Opinion ID: 423650
Heading Depth: 1
Heading Rank: 4

Heading: the taxpayer's appeal--the cotgo leasing issue

Text: 44 In the past, Strick has both leased and sold its products directly to ultimate users. In 1974, Strick's parent corporation, Distribution International Corporation, revived another of its subsidiaries, Cotgo Leasing Co. (Cotgo) to assume financing and leasing responsibilities for the Strick trailers. 45 Under the new arrangement, Cotgo purchased the trailers or truck chassis from Strick with money obtained from various lenders under a revolving credit agreement. This agreement required that the price paid to Strick was to be equal to or not more than the price paid in an arms length transaction by a customer of similar size and credit rating. Cotgo then leased the trailers to customers and assigned the leases to the lenders as security for the loan. The lenders also acquired a security interest in the leased trailers or chassis and in Cotgo's unleased inventory. Title of the vehicles passed from Strick to Cotgo and remained in Cotgo subject to the security interests of the lenders. The transfer of title was essential to the financing arrangement, since a principal reason for the use of Cotgo as the financing intermediary was to accommodate lenders by isolating the collateral from the claims of other creditors of Strick. 46 Cotgo has no separate employees, sales force or business location. The officers and managers of Strick handle the business operations of Cotgo, including the leasing of the trailers. Most of the directors of Strick are also directors of Cotgo. Advertising materials put out by Strick advises customers that they can either buy or rent trailers. 47 Section 4061(a) of the Code imposes a federal manufacturer's excise tax upon the sale of a truck chassis or trailer body. The lease of a trailer or chassis is regarded as a sale for purposes of imposition of the tax, but the manufacturer's liability for payment of the tax in a lease situation arises ratably as payments are made under the lease. 6 A manufacturer's liability also accrues ratably if the transaction is either an installment sale, a conditional sale or a chattel mortgage arrangement. 7 There is no dispute as to the amount of excise tax which Strick ultimately must pay in connection with the leasing of the trailers; the sole issue is whether the tax must be paid upon the sale or over the term of the lease as payments are received. 48 Strick argued before the district court that Cotgo should be disregarded as a corporate entity and that Strick should be regarded as the lessor of the trailers for purposes of accrual of excise tax liability. The district court held that Cotgo had insufficient economic substance to be recognized for excise tax purposes and that the transfer between Strick and Cotgo was not a sale. The court then held, however, that the transactions with the lessees should be regarded as sales for purposes of imposition of the excise tax. The court therefore denied the taxpayer's refund claim for credit. 49 Strick seeks a refund of $3,195,591, representing the amount of alleged overpayment of the excise tax, plus interest, during all calendar quarters of 1974 through 1978. 50 With respect to the question of Cotgo's economic substance, the issue to be determined is whether the rule of law set forth in Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 63 S.Ct. 1132, 87 L.Ed. 1499 (1943), is applicable to the facts in this case. 51 Strick argues that the finding that Cotgo had insufficient economic substance is a factual finding that may not be overturned on appeal unless it is clearly erroneous. Fed.R.Civ.P. 52(a). The clearly erroneous standard of review does not control, however, when the issue is the applicability of the correct legal standard. Commissioner v. Danielson, 378 F.2d 771, 774 (3d Cir.1967). If Moline applies, the factual finding of the district court was unnecessary. 52 The taxpayer in Moline was the sole shareholder of a corporation which owned real estate. Upon the sale of the property at a profit, the taxpayer sought to have the gain treated as income taxable to him as an individual. The Supreme Court rejected his claim, stating: 53 The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. (Citations omitted). In Burnet v. Commonwealth Improvement Co., 287 U.S. 415 [53 S.Ct. 198, 77 L.Ed. 399], this Court appraised the relation between a corporation and its sole stockholder and held taxable to the corporation a profit on a sale to its stockholder. This was because the taxpayer had adopted the corporate form for purposes of his own. The choice of the advantage of incorporation to do business, it was held, required the acceptance of the tax disadvantages. 