author: PER CURIAM: FLETCHER, Commissioner: NICHOLS, J.,

text:
    BORDO PRODUCTS COMPANY v. The UNITED STATES.
    No. 223-69.
    United States Court of Claims.
    April 13, 1973.

      Don S. Harnack, Chicago, Ill., attorney of record, for plaintiff. McDermott, Will & Emery, Chicago, Ill., of counsel.
    Jane C. Bergner, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant. Joseph Kovner, Washington, D. C., of counsel.
    Before COWEN, Chief Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA, KUNZIG, and BENNETT, Judges.
   OPINION

PER CURIAM:

This case comes before the court on plaintiff’s motion, filed March 12, 1973, for judgment pursuant to Rule 141(b), requesting that the court adopt the recommended decision of Trial Commissioner Lloyd Fletcher filed November 29, 1972, under Rule 134(h), as modified by order of February 22, 1973, defendant having withdrawn its notice of intention to except thereto. The court has considered the case without oral argument of counsel and since it agrees with the trial commissioner’s recommended decision, as hereinafter set forth, it grants plaintiff’s motion and adopts the decision as the basis for its judgment in this ease. Therefore, it is concluded that plaintiff is entitled to recover and judgment is entered for plaintiff with the amount of recovery to be determined pursuant to Rule 131(c) in accordance with the decision.

OPINION OF COMMISSIONER

FLETCHER, Commissioner:

This income tax refund suit requires the court, once again, to enter an area which has been aptly described by Judge Nichols as “devoid of blackletter law, as is true of any tax inquiry seeking the ‘substance’ of a given transaction.” Jack Daniel Distillery v. United States, 379 F.2d 569, 580, 180 Ct.Cl. 308, 326 (1967). The area is frequently referred to as the “debt-equity distinction,” and the hundreds of court decisions involving it “defy symmetry.” Tyler v. Tomlinson, 414 F.2d 844, 847 (5th Cir. 1969). In the context of the present case, the primary question before the court is whether losses suffered by plaintiff, Bordo Products Company (Bordo), upon the failure of C. M. Pitt & Sons Company (Pitt) to repay some $740,000 loaned it by Bordo qualifies as bad debt under Section 166 of the Internal Revenue Code. Alternatively, says Bordo, in the event these loans or advances do not meet the test of bad debt under Section 166, the advances to Pitt should be deductible as ordinary and necessary business expenses under Section 162 or losses under Section 165(a). Defendant, on the other hand, views the advances made by Bordo to Pitt as having been made to obtain an equity interest in Pitt with an investment motive and thus constituted capital contributions to Pitt. A secondary question is whether Bordo is entitled to claimed deduction for additional depreciation expenses, abandonment losses, salary and travel expenses, legal and accounting fees, and escrow and settlement expenses, all of which were related to the transactions between Pitt and Bordo which are described in detail in the findings of fact but which now will only be summarized.

During the years 1958 through 1961 (and for some time prior thereto), Bordo, from its Chicago headquarters, was engaged in the importation, packaging, and resale of dates through a national organization of food brokers. In addition, Bordo also produced and marketed a full line of citrus products from its citrus plant in Florida. The citrus operation was considerably larger than the date operation, although the latter produced by far the larger profit margin. During these years, plaintiff’s principal competitor in the wholesale date market was Dromedary, a division of the National Biscuit Company. Along with dates, Dromedary also marketed glacé fruits, cake mixes, and other related food items. Originally, Dromedary had marketed these products through a national food broker organization, but in the first quarter of 1958, Dromedary advised substantially all of its brokers that it was changing its method of marketing and that future sales of these products would be handled by the parent corporation. Accordingly, Dromedary’s brokers were terminated as of the end of the year 1958.

This termination action by Dromedary became common knowledge in the wholesale date and glacé fruit business during the spring of 1958. In late April of that year, Bordo began actively to solicit Dromedary’s brokers, and by the end of May had succeeded in obtaining the services of over thirty of the former Dromedary brokers. All of these newly acquired brokers had formerly marketed both dates and glacé fruits for Dromedary, and they advised Bordo that they would be interested in continuing to market a line of glacé fruits and peel since it was common for the same buyers to purchase both dates and glacé fruits. Bordo’s management tended to agree and reasoned that there were several advantages to having a line of glacé fruits to 'sell along with its dates. 1) Such a development would no doubt increase the importance of the Bordo account with its newly acquired brokers, thus stimulating the sale of dates. 2) Increased date sales would enable Bordo to secure additional volume discounts in purchasing bulk dates from abroad. 3) Additional profits should be realized from selling refuse citrus peel to a glacé fruit concern rather than to a cattle food processor as had been the custom. 4) Freight costs could be cut by pooling shipments of glacé fruits and dates. 5) Sales of glacé fruit under the Bordo label should provide increased revenues for Bordo.

Accordingly, in the summer of 1958, Bordo’s management looked for sources of glacé fruits and related products to supplement its date line with its food brokers. A former Dromedary broker advised Bordo that C. M. Pitt & Sons Company might constitute a good source of supply of glacé fruit and related products.

Pitt, a Maryland corporation, maintained its principal office and place of business in Baltimore at all times relevant to this action. Its principal activity during the years 1958 through 1961, and for some time prior thereto, was the production and sale of glacé fruit, dates, cherries, fountain products, flavors, and currants. In 1958, it enjoyed an excellent reputation in the trade as a quality manufacturer and had recently taken occupancy, under a 20-year lease, of a new plant built to its specifications.

In January of 1959, Arthur Koch, a Bordo vice president, conferred with William Pitt, Sr., president and majority stockholder of Pitt, and another Pitt official at Bordo’s Chicago headquarters. Mr. Pitt brought with him financial reports covering his firm’s last five years of operations. In March 1959, Bordo’s president, Adolph Ketzler, its auditor, George V. Rountree, C.P.A., and other Bordo employees visited the Pitt facility in Baltimore.

During these negotiations, Pitt advised Bordo that it was desirous of obtaining both long- and short-term credit, additional sales volume of glacé fruit products and assistance in the area of financial management. Bordo advised Pitt that it needed a recognized source of glacé fruits for its brokers, an eastern seaboard location to obtain economies in the marketing of its packaged dates, and a market for its citrus byproducts.

Bordo’s investigation of Pitt disclosed that Pitt’s line of credit with the Fidelity Baltimore National Bank (Baltimore Bank) had been discontinued in 1959, and that as a consequence, Pitt had been forced to factor some of its receivables. Pitt’s credit needs were greatest in March through September, its months of inventory buildup. In contrast, Bordo manufactured its citrus products primarily during the months of November through March and borrowed heavily during that period.

