
    NORTH AMERICAN FINANCE CORPORATION OF SAVANNAH v. THE UNITED STATES
    [No. 166-58.
    Decided January 11, 1963]
    
      Robert Ash for the plaintiff. Oarl F. Bauersfeld and L. J. Holroyd were on the briefs.
    
      Robert Livingston, with whom was Assistant Attorney General Louis F. Oberdorfer, for the defendant. Lyle M.. Turner and Philip R. Miller were on the brief.
   Davis, Judge,

delivered the opinion of the court:

Plaintiff, a wholly-owned subsidiary of State Loan and Finance Corporation, is a Georgia company doing a small loan business in Savannah. Its suit for an excess profits tax refund turns on the special manner in which it carried on its loan and thrift activities during the taxable years (1952 and 1953), as permitted by Georgia law.

The applicant for a small loan, once he was approved for credit, signed a “Subscription and Application” form subscribing to a certificate of investment to be issued by the plaintiff in the amount of the prospective loan; this certificate of investment was to be used as collateral for the loan by plaintiff which would be equal to the face amount of the certificate. The applicant was also required at the same time to sign a promissory note referred to in the “Subscription and Application” form; this note, made out to plaintiff, was in payment for the certificate of investment which was simultaneously being purchased; the note bore interest at 8% per annum and was payable in 12 monthly installments; it was secured by the applicant’s personal property (usually household furniture or an automobile). The next step was for the applicant to sign a second promissory note payable to plaintiff at the end of 12 months — this was deemed, the applicant’s promise to pay back the loan made to him — and to assign the certificate of investment (issued in the same amount) back to the plaintiff as collateral for this loan. (The plaintiff then held the certificate.) The due date of this term note was the same as the day on which the final installment was payable on the installment note used to pay for the certificate of investment.

When these forms were completed, the plaintiff lent to the borrower the face amount of the second note (i.e., the term note), less 8% interest discounted in advance and less a 2% service fee. At this stage the borrower had signed two notes payable to plaintiff, one to be paid in 12 monthly installments, the other to be discharged in a lump sum at the end of 12 months. In return, he had received the amount of his loan; and he had also purchased a certificate of investment, which was to be paid for through the installment note and which was held as security for the term note.

If the borrower remitted the installments on the installment note as he was obligated to do, the final payment on that note would be made on the same date as the term note became due (at the end of 12 months). That final payment on the installment note would also complete the borrower’s payments on his certificate of investment, and the fully paid certificate would automatically be used to pay off the term note and discharge the borrower’s debt to the plaintiff. At that time the plaintiff would pay the borrower the 3% interest provided in the certificate of investment. The borrower could theoretically pay the term note with cash and retain the certificate, but this was not in fact done. It is also significant that, in the taxable years, all the certificates of investment were issued to borrowers under the procedure we have outlined; none of the certificates was sold to or owned by persons not indebted to plaintiff for loans.

During 1952, the first taxable year, there was an average daily difference of $212,342.51, in plaintiff’s favor, between the face amount of the outstanding certificates of investment and the unpaid balance on the installment notes used to pay for the certificates. In 1953, this difference was $204,965.13. This money, representing the sums paid (on the average) on the installment' notes, was' available to plaintiff for its business.

Plaintiff’s claim here is that, in computing its excess profits tax credit based on invested capital for 1952 and 1953, it was entitled to include as borrowed capital the face amounts of these certificates of investment. Section 431 of the Internal Revenue Code of 1939, as amended, included 75% of “the average borrowed capital for the taxable year” in making up the invested capital credit; and Section 439 defined “borrowed capital” for this purpose as “the amount of the outstanding indebtedness (not including interest) of the taxpayer, incurred in good faith for the purposes of the business, which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, deed of trust, bank loan agreement, or conditional sales contract. * * The position of the Commissioner-of Internal Revenue is that the certificates do not come under the provisions of Section 439.

