Case Name: Louis Adler Realty Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1946-04-19
Citations: 6 T.C. 778
Docket Number: Docket No. 5643
Parties: Louis Adler Realty Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
Judges: DisNEY, J., concurs only in the result.
Reporter: Reports of the Tax Court of the United States
Volume: 6
Pages: 778–789

Head Matter:
Louis Adler Realty Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
Docket No. 5643.
Promulgated April 19, 1946.
Ferdinand Tannenbawm, Esq., Seymour Klein, Esq., and Henry Homes, C. P. A., for the petitioner.
Sidney B. Gambill, Esq., and Laurence F. Casey, Esq., for the respondent.

Opinion:
OPINION.
Black, Judge:
Section 23 (b) of the Revenue Act of 1938, the applicable statute involved, provides that in computing net income there shall be allowed as a deduction "All interest paid or accrued within the taxable year on indebtedness
Petitioner contends that during the entire taxable year it had an outstanding indebtedness of $1,717,500 upon which it was obligated to pay interest at the rate of 5 percent per annum. The respondent contends that Thurlim and the three trusts were in substance petitioner's controlled agents or nominees; that, through Thurlim and . the trusts, petitioner must be considered as having purchased its own indebtedness, which thereupon ceased to be an outstanding indebtedness upon which interest is accruable and deductible for tax purposes; and that the only indebtedness upon which petitioner' is entitled to deduct interest is the outstanding indebtedness o,f petitioner's subservient agent, Thurlim, to Manufacturers Trust Co., which bore interest at the rate of 4 percent per annum and consisted of $350,000 at the beginning of the taxable year, which amount was reduced to $300,000 on July 1, 1938, and to $200,000 on December 9, 1938. We agree with the respondent.
The respondent does not question the validity or bona ftdes of the original bond and mortgage which were issued by petitioner's wholly owned subsidiary, Stiplate, in 1935 as consideration for the transfer of title to the real estate in question. It is the manner in which this bond and mortgage were acquired from Trinity that raises the tax question at issue. In 1937 it was learned that Trinity was willing to accept $600,000 in cash in full payment for the obligation of $1,717,500 which had been created two years before. If petitioner had directly liquidated its 1935 obligation by paying Trinity the $600,000 either with its own or borrowed funds, it is obvious that the present question would not have arisen. We think, however, that petitioner has indirectly accomplished the same result by permitting its funds to be used by Thurlim and the three trusts in the manner set out in our findings.
In 1432 Broadway Corporation, 4 T. C. 1158 (on appeal to C. C. A., 2d Cir;), we had the question of the deductibility of interest before us and in the course of our opinion we said:
Although a taxpayer has the right to cast his transactions in such form as he chooses, and the form'he chooses will generally be respected, the Government is not required to acquiesce in the taxpayer's election of form as necessarily indicating the character of the transaction upon which his tax is to be determined. "The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purpose of the tax statute." Higgins v. Smith, 308 U. S. 473. See also Commissioner v. Court Holding Co., 324 U. S. 331.
Cf. W. C. Hay, 2 T. C. 460; affd., 145 Fed. (2d) 1001. In the Hay case the taxpayer, with the primary object of escaping estate and income taxes, being a naturalized citizen, repatriated himself as a Canadian citizen, organized a Nassau corporation, transferred to that corporation all the stock of a California company, and four months thereafter caused the Nassau corporation to liquidate the California company. On these facts, relying on such cases as Higgens v. Smith, 308 U. S. 473, and Griffiths v. Commissioner, 308 U. S. 355, we held the Nassau corporation lacked business purpose, its existence should therefore be disregarded for tax purposes, and the liquidation of the California company was in effect a distribution to the taxpayer, William C. Hay, individually.
We think the principles stated in the foregoing cases are applicable here. In 1937, when Adler learned that Trinity was considering discounting the second mortgage for approximately one-third of its face value, he talked the matter over with his wife and son and they in turn consulted their accountants and lawyers. At that time Thurlim was nothing but an empty shell. It had not yet issued any of its capital stock. It owned no assets. Adler, the sole stockholder of petitioner, had caused Thurlim to be incorporated several months before, but it transacted no business until October 29, 1937, when it wrote the letter to Trinity offering to purchase the bond and mortgage in question for the sum of $600,000 and tendered its check for $50,000 as a down payment. As indicated in our findings, this $50,000 originally came from petitioner in the manner detailed in our findings, Trinity accepted the offer to purchase on November 2, 1937, and on the following day the trusts were created and Thurlim issued all of its stock to the trusts for a total consideration of $1,000 and entered into an agreement with the trusts to sell them the bond and mortgage it was purchasing from Trinity for the same amount of $600,000, agreeing to take a promissory note from each trust for the amount of $200,000. Adler arranged with the Manufacturers Trust Co. for it to loan Thurlim $400,000 on his personal signature and security deposited by Adler and his wife. The balance of the purchase price was furnished by Adler as a loan to Thurlim. After this was done, petitioner began paying the so-called interest on the original amount of $1,717,500 to the trusts, which in turn would pay it over to Thurlim as a part payment on the $200,000 notes, and Thurlim would then use it to pay off its obligations to the Manufacturers Trust Co., petitioner, and Adler. As shown in our findings, petitioner loaned Thurlim a total of $308,100 from May 7,1938, to June 10,1942. This was separate and apart from the so-called interest. Most of this $308,100 was used by Thurlim to pay off its borrowings from the Manufacturers Trust Co. Up to May 31, 1941, petitioner had also advanced to the trusts a total of $110,833.73 in addition to the so-called interest which was used by the trusts to pay taxes, insurance, premiums and other such items. After Trinity had received the final payment on January 14, 1938, it executed and delivered an assignment of the bond and mortgage to Thurlim, which was then placed in petitioner's safe, where it has since remained. We think that, when consideration is given to the entire record, the conclusion must be that Thurlim and the trusts were simply being used by petitioner as its agents or nominees in the purchase of petitioner's outstanding indebtedness at a substantial discount.
The Supreme Court has held that the usual import of the term interest "is the amount which one has contracted to pay for the use of borrowed money." Old Colony Railroad Co. v. Commissioner, 284 U. S. 552; Deputy v. Du Pont, 308 U. S. 488. During the taxable year petitioner made two payments of so-called interest to the trusts; one on July 1, 1938, in the amount of $47,470, and one on January 3, 1939, in the amount of $42,937.50. The trusts passed both payments over to Thurlim, to be applied on the notes. Thurlim turned the first payment over to Manufacturers Trust Co. and returned the second payment to petitioner. Petitioner has not shown to our satisfaction that these payments by petitioner were in truth and substance compensation for the use of money. We think the only real payments of interest were those made by Thurlim to Manufacturers Trust Co., which we hold were made for petitioner's benefit. The parties agree that the sums so paid or accrued during the tax year amounted to $10,235.62. As has already been stated, the Commissioner in his determination of the deficiency allowed petitioner a deduction of $30,000 interest on account of the transactions here involved. Respondent in his amended answer alleges that he erred in this respect and that he should have allowed only $10,235.62, and he asks for an increased deficiency accordingly. The burden of proof is, of course, upon respondent to sustain these affirmative allegations. For reasons we have stated above, we think that burden has been discharged and that petitioner is entitled to. have allowed a deduction for interest of only $10,235.62, as the Commissioner has claimed in his amended answer. We so hold.
Reviewed by the Court.
Decision will be entered u/nder Rule 50.
DisNEY, J., concurs only in the result.