54 319 U.S. at 438-39, 63 S.Ct. at 1133-34 (Footnotes omitted). The continuing validity of the Moline doctrine in the income tax area has recently been affirmed by the Eighth and Tenth Circuits. See Bennett Paper Corporation v. Commissioner, 699 F.2d 450, 451-52 (8th Cir.1983); Crouch v. United States, 692 F.2d 97, 99 (10th Cir.1982). Accord, Collins v. United States, 514 F.2d 1282 (5th Cir.1975), aff'g per curiam, 386 F.Supp. 17 (S.D.Ga.1974). No cases have been found which have applied Moline in the excise tax area. 55 It is undisputed that Cotgo was established as a separate corporate entity for substantial and legitimate business purposes. Cotgo provided a vehicle which made financing for the production of the trailers more obtainable by isolating the assets which would serve as security for the borrowing. Compliance with the demands of creditors was specifically named by the Moline court as one of the useful business purposes for which corporations are formed. 319 U.S. at 438, 63 S.Ct. at 1133. The existence of Cotgo insulated Strick from liability for the repayment of the loans made in connection therewith. Title to the trailers and truck chassis was transferred from Strick to Cotgo in return for full payment from Cotgo to Strick. The legal obligations imposed by the loan documents ran only from Cotgo, not from Strick. Strick did not guarantee payment of the loans. In addition to incurring an obligation for payment of the loans, Cotgo assumed other substantial responsibilities as a debtor under the revolving credit agreement, including the maintenance of a net worth in the minimum amount of $6,000,000 with a stockholders' equity in the minimum amount of $3,000,000. Cotgo entered into numerous leases as a lessor and received rental payments in connection therewith. These facts indicate that although Cotgo had no separate business location or staff, it functioned as a separate and distinct corporate entity in furtherance of a significant purpose which was the equivalent of business activity. 56 Strick argues, however, that we should look to the substance of the transactions between Strick, Cotgo and the lessees rather than their form. Strick would have us conclude that, in effect, the trailers were being leased directly from Strick, and that Cotgo was merely being utilized as a conduit. In support of its position, Strick cites several cases and revenue rulings where an affiliated corporation in a position similar to that of Cotgo has been disregarded. 57 In most of these cases, use of the affiliated corporation conferred an excise tax saving on the manufacturer who was therefore arguing for recognition. In Ayer Co. v. United States, 38 F.Supp. 284 (Ct.Cl.1941), for example, the issue was whether sales by a manufacturer of cosmetics were at retail for purposes of applying the constructive sales provisions of the excise tax statute then in force. The manufacturing corporation formed a selling corporation to handle the sales of its products. All of its inventory was transferred to the second corporation on credit for an amount equal to the cost of manufacture, plus 15%, plus the amount of the excise tax. The manufacturer sought to have the tax levied against this price, which was less than the constructive sales price that would have been imposed by the Commissioner. Because the selling corporation had no capital, no separate business location and shared employees, managers and directors with the manufacturing corporation, the Court of Claims found that the selling corporation was a mere shell. 38 F.Supp. at 288. The court held that sales to the public by the selling corporation would be regarded as retail sales by the manufacturing corporation and that the constructive sale price provisions of the Commissioner would apply. Id. 58 In Kin-Septic v. United States, 64 F.Supp. 142 (Ct.Cl.1946), the owner of a cosmetics manufacturing corporation set up a distributing corporation which assumed responsibility for the packaging, shipment and sale of the manufacturer's products. The manufacturer sought to have the tax assessed against the price it charged the affiliated corporation. Relying on Ayer, the Court of Claims found that the primary purpose of the new arrangement was to reduce the amount of the tax and imposed the tax payable by the manufacturer had it sold directly at retail. Id. at 148. 59 Most of the revenue rulings relied on by the taxpayer essentially replicate these holdings or involve minor variations. See, e.g., Rev.Rul. 59-163, 1969-1 C.B. 353; Rev.Rul. 62-68, 1962-1 C.B. 216, Rev.Rul. 75-130, 1975-1 C.B. 347. 