Clayton E. Greenfield and Carmen F. Greenfield,petitioners-appellants Cross Appellees, v. Commissioner of Internal Revenue, Respondent-appellee Crossappellant.fred S. Bugg and Pauline C. Bugg, Petitioners-appellantscross Appellees, v. Commissioner of Internal Revenue, Respondent-appellee Cross Appellant, 506 F.2d 972 (5th Cir. 1975)

This suit arose after appellants Greenfield and Bugg were assessed $34,594.56 and $43,264 for claimed deficiencies with respect to 1964 income tax. The Commissioner grounded these assessments on two 1964 trnasactions which involved appellants and their wholly-owned corporations, Carline Electric Corporation ('Domestic') and Carline, Ltd., ('Offshore'). The Tax Court sustained the Commissioner's contention that the two transactions involved investments by a controlled foreign corporation in United States property resulting in pro rata inclusion in the gross incomes of the corporation's stockholders under Section 951(a) of the Internal Revenue Code of 1954.¹  As to one of the pertinent transactions, however, appellants were adjudged deficient in an amount less than that assessed.² 

This appeal is from the Tax Court's determination of deficiency. The Commissioner cross-appeals as to the difference between the assessment and the deficiency found by the Tax Court. We affirm as to the appeal and cross-appeal.

Appellants each owned fifty per cent of the capital stock in Domestic, a Florida corporation, and Offshore, a controlled foreign corporation as defined in Section 957(a) of the Internal Revenue code.³  During the five-year period prior to 1964, the two corporations had a continuing business relationship. An open account was maintained on the books of each company as a record of intercompany transactions.

In 1964, Domestic was successful in its bid on an electrical contracting job at Key West, Florida. Pursuant to its bid, Domestic was required to obtain a performance bond, which it sought from the Travelers Insurance Company. Before issuing the bond, Travelers required that Domestic increase its paid-in capital by $100,000, and that $100,000 of the open account indebtedness currently owed by Domestic to Offshore be subordinated to Travelers' bond.

Domestic complied with the first requirement by authorizing the issuance of $50,000 worth of stock to each appellant ('Transaction I'). To pay for the stock, $100,000 was funnelled from Offshore through appellants to Domestic. The Tax Court determined upon stipulation of the parties that this transaction was a direct loan from Offshore to Domestic. The Commissioner had contended that this transaction was, in substance, either a constructive dividend paid by Offshore to appellants or an 'increase in earnings invested in United States property' by Offshore in 1964, and thus includible in appellants' gross incomes under IRC 951(a) (1) (B). The Court sustained the Commissioner in the latter of these alternative arguments, and felt it unnecessary to resolve the former argument.

Appellants accomplished the subordination requirement of Travelers by, in effect, having Offshore subordinate the open account due it by Domestic ('Transaction II'). This was done in a loose fashion. A note containing a subordination clause was prepared but never executed. The Tax Court apparently treated it as a memorandum of the subordination transaction, and as such, it explained the entries on the books of the respective corporations which were made in furtherance of the subordination.

The cross-appeal arises by virtue of the debt from Domestic to Offshore being only $94,129.53 on the date of the subordination, July 31, 1964, while Travelers required, and appellants provided, a subordination in the amount of $100,000. It is important at this point to note that (1) the tax involved in Transaction II is not imposed upon the subordination agreement but upon the open account previously due Offshore by Domestic and (2) the $100,000 subordination was a sum selected to approximate the open account balance due Offshore at the time. This balance fulctuated, and the parties to the bond transaction elected the $100,000 figure as a convenience.

Despite these facts, the Commissioner urges that a tax should be imposed according to the balance due on the open account, as was done, plus the overage between the open account due and the $100,000 subordination.⁴  The Tax Court rejected this contention and we agree. This position is based wholly on form, rather than substance. Substance, and not form must be relied upon in determining the taxable significance of a transaction. Commissioner v. Court Holding Co., 1945, 324 U.S. 331, 334, 65 S. Ct. 707, 89 L. Ed. 981, 985; Gregory v. Helvering, 1935, 293 U.S. 465, 470, 55 S. Ct. 266, 79 L. Ed. 596, 599; Holbrook v. Commissioner, 5 Cir., 1971, 450 F.2d 134, 141. The overage in question ($5,986) was a mere paper figure lacking reality.

We turn now to Transactions I and II from the standpoint of appellants' position as distinguished from the cross-appeal. The central issue before the Tax Court was whether these transactions constituted investments in 'United States property' as defined in Section 956 of the Internal Revenue Code and accompanying Treasury Regulations.⁵  Section 956(b) (1) (C) defines 'United States property' to include 'an obligation of a United States person.' The court determined that both transactions fell within the obligation category of United States property, and that the three relevant exceptions within this category were inapplicable to the two transactions.⁶ 

The Tax Court's findings that these transactions were investments in obligations of a United States person, and that the three pertinent exceptions were inapplicable to both transactions, are essentially findings of fact, and are consequently not reversible unless clearly erroneous. See Commissioner v. Duberstein, 1960, 363 U.S. 278, 291, 80 S. Ct. 1190, 4 L. Ed. 2d 1218, 1228; Estate of Broadhead v. Commissioner, 5 Cir., 1968, 391 F.2d 841, 843. Under this standard, and after a thorough review of the record, we are of the view that the result reached by the Tax Court is correct and that the cause is otherwise without prejudicial error.

Affirmed on the appeal and cross-appeal.