The courts have on several occasions dealt with the problem of whether the concepts of “borrowed capital” or “outstanding indebtedness” — for the excess .profits tax credit based on invested capital — include certificates, some more and some less comparable to plaintiff’s, issued by small loan and thrift companies. Economy Savings and Loan Co. v. Commissioner, 5 T.C. 543 (1945), modified on other issues, 158 F. 2d 472 (C.A. 6, 1946); Jackson Finance & Thrift Co. v. Commissioner, 260 F. 2d 578 (C.A. 10, 1958), reversing 29 T.C. 272 (1957); Commissioner v. Valley Morris Plan and Morris Plan Company of California, 305 F. 2d 610, 629 (C.A. 9, 1962), cert. denied, 371 U.S. 922 (1962), reversing 33 T.C. 572 (1959) and 33 T.C. 720 (1960); North American Loandb Thrift Co. No. 2 v. Commissioner, 39 T.C. 318 (1962).

The latest decision, North American Loan & Thrift Co. No. 2, is the only one directly in point. That taxpayer is plaintiff’s sister corporation, likewise a wholly-owned subsidiary of State Loan and Finance Corporation operating a small loan business in Georgia (at Atlanta); both parties agree that its mode of procedure was exactly like the plaintiff’s and its certificates of indebtedness the same. The full Tax Court (with three judges dissenting) ruled that no part of the certificates could be included in borrowed capital. We agree with Judge Naum’s opinion for the Tax Court, and need only select and summarize the core of its reasoning. The opinion points out that:

(a) the status of the certificates under Georgia law does not determine the federal question;

(b) “The net effect of coupling certificates with all small loans made by petitioner was to require the borrower to sign two notes to petitioner instead of one for each loan he needed and thereby to pay a net total of interest vastly in excess of the purported 8 percent”;

(c) although taxpayer argued that the borrowers, “at the instant they borrow money from petitioner, immediately lend a like amount of money back to petitioner on its certificates”, “we can accept no such fiction. Petitioner’s customers are borrowers; they are neither lenders nor investors. They have no funds to lend to petitioner’s business or to anyone else. They come to petitioner because they need funds, and their need is sufficient that they are willing to pay the price exacted from them through the medium of these inextricably interrelated transactions in order to obtain their loans. * * * [T]he facts show that in every case the substance of the transaction was that petitioner was the lender and its customer was the borrower”;

(d) “In reality in every case the money paid by petitioner’s borrowers on the installment note constituted merely a partial repayment of the money lent by petitioner to the borrowers. In no case did this money represent new capital lent to petitioner. * * * Petitioner obtained no new, added capital by the use of these forms; it obtained only the repayment of the money it had lent to its customers, with additional interest as an added, important feature”; and, finally,

(e) “We think it clear that petitioner did not in fact intend to borrow money from its customers by the use of its certificates, and certainly its customers did not in fact intend to lend petitioner money by the use of such certificates.”

The essence of the Tax Court’s ruling, with which we concur, is that, when the taxpayer’s connected series of transactions with its . customer are viewed together, it is plain that nothing was borrowed by the taxpayer and no additional capital was invested in its business. There is therefore no reason' to increase its excess profits tax credit, based on invested capital, by any amount attributable to the certificates.

Petitioner is not entitled to recover. Its petition will be dismissed.

Prettvman, Circuit Judge, sitting by designation; Beed, Justice (Bet.), sitting by designation; Durfee, Judge; and Whitaker, Judge, concur.

Labamore, Judge; and Jones, Chief Judge, took no part in the consideration and decision of this case.

FINDINGS OF FACT

Tbe court, having considered the eyidence, the report of Trial Commissioner.Mastin G. White, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff, North American Finance Corporation of Savannah (formerly North American Loan & Thrift Company of Savannah), is a corporation organized and existing by virtue of the laws of the State of Georgia. Its principal place of business is located at 26 Drayton Street, Savannah, Georgia.

2. At all times material to this litigation, the plaintiff’s stock has been wholly, owned by the State Loan and Finance Corporation.