8 In each of these cases and rulings, the finding that no sale had occurred between the manufacturer and the distributing corporation was a necessary preliminary to the imposition of tax liability on the manufacturer on the basis of a constructive sales price. For the most part, the holdings of these authorities are consistent with the recognized exception to the Moline rule that the Commissioner may disregard the corporate form in order to avoid a fraud on the taxing statute. Moline Properties, 319 U.S. at 439, 63 S.Ct. at 1134. Here the issue is whether the manufacturer should be taxed all at once or ratably. 60 Rev. Ruling 59-299, 1959-2 C.B. 253 provides the strongest support for Strick's position. In this ruling, the IRS considered transfers between a company which manufactured trailers taxable under section 4061(a) and a leasing company where (1) both companies were owned and operated by the same individual and where (2) both companies were owned by the same partners. It held that the transfers were not sales but that the manufacturer would be liable for excise tax upon lease of the trailers. This ruling is not cluttered by considerations of shifting functions in an effort to lower the tax. Rev.Ruling 59-299 is distinguishable, however, because in the one case the companies were sole proprietorships operated by the same individual and in the second case, the companies were operated by partnerships with common partners holding identical interests in both. The ruling is expressly grounded on the principle that a person may not sell to himself. In the present instance, the affiliated entities and the common parent are all corporations which are generally recognized as separate taxable entities. See Moline Properties, 319 U.S. at 438-39, 63 S.Ct. at 1133-34. 61 Strick argues that the revenue rulings upon which it relies indicate that a practical and a flexible view of corporate structures prevails in the excise tax area. We are convinced, however, that results reached in these authorities further the congressional purpose of preventing manufacturers from avoiding constructive sales price provisions by selling to the ultimate consumer through a related corporation or from reducing their excise tax liability by charging lower prices to related buyers. See Creme Manufacturing Co. v. United States, 492 F.2d 515, 519 n. 4 (5th Cir.1974); Rev. Ruling 62-68, 1962-1 C.B. 216. None of the cases or other authorities relied on by Strick considered issues related to the timing of a manufacturer's excise tax liability when a related corporation is used to assume financing obligations. 62 The position of the government is essentially that the taxpayer may not have a legitimately established corporation disregarded in order to obtain a tax advantage. In addition to relying on Moline, the government points out that this court recognized the appropriateness of a similar double standard in Commissioner v. Danielson. In that case, a taxpayer appealed the tax consequences of a contractual allocation of the purchase price of a business. We commented: 63 Next, we are not here involved with a situation where the Commissioner is attacking the transaction in the form selected by the parties, e.g., Schulz v. C.I.R., 294 F.2d 52 (9th Cir.1961). Where the Commissioner attacks the formal agreement the Court involved is required to examine the substance and not merely the form of the transaction. This is so for the very good reason that the legitimate operation of the tax laws is not to be frustrated by forced adherence to the mere form in which the parties may choose to reflect their transaction. Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935); C.I.R. v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981 (1945). In contrast, the Commissioner here is attempting to hold a party to his agreement unless that party can show in effect that it is not truly the agreement of the parties. And to allow the Commissioner alone to pierce formal arrangements does not involve any disparity of treatment because taxpayers have it within their own control to choose in the first place whatever arrangements they care to make. 64 378 F.2d at 774-75. Underlying the decision in Danielson, however, were policy considerations such as the desire to avoid a unilateral reformation of a contract, possible unjust enrichment of one of the parties to the contract and a concern for predictability in allocating the tax consequences in the sale of a business. See Sullivan v. United States, 618 F.2d 1001, 1004 (3d Cir.1980). These policy considerations are not present here. 65 The Second Circuit has taken the position in reviewing organizational patterns chosen by corporate families that whether probing form for substance leads to a decision favorable to the Government or to the taxpayer is immaterial.... Hoffman Motors Corporation v. United States, 473 F.2d 254, 257 (2d Cir.1973). See also Cleary v. United States, 232 F.Supp. 828, 830 (W.D.Pa.1964). 