Opinion
No. 68444.
March 6, 1936.
This proceeding is for the redetermination of a proposed deficiency in income tax for the year 1929 in the sum of $2,016.49.
Petitioner claims there is no deficiency and that he is entitled to a refund of $406.30.
Philip D. Johnston, Esq., for the petitioner.
Eugene G. Smith, Esq., for the respondent.
1. Money obtained to carry on a business under a contract purporting to be an outright sale and purchase of accounts held to be advancements in the nature of loans, notwithstanding the form of the contract and that it violated the law of the state of the contracting parties as to usury.
2. Where merchandise shipped to petitioner's customers was not repurchased by petitioner in accordance with a contract existing between him and his customers, wherein he was obligated to repurchase if a specified amount had not been resold by him within a given time, held the title to such merchandise was in customers and it should not be included in inventoried assets taken over when the business was incorporated.
FINDINGS OF FACT.
The petitioner was doing business as an individual, in the name of the California Grape Concentrators, and continued as an individual until August 31, 1929, at which time the business was incorporated in the name of the California Grape Concentrators, Ltd. All accounts and assets were transferred to the corporation and the business was thereafter conducted by the corporation.
The business consisted of selling concentrates, or condensed grape juice, to jobbers or wholesalers and through them to retailers. Contracts in writing made with petitioner's customers provided that petitioner would resell 75 or 80 percent of the amount of merchandise ordered. As resales were made, petitioner's customers were to pay 25 percent of the total bill when 25 percent of the goods had been resold, and 25 percent more when an additional 25 percent had been resold, and the balance when 75 or 80 percent had been resold. Bills did not become due and payable unless petitioner made the resales for his customers within the period specified, generally 90 days. . Petitioner paid the freight to destination and furnished and paid salesmen for making resales until the required 75 or 80 percent had been resold. If the required amount had not been resold within the time specified, petitioner was under obligation to repurchase all remaining unsold merchandise at cost, or continue his selling efforts until the required amount was resold. The customer was under no obligation to make resales until after the 75 or 80 percent of the merchandise ordered had been resold by the petitioner. As merchandise was shipped to customers, bills for the entire purchase price were made out and entered on the books of the petitioner to be paid by the customers as resales progressed, as above stated. Petitioner made all collections from his customers and credited all collections on his books as made.
Petitioner needed money to carry on his business. He could not get sufficient bank credit, and on March 15, 1929, entered into a written contract with Pacific Factors, Inc., in which it was provided that Pacific Factors, Inc., were to buy such accounts of petitioner as were acceptable to it and agreed to pay petitioner therefor, upon acceptance, 80 percent of the full face value of such accounts, less a discount of 1¼ percent per month of their accepted face value, prorated per day over the time required to make collections, less a service charge of ½ percent on the first $200,000 annual business. The contract further provided that if Pacific Factors, Inc., received more than the acceptable face value of the accounts so purchased, it was to pay in cash the excess thereof to petitioner at the end of the credit term of such accounts, less any deductions, discounts and the service charge. It was further provided that any moneys, accounts, or properties of petitioner in the hands of Pacific Factors, Inc., might be held to satisfy any breach of contract or warranty, and later applied to any accounts or further indebtedness of petitioner to Pacific Factors, Inc. Thoughout the contract expressions of "sale" by petitioner and "purchase by Pacific Factors" are used.
As merchandise was shipped by petitioner to his customers, bills therefor were made out for the purchase price and a list of the bills by invoice numbers, together with bills of lading, was listed on a schedule and the schedule and bills of lading attached were delivered to Pacific Factors, Inc.
The accounts of the petitioner were never delivered to Pacific Factors, Inc. All it received was a schedule or printed form listing the names and amounts of the invoices with copies of bills of lading attached. The accounts were retained by petitioner and collected direct by him from his customers, and as collections were made they were turned over to Pacific Factors, Inc., either in cash or by delivering checks given in payment on the accounts. Customers had no dealings with Pacific Factors, Inc., nor had Pacific Factors, Inc., with petitioner's customers. If payments received from customers and delivered by petitioner to Pacific Factors, Inc., did not repay Pacific Factors, Inc., by the end of 60 days, petitioner was required to use his own funds for this purpose, or substitute other schedules of accounts. Upon receipt of the amount advanced on a schedule, after making deductions aforesaid, the schedules were returned to petitioner and any accounts on the schedule not paid were released to petitioner and petitioner was entitled to any payments thereafter made on accounts listed in such schedule. Accounts listed on the schedule turned over to Pacific Factors, Inc., were kept on the books of petitioner as open accounts and were not closed on his books until paid by his customers. In the schedules listing the accounts delivered to Pacific Factors, Inc., petitioner certified the parties named as owing the accounts were indebted to him in the amounts specified for personal property sold and delivered, or for work and labor done. Petitioner represented in the schedules that they set forth undisputed open accounts then owing to him for bona fide sales and deliveries of merchandise; that he sold, assigned, and set over to Pacific Factors, Inc., all his right, title, and interest in and to the open accounts and contracts listed, represented by invoices and shipping documents, including all moneys due and to become due upon the same and absolute title to the merchandise represented thereby, including all merchandise returned, rejected, or reassigned, together with the right of stoppage in transit. The schedules further recited that the accounts and contracts listed were purchased and paid for by Pacific Factors, Inc., and that the same were sold and purchased pursuant to and in accordance with the terms of the contract of March 15, 1929.
