Petitioners were U.S. shareholders of a controlled foreign corporation. That corporation "invested" funds in, and also subordinated an indebtedness to it from, a domestic corporation whose stock was also owned by petitioners.
60 T.C. 425">*425 Respondent determined the following deficiencies for 1964 in these consolidated cases:
| Docket | Petitioners | Deficiency |
| No. | ||
| 5516-67 -- | Clayton E. Greenfield and Carmen F. Greenfield | $ 43,264.00 |
| 5530-67 -- | Fred S. Bugg and Pauline C. Bugg | 34,594.56 |
The only question presented is whether each petitioner 1 is properly chargeable with $ 100,000 of income as a result of an alleged increase in the investment of their controlled foreign corporation in U.S. property; alternatively, respondent asserts that each petitioner received a $ 100,000 dividend from their controlled foreign corporation.
FINDINGS OF FACT
Some of the facts have been stipulated and are incorporated herein by reference.
The parties in these cases filed joint returns for the 1964 calendar year with the district director of internal revenue, Jacksonville, Fla.; 60 T.C. 425">*426 they resided in Dade County, Fla., at the time the petitions herein were filed.
At all times 1973 U.S. Tax Ct. LEXIS 108">*110 pertinent herein, Clayton E. Greenfield (hereinafter Greenfield) and Fred S. Bugg (hereinafter Bugg) each owned 50 percent of Carline Electric Corp., a Florida corporation formed in 1957 and henceforth referred to as Domestic, and Carline Ltd., a Bahamian corporation formed in 1958 and henceforth referred to as Offshore. At all times relevant herein, Offshore was a controlled foreign corporation under section 957. 2Both corporations were engaged in the electrical-contracting business and related activities, Domestic in the United States and Offshore in and around the Bahamas and Bermuda. The officers of Domestic were as follows: Greenfield, president; Bugg, vice president; Carmen F. Greenfield, secretary-treasurer. Bugg was also vice president of Offshore. 3
Domestic provided a number of services to Offshore including procuring materials and manpower and preparing estimates which Offshore utilized in formulating bids. 41973 U.S. Tax Ct. LEXIS 108">*111
It was tacitly understood that Domestic would procure any materials needed for Offshore's operations. Domestic charged Offshore cost plus 15 percent for goods and services in 1964; in earlier years, the additional charge was 5 to 10 percent. Offshore customarily advanced sums to Domestic in order to permit the latter to take advantage of discounts for cash purchases, prepay freight charges, and pay customs duties in order to receive materials from the docks.
Transactions between the two corporations were reflected in an open account maintained by each corporation on its books. For Offshore's fiscal years ended August 31, 1959, through August 31, 1965, the accounts reflect the following:
| Open balance | Amounts billed | Amounts paid | Closing balance | |
| FYE Aug. 31 -- | in favor of | to Offshore by | to Domestic by | in favor of |
| Domestic | Domestic | Offshore | Domestic 11973 U.S. Tax Ct. LEXIS 108">*112 | |
| 1959 | $ 85,938 | $ 64,516 | $ 136,072 | $ 14,382 |
| 1960 | 14,382 | 145,787 | 161,996 | (1,827) |
| 1961 | (1,827) | NA | NA | (41,208) |
| 1962 | 2 (41,208) | NA | NA | (95,342) |
| 1963 | (95,342) | 41,881 | 10,595 | (64,056) |
| 1964 | (64,056) | 128,098 | 158,056 | (94,014) |
| 1965 | (94,014) | 98,804 | 100,025 | (95,235) |
This account did not bear any interest.
60 T.C. 425">*427 Offshore's earnings and profits totaled $ 167,296 5 and $ 241,545.56 as of August 31, 1963, and August 31, 1964, respectively.
In 1964, Domestic was the successful bidder on an electrical-contracting job for the U.S. Navy at Key West, Fla. Under the terms of the contract, a performance bond was required. Domestic sought to obtain one from Travelers Insurance Co. (Travelers). Normally, both corporations and all four petitioners subjected themselves to liability on a bond issued for either Offshore or Domestic. In this instance, Travelers insisted that Domestic increase its paid-in capital account by $ 100,000 and that Offshore subordinate $ 100,000 of the open-account indebtedness to Traveler's bond. These requirements were met through the two transactions hereinafter described.
