Ganey and Adams, Circuit Judges, and Weis, District Judge.
The appeals in these three consolidated actions pose the recurring issue whether sums withdrawn from a corporation by a taxpayer owning all of its common stock were dividends to be taxed, as ordinary income, or loans, the total of which could be treated as long-term capital gains upon the sale of the corporation. The district court found that they were dividends rather than loans for the taxable years 1958, 1961 and 1962, and ordered judgment be entered in favor of the United States in each of the actions for refunds of taxes and interest on behalf of the taxpayer's estate, and by the taxpayer's widow.*fn1
During the year 1957, through July 15, 1963, the taxpayer, John R. Taschler, was employed as president of Down-State Finance Corporation, a small loan (up to $600) company, with its office and principal place of business in Bradford, Pennsylvania. From the time it was organized until it was sold, the taxpayer received annually from Down-State the following salaries paid on a monthly basis: 1957, $19,980; 1958, $21,980; 1959, $22,980; 1960, $19,860; 1961, $14,400; 1962, $14,400 and 1963, $6,600. They totaled $100,220 and averaged about $1,200 a month. The taxpayer, at his discretion within limits, fixed the amount of his salary and the time of its receipt.
Beginning in late 1958, the small loans business began to fall off and the taxpayer sought to make investments elsewhere. During the five and one-half years from the end of 1957, through July 15, 1963, the following amounts totaling $102,000 were advanced in twenty-three payments of between $500 and $24,000 to the taxpayer at his request for his personal use from Down-State: 1958, $27,000; 1959, $13,000; 1960, $10,000; 1961, $10,000; 1962, $17,000 and 1963, $16,500. For 1963 and the three years involved, they totaled $70,500. These payments approximated $1,500 a month. Each time, with a few exceptions, when the taxpayer would request informally the office manager of Down-State to forward him a check drawn on Down-State for one of the twenty-three disbursements, he would send him a signed unsecured demand note for the total amount withdrawn up to that time, and the previous note was either destroyed or returned to the taxpayer.*fn2 But for a $5,000 payment in 1959, a year not involved here except for evidentiary matters, the taxpayer never paid Down-State any sum of money to offset the total amount withdrawn. However, the amount of his monthly salary check was reduced by a sum equal to the monthly charge of the rate at one-half of one percent on the total amount withdrawn up to that time. A notation of this amount was made in the records of Down-State under the heading "Memorandum of loans, interest repayments, etc." During the same period in which the above withdrawals were made, no formal dividends were paid by DownState on its common stock.*fn3 A dividend of $2,349 was paid in 1957.
For some years the taxpayer had contemplated selling Down-State, and on July 15, 1963, he sold his common stock in that corporation to Carson Finance Company for $100,000. Upon the completion of the sale, his demand note to the corporation for $97,000 ($102,000 minus $5,000) was marked paid by Down-State's officer manager and returned to the taxpayer. He died less than a month later on August 6, 1963. The income tax return for 1963 filed on behalf of taxpayer's estate listed the sales price of Down-State as being $197,000 ($100,000 plus the face amount of taxpayer's demand note) and after the original cost ($78,000) and other expenses were subtracted from the sales price, treated the gain, for income tax purposes, as a long-term capital gain. In 1965, Internal Revenue Service audited the 1963 tax return and also those filed by the taxpayer for the years 1958, 1961 and 1962. The years 1959 and 1960 were not available for auditing. The Service reduced the capital gain figure of the 1963 return by $70,500, the total of the amounts advanced to him as loans by Down-State in 1958, 1961, 1962 and 1963, and entered as dividend income on taxpayer's returns for each of the years 1958, 1961 and 1962, and also the 1963 return filed on behalf of his estate the amount received by him in each of those years. Taxpayer's estate paid the increased tax assessment*fn4 of $7,875.13, plus interest of $4,947.22, for the years 1958, 1961 and 1962, and brought three separate actions for refunds, one for each of those years.
The district court found from the circumstances surrounding the payments that the taxpayer never intended to actually repay any part of the $97,000 withdrawn from Down-State. The court's findings, unless clearly erroneous, may not be set aside. Rule 52(a) of the Federal Rules of Civil Procedure; Commissioner of Internal Revenue v. Duberstein, 363 U.S. 278, 80 S. Ct. 1190, 4 L. Ed. 2d 1218 (1960).
The estate claims the findings were erroneous on a number of grounds. One is that the "debt" of $97,000 was repaid when Down-State was sold, and this was long before the "investigation" of taxpayer's previous tax returns occurred. Repayment of funds received is an important factor in determining whether those funds were loans. The contention here begs the question. whether the amount was repaid depends on whether the amounts paid the taxpayer during the six and one-half years were in fact loans. This Court in C.I.R. v. Makransky, 321 F.2d 598, 600 (C.A. 3, 1963), stated:
"While in many cases various factors must be weighed in determining for income tax purposes the true character of a purported loan, there is one essential without which a transaction cannot be recognized as a loan. The parties must have entered into the transaction with the intention that the money advanced be repaid."*fn5 (Cited authorities omitted.)
The district court found that: "The evidence in the cases clearly shows that Mr. Taschler handled the corporate funds as his own and withdrew sums at will as needed by him with no real intention of even repaying the monies to the corporation." The evidence produced at a trial to the court sitting without a jury supports the court's finding on this vital issue.
With the exception of the day-to-day routine small loan transactions, taxpayer was in complete control of Down-State. He decided when the notes of small loan customers should be assigned to other lending institutions for loans. In a letter to the Service dated September 28, 1959, the taxpayer admitted: "Inasmuch as I am owner of Down-State Finance Corp., I utilize the money in that Corporation for my own personal use when necessary. As you will note, I paid off my mortgage loan and personal loan of $15,000 to Producers Bank & Trust Co., through a loan acquired from them August 30th, 1958." He instructed the office manager of Down-State to permit taxpayer's personal friends to receive loans in excess of the $600 maximum. Dan White borrowed $10,000, Andy George $1,500, and Dan's Auto Mart, in which he held a half interest, $6,000. All of these were without collateral, and the last one mentioned was without a note. Additionally, DownState purchased a $5,000 saving certificate from Seneca Finance Company, an institution in which taxpayer was making an investment. When he sustained a loss in the used car selling venture and the loan to Dan White became uncollectable, he instructed the office manager to increase the allowance for bad debts so as to absorb the loss in whole or in part.
In support of its pivotal finding on the issue of intent, the district court found that the taxpayer, after 1958, did not have the financial ability to repay the withdrawals. The estate argues that this finding is completely erroneous. Where a taxpayer is financially unable to repay amounts claimed to be loans from his closely held corporation, it is some indication that he never intended to repay the sum in the ascertainable future. See C.I.R. v. Makransky, supra. On the other hand, the fact that he is able during a part or all of the periods in question need not, as a matter of law, prevent the fact-finder from concluding that the intent to repay did not exist. But since the court's finding appears to be an important factor in its ultimate finding on taxpayer's intent, we will canvass the evidence on this point.
When the taxpayer began withdrawing funds from Down-State he was financially able to repay those funds. As the withdrawals increased, we think the evidence supports the inference that unless he sold his interest in DownState or borrowed elsewhere, ...