Schnackenberg, Kiley and Swygert, Circuit Judges.
Petitioner Sherwood Memorial Gardens, Inc. seeks to set aside a judgment of the Tax Court confirming, though reducing, the Commissioner of Internal Revenue's deficiency assessment in its 1959 income tax.*fn1 We affirm.
The facts, as found by the Tax Court and reported at 42 T.C. No. 12, are not in dispute. Sherwood Memorial Gardens, Inc. is a Tennessee corporation organized with the minimum capital of $1,000 and empowered to acquire land for, and to operate for profit, a cemetery business. All but two of its 1,000 shares of stock were owned by Fred W. Meyer, Jr., who served as petitioner's president and on its board of directors. Meyer for many years had been active in the commercial cemetery business.
As a result of discussions between Meyer and Abe Berkowitz, a Birmingham, Alabama lawyer, it was decided, in October, 1955, that Berkowitz, who also was in the cemetery business, and a group of associates would invest in Meyer's proposed Tennessee cemetery venture. A plot of land in Knoxville, Tennessee selected by Meyer and his associates was purchased by Berkowitz and Meyer's wife, Jean Hope Meyer, for $30,000. Berkowitz did not see the land prior to the sale, nor did he know Mrs. Meyer.
By an agreement of October 4, 1955, and as later amended, petitioner issued to Berkowitz and to Jean Hope Meyer 1,000 "certificates of indebtedness" in exchange for the transfer to it of the land in Knoxville and $30,000, the money to be used for development and improvement of the land for use as a cemetery. In the certificates petitioner agreed to pay the holders twenty-five percent of the "base sales price of each and every burial space sold * * * during a period of fifteen (15) years * * *" from the date of the first sale. The certificates were transferable only on the books of petitioner by endorsement of the registered owner. Certificate holders could not, and did not, vote or participate in the management of petitioner.
In return for their fifty per cent investments, Berkowitz and his group and Jean Hope Meyer each received twenty per cent of the certificates of indebtedness. The remaining sixty per cent of the certificates were distributed as follows: By means of a "Joint Venture Agreement" Berkowitz designated $18,000 of the original $30,000 investment as loans to certain persons, including Jean Hope Meyer and Berkowitz's associates. The purported borrowers executed promissory notes to Berkowitz and their certificates were placed in escrow along with the promissory notes, and the escrow agent was to apply the payments from petitioner on the certificates to the promissory notes. When the notes were paid in full they were to be cancelled and the certificates delivered to the makers. By means of this agreement Jean Hope Meyer received 140 units in addition to the 200 units received for her investment. She received 300 more shares by treating sixty per cent of her $30,000 investment as a loan to herself and executing a promissory note to herself, to be repaid from payments on the certificates representing the amount of the loan. As a result of this series of transactions sixty per cent of the certificates were issued to persons who had made no actual cash outlay for them and Jean Hope Meyer became the holder of 640 of the 1,000 units.
Prior to entering into the above agreements, Berkowitz wrote to his associates concerning the expected results of the proposed venture. He told them
In our opinion, there are certain tax advantages in the holding of such certificates as we shall buy, provided the enterprise is successful, in that sums first received on account will properly apply to reduction of your base cost until your investment shall have been first fully recovered. The tax impact thereafter may be either at short or long term capital gains rate, dependent upon what we can work out.
It is not impossible to lose money in a venture of this kind. In fact, I should imagine that it would not be extremely difficult. However, on the assumption that the promoters shall achieve sales comparable to those of their operation in Birmingham, the results could and would be profitable for all of us.
On its income tax returns for 1957 to 1959 inclusive, petitioner reported as amounts paid by it to certificate holders for those years, respectively, $33,877.41, $34,324.15, $18,207.07, and deducted these amounts as the cost of land sold. The Commissioner disallowed the deductions with the explanation that the payments were "distributions with respect to equity capital" and not deductible land costs.
The Tax Court found that the transfers of land and money to petitioner "may be characterized as contributions to equity capital * * * notwithstanding the fact * * *" that the transferors were not shareholders of record. This result is clearly possible if the facts justify that conclusion, Brown Shoe Co. v. Commissioner, 339 U.S. 583, 589, 70 S. Ct. 820, 94 L. Ed. 1081 (1950); Veterans Foundation v. Commissioner, 317 F.2d 456 (10th Cir. 1963), as we think they do in this case.
The Tax Court first decided that petitioner's certificates did not represent a bona fide indebtedness, but evidenced instead "a proprietary equity * * * not unlike preferred stock." Petitioner contends that this finding is "clear error," since (a) the holders are entitled to twenty-five per cent of the proceeds of sales regardless of petitioner's net income, (b) holders receive nothing on the certificates after their fifteen year life, (c) holders cannot vote or otherwise manage petitioner, and (d) in case of insolvency the holders would be classified as creditors. It relies principally upon Gregory v. ...