In July 1964, Domestic by corporate resolution authorized the issuance to Bugg and Greenfield of 50 shares each of preferred stock at $ 1,000 1973 U.S. Tax Ct. LEXIS 108">*113 per share. 6 Similar authorization is contained in an undated extract of minutes signed by its secretary (Carmen F. Greenfield) and president (Greenfield), which also recites an indebtedness of $ 50,000 each to Greenfield and Bugg. The stock was not issued. On or about July 8, 1964, Offshore drew two checks of $ 25,000 each, payable to Bugg and Greenfield, respectively. They endorsed the checks and on July 10 the checks were deposited in Offshore's Miami checking account. Then, on July 16, the money was transferred to Domestic's account. On August 1, 1964, Offshore drew a $ 50,000 check payable jointly to Bugg and Greenfield; this check was deposited directly into Domestic's account on August 10, 1964. Two notes of $ 50,000 each were drawn in favor of Bugg and Greenfield, respectively, backdated to December 1, 1963. 7
Domestic kept its books and records and filed its tax returns on the basis of a fiscal year ending July 31. Schedule E (compensation of officers) of the fiscal 1964 Federal income tax return of Domestic showed that it had preferred 1973 U.S. Tax Ct. LEXIS 108">*114 stock issued with 50 percent being owned by Bugg and 50 percent by Carmen F. Greenfield. Schedule L (balance sheets) of that return showed $ 100,000 of preferred stock as of the close of the taxable year as compared with zero at the beginning of the taxable year.
Schedule E (compensation of officers) of the fiscal 1965 Federal income tax return of Domestic showed that it had preferred stock 60 T.C. 425">*428 issued, with 46.91 percent owned by Greenfield and 46.91 percent owned by Bugg. 8 Schedule L (balance sheets) of that return showed zero preferred stock at both the beginning and the end of the taxable year. 9
On or about January 13, 1965, Domestic issued two $ 45,000 checks to Bugg and Greenfield, respectively. On January 14, they deposited these checks in Offshore's Canadian account, and then immediately deposited them back into Domestic's Miami account. The redeposit of the moneys to Domestic's account was allegedly due to that corporation's financial instability due to its failure to make a profit on the Key West job.
As 1973 U.S. Tax Ct. LEXIS 108">*115 of July 31, 1964, Domestic carried a balance in favor of Offshore in the amount of $ 94,129.53. In order to meet the subordination requirements of Travelers, that account was charged with $ 100,000, leaving a debit balance in favor of Domestic of $ 5,870.47. No money actually changed hands, but an unsigned, non-interest-bearing promissory note for $ 100,000 in favor of Offshore, subordinated to Travelers' bond, and payable on demand only upon approval from Travelers, was created, also backdated to December 1, 1963. 10
Schedule L (balance sheets) of Domestic's Federal income tax returns for fiscal 1964 and 1965 showed the following:
| Mortgages, Notes, and Bonds Payable in Less Than 1 Year | ||
| Year | Beginning of year | Ending of year |
| 1964 | 0 | $ 2,638 |
| 1965 | $ 2,638 | 32,696 |
| Mortgages, Notes, and Bonds Payable in 1 Year or More | ||
| Year | Beginning of year | Ending of year |
| 1964 | 0 | $ 100,827 |
| 1965 | 11 $ 200,827 | |
OPINION
The focus 1973 U.S. Tax Ct. LEXIS 108">*116 of this case is the provisions of subpart F of part III, subch. N, ch. 1, I.R.C. Although we fortunately are relieved of the necessity of dealing herein with many of the complexities of those 60 T.C. 425">*429 provisions, we are nevertheless reminded of Judge Learned Hand's telling remarks, in commenting on the income tax act:
In my own case the words of such an act * * * merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception -- couched in abstract terms that offer no handle to seize hold of -- [leaving] in my mind only a confused sense of some vitally important, but successfully concealed, purport, which it is my duty to extract * * * 12
Having, we think, penetrated the veil of confusion, we proceed to discharge our duty of extraction. Our starting point is
(a) Amounts Included. -- (1) In General. -- If a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any taxable year beginning after December 1973 U.S. Tax Ct. LEXIS 108">*117 31, 1962, every person who is a United States shareholder (as defined in subsection (b)) of such corporation and who owns (within the meaning of section 958 (a)) stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends -- * * * * (B) his pro rata share (determined under
The parties agree that Offshore was a controlled foreign corporation (as defined in section 957(a)) during fiscal year 1964 and that petitioners were U.S. shareholders as that term is used in
60 T.C. 425">*430
(C) any obligation of a United States person arising in connection with the sale or processing of property if the amount of such obligation outstanding at no time during the taxable year exceeds the amount which would be ordinary and necessary to carry on the trade or business of both the other party to the sale or processing 1973 U.S. Tax Ct. LEXIS 108">*119 transaction and the United States person had the sale or processing transaction been made between unrelated persons;
We deal first with the transfer of funds by Offshore in the aggregate amount of $ 100,000 in July and August 1964, i.e., the first transaction. These funds, as shown by our findings of fact, were funneled from Offshore to Domestic via checks of Offshore to Greenfield and Bugg, half of which was promptly deposited by them in Offshore's Miami account and transferred from that account to Domestic and the other half of 1973 U.S. Tax Ct. LEXIS 108">*120 which was transferred directly to Domestic. The record herein is confusing as to the precise relationship of Greenfield, Bugg, and Offshore to the obligation of Domestic created by these transfers. Given the fact that petitioners have the burden of proof and the evidence indicating that an indebtedness from Domestic to Greenfield and Bugg was apparently created through the use of Offshore's funds, it would be possible to conclude that Greenfield and Bugg in fact received a dividend distribution from Offshore. But the parties have treated the transaction as taking place between Offshore and Domestic and we accept that treatment for purposes of decision herein. In this context, we conclude that it is unnecessary for us to determine whether the transfer of funds by Offshore represented payments for preferred stock, a contribution to capital, or a loan. Whichever of these characterizations is adopted, we conclude that these funds were invested in U.S. property within the meaning of
