The opinion of the court was delivered by: COHEN
Plaintiff, WOFAC CORPORATION,
a Delaware corporation, engaged in the management-consultant business, seeks refund of corporate income taxes paid, which it claims were improperly assessed in the amount of $26,371.17, together with statutory interest thereon. Jurisdiction is properly invoked pursuant to 28 U.S.C. § 1346(a)(1).
The matter was tried to the Court without a jury, therefore, the stipulations of facts, as supplemented by brief oral testimony offered primarily for the introduction of documentary exhibits, shall constitute the matrices of this opinion in lieu of findings of fact and conclusions of law required under F.R. Civ. P. 52.
Application for the refund was filed by the plaintiff corporation in February of 1959, for a claimed net operating loss for 1958, in the amount of $14,523.82, which it sought to apply to its net income for 1957 of $8,593.48, leaving the sum of $5,930.34 as a carryover deduction against income of succeeding years. The claim was rejected by the Internal Revenue Service; additionally, it examined the 1957 and 1958 returns and disallowed the corporation's accumulated net operating losses aggregating $38,595.71 and the loss of $14,228.02 on the sale of its land, factory building, machinery and equipment that was claimed in its 1957 income tax return and as well, the sum of $435.75 of its 1958 net operating loss of $14,523.82, which was attributable to the sale of its inventory and which had been claimed on its 1958 income tax returns. The reasons assigned by the Internal Revenue Service for its disallowance of the net operating loss deduction, and for the loss claimed on the sale of the business property was that these losses were incurred in a business different from the one which had produced the profits sought to be offset.
The disallowance of the $435.75 portion of the 1958 net operating loss was ruled to be a loss sustained in the sale of material which represented the business activity of a corporation other than the taxpayer corporation which sought the deduction.
The determination was made that the losses were incurred by Warsaw Products, Inc., a New York woodworking corporation, whereas the taxpayer which sought deduction against its income was a Delaware corporation engaged in the management-consultant business, now known as WOFAC Corporation. Accordingly, the Internal Revenue Service made a deficiency assessment of $16,533.11 against plaintiff for the year 1957. Assessments made for this and subsequent years were paid and totaled the amount sued for.
These rulings gave rise to the present action to recover the amounts of taxes paid for 1957 and subsequent years that are attributable to the disallowance of deductions taken by the plaintiff corporation for the net operating losses sustained by it, prior to the transfer in 1957 to it of the management-consultant business.
While the parties have stipulated certain facts and events, the complexity of the legal issues involved prompts incisive treatment of the generic structure of the plaintiff corporation.
In 1951, four equal partners, James H. Duncan, William G. O'Brien, Joseph H. Quick, and George A. Goodwin owned a partnership located in New York City, New York, known as The Work-Factor Company which had engaged in a management-consultant business for a number of years.
Early in 1951, the partners learned of an opportunity to purchase the assets of a woodworking corporation known as the Warsaw Button Co., a New York corporation. Instead of purchasing and conducting the woodworking business through their partnership, the four partners formed a corporation on March 13, 1951 under the laws of the State of New York, known as Warsaw Products, Inc. The four partners became its sole stockholders and its capital stock was issued to them in equal shares. Because under New York law five directors were required, George A. Goodwin transferred a nominal part of his shares to qualify his wife.
In order to finance the purchase of the Warsaw Button Co., the assets of which totalled $50,000.00 (comprising inventory of raw materials $2,199.39; inventory of work in process $615.61; machinery and equipment $4,806.00; office equipment $279.00; land $2,600.00 and building $39,500.00),
the new corporation, Warsaw Products, Inc., negotiated a loan with the Wyoming County Bank and Trust Company, of New York. On March 16, 1951, before any funds were advanced by the bank on a mortgage loan of the same date in the amount of $35,000.00, with a 5 year amortization term, the four partners, together with their respective wives, were required and did execute an agreement to guarantee payment of the mortgage loan with interest, severally to the extent of $3,750.00, and jointly in the aggregate, $15,000.00; the guarantee agreement also provided for the application of all mortgage payments first to the portion of the loan not so guaranteed, i.e. the unpaid balance.
The purchase of the woodworking business was effected and it was operated by the new corporation, Warsaw Products, Inc., during the remainder of 1951 and 1952. The anticipated ability of the corporation to operate the woodworking business at a profit did not materialize. Using the calendar year for its accounting base, for 1951 it showed a net operating loss of $11,418.55; for 1952 it showed another net operating loss in the amount of $10,808.03. In face of these losses, the woodworking activity, as such, was discontinued after 1952. Thereafter, the corporation sought to sell or rent its factory building, as well as its inventory, machinery and equipment. It was not able to do so at that time.
Unlike its failure in the woodworking venture, during the years of 1951 and 1952, the management-consultant partnership, the Work-Factor Company, prospered. In 1951 its gross income was $95,263.35, with a net distributable to the partners of $27,509.50; in 1952 its gross income was $151,784.71, with a net distributable of $59,891.16. And since the corporate assets of the discontinued woodworking business exceeded its liabilities and were a source of potential capital gain, the partnership advanced various sums of money to it during 1953 aggregating $5,500.00 with which it paid its accruing debts for interest, taxes, insurance and for the amortization of its mortgage, as the individual partners and their wives had guaranteed, as stated above, a portion of the unpaid balance of the mortgage loan. (See 26 U.S.C. § 1231, infra Capital gain and ordinary loss.)
So also in the years 1953, 1954, 1955 and 1956, the corporation continued its endeavors to rent or sell its assets, but unsuccessfully; the partnership continued to advance money to it to meet its current and accruing obligations. In 1954 the advances aggregated $6,833.55; in 1955, $4,685.00; and in 1956, $3,037.50, all by way of partners' loans to the corporation.
On January 1, 1956 the remaining three partners formed a new partnership, and the loans to the corporation still being outstanding, the capital accounts of the three remaining partners were adjusted to charge them respectively with one-third of the aggregated advances for the years 1953 to 1955 inclusive.
Warsaw Products, Inc. continued to flounder during the years 1953, 1954, 1955 and 1956, showing net operating losses for those years, respectively, of ...