Under this arrangement petitioner received from Pacific Factors, Inc., from time to time during the period from January 1 to August 31, 1929, $135,223.28. Petitioner claims the moneys received from Pacific Factors, Inc., under the contract of March 15, 1929, were advancements in the nature of loans. Respondent claims it was money received by petitioner on a sale of accounts to Pacific Factors, Inc., under the contract of March 15, 1929. The business finally went bad, resales could not be made, customers did not pay their accounts to petitioner, and petitioner was in default with Pacific Factors, Inc. Suit was instituted by Pacific Factors, Inc., to recover the balance it claimed petitioner owed it.
Petitioner further contends that the unsold merchandise in the hands of his customers at the time the business was incorporated was out on a consignment and should be added to his inventory at the time the business was taken over by the corporation. Respondent contends the undisposed of merchandise in the hands of petitioner's customers had been sold by petitioner to his customers and that the same was customers' property until repurchased or taken back by petitioner.
OPINION.
ARNOLD: Under the above state of facts was the $135,223.28 received by petitioner from Pacific Factors, Inc., prior to the incorporation of petitioner's business, income to petitioner from the sale of his accounts, or was it money advanced to him in the nature of loans? Respondent contends that under the contract of March 15, 1929, petitioner sold and Pacific Factors, Inc., bought outright the accounts of petitioner's customers and the use of the words, sale and purchase, and other like expressions in the contract are controlling on the issue here presented. He further contends that any evidence tending to prove the moneys received from Pacific Factors, Inc. were received as advancements in the nature of loans, is in conflict with the contract of March 15, 1929, and is incompetent, and that such construction would be in effect placing the stamp of approval on a contract in violation of the law of California as to usury. While the contract carries language indicating a sale and purchase of the accounts, we should consider the whole contract and all facts and circumstances in connection with the method of conducting the business to ascertain the merits of the controversy. Pacific Factors, Inc., advanced petitioner 80 percent of the face value of the accounts
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which was determined as the accepted value. Petitioner was charged with a discount at the rate of 1¼ percent per month, prorated per day until the amounts received were repaid. This discount was not taken when the money was advanced but collected when repayment was made by a charge against petitioner. This so-called discount of 1¼ percent per month, prorated per day over the time required to make collections, was equivalent to interest at the rate of 15 percent per annum during the time petitioner had the use of the money. In addition to that there was a service charge of ½ of 1 percent of the accepted value of the accounts in the schedules. Petitioner was required to take up the schedules listing accounts which were not paid and substitute new schedules of accounts, or pay the difference between the amount advanced and the amount collected in cash. The schedules were then returned to petitioner. Collections on accounts in schedules returned to petitioner were retained by him. Pacific Factors, Inc., never had the accounts in its possession and had nothing to do with their collection. Pacific Factors, Inc., brought suit to recover the amount it claimed petitioner owed it, which shows that it considered the transactions as loans. The method of handling the business indicates petitioner considered it as advancements in the nature of loans. It is proper in the construction of contracts to take into consideration the acts of the parties themselves under the contract in arriving at the true intention of the parties in entering into the contract. This does not do violence to the rule against varying the terms of a written contract by parol. 13 Corpus Juris, p. 546, sec. 517; 13 Corpus Juris, p. 549, and cases thereafter cited. Woodard v. Glenwood Lumber Co., 153 Pac. 951; 171 Calif. 513. In the appeal of J. W. Solof, 1 B. T. A. 776, acquiesced in by the Commissioner, evidence was held admissible to show that a transaction with a bank, while in the form of a sale of stock to the bank, was a pledge for a loan and the amount so received was not proceeds of a sale but a loan to taxpayer.
