The opinion of the court was delivered by: DITTER
The question presented in this case is whether certain advances to a closely held corporation were loans or contributions to capital, and, if loans, whether they should be treated as business or nonbusiness debts for federal income tax purposes. Plaintiff asserts that these advances were business bad debts and seeks a tax refund for the years 1967 through 1969 as well as the right to apply the remainder of the claimed deduction against his income for the years 1971 through 1975. Cross-motions for summary judgment are now before the court. I conclude the advances were contributions to capital and, therefore, grant the government's motion.
I. The Factual Background1
On October 31, 1962, the plaintiff, Joseph L. Fischer,
purchased 50 percent of the common stock of Yank Chevrolet, Inc. (Yank), an automobile dealership then located in Vineland, New Jersey, for $15,000. Thereafter, plaintiff became Yank's general manager and executive vice-president. On January 21, 1964, Fischer acquired 50 percent of Yank's preferred stock for $17,500. The remaining 50 percent interest in Yank was held by its president, Arnold Yank. As of October, 1962, the business had had a history of financial losses and continued to suffer severe setbacks in the next few years, leaving the dealership with a net worth deficit of $312,132 at the close of 1966. To keep the business from closing, plaintiff, beginning in February, 1965, obtained funds from a number of third parties which were either paid directly to Yank or transferred to Yank through plaintiff. Between February 8, 1965, and August 1, 1966, Dr. Joseph Brenner, plaintiff's father-in-law, issued four separate checks totalling $37,000, and made payable to Yank. In return, Mr. and Mrs. Fischer issued a promissory note to Dr. Brenner.
Thereafter, in late 1966, plaintiff was approached by the Ford Motor Company and offered the position of general manager for a new dealership to be known as Presidential Ford, Inc. (Presidential). He signed a management contract with Presidential on June 1, 1967, which provided him with a $36,000, per year salary, 25 percent of the dealership's net profits, excluding rent expense, and a five-year option to purchase the assets of the dealership. Three days prior to the formalization of the agreement with Presidential, Mr. and Mrs. Fischer borrowed $40,000. from Continental Bank and the money was turned over to Yank on May 31, 1967. Of this amount $6,959. was repaid by Yank, leaving a balance of $33,041. at the end of 1969.
On August 3, 1967, Fischer received $12,500. from Martin Coopersmith, and passed it on to Yank;
at least $2,500. of this amount was subsequently repaid by Yank. The next advance occurred in December, 1967, when Dr. Glen F. Ulansey, a cousin, forwarded $62,500. in the form of six checks to plaintiff. Five months thereafter, Harry K. Cohen, a former employer of plaintiff, advanced $125,000. by twelve checks.
Both individuals received an interest in plaintiff's option to buy Presidential
under agreements reached between them and Fischer, which evidenced an obligation to repay in six month installments over a five-year period with interest at the rate of approximately seven percent. See Stip. Fact C(7)-C(10); Defendant's Exhibit G; Deposition of Joseph L. Fischer, dated January 29, 1975, p. 17. These amounts were transferred to Yank and two payments of principal plus interest were funneled to each through Fischer.
Yank subsequently was placed in receivership and the assets sold, the gross proceeds of which were distributed by order of the New Jersey Superior Court, leaving an amount in excess of $210,000. advanced by or through plaintiff still unreturned.
On November 22, 1971, Mr. and Mrs. Fischer filed joint federal income tax returns for the calendar years 1967, 1968, 1969, and 1970. Amended returns were filed on December 30, 1971, in which the Fischers claimed a business bad debt deduction for 1970, based on the moneys advanced to Yank by plaintiff less the amount received from Yank. Defendant refused to grant plaintiff's requested treatment and on April 5, 1974, this action commenced.
In order for a summary judgment motion to be granted the movant must show two things: (1) there is no genuine issue as to any material fact and (2) he is entitled to judgment as a matter of law. Fed. R. Civ. Proc. 56(c); see generally 6 Moore's Federal Practice §§ 56.09-56.23 (1974). It is clear that plaintiff may not rely on the conclusory allegations in his complaint, but must submit sufficient evidence to demonstrate that there is a genuine issue as to a material fact. Kirkland v. National Broadcasting Co., Inc., 425 F. Supp. 1111, 1114 (E.D. Pa. 1976). I find no factually disputed issues which are material and accordingly resolve the instant motions solely on the questions of law.
Section 166(a) of the Internal Revenue Code (Code), 26 U.S.C. § 166(a), provides that, in computing taxable income, a taxpayer may take a deduction for any debt owed to him that becomes worthless (bad debt) within the taxable year. The starting point for any consideration of this deduction is whether the investment in question was a debt or not. "A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. A gift or contribution to capital shall not be considered a debt for purposes of section 166." Treas. Reg. § 1.166-1(c). Although plaintiff does not address this question, it must be the initial inquiry.
In this regard, Section 385 of the Code sets forth a number of criteria that the Secretary of the Treasury may apply in determining whether any advance is to be considered within a debtor-creditor relationship or a corporation-shareholder relationship.
Interestingly enough, the Secretary has yet to prescribe regulations under this section, although it was originally enacted on December 30, 1969. Consequently, exactly which standard to apply has been of some difficulty and, as I pointed out in Scriptomatic, Inc. v. United States, 397 F. Supp. 753 (E.D. Pa. 1975), aff'd 555 F.2d 364 (3d Cir. 1977), the "result has been a plethora of ambiguous and contradictory opinions." Id. at 758. For instance, a list of sixteen factors was identified by the Third Circuit in Fin Hay Realty Company v. United States, 398 F.2d 694, 696 (3d Cir. 1968), but where not all the criteria are pertinent, an analysis of a lesser number will suffice. Joseph Lupowitz Sons, Inc. v. Commissioner of Internal Revenue, 497 F.2d 862, 865-66 (3d Cir. 1974); Trans-Atlantic Co. v. Commissioner of Internal Revenue, 469 F.2d 1189, 1192-93 (3d Cir. 1972).
However, as Judge Reedman pointed out in Fin Hay, no single criterion or group of criteria is decisive in this determination and the factors should only be used as aids in analyzing the realities of the transaction, i.e., whether it is actually a contribution to capital or a true loan. 398 F.2d at 697. In any case, the burden is on the taxpayer to demonstrate that the advances were indeed indebtedness. P. M. Finance Corp. v. Commissioner of Internal Revenue, 302 F.2d 786, 789 (3d Cir. 1962).
Three primary facets of the advances must be considered in determining whether debt or equity was created: (1) the form of the instruments; (2) the intent of the parties, and (3) the objective economic reality as it relates to the risks taken by investors. This analysis can only lead to the conclusion that the advances here were capital contributions.
First and foremost in this case is the absence of a written document which would create in taxpayer an unconditional right to demand payment. There are no papers or other formal indicia evidencing the arrangement, with the possible exception of a February 7, 1967, note from Yank to Fischer.
See Fin Hay, supra (criteria 7); Lupowitz, supra (criteria e). Thus, there was no provision for interest, no enforceable obligation on Yank's part to repay the funds advanced, no maturity date, no provision for prepayment by the corporation, Fin Hay, supra (criteria 10, 13, and 14); Lupowitz, supra (criterind g), and no provision for superiority of lien on Yank's assets.
The absence of an unconditional right to demand payment is practically ...