From an examination of Pitt’s financial statements, it was clear that during the 1950’s Pitt’s profit margins had eroded until it had sustained an operating loss in 1957 and 1958. The operating losses in those two years had depleted Pitt’s working capital. Pitt’s profit (loss) from operations as a percentage of net sales showed a decline from 2.14 percent to (7.08 percent) in the years 1954 through 1958. Additionally, Pitt’s current ratio (current assets to current liabilities), a factor which Bordo found important in evaluating its own performance, had declined from 5.-99:1 in 1954 to 1.16:1 in 1958.

In March 1959, George Rountree, Bordo’s accountant, a recognized expert in the field of accounting for the food processing industry, prepared a comprehensive document entitled “The C. M. Pitt and Sons Company Baltimore, Maryland Sales, Production and Cash Budgets Year Ending December 31, 1959.” Budget figures were prepared for three levels of sales, $2,400,000, $2,700,000, and $3,000,000. Net income on these three levels of sales was projected to be $140,000, $171,000, and $209,000, respectively.

In March 1959, Bordo applied for and obtained its seasonal, 2.2 million-dollar line of unsecured credit from its primary banking affiliation, the Harris Trust and Savings Bank of Chicago. Bordo described in detail its negotiations with Pitt to Robert Rodgers, an official of that bank, who had handled the Bordo account since 1942. Rodgers understood that the Fidelity Baltimore National Bank would be extending a $200,000 line of credit to Bordo and that Bordo would guarantee the bank’s $450,000 line to Pitt. He thought that, in addition, Bordo would be making a $200,000 advance to Pitt. Rodgers’ understanding that Bordo would provide Pitt with sales and managerial assistance and his receipt of an opinion from counsel that Bordo would not become liable on Pitt’s 20-year plant lease with the Chatim Corporation were important factors in his ultimate decision to recommend approval of Bordo’s credit application.

On April 8, 1959, Bordo and Pitt entered into a written agreement whereby Bordo obligated itself to furnish Pitt a 5 percent 5-year term loan of $200,000. As security, Bordo obtained a chattel mortgage on substantially all of Pitt's office and plant equipment (net book value $297,208.58).

There were certain preconditions to Bordo’s $200,000 loan. Pitt restructured and realigned its management team in order to facilitate success. Upon Bordo’s advice, Pitt’s board of directors created and staffed the position of controller in order to insure improved financial recordkeeping, as Pitt’s system of accounting had been characterized by Bordo’s accountant as inadequate and outdated. Pitt’s common stockholders entered into an agreement with Bordo whereby Bordo was granted a five-year option to purchase all (945) or any portion of Pitt’s outstanding common stock at par value ($100 per share). Pitt underwent a recapitalization whereby Pitt’s 8 percent first (1,021 shares outstanding) and second (authorized but unissued) preferred capital stock classes were eliminated. A class of 5 percent preferred stock was issued in their place and offered to holders of first preferred on a one-for-one basis.

Bordo informally agreed to make available to Pitt production advances, as needed, and management assistance in the area of financial controls. Bordo’s management projected that Pitt would require $450,000 to $850,000 of such financing in the months of April through September 1959. Pitt and Bordo informally agreed that Pitt would sell Bordo glacé fruit under both Bordo’s and Pitt’s label at dealer’s cost, less 10 percent. Bordo anticipated no direct profit on its sales of glacé fruit, but contemplated a proportional reduction in its overhead, as well as stimulation of its date sales. Pitt also agreed to purchase Bordo’s refuse peel for use in glacé fruit production and promised to make available warehouse space in its Baltimore facility for the storage of Bordo’s dates.

Bordo advanced $876,000 to Pitt in calendar year 1959 in exchange for unsecured 51/2 percent cognovit demand notes. These advances were based upon Pitt’s cash needs to produce inventory for the 1959 selling season and were to enable Pitt to keep its other creditors on a current basis. Throughout this period, Pitt prepared and submitted to Bordo monthly cash flow statements detailing Pitt’s situation. At Bordo’s request, a telex machine was installed at Pitt as a means of facilitating communication. Ray Watkins, a Bordo employee, spent 124 workdays during 1959 at the Pitt plant. He set up accounting, cost, and financial systems for Pitt; audited Pitt’s first six months’ operations; worked on production control; and assisted Arthur Koch who spent 45 workdays in 1959 at the Pitt facility.

In July 1959, George Rountree, Bordo’s accountant, prepared a revised budget for 1959. This budget was less optimistic than his prior projections, and contemplated a $76 net loss for the year (net operating gain $18,718). However, the news was far from totally negative. Even based upon concededly conservative assumptions, the revised budget forecast that Pitt would be able to repay all its existing and projected 1959 borrowings by the close of that calendar year.

In August 1959, however, Bordo became uneasy about Pitt’s condition. Pitt was experiencing production problems, and Bordo’s Arthur Koch expressed concern whether Pitt would be able to make timely delivery of its products. Bordo’s Florida general manager and plant superintendent both spent time at the Pitt plant reviewing its production facilities. Bordo’s executives thought it would be prudent to exert Bordo’s influence as a creditor to force out Pitt’s general manager and with Pitt, Sr.’s agreement, began to search for a professional manager from another company.

Toward the end of the month, Bordo began to doubt that Pitt’s sales would be as high as predicted in the revised budget. Bordo contacted its Baltimore attorneys to determine its creditor’s remedies. Bordo’s attorneys responded in the following manner:

It will be seen that if Pitt should make payments or transfer assets to Bordo on account of its existing debts and if bankruptcy proceedings should be started against Pitt within four months thereafter, any payments which may be made to Bordo or any property which may be transferred to Bordo on account of prior loans at a time when Bordo has knowledge of the insolvency of Pitt, may be set aside by a bankruptcy trustee thereafter appointed as voidable preferences and Bordo may be required to repay any amounts so received, so that money can be divided among the creditors in accordance with the Bankruptcy law.
It is important, therefore, if any payments are to be made to Bordo, that no Petition in Bankruptcy can be filed against Pitt within a period of four months after any such payments are made.
To that end, if Pitt is to begin liquidating its assets so as to make payments to Bordo on account of its debt, we strongly recommend that all general creditors of Pitt be paid in the ordinary course of business, and that no unpaid indebtedness be allowed to exist which would form the basis for a Petition in Involuntary Bankruptcy.

In accordance with its attorneys’ advice, Bordo never demanded repayment and advanced another $60,000 in September 1959 to permit Pitt to keep its other creditors on a current basis. By yearend, Pitt had repaid $390,000 of the 1959 production advances.