In Peugh v. Davis, 96 U. S. 332, it was held that the rule against varying or contradicting writings by parol evidence obtained only in suits between, and was confined to, the parties to the contract and their privies and had no operation with respect to third persons, or even the parties themselves in controversy with third persons. Sigua Iron Co. v. Greene, 88 Fed. 207; O'Shea v. New York C. St. L. R. Co., 105 Fed. 559; Mitchell v. McShane Lumber Co., 220 Fed. 878. See also Gates v. Helvering, 69 Fed. (2d) 277, affirming 26 B. T. A. 998, on the points here involved. In William J. Snyder, 11 B. T. A. 807, an absolute conveyance for a recited consideration of $23,385.41, receipt of which was acknowledged in the instrument, was shown to be a conveyance in trust, the proceeds of sale to be used by trustee to pay grantor's debts, and the acknowledged consideration not taxable to grantor as income. In First National Bank in Wichita, 19 B. T. A. 744; aff'd., 57 Fed. (2d) 7, a customer of the bank, a dealer in securities, could not get a sufficient line of credit by direct loans on account of the limitations of the Federal banking laws. Certain tax-exempt bonds were turned over to petitioner bank, under a contract on its face a sale and purchase, with a repurchase agreement. Interest coupons on the bonds at maturity were delivered to the customer, who collected them and paid the bank at a rate of interest provided to be paid in the sale and repurchase agreement. Taxpayer claimed it acquired complete title to the bonds, and as the interest on the bonds was tax exempt it was entitled to exclude such interest from his income tax returns. Holding against petitioner's contentions, the Board said:
The question here, as we view it, is not dependent upon who held the bare legal title to the bonds during the dates of sale and repurchase, but rather upon the broader issue as to whom, under the understanding between the bank and its customers, was entitled to receive, and who, as carried out, did receive the interest payments made by the issuing authorities of such bonds when collected and paid. The record shows that the true relationship between the petitioner and its customers, in these transactions, was that of a lender of money in consideration for the legal rate of interest payable on the amount advanced, and not that of an investor in the securities assigned to it by such customers. The history of these transactions and the manner in which they were carried out can lead to no other conclusion.
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The true relationship between the petitioner and the customer, in these transactions, was that of borrower and lender, in which the securities were employed as a mere convenience. In these circumstances, the ad interim ownership of the bare legal title to the bonds would not affect the character of the transactions between the parties or change their true relationship. Peugh v. Davis, 93 U. S. 332; Jackson v. Laurence, 117 U. S. 679; Morris v. Nixon, 1 How. 117; and see also Russell v. Southard, 12 How. 139.
Also compare Sioux Falls Metal Culvert Co., 26 B. T. A. 1324. Arthur R. Jones Syndicate v. Commissioner, 23 Fed. (2d) 833, reversing Arthur R. Jones Syndicate, 5 B. T. A. 853.
Arthur R. Jones Syndicate v. Commissioner, supra, was a case where resort was had to a scheme to issue and in form sell preferred stock and provide for dividends to be paid at the rate of 14 percent per annum to avoid the transaction from being usurious under the Illinois law. Notwithstanding it violated the Illinois law as to usury and the form of the transaction was an outright sale of the preferred stock, it was held to be a loan and the usurious interest deducted from taxpayer's income. The Seventh Circuit Court of Appeals, in reversing the Board, said:
But the better reasoning sustains the view that a borrower whose necessities lead him to the door of the usurer may always show — by evidence aliunde the contract — the real character of the transaction. The very necessities of the borrower who pays a usurious rate of interest make it necessary for courts to admit his oral testimony to dispute his written word. Houghton v. Burden, 228 U. S. 161, 170, 33 S. Ct. 491, 57 L. Ed. 780, 27 R. C. L. 212. For an additional reason such evidence is admissible against third parties. [Citing authorities.]
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We therefore conclude that a taxpayer who borrows money at a usurious rate of interest and who, to conceal the usury, is compelled to execute a document which does not correctly describe the relationship of the parties, may, as against the government, disclose the true relationship of debtor and creditor. Sums by it paid as interest, regardless of the name by which it is called, may be deducted by the taxpayer from its income.
We hold the $135,223.28 received by petitioner from Pacific Factors, Inc., was advancements in the nature of loans and not money received outright on sales to be accounted for as gross income. The moneys received by petitioner from his customers should be included in his gross income.
Petitioner contends that the unsold goods in the hands of his customers at the time the business was incorporated was out on consignment and should therefore be included in the inventory at the time of incorporation and not treated as gross income from sales. Under Regulations 74, article 101, applicable to the year in question, it is provided that only merchandise, title to which is vested in the taxpayer, should be included in the inventory and that there should be excluded from the inventory goods sold, title to which had passed to the purchaser. The Grape Juice Concentrates were sold and delivered to petitioner's customers and a bill for the purchase price was rendered when the merchandise was shipped. Under the contract between the petitioner and his customers and the method of billing and handling the accounts, it was a sale and purchase on a deferred payment plan, with the obligation on the part of the petitioner to repurchase such quantities as were not sold in accordance with the terms of the contract. Petitioner so treated it in his dealings with Pacific Factors, Inc. The schedules delivered to Pacific Factors, Inc., contained a list of accounts, together with bills of lading, and petitioner in the schedules on which he received money certified to Pacific Factors, Inc., that the amounts listed were due and owing to him in the amount specified for personal property sold and delivered; that the accounts listed in the schedules were undisputed, open accounts for bona fide sales and deliveries of merchandise; that there were no offsets or counter claims. A form of contract between petitioner and his customers was submitted in evidence as an exhibit, in which the transactions were treated as sales, and provided for repurchase of any unsold portions of grape concentrates if the required amount had not been resold by him. Under such circumstances, the merchandise outstanding which petitioner had not repurchased or revested title in himself should not be included in the inventory of property taken over by the corporation.
Judgement will be entered under Rule 50.