3. The plaintiff was incorporated as the'“North American Loan & Thrift Company of Savannah” on December 15, 1948, under the laws of the State of Georgia. The plaintiff’s original charter, which remained in effect through the years that are involved in the present litigation (1952 and 1953), authorized it to engage in'“The principal business * * * of a general loan business or a general savings business or both, and among other things to lend its funds to its members and' members of the industrial and working classes and others * * * in the manner provided by Title 16, Section 101, of' the Code of Georgia, of 1933.” ' ■

' 4. Section 101 of Title 16, Code of Georgia of 1933, provided as follows.in. 1952 and 1953:

. All building and loan associations, and other like associations' doing business in this State (and the .term, “other like associations” shall include a corporation organized to. do a general savings and loan business, and among other things' lending its funds to members of the industrial and working classes, or others, and- secured • in whole or in, par,t by .personal indorsements and its own fully .paid or- installment' stock, or its own fully. paid or installment certificates’ of. indebtedness, or other personal property), are.authorized to lend money to persons not members thereof, nor shareholders therein, at eight per cent or less, and to aggregate the principal and interest at the date of the.loan for the entire period of the loan, and to divide the sum of the principal and the interest for the entire period of the loan into monthly or other installments, and to take security by mortgage with waiver of exemption or title, or both, upon and to real estate situated in the county in- which said building and loan association may be located; and such building and loan association shall be construed to be located in any county wherein it has an-office, agent or resident correspondent: Provided, however, the associations shall not be compelled to lend -their funds exclusively in the manner hereinbefore specified, but also shall have. authority to make loans to members of the industrial and working classes and to all other persons, due at fixed intervals' not exceeding 12 months, and secured in whole-or in part by personal.indorsements and by its own fully paid stock, or stock payable on the installment plan, certificates of indebtedness, fully paid or payable on the installment plan, or both indorsements- and such securities, or other personal security and choses in action,' and on such loans so made and secured as aforesaid, it shall be lawful to deduct interest in advance, but not to exceed eight per cent, discount, and the installment payments, if any, made on such hypothe-cated stock or certificates of indebtedness during the time the loan is of force may or may not bear interest, at the option of the association, and the taking of said installment payments on said hypothecated stock, certificates of indebtedness, choses in action, or other evidences of indebtedness shall not be deemed usurious.

5. (a) During the years 1952 and 1953, the plaintiff was engaged in what its literature referred to as the “loan and thrift” business. " This.involved'the making and collection of small loans in accordance with the procedure that is outlined .in .the succeeding paragraphs of this finding.-

(b) The initial step .-was ;the making of an oral application for a loan, by a prospective borrower. ■ ■ ■

(c) If the plaintiff was willing to make a loan to the applicant in the amount desired by the latter, the next step was. to have the. applicant sign a “Subscription and Application” form--provided by the plaintiff. This form stated in part as follows: ■

I hereby subscribé -for a Certificate- of Investment of your Company of the par value shown above and offer in payment therefor a nóte signed by me * *. * which said Certificate of .Investment, if -issued to . me, shall be used as'collateral security fór a loan by your'Company in a sum equal to the face amount of said certificate. * * *

The “par value shown above” on this form was the amount of the prospective loan that had been agreed upon between the applicant and the plaintiff, and it similarly was the amount of the Certificate of Investment that was to be issued to the applicant in connection with the making of the loam

(d) At about the same time that the loan applicant signed the “Subscription and Application” form, he was also required to sign the promissory note referred to in that form. This promissory note was payable to the plaintiff and was given in payment for the Certificate of Investment that was to be issued to the loan applicant; it bore interest at the rate of 8 percent per annum; and it was payable in monthly installments (usually 12, and never more than 12). The face amount of the installment note was the same as the face amount of the Certificate of Investment, and it was the same as the amount of the loan that had been agreed upon between the parties. The installment note was customarily secured by personal property of the loan applicant, such as household furniture or an automobile.