66 We conclude, however, that in this case the taxpayer should be bound by the form in which it has chosen to conduct its business. Substantially all of the authorities relied on by Strick involved an attempt to avoid taxes, in effect, finding that the arrangement on paper was a sham and should not be utilized to avoid the normal tax consequences of the transaction. Here, having chosen to do business as separate entities, certainly Strick and Cotgo should be estopped from contending that their relationship was a sham and that they should be treated as one and the same. The taxpayer cannot now claim that it is entitled to all of the benefits but not the normal tax detriments that flow therefrom. See Bennett Paper Corporation, 699 F.2d at 451-52. 67 The circumstances which permit the Internal Revenue Service to look to the substance rather than the form of a transaction in order to seek payment of taxes which would otherwise be due but for the form, does not require the mutuality that Strick contends. The government has the right to claim that the form of a transaction should not be utilized to postpone taxes that are otherwise due. The taxpayer does not have the like right to contend that the form that it has chosen should be ignored so that avoidance or postponement of the tax can be accomplished. No such mutuality of remedy is or should be required. 68 Even if we were to accept the taxpayer's invitation to focus on the substance of the relationships here rather than the form, the substance of the corporate structure and financing arrangements entered into by Strick and Cotgo allowed Strick to receive the benefit of financing its manufacturing operations with borrowed money without incurring any of the obligations normally incident to such borrowing. The obligations for which the trailers were security were the responsibility of Cotgo alone. Strick's argument that it was in effect the borrower flies in the face of the legal import of the loan documents which obligate only Cotgo. [A] transaction is to be given its tax effect in accord with what actually occurred and not in accord with what might have occurred. Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148, 94 S.Ct. 2129, 2137, 40 L.Ed.2d 717 (1974). In return for full payment, Strick transferred title and control. Thus, even if the court accepts the substance over form argument of Strick, these facts indicate that the separation between the two corporations and the transfers between them had significant economic consequences and were not merely a matter of form. 69 The full payment received by Strick when it transferred title to Cotgo is crucial in another respect. If we view the subsequent leases as the only operative transaction, Strick's liability will arise only ratably. 26 U.S.C. § 4217(b). Strick would thus receive a bonanza through a combination of full payment and deferred taxation. Although we have found no legislative history or cases which discuss the purpose of the deferred payment provision, the apparent purpose was to alleviate a cash flow hardship for the manufacturer, not to confer a windfall. 70 There is no dispute in the record that Cotgo was established to facilitate the financing of production of the Strick vehicles. The district court so found. Organizing one's business in order to comply with the requirements of lenders is a legitimate business purpose under Moline. 319 U.S. at 438, 63 S.Ct. at 1133. There is also no dispute that Cotgo engaged in business activity in furtherance of the purpose for which it was established. We find therefore that Moline is applicable to the facts of this case and that Cotgo must be recognized as a separate entity for excise tax purposes. We are not bound by the factual determination of the district court that Cotgo had insufficient economic substance to be recognized for excise tax purposes because the district court failed to apply the applicable legal standard. Commissioner v. Danielson, 378 F.2d at 774. We conclude that the sale of the truck and trailer chassis to Cotgo was the taxable event under section 4061(a). Strick's liability for payment of the manufacturer's excise tax arose in full at that time. Because the taxpayer paid the tax on this basis originally, the denial of the court below of the taxpayer's refund claim will be affirmed. 9 71 For the foregoing reasons, the portion of the judgment from which the taxpayer appeals will be affirmed, and the portion of the judgment from which the government appeals will be reversed.