Court Opinion

ID: 185480
Source: CourtListenerOpinion
Date Created: 2011-02-05 02:32:35+00
Date Added: 2024-06-11T17:26:16.246263
License: Public Domain

254 F.3d 258 (D.C. Cir. 2001)
Cerand & Company, Incorporated, Appellantv.Commissioner of Internal Revenue Service, Appellee
No. 99-1252
United States Court of Appeals  FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued December 4, 2000Decided July 6, 2001

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.
Before:  Williams, Ginsburg and Garland, Circuit Judges.
Ginsburg, Circuit Judge:

1
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

2
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.

3
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.

4
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 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.

5
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.

6
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.

7
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  have allowed Cerand to take all the claimed deductions from  ordinary income under 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

8
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  165(g)(3).

9
The Commissioner contends that Cerand first raised the  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]."

10
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 165(g)(3).

11
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 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).

12
"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.

13
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.

14
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

15
The appeal is granted and the case is remanded to the tax  court for further proceedings consistent with this opinion.

16
So ordered.

Notes:

*
 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.