Through contacts in the food industry, Bordo located one Lawrence Weitz, a man exceptionally well-qualified in the production of glacé fruit and an experienced executive. Weitz was interviewed in Baltimore for the general managership of Pitt by Bordo’s Ketzler, Koch, and Watkins and by Pitt’s controller, Fred Coover. Upon Bordo’s advice, Pitt’s president offered Weitz the position ; Weitz accepted and began work at Pitt in December of 1959.

Unhappily, Pitt’s 1959 audit report, available February 1, 1960, revealed a net loss of $264,103. This figure did not take into account the interest owing on Bordo’s advances. In fiscal 1959, Bordo received $941.66 interest from Pitt and waived interest of $28,697.58. Bordo never accrued this interest on its books, financial statements, or tax returns. While a net loss of $76 (net operating gain of $18,718) had been projected as early as July, Bordo’s management was surprised and displeased with the actual results. Mr. Rodgers of the Harris Bank indicated that his bank would be reluctant to continue its line of credit to Bordo unless Bordo got the Pitt operation under control and made sure that Pitt’s management problems were corrected.

In early 1960, Bordo learned from Weitz that although Pitt’s building was new, much of its plant equipment was old, poorly designed or otherwise inappropriate. Pumps and other equipment were damaged by corrosion and were often leaking because they were made of materials other than stainless steel. These and other equipment defects produced food discoloration, contamination, and similar quality control problems. Additionally, it appeared that Pitt was losing up to $100 per day in sugar syrup due to a defect in a machine fitting.

Early in 1960 Bordo’s accountant furnished Bordo with an appraisal of Pitt’s “Company Procedures.” The report stated that as of January 18, 1960, Pitt’s accounts were not balanced; its bank statements were not reconciled; its social security records were not up to date; its commissions payable were not properly analyzed, and its inventory records were inaccurate. The report also criticized Pitt’s lack of a fixed billing policy and poor customer credit evaluation procedures.

Other problems at Pitt came to the attention of Bordo management in late 1959 and early 1960: 1) It appeared that in some cases Pitt had purchased five, ten, or even fifteen times its raw material requirements in order to avail itself of a small noncompensating volume discount. Much of the material purchased was of a quality higher than that needed to be competitive, and even then Pitt failed to follow up with suppliers who furnished defective products. 2) Pitt’s quality control procedures were inadequate as there was a tendency to test products only on completion, rather than at each step in processing. Errors were caught only after large batches had been defectively manufactured. 3) There was no systematic program for analyzing Pitt’s product mix to determine a) why some items were declining in sales; b) whether new products or formulations could be developed; and c) whether each of Pitt’s many low-volume products was profitable to the corporation. 4) It appeared that Pitt’s income in 1959 had been affected by a price war which had developed in the glacé fruit business. Intense price competition was initiated by such nationally advised firms as S and W Fine Foods, Inc., and the National Biscuit Company (Dromedary) .

In February 1960, Bordo’s management reappraised its position with respect to Pitt. They consulted Weitz, George Rountree, and Rodgers of the Harris Bank. Weitz expressed the opinion that under his supervision Pitt could break even in 1960, without reference to the interest on or the balance of Bordo’s 1959 advances still outstanding. Bordo saw that it had two alternatives: 1) enforcing its rights as a creditor to the fullest extent, advancing no more money to Pitt and demanding immediate repayment of existing advances, or 2) letting the existing advances remain outstanding and extending additional credit in order to permit Pitt to operate in rehabilitated form in 1960. Bordo determined to finance Pitt through the fall of 1960 in the then reasonable belief that its 1960 advances would be repaid by the end of the 1960 selling season. Bordo hopefully anticipated that Pitt would then be in a position to generate enough profits so as to be able to repay Bordo in full.

Bordo advanced $865,000 in cash to Pitt during the calendar year 1960 in exchange for interest bearing, unsecured demand notes. Like their 1959 counterparts, these advances were used to finance Pitt’s 1960 inventory. As was the case with the 1959 advances, Bordo did not intend to profit from the interest it charged Pitt, since the rate which Bordo paid the Baltimore bank for the money was substantially equivalent to the rate which Bordo charged Pitt for these same funds. Bordo expected that the continued availability of a source of glacé fruit would stimulate date sales as had been the case in 1959.

Advice from Weitz on Pitt’s six months’ operating results caused Bordo’s management to conclude that Pitt would operate at least on a break-even basis in 1960. Sometime during the first week of October, Weitz informed Bordo that based upon the third quarter inventory, it now seemed that Pitt would suffer a loss for the year. Upon notification of this fact, Bordo requested that Pitt take all possible steps to reduce cash expenditures until the fourth quarter operating results were ascertained. Bordo made no further advances to Pitt after October 5, 1960.

During the months October through December 1960, Pitt repaid $280,000 in production advances and made a single payment of $20,000 on the loan secured by the chattel mortgage. In addition, Pitt paid $10,112.45 interest on production advances to Bordo in fiscal 1960. Bordo returned this interest to Pitt, and never accrued interest on these advances to Pitt on its books, financial statements or tax return.., Pitt paid interest on its chattel mortgage once on April 14, 1960, in the amount of $1,019.18. There were no interest expense accruals on Pitt’s books after June 30, 1960.

Pitt’s 1960 report disclosed net sales of $2,050,492 and a net loss of $348,539 after waiver by Bordo- of interest due it in 1960 in the amount of $46,971. Pitt’s book liabilities exceeded its assets by $201,570. The prices charged for Pitt’s products were reduced approximately 8% percent during 1960. This reduction was essentially a consequence of the above-mentioned price war which was begun in 1959 by industry leaders. If Pitt had maintained the same level of prices in 1960 as it had charged in 1959 and it had not been forced to meet Dromedary’s policy of prepaying freight on Christmas shipments of glacé fruit, $200,000 of Bordo’s loss probably would have been eliminated.

After learning of these results, Bordo officials conferred with Messrs. Weitz, Rodgers, and Rountree. Rodgers advised that his bank would not continue its line of credit to Bordo unless Bordo stopped advancing money to Pitt. As a condition to Bordo’s own inventory financing, Rodgers insisted that Bordo take steps to liquidate the funds it had lent Pitt.