' (e) After the loan applicant had signed the “Subscription and Application” form and the installment promissory note referred to in paragraphs (c) and (d) of this finding, the plaintiff issued a Certificate of Investment to him. The face amount of this instrument was the same as the amount of the loan that had been agreed upon by the parties. The instrument provided in part as follows:

This certifies that the holder named above is the owner of an investment in the Company named above, in the sum indicated above, and as such is a member of said Company.
This certificate bears interest at the rate of three (3%) per cent per annum upon the face amount hereof from date of issuance, provided however, no interest shall be paid for less than full monthly periods from date of purchase. Interest shall be paid to the owners thereof on January fifteenth of each year for the period ending December thirty-first of the previous year, or at the time this certificate is repurchased and cancelled, unless the certificate be hypothecated with the Company for a loan, in which event interest shall be paid ana credited at the time the loan for which this certificate is hypothecated is paid or settled. Interest shall then be paid on January fifteenth of each year as above provided unless the holder has elected to and does carnal the loan in whole or in part by surrendering this certificate. The Company may apply interest on any certificate to any indebtedness due it by the holder of such certificate. In the event the holder of any certificate which has been hypothecated with the Company for a loan, fails and refuses to pay any indebtedness due to the company for a period of thirty days after its maturity date, then and in that event, such holder shall lose and forfeit his right to receive any and all interest which may have accrued on such Certificate of Indebtedness and no further interest shall accrue thereon until all such indebtedness shall have been fully paid.
The holder or holders of this certificate may borrow from the Company and secure their loan or loans by an assignment of this certificate and at their option may cancel such loan or loans at maturity in whole or in part by surrendering this certificate.

(f) The next step was for the applicant to execute another promissory note payable to the plaintiff. This second note was for the amount of the loan that had been agreed upon between the parties. In this note, the maker promised that, on the due date of the loan (which was usually 12 months, and never more than 12 months, after the date of the instrument) , he would:

* * * pay to the order of the Company named above, at its above office, the principal amount of this note, shown above, and secured by the Certificate of Investment, the number of which is set out above. * * *

The due date of the term note mentioned in this paragraph was the same as the date on which the final installment of the promissory note referred to in paragraph (d) of this finding became due.

(g) At about the same time that the loan applicant executed the term promissory note referred to in paragraph (f) of this finding, he assigned the Certificate of Investment to the plaintiff as collateral for the lpan.

(h) After the various steps referred to in the previous paragraphs of this finding had been taken, the plaintiff delivered to the applicant the amount of the loan that had been agreed upon, less 8 percent interest on the term note (see paragraph (f) of this finding) discounted in advance, and less a 2 percent service fee.

(i) The Certificate of Investment became fully paid up (see paragraph (d) of this finding) at the same time that the term note (see paragraph (f) of this finding) became due; and the Certificate of Investment was used to pay off the term note and thus to discharge the indebtedness on the loan. At about the same time, the plaintiff paid to the borrower the 3 percent interest provided for in the Certificate of Investment.

|6. The plaintiff incurred some losses from the failure of its borrowers to pay the installment notes that were executed in order to acquire the Certificates of Investment (see finding 5(d)). The average delinquencies on the part of the borrowers were less than 2 percent.

7. The plaintiff qualified its Certificates of Investment with the Securities Division of the State of Georgia as corporate securities under what is commonly referred to as the Georgia “Blue Sky Law” (Title 97 of the Code of Georgia). The filing and issuance fees with respect to the Certificates of Investment were paid by the plaintiff.

8. All of the plaintiff’s outstanding Certificates of Investment in 1952 and 1953 were issued by the plaintiff to persons who were borrowers from the plaintiff under the procedure outlined in finding 5. During the years in question, none of the Certificates of Investment was sold to or owned by persons who were not indebted to the plaintiff for loans.

