1990 and FWC

followed suit in 1991. In 1992 Cerand recovered the single

valuable asset owned by any of them -- a key man insurance

policy on the life of Gerard Cerand, held by FWC and valued

at $160,859. In 1990 and 1991 Cerand claimed bad debt

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losses of $223,591 and $851,274, respectively, on its federal

income taxes, and deducted those amounts from its ordinary

income. The Commissioner of Internal Revenue issued a

notice of deficiency based upon his conclusion that the initial

transfers from Cerand to its sister corporations were capital

contributions rather than loans; that would entitle Cerand to

deduct the losses only from capital gains, if any, and not from

ordinary income. Cerand filed a petition in tax court challenging the deficiencies.

The tax court, after a trial and briefing, stated that, in

determining whether the transfers were loans or capital

contributions, "[t]he ultimate question is whether there was a

genuine intention to create a debt, with a reasonable expectation of repayment." 76 T.C.M. (CCH) 933, 935 (1998). The

court then examined three groups of factors -- relating to the

original transfers, to the subsequent repayments, and to the

objective likelihood of repayment -- that might bear upon the

nature of the payments.

The tax court first determined that the factors relating to

the original transfers did not support Cerand's claim that the

transactions were loans: "Petitioner never used any certificate or instrument to memorialize the debt; no loan agreements or notes were ever signed. Nor did petitioner set a

fixed maturity date or repayment schedule .... [or] show

that a predetermined interest rate applied." Id. The tax

court next concluded that the factors relating to repayment

also indicated that the transactions were not loans: "The

repayment to petitioner was inconsistent and appeared dependent on financial success." Id. Finally, the court found

that the objective likelihood of repayment was low: "With

thin capitalization and no historical success, there was considerable risk in advancing the funds." Id. Accordingly, the tax

court concluded that Cerand had intended that the original

transfers be capital contributions, and it sustained the notice

of deficiency.

Cerand filed a motion to reconsider the judgment, arguing

first that the transfers were loans and, second, that if they

were capital contributions, then the court nonetheless should

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have allowed Cerand to take all the claimed deductions from

ordinary income under s 165(g)(3) of the Internal Revenue

Code (IRC). Cerand also moved, in the alternative, to amend

the decision in order to allow a partial deduction against

ordinary income based upon a concession the Commissioner

had made at trial. The tax court rejected Cerand's two

arguments for reconsideration but amended the judgment as

requested to reflect the Commissioner's concession. Cerand

appealed to this court.

II. Analysis

Cerand raises two arguments on appeal. First, Cerand

argues that the tax court erred in concluding that the payments were capital contributions rather than loans. Second,

Cerand argues that the tax court erred in refusing to consider

its argument that, if the payments were capital contributions,

then Cerand was nonetheless entitled to deduct them from

ordinary income as "worthless securities" under IRC

s 165(g)(3).

The Commissioner contends that Cerand first raised the

s 165(g)(3) argument in its motion for reconsideration. In

response Cerand states that its expert witness raised the

issue in his report at trial, but it does not controvert the

Commissioner's statement that, when the court excluded that

portion of the expert's report because it was purely legal

argument, "[t]he court specifically informed taxpayer [ ] that

the exclusion ... did not prevent taxpayer from presenting

the argument in its post-trial brief. Despite this invitation

... taxpayer did not [do so]."

The tax court's practice is not to consider an argument

raised for the first time in a motion for reconsideration, see,

e.g., Estate of Quick v. Commissioner, 110 T.C. 440, 441-42

(1998), and Cerand presents no reason for us to override that

rule. Therefore, we shall not pass upon Cerand's argument

from s 165(g)(3).

With respect to Cerand's primary argument, we note a split

in the circuits over the standard of review: Should the tax

court's conclusion that a taxpayer intended a payment as debt

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or equity be reviewed as a question of fact or of law? The

Ninth and Sixth Circuits say the issue is one of fact, to be

reviewed for clear error, see, e.g., Bauer v. Commissioner,

748 F.2d 1365, 1367 (9th Cir. 1984); Smith v. Commissioner,

370 F.2d 178, 180 (6th Cir. 1966), but the Fifth Circuit says

the issue is one of law, to be reviewed de novo. See Estate of

Mixon v. United States, 464 F.2d 394, 402-03 (5th Cir. 1972).

"The [Supreme] Court has long noted the difficulty of

distinguishing between legal and factual issues." Cooter &

Gell v. Hartmax Corp., 496 U.S. 384, 401 (1990) (citing

Pullman-Standard v. Swint, 456 U.S. 273, 288 (1982)). This

recurrent difficulty arises in the present case because whether a transaction is properly characterized as debt or equity,

like the question at issue in Cooter & Gell, requires the court

"to marshal the pertinent facts and apply [a] fact-dependent

legal standard." Cooter & Gell, 496 U.S. at 402. In part

because "[f]act-bound resolutions cannot be made uniform

through appellate review, de novo or otherwise," id. at 405

(quoting Mars Steel Corp. v. Continental Bank N.A., 880

F.2d 928, 936 (7th Cir. 1989)), and in part because the district

court is better positioned to make the relevant factual determinations, the Supreme Court in Cooter & Gell concluded

that the appropriate standard of review was for abuse of

discretion, with the appellate court reversing a ruling if that

ruling was "based .. on an erroneous view of the law or on a

clearly erroneous assessment of the evidence." Id.

In the present case, we hold that the tax court abused its

discretion in assessing the evidence. The critical flaw in the

tax court's analysis is its failure, despite the taxpayer having

pressed the point, to consider Cerand's contemporaneous

treatment of sums received from its sister corporations as in

part the payment of "interest," taxable as income to Cerand.

Over a period of several years, Cerand received $414,220

from the three corporations, of which it booked more than

$175,000 as interest income. Even though Cerand had taxable income in only two of the years in question (1986 and

1987), treatment of the repayments as income in other years

reduced the amount of the net operating loss Cerand could

carry forward into years when it had taxable income.

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Although the tax court abused its discretion by omitting

from its analysis a highly significant bit of evidence, we

cannot say that, had the court properly weighed this evidence,

it necessarily would have reached a different conclusion,

because we do not know what weight it assigned to the other

evidence. Therefore, we remand this case for the tax court to

weigh all the evidence in the first instance.*

III. Conclusion

The appeal is granted and the case is remanded to the tax

court for further proceedings consistent with this opinion.

So ordered.

* We also note that the tax court placed considerable weight upon

the lack of documentation indicating that the transfers of funds

from Cerand to its sister corporations were loans. Because there

were no documents recording the transfers there necessarily were

no stated maturity dates, no repayment schedules, and no set

interest rates. As the Seventh Circuit recently observed in similar

circumstances, "it is hazardous to say ... that an investment must

be equity because it is not documented as debt; lack of documentation does not help us choose." J & W Fence Supply Co. v. United

States, 230 F.3d 896, 898 (2000). Cerand does not raise this

argument, however, and we therefore do not consider it.

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