Rountree was of the opinion that Pitt’s indebtedness to Bordo could be collected, with at worst a loss of $151,000. He recommended that Pitt be sold as a going concern. Bordo representatives were elected to Pitt’s board with a view to facilitating Pitt’s sale or liquidation. Bordo was advised by its Baltimore attorneys that its losses would be increased if it allowed Pitt to be thrown into bankruptcy by its general creditors. Bordo was advised to see that Pitt was liquidated in a manner so as to maintain all of its creditors other than Bordo on a current basis. Bordo supervised the liquidation of Pitt’s assets, and Pitt vacated its plant by August 31, 1961. During the period January 1 to September 30, 1961, Pitt repaid $510,811.40 of the amount owed Bordo.

Pitt’s landlord, the Chatim Corporation, filed an action for damages totaling one million dollars against Pitt and Bordo on April 9, 1962. Chatim alleged that Pitt had broken its lease, and also alleged improper action on the part of Bordo, due to alleged responsibility for the breaking of Pitt’s lease to Chatim. This action was dismissed with prejudice following Bordo’s compromise payment to Chatim of $22,500.

Insofar as pertinent to the present controversy, Section 166(a) of the 1954 Internal Revenue Code provides as follows:

(1) Wholly Worthless Debts. — There shall be allowed as a deduction any debt which becomes worthless within the taxable year.

The apparent simplicity of this provision is entirely delusive. In the present context, the problem is the meaning of the statutory word “debt.” Defendant, as pointed out above, contends that Bordo’s loans to Pitt were in reality merely “advances” of capital contributions for the purpose of acquiring an “equity” interest in Pitt, and hence no debtor-creditor relationship between the two corporations ever came into being. Plaintiff, to the contrary, asserts that under the circumstances of the case, Bordo’s “advances” were clearly intended to be loans to Pitt both in form and substance. This question of whether a particular corporate obligation is “debt” or “equity” has been presented to this court on a number of prior occasions. See Affiliated Research, Inc. v. United States, 351 F.2d 646, 173 Ct.Cl. 338 (1965); American Processing and Sales Co. v. United States, 371 F.2d 842, 178 Ct.Cl. 353 (1967); Jack Daniel Distillery v. United States, 379 F.2d 569, 180 Ct.Cl. 308 (1967); Liflans Corp. v. United States, 390 F.2d 965, 182 Ct.Cl. 825 (1968); and Sayles Finishing Plants, Inc. v. United States, 399 F.2d 214, 185 Ct.Cl. 196 (1968). Experience with § 166 and § 163(a) (allowing a deduction for interest on “indebtedness”) has not proven that the terms “debt” and “equity” are well understood and need no further definition. On the contrary:

There is no dearth of eases in this province of tax law. So large is their number and disparate their facts, that for every parallel found, a qualification hides in the thicket. At most they offer tentative clues to what is debt and what is equity for tax purposes; * * * (American Processing and Sales Co., supra, 371 F.2d at 848,178 Ct.Cl. at 362-363.)

In Liflans Corp. v. United States, supra, 390 F.2d 968, 182 Ct.Cl. at 831-832, this court identified five factors which it called “basic to the debt-equity distinction”, and in Cuyuna Realty Co. v. United States, 382 F.2d 298, 302, 180 Ct.Cl. 879, 886 (1967) eight “indicia of contributions to capital” were listed. Other courts have listed as many as fifteen, and a recent commentator has listed at least 25 “evidentiary factors.” In the final analysis, each case must be reviewed with an eye to its “unique factual flavor,” and as a composite of “many diverse external elements pointing in the end to what is essentially a subjective conclusion.”

American Processing and Sales Co., supra, 371 F.2d at 848, 178 Ct.Cl. at 363.

The Formal Rights of Creditors as Opposed to those of Stockholders

Classic definitions of debt emphasize the necessity for a fixed or determinable time when the debtor can be unconditionally required to make repayment. Undeniably, the April 8, 1959 mortgage agreement provided a definite schedule for the repayment of the $200,000 advance. The 1959 and 1960 production advances were all evidenced by issue-dated cognovit demand notes and thus were comfortably within the ambit of the classic definition since Bordo could demand repayment at any time. In his article cited in footnote 7, supra, Mr. Plumb makes the following pertinent observation at 418:

A demand note, although it sets no definite time for payment, does have an ascertainable due date which is within the control of the purported creditor- [citing cases], and therefore may be recognized as debt if other factors are favorable [citing cases].

It is clear that both the $200,000 loan secured by the chattel mortgage and the 1959-1960 unsecured production advances evidenced by demand notes provided Bordo with the usual rights of a creditor upon default.

The 1959 and 1960 demand notes contained no provisions compromising Bordo’s position as a creditor, and no subsequent agreements were executed subordinating either those notes or the $200,000 mortgage loan. While subordination may negate “an important characteristic of a debtor-creditor relationship: the right to share with general creditors in corporate assets upon dissolution or liquidation” (Liflans Corp., supra, 390 F.2d at 971-972, 182 Ct.Cl. at 837) the absence of subordination has been recognized as evidence of debt. Royalty Service Corp. v. United States, 178 F.Supp. 216, 220 (D.Mont.1959). Interest on both the $200,000 loan and the 1959 and 1960 production advances was payable unconditionally, a factor indicative of debt. Liflans, supra, 390 F.2d 965, 182 Ct.Cl. at 832. The Government has stressed repeatedly the admitted fact that Bordo did not contemplate making a direct profit from the interest generated by its advances to Pitt. It is not denied that the funds borrowed from the Baltimore bank by Bordo were loaned to Pitt at approximately the same rate as the bank charged to Bordo. Most lenders, of course, do intend to profit directly from the interest charged, and the interest rate is adjusted in accordance with the risk undertaken. Absent countervailing considerations, the failure to charge a rate of interest commensurate with the risk undertaken points to the conclusion that a capital contribution is involved. Here, other factors are involved, however, and this court has recognized as a “commercial commonplace” certain instances where the quid pro quo is other than a direct profit on the money advanced. American Processing and Sales Co., supra, 371 F.2d 842, 178 Ct.Cl. at 379; see also, George E. Warren Corp. v. United States, 141 F.Supp. 935, 938, 135 Ct.Cl. 305, 309 (1956), and Byerlite Corp. v. Williams, 286 F.2d 285, 290-291 (6th Cir. 1960). In the instant case, by its dealings with Pitt, Bordo looked toward a more profitable market for its citrus by-products, increased volume discounts on dates purchased from abroad, and reduced freight charges brought about by the pooling of date and glacé fruit shipments. Most importantly, Bordo looked toward the stimulation of date sales which it considered would be brought about by furnishing its newly acquired brokers with a recognized glacé line.