9. The daily average amount of the plaintiff’s outstanding Certificates of Investment, and borrowers’ term notes secured thereby, during the year 1952 was $915,453.63. The daily average unpaid balance of the outstanding installment notes used by borrowers to acquire the plaintiff’s Certificates of Investment during the year 1952 was $703,111.12. The difference, or $212,342.51, represents the amount of money that was available to the plaintiff, on a daily average basis, from the payments that were made on the installment notes during the year 1952.

10. The daily average amount of the plaintiff’s outstanding Certificates of Investment, and borrowers’ term notes secured thereby, during the year 1953 was $863,625.11. The daily average unpaid-balance of tbe outstanding installment notes used by borrowers to acquire the plaintiff’s Certificates of Investment during the year 1953 was $658,659.98. The difference, or $204,965.13, represents the amount of money that was available to the plaintiff, on a daily average.basis, from the payments that were made on the installment notes during the year 1953.

11. During the years 1952 and 1953, the plaintiff paid interest to the borrower-holders of Certificates of Investment in the amounts of $14,250.46 and $18,706.49, respectively.

12. A substantial portion of the plaintiff’s capital in 1952 and 1953 was derived from amounts borrowed from banks by its parent corporation, the State Loan and Finance Corporation, and reloaned to the plaintiff. As reflected on the plaintiff’s balance sheets, the total outstanding advances to it from the parent corporation amounted to $363,155.71 at the end of 1952 and $291,242.28 at the end of 1953.

13. The plaintiff timely filed its income tax returns for the years 1952 and 1953. On these returns, the plaintiff, in computing its excess profits tax credit based on invested capital, showed (among other things) as borrowed capital the face amounts of all the outstanding Certificates of Investment issued by it, in the total sums of $915,453.63 for 1952 and $863,625.11 for 1953 (see findings 9 and 10).

14. After audit and examination, the Commissioner of Internal Revenue determined that the sums referred to in finding 13 were not includible in the plaintiff’s borrowed capital for the purpose of determining its invested capital credit. Accordingly, deficiencies in excess profits taxes for the years 1952 and 1953 were assessed against the plaintiff in the respective amounts of $15,220.99 and $15,403.23, and interest in the respective amounts of $3,688.50 and $2,808.02. These amounts were paid by the plaintiff on April 3, 1957.

15. After paying the tax deficiencies and interest referred to in finding 14, the plaintiff timely filed on July 31, 1957,. claims for the refund of such amounts. Refunds were claimed on the ground that the face amounts of the plaintiff’s Certificates of Investment were includible in the plaintiff’s borrowed capital for the purpose of determining its invested capital credit.

16. The claims for refund referred to in finding 15 were disallowed by the Commissioner of Internal Revenue by means of registered letters dated February 27, 1958.

17. Subsequent to the years that are involved in the present litigation, the plaintiff’s name was changed to “North American Finance Corporation of Savannah” on April 22, 1955, and its charter was amended in certain respects. Thereafter, the plaintiff’s method of doing business was different from that described in finding 5 with respect to the years 1952 and 1958.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is not entitled to recover and its petition is dismissed. 
      
      
         The Tax Court also held, alternatively, that, since the taxpayer’s liability on the certificates was contingent upon the borrower’s paying the term note for which they served as “collateral”, no definite outstanding Indebtedness ■existed, as required by the statutory definition of borrowed capital. We agree, too, with that conclusion. See C. L. Downey Co. v. Commissioner, 172 F. 2d 810, 812 (C.A. 8, 1949), affirming 10 T.C. 837, 839-40 (1948); Frazer-Smith Co. v. Commissioner, 14 T.C. 892, 899, 900 (1950); cf. Wm. A. Higgins Co. v. Commissioner, 4 T.C. 1033, 1043 (1945).
     
      
       On somewhat different facts, the Ninth Circuit recently reached the same result, by a different route, in Commissioner v. Valley Morris Plan and Morris Plan Company of California, 305 F. 2d 610, 629 (1962), cert. denied, 3.71 U.S. 922 (1962) (reversing 33 T.C. 572 (1959) and 33 T.C. 720 (1960)).
     