But, assuming
As far as
60 T.C. 425">*432 We hold that the funds represented by the first transaction constituted an increase in the earnings of Offshore invested in U.S. property and are accordingly taxable to petitioners under the provisions of
We now turn to the $ 100,000 represented by the subordination of an obligation in the form of a note from Domestic to Offshore in order to meet the second condition imposed by Travelers. The origin of the note is clear -- an open account purportedly representing advance payments for materials and services supplied to Offshore by Domestic. Petitioners' basic argument is that the transactions represented by these activities fall within the exception contained in
We wend our way to decision via a different route from that advanced by either party. We disagree with respondent that, under the circumstances of this case, the obligation represented by the subordinated note can be separated from the 1973 U.S. Tax Ct. LEXIS 108">*125 open account out of which it arose and from the transactions reflected in that account. This is not to say that there may not be situations in the future where the terms, conditions, and nature of an obligation which would have otherwise been entitled to the benefit of the
On the other hand, on the basis of the record before us, we are not convinced that the balance in favor of Offshore should be treated as falling within the exception contained in
Nor do we think that this amount can be excluded under the collection or 1-year maturity provisions of
In short, we hold that, to the extent of $ 29,958 of the second transaction, Offshore increased its invested earnings in "United States property" 1973 U.S. Tax Ct. LEXIS 108">*129 during fiscal 1964 and that the amount is accordingly taxable to petitioners under
Respondent has also sought to tax the full $ 200,000 to petitioners on the theory that they received a constructive dividend in this amount from Offshore. As to the $ 100,000 involved in the first transaction, since we have held that this amount is taxable to petitioners as an investment of earnings by Offshore in "United States property," it is unnecessary to resolve the constructive-dividend issue. We are constrained to note, however, that petitioners were apparently entitled to receive preferred stock (and may have received notes) for that $ 100,000 and that these circumstances might well be held to justify the conclusion that the funds were siphoned off from Offshore for their personal benefit. Cf.
*. Pursuant to a notice of reassignment sent to counsel for all parties, and to which no objections were filed, these cases were reassigned by the Chief Judge on Dec. 11, 1972, from Judge Austin Hoyt to Judge Theodore Tannenwald, Jr., for disposition.
1. Carmen F. Greenfield and Pauline C. Bugg are parties herein solely because they filed joint returns with their husbands for the year in question. Any references to petitioner or petitioners refer to Mr. Greenfield and Mr. Bugg only.↩
2. All Code references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue.↩
3. The record is silent as to the identity of Offshore's other officers.↩
4. The preparation of estimates and procurement of manpower for Offshore's operations was done by Bugg and Greenfield, who traveled to the Bahamas as the need arose.
1. Figures in parentheses indicate that the balance is in favor of Offshore.
2. On Dec. 31, 1962, the account had a balance of $ 95,465 in favor of Offshore.↩
5. For ought that this record discloses, the figure represents earnings and profits accumulated after Dec. 31, 1962.↩
6. The evidence submitted consists of an unsigned copy of a resolution, dated July 9, 1964.↩
7. The notes submitted in evidence were unsigned.↩
8. The record contains no explanation for the variations between this information and that contained in Schedule L of the fiscal 1964 return.↩
9. See fn. 11
10. This date was apparently used because the open account balance at that time was at least $ 100,000 in favor of Offshore.↩
11. It seems clear that this figure includes the amount of the "subordinated loan" and the amount which had previously been treated as "preferred stock." See pp. 427-428
12. Hand, "Thomas Walter Swan,"
13. It is not denied that Domestic and petitioners are U.S. persons. See sec. 957(d) and sec. 7701(a)(30).↩
14. Such excess would not exist if the $ 100,000 represented by the second transaction were counted, but this account could not be paid without Travelers' consent and there is no indication that any such consent was requested or obtained. See p. 428
15. In making this statement, we have accorded unitary treatment to the open account and the subordinated notes.
The legislative history of
16. The terms of the note, combined with the customary practice of Offshore to provide funds in advance to Domestic, indicate that the amounts billed by Domestic to Offshore and paid by Offshore to Domestic during fiscal 1965 were for current transactions arising in that year.↩
17. See fn. 14
18. We would reach the same result if we treated the entire account (including the subordinated note) as constituting an investment in U.S. property, since the amount to be treated as income to petitioners would be the difference between the balance in that account at the end of fiscal 1963 and at the end of fiscal 1964. See
19. See also