At page 13 of its brief to the commissioner, defendant discusses Bordo’s management assistance to Pitt, stating:

«■ * * * * *
While there is some disagreement between the parties as to the degree to which Bordo supervised Pitt’s operations in 1959 and 1960, it is clear from both the testimony and the exhibits that Bordo did participate to a substantial extent in Pitt’s operations. Defendant contends that such participation is sufficient to support a holding that Bordo’s unpaid advances to Pitt were equity as a matter of law. [Emphasis supplied.]
* -X- -X- * -X- *

It is true that courts have listed participation in management as one of the factors to be considered in making the debt-equity distinction, e. g. Berkowitz v. United States, 411 F.2d 818, 820 (5th Cir. 1969). See, Plumb, supra, at 447-450. However, this factor while meriting close scrutiny can hardly be considered as converting the entire question to one of law. The validity of loans even to a controlled corporation is well established. George E. Warren Corp., supra, 141 F.Supp. 935, 135 Ct.Cl. at 312; Wilshire & Western Sandwiches, Inc. v. Commissioner, 175 F.2d 718, 721 (9th Cir. 1949); Byerlite Corp. v. Williams, supra.

Indeed, as noted in Plumb, supra, at 447:

******
* * * it is still almost, correct to say, as one court said long ago, that “The question of voting rights and a voice in management of the company has frequently been discussed but has never been stressed in the determination of the issue.” Citing Jordan Co. v. Allen, 85 F.Supp. 4377 443 (M.D.Ga.1949).

Even if defendant’s statement of the law were correct, its factual predicates are hardly supported in the record. While the loan agreement and chattel mortgage contain some creditor-type language restricting Pitt’s conduct as a corporate entity, neither agreement grants Bordo a voice in the management of Pitt’s affairs, nor does any subsequent agreement. The substance does not betray the form as defendant urges. From the outset of the negotiations, it was recognized that Pitt was in serious need of assistance in the area of financial management, and that Bordo’s management would endeavor to furnish it. On Bordo’s advice, Pitt hired a controller. Bordo’s Ray Watkins spent considerable time at Pitt’s plant in 1959 where he set up accounting, cost, and financial systems for Pitt, audited Pitt’s operations for the first six months of 1959, worked on production control, and assisted Bordo’s vice president, A. L. Koch.

It is true that during times of unexpected disappointment in Pitt’s operations during August and September of 1959, Koch spent considerable time at the Pitt plant and that he was frequently consulted with respect to overall policy guidance. This fact is partly attributable to the unforeseen inability of Pitt’s general manager to produce an acceptable product at a competitive price and partly to Bordo’s concern as Pitt’s largest creditor for firsthand information on the condition of its debtor. With the prior agreement of Pitt, Sr., Bordo was instrumental in procuring the services of an experienced manager in the glacé fruit field, Lawrence Weitz. Once Weitz had been employed by Pitt as its genera] manager, Bordo’s involvement in Pitt’s operations dramatically declined since Bordo had the utmost confidence in Weitz’s managerial abilities.

Even after giving the matter the close scrutiny it deserves, it can only be concluded that Bordo’s advice and participation in management activities were no more than should be expected of a large creditor sincerely worried about its debtor’s inefficient operations and bad financial plight.

Factors Indicating an Intention to Create a Debtor-Creditor Relationship

The names ascribed to the Bordo-Pitt documents in question were “loan agreement,” “chattel mortgage,” and “demand notes.” “While the form of the instrument is not controlling, it is relevant and entitled to consideration.” Liflans Corp., supra, 390 F.2d at 969, 182 Ct.Cl. at 832. See, also, Crawford Drug Stores, Inc. v. United States, 220 F.2d 292 (10th Cir. 1955). Whatever the nomenclature, of course, any instrument is vulnerable to a challenge that its form does not comport with its substance. On this record, it is believed that the form and substance of the Bordo-Pitt transaction coincide.

Defendant devotes a significant portion of its brief to the contention that “plaintiff’s declarations of subjective intent are irrelevant and immaterial.” Defendant’s case citations do not support its conclusion, but rather confirm that such declarations are relevant and will be considered but with the caveat that they will never be determinative by reason of being infected with a self-interest that cannot prevail over inferences drawn from objective acts. Cf. Rombach v. United States, 440 F.2d 1356, 1359, 194 Ct.Cl. 530, 534 (1971). The fact that a party has sought to protect its creditor status by obtaining security enhances the possibility that its advances will be considered debt rather than capital contributions. See, Ackerson v. United States, 277 F.Supp. 475, 477 (W.D.Ky.1967). Bordo’s initial $200,000 advance was secured by a chattel mortgage on substantially all of Pitt’s office and plant equipment with a net book value of $297,208.58. Defendant makes much of the fact that the 1959 and 1960 advances evidenced by numerous demand notes were unsecured. Defendant suggests that a true creditor would have sought “ * * * the minimal protection of an inventory financing lien * * *.” However, on this record, I have concluded that, by assuring itself through monthly cash flow and production reports that its 1959 and 1960 production advances were being converted into inventory, and by effective restrictions in the mortgage documents of Pitt’s ability to encumber its assets, Bordo was behaving in the manner of a true creditor as distinguished from an equity investor. Only by virtue of 20-20 hindsight is it now possible for defendant to suggest other means whereby Bordo’s attorneys might have more effectively protected Bordo’s rights against Pitt.

Proportional holdings of debt and stock have always been considered as indicative of equity rather than debt. American Processing and Sales Co., supra, 371 F.2d 842, 178 Ct.Cl. at 363; Liflans Corp., supra, 390 F.2d 965, 182 Ct.Cl. at 836-837; Affiliated Research, Inc., supra, 351 F.2d 646, 173 Ct.Cl. at 344-345. However, it is also clear from Liflans that something more than this single factor must be present, and this would seem consistent with the fact that a viable debt may be recognized even where the debtor is a controlled corporation. Byerlite, supra; George E. Warren Corp., supra. It is better to characterize the impact of such a fact as rendering the transaction “suspect” and subject to “close scrutiny.” Sayles Finishing Plants, Inc., supra, 399 F.2d 214, 185 Ct.Cl. at 208; George E. Warren Corp., supra, 141 F.Supp. 935, 135 Ct.Cl. at 312.

It is reasoned that the holder of proportionate amounts of debt and equity will not force repayment of the debt if such enforcement would jeopardize its equity interest. Tyler v. Tomlinson, supra, 414 F.2d at 849. Bordo owned 125 shares of Pitt Common and 50 shares of Pitt Preferred, as well as an option to purchase the remaining 820 shares of Common at $100 per share. Defendant argues that there was thus an identity of interest between Bordo’s and Pitt’s shareholders which indicates that the “1960 advances were not conceived of as debt,” citing P. M. Finance Corp. v. Commissioner, 302 F.2d 786 (3d Cir. 1962); Indian Lake Estates, Inc. v. Stewart, 448 F.2d 574 (5th Cir. 1971); Foresun, Inc. v. Commissioner, 348 F.2d 1006 (6th Cir. 1965); Motel Co. v. Commissioner, 340 F.2d 445 (2d Cir. 1965); Wilbur Security Co. v. Commissioner, 279 F.2d 657 (9th Cir. 1960); cf. Brown Shoe Co., Inc. v. Commissioner, 339 U.S. 583, 70 S.Ct. 820, 94 L.Ed. 1081 (1950).

None of defendant’s cases present a fact situation truly comparable to the transaction in question. These cases primarily stand for the proposition that the “non-issuance of shares of stock * * * is not necessarily controlling in determining the character of the transaction for tax purposes.” Foresun, Inc., supra, 348 F.2d at 1009; see Indian Lake Estates, Inc., supra, 448 F. 2d at 579. While it is true that the value of Bordo's stock option could be expected to increase with the success of Pitt’s business, it is unreasonable to assume on this record that Bordo would therefore have risked its very substantial loans and advances merely to shore up a potential equity position. The most the Government can expect from the existence of the option is that this will cause the court to scrutinize closely all other factors.

Failure of a creditor to insist on regular interest payments has been viewed as a pertinent factor in making the debt-equity distinction. Tyler v. Tomlinson, supra, 414 F.2d at 849. In 1959 Bordo received a total of $941.66 interest from Pitt. It waived interest of $28,697.58. Bordo never accrued this interest on its books, financial statements, or tax returns. Failure of a creditor to insist on repayment of an installment of a note when due or an inappropriate delay in making demand in the case of a demand note is also indicative of concern for an equity investment, Tyler v. Tomlinson, Id. at 849; Cuyuna Realty Corp., supra, 382 F.2d 298, 180 Ct.Cl. at 886.

However, intent at the time the advances were made is an important consideration, and subsequent unexpected economic developments may well explain the fact of forbearance. Liflans Corp., supra, 390 F.2d 965, 182 Ct.Cl. at 830-831. Here, Pitt's inability to make interest payments and to repay production advances was caused by unexpected production problems, lower than anticipated sales, and spiraling manufacturing costs. The advice of Bordo’s attorneys was also important in Bordo’s decision not to make an immediate demand for its production advances or to declare the $200,000 loan in default. In August of 1959, Bordo’s attorneys advised it to see that Pitt’s general creditors were paid in the ordinary course of business in order to insure that a petition for involuntary bankruptcy was not filed against Pitt. Such an eventuality, they advised, would have rendered any payments to Bordo voidable preferences if made within four months of Bordo’s knowlege of Pitt’s insolvency. Additionally, such an eventuality would have interfered with the orderly liquidation of Pitt’s inventory. Thus, Bordo advanced Pitt an additional $60,000 in September 1959 in compliance with its attorneys’ advice.

The question whether Bordo’s decision to forbear and continue advances in 1960, once 1959 adverse results were known, was a creditor’s decision or an equity investment will be discussed below.

Factors Bearing on the Reasonableness or Economic Realities of of the Transaction

This court and others have mentioned the purported debtor’s inability to obtain funds from an outside lender under the same conditions as a factor in making the debt-equity distinction. Cuyuna Realty Co., supra, 382 F.2d 298, 180 Ct.Cl. at 886; Lynch v. United States, 337 F.Supp. 1297, 1299 (N.D.Ga. 1971). While it may be an adverse fac- . tor, the inability of a purported debtor to procure such a loan is not an unfailing bar to bad debt treatment for the purported creditor. Brighton Recreations, Inc. v. Commissioner, 20 T.C.M. 127, 135 (1961); American Processing and Sales Co., supra, 371 F.2d 842, 178 Ct.Cl. at 370.

In the present case, it has been found, over plaintiff’s objection, that the Baltimore bank had curtailed its line of credit to Pitt in 1959. That is at least one reason why Pitt sought the financial and other arrangements with Bordo which have been described at length herein. Ordinarily, this fact would weigh against plaintiff’s claim. However, it is to be remembered that in this case the motivation and effective rate of return to Bordo was much higher than the 5, 5%, or 5% percent interest charged. Bordo contemplated that substantial indirect profits and other benefits would inure to it from this transaction. Thus, the availability of loans to Pitt from outside sources at the 5-5% percent rate with the security offered is not particularly material.

Plumb, supra, ftn. 7, at 526 states:

* -X- * * *x* *
Perhaps the most obvious criterion of whether payment of a purported debt may reasonably be expected is the . projection of the sources from which payments may be made. In general, there are only four possible sources for consideration: (1) liquidation of assets, (2) profits from the business, (3) cash flow, and (4) refinancing with another lender.
* * -X- -X- -X- *

Pitt and Bordo predicted that Pitt would realize a substantial profit in 1959. There was no question in the minds of the respective managements that there would be funds for the repayment with interest of both the $200,000 loan installment and projected production advances. It is true that in July 1959, Bordo’s accountant prepared a revised budget for Pitt projecting a net loss of $76. Even based upon concededly conservative assumptions, however, the revised budget forecast a cash flow sufficient to repay all existing and projected advances with interest at the conclusion of Pitt’s selling season. Thus, as plaintiff contends, the absence of a sinking fund is without significance. Unhappily, Bordo’s and Pitt’s reasonable projections were frustrated by unexpected events: lower than anticipated sales, production problems, and spiraling manufacturing costs.

Early in 1960, Bordo was faced with a Hobson’s choice between asserting immediately its creditor’s rights (which no doubt would have meant liquidation of Pitt) or forbearing its right and continuing to advance funds on the same basis as in the previous year. The decision had to be made before Pitt was called upon to commit funds for raw materials. Defendant contends that “ * * * Bordo would be repaid only if Pitt’s 1960 selling season were successful; if the season were not successful, Bordo anticipated that it would not be repaid.” If this were true, Bordo’s advances would surely have been “at the risk” of Pitt’s business, and more likely capital contributions than debt.

However, defendant errs factually. The predicted cash flow from a breakeven year would have been sufficient to repay 1960 production advances and the mortgage debt installment, with interest. Plaintiff’s decision to continue was based upon the reasonable belief that Pitt’s new general manager could control the production problems and wasteful expenditures which had plagued Pitt in the previous year.

The first six months’ results supported Bordo’s predictions, but third-quarter results indicated that Pitt would again suffer a loss. A buyer for the firm was sought both by Bordo and Pitt principals but without success. Rightly or wrongly Bordo was again advised to see that Pitt’s general creditors were paid in the ordinary course in order to avoid the problem of voidable preferences. This was also necessary to insure the orderly disposition of Pitt’s inventory.

It is significant that the decision to continue advancing funds to Pitt in 1960 was reviewed by Bordo’s bankers. It will be remembered that the Harris Bank was also consulted when Bordo initially considered the transaction and after problems developed in August of 1959. Rodgers of the Harris Bank made it quite clear at trial that he would not have recommended to his bank an advance of funds to Bordo for its own inventory financing in 1960 if he had fully understood that Bordo planned to commit funds to Pitt other than on a short term basis until Pitt’s inventory was liquidated. Any other type of commitment would have reduced Bordo’s own working capital and reduced its ability to pay back its own seasonal borrowing to the Harris Bank.

From the foregoing consideration of all the many factors involved, Bordo’s status as a creditor of Pitt emerges clearly. Accordingly, upon Pitt’s ultimate failure to repay the loan balance of approximately $740,000, Bordo suffered a bad debt loss within the meaning of section 166.

There remains only the secondary question of whether, in addition, Bordo is entitled to deductions for certain depreciation expenses, abandonment losses, salary and travel expenses, legal and accounting fees, and stock escrow and settlement expenses, all connected directly to the Bordo-Pitt transaction. The facts with respect to these several items are detailed in findings 84 through 89. (See commissioner’s report of November 29, 1972.) It is sufficient here to note only salient facts as to the major items.

The depreciation expense and abandonment loss arose out of machinery and equipment admittedly owned by Bordo but loaned by it to Pitt; the salary and travel expenses were those of Bordo’s officials incurred in traveling to Baltimore for consultation with Pitt’s officials; and the legal and accounting fees related mainly to Pitt’s liquidation and the defense of a lawsuit filed against both Pitt and Bordo by Pitt’s landlord, a lawsuit ultimately settled by Bordo.

Defendant agrees that the resolution of this issue “is directly related to the determination of the debt-equity issue.” Since the latter issue has been resolved in favor of plaintiff, it logically follows that this secondary issue must likewise be resolved for plaintiff.

However, of “additional concern here,” says defendant, is whether Bordo received the benefit of these expenses so as to be entitled to their deduction. In defendant’s view only Pitt benefited from these expenses.

This specious argument deserves but little comment. From the record it is entirely clear that, while Pitt was indeed an incidental beneficiary of these expenses, it was Bordo who primarily benefited therefrom. Therefore, Bordo, not Pitt, is the taxpayer entitled to the deduction.

Plaintiff is entitled to judgment with the exact amount of recovery to be determined pursuant to Rule 131(c).

NICHOLS, J.,

concurs in the result.

CONCLUSION OF LAW

Upon the findings of fact and the foregoing opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover, and judgment is entered to that effect, with the determination of the amount of recovery to be reserved for further proceedings under Rule 131(c) in accordance with this opinion.

       Whereas the court adopts the commissioner’s separate findings of fact, which are set forth in his report filed November 29, 1972, they are not printed herein since such facts as are necessary to the decision are contained in his opinion.

      . Whether or not these statements included the statement for 1958 is not clear from the record, as the 1958 statement bears the date January 27, 1959. However, it is certain that this report was seen by Bordo prior to the finalization of the agreement described below.

      . Because the holders of 125 of the common shares dissented to the above arrangements, a Bordo stockholder purchased the shares from the shareholders at par prior to the execution of the agreement. In June of that year Bordo acquired these 125 shares from its stockholder at par.

      . When a trustee holding 50 of Pitt’s first preferred shares refused to consent to the above transaction, his shares were purchased by Bordo at $60 per share.

      . Freight and brokerage charges, cash discounts and administrative costs eliminated the possibility of a direct profit.

      . But see John Kelley Co. v. Commissioner, 326 U.S. 521, 530, 66 S.Ct. 299, 90 L.Ed. 278 (1946).

      . Tomlinson v. 1661 Corp., 377 F.2d 291, 296 (5th Cir. 1967).

      . Plumb, The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal, 26 Tax L.Rev. 369, 411-412 (1971). This brilliant analysis of the debt-equity area of tax law stands in a class by itself. The article is the most comprehensive treatment of the subject to date.

      . One recent decision compared the “often intuitive and subjective” process here involved to the problem of judicially defining pornography, of which Mr. Justice Stewart said, “perhaps I could never succeed in intelligibly doing so. But I know it when I see it. * * * ” Sansberry v. United States, 70-1 U.S.T.C. ¶9216 (S.D.Ind.1970), citing Mr. Justice Stewart’s concurring opinion in Jacobellis v. Ohio, 378 U.S. 184, 197, 84 S.Ct. 1676, 12 L.Ed. 2d 793 (1964). See also, Waldemar J. Coliz, 22 T.C.M. 1775, 1785 (1963).

      . In Sayles Finishing Plants, Inc., supra, 399 F.2d at 218, 185 Ct.Cl. at 203, the court characterized the following from Gilbert v. Commissioner, 248 F.2d 399, 402 (2d Cir. 1957), ns a “well-stated definition of debt”:
      “The classic debt is an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor’s income or lack thereof. While some variation from this formula is not fatal to the taxpayer’s effort to have the advance treated as a debt for tax purposes, * * * too great ’ a variation will of course preclude such treatment.”

      . Finding 33 (note 4). (See commissioner’s report of November 29, 1972.)

      . The loan agreement and the recorded chattel mortgage, both dated April 8, 1959, contained standard default clauses for the protection of Bordo as mortgagee.

      . Jewel Tea Co., Inc. v. United States, 90 F.2d 451, 453 (2d Cir. 1937); United States v. South Georgia Ry. Co., 107 F.2d 3, 5 (5th Cir. 1939).

      . In fact, the loan agreement contained clauses which had precisely the opposite effect.

      . “Subordination to general creditors is not necessarily indicative of a stock interest. Debt is still debt despite subordination.” Kraft Foods Co. v. Commissioner, 232 F.2d 118, 125-126 (2d Cir. 1956); accord, Jack Daniel Distillery, supra, 379 F.2d 569, 180 Ct.Cl. at 328-329; Commissioner v. O. P. P. Holding Corp., 76 F.2d 11, 12 (2d Cir. 1935).

      . “The question always is whether the transaction under scrutiny is in fact what it appears to be in form; a marriage may be a joke; a contract may be intended only to deceive others; an agreement may have a collateral defeasance.” Chisholm v. Commissioner, 79 F.2d 14, 15 (2d Cir. 1935), cert. denied, Helvering v. Chisholm, 296 U.S. 641, 56 S.Ct. 174, 80 L.Ed. 456 (1935).

      . No proof has been offered concerning the ability or inability of Pitt to obtain credit from another source.


source: Caselaw Access Project

author: PER CURIAM:

license: Public Domain

text:
    HEAVEN HILL DISTILLERIES, INC. v. The UNITED STATES.
    No. 372-68.
    United States Court of Claims.
    April 13, 1973.
    As Amended May 24, 1973.

      David Sachs, New York City, for plaintiff; John Tarrant, Louisville, Ky., attorney of record. Myer Galanter, Louisville, Ky., Paul J. Bschorr, New York City and Tarrant, Combs, Blackwell & Bullitt, Louisville, Ky., of counsel.
    Joseph Kovner, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant; Gilbert E. Andrews, Jr. and James C. Bergner, Washington, D. C., of counsel.
    Before COWEN, Chief Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA, KUNZIG, and BENNETT, Judges.
   OPINION

PER CURIAM:

The ultimate issue is whether plaintiff corporation, a distiller of bourbon whiskey, may currently deduct in its fiscal years 1962-64 the expenses of “carrying charges” for storing the whiskey in barrels in its warehouses while it ages and awaits customers, rather than adding such carrying charges to the cost of its bulk whiskey inventory and deferring recovery of the charges to ultimate sale or disposition. While the plaintiff expensed all such carrying charges, including those associated with the storage of whiskey sold in bulk to others (about 95 percent of its production), the present claim relates only to those carrying charges associated with the whiskey which plaintiff owned, i. e. which it bottled on its own account and under its own labels for wholesale disposition by the case, or which it sold in bulk after the year of production. In deciding this question, the dispositive issue is whether the aging of the whiskey is part of its manufacturing or production process. If it is not, defendant concedes it has no defense.

Since its inception in 1946 the plaintiff has engaged in distilling, storing during the aging period, and selling bourbon whiskey in the State of Kentucky. After distillation the raw (“cistern”) whiskey is entered into 50 or 51 gallon white oak barrels which have been charred on the inside. The barrels are then stored in plaintiff’s warehouses, which have no temperature or humidity controls. While the barrels are thus stored their contents, through chemical interaction between the whiskey and the charred interior surfaces of the barrels, gradually change in color, aroma, and taste. This is' the aging process which takes place automatically without human or mechanical intervention, except for routine checking of the barrels for leaks, random sampling before bottling, and sporadic rotation of some barrels in the warehouses whenever time permits, although rotation is not necessary to proper aging and many barrels are not disturbed.

Each barrel in storage bears a separate serial number and the date when it is filled with raw whiskey and placed in the warehouse. That is the production date. Similar data is carried in plainiff’s inventory records. Because of the progressive chemical change that occurs in the barreled whiskey while aging in storage, each age acquires a distinctive quality with respect to its color, aroma, and taste that differentiates it from other barreled whiskey which has been in storage for a lesser or greater period of time. Whiskey stored for 2 years is called straight whiskey, and for 4 years or more it is called bonded whiskey when bottled and labeled.

Approximately 95 percent of plaintiff’s production is sold in bulk to purchasers, some of it being bottled for them. The rest is retained and bottled by plaintiff under its own labels for wholesale case disposition. Heaven Hill labels are applied only to whiskey which is at least 4 years of age. The bulk whiskey is salable from the moment it is barreled and stored. During the tax years in suit from 67 to 77 percent was sold to customers during the first year of storage, and kept in storage for the customer until it reached the age desired, whereupon it was delivered in that form to the customer or, at the customer’s direction and cost, bottled for him by plaintiff. The customer pays plaintiff storage charges from the date of purchase, which yields plaintiff a profit over its storage costs.

When plaintiff offers its bulk whiskey for sale the quoted prices vary according to the posted age of the product. Generally the price increases with the product’s age. The difference in price approximates the accumulated storage charges for the longer period. But the chief determinant of price is the competitive factor of market supply and demand. Over the years there has been wide fluctuation in the price of bulk whiskey. Older bourbon whiskey is assessed an ad valorem tax by the State of Kentucky at a’higher value than younger whiskey. The State determines the value for tax purposes, which increases for each year of age, but whiskey of the same age and type by all producers in the State is assessed the same value. There is no necessary correlation between the assessed value of the whiskey for state tax purposes and its market value.

Since its incorporation in 1946 the plaintiff has consistently accounted for its bulk whiskey inventories by recording the average production cost of each barrel produced. Plaintiff’s recorded production cost has included everything except the warehouse cost for the aging period, which warehouse cost the plaintiff has charged off to ordinary and necessary business expense under section 162 of the 1954 Code, or its predecessor counterpart. The warehouse cost per barrel is known. Only the warehouse costs attributable to the bulk whiskey inventory which plaintiff owns and bottles for its own account are in issue here, as stated before. The warehouse costs for bulk whiskey owned by plaintiff’s customers and left to age in plaintiff’s facilities are also currently deducted as expense on plaintiff’s books, but these deductions are not part of our problem.

Plaintiff’s certified public accountant has certified its financial statements, which expensed the warehouse costs, as being in accordance with generally accepted accounting principles and fairly presenting the results of plaintiff’s operations, i. e., its net income. The approval of plaintiff’s consistent practice of expensing its warehouse costs rather than adding them to inventory was based on the assumption that the storing of bulk whiskey while it aged was not part of the production or manufacturing process of bourbon whiskey, but represented only storage costs of a finished, salable product.

On audit of plaintiff’s Federal income tax returns for fiscal years 1962 through 1964 the Commissioner of Internal Revenue determined that the storage costs were costs of production not to be deducted as period costs but deferred until sales of the inventory by capitalization or additions to inventory costs incurred in the year for goods held for future sale. Deficiencies were assessed and paid as itemized in findings 36 and 37, infra, claims for refund duly filed and disallowed, and this suit followed.

The plaintiff does not consider the storage interlude of its bourbon whiskey business to be manufacturing, or production, primarily because the product becomes salable the moment it is barreled and placed in the warehouse, two-thirds of total production being sold in the first year before it is matured enough to please the palate. Defendant contends that the storage phase (which it terms “maturation period,’’ the costs of which are accordingly “maturation costs”) is a continuation of the manufacturing process because whiskey of a particular age is a separate and distinct production from whiskey of any other age, and this distinction is recognized by the trade, the public, and by plaintiff in its pricing and record-keeping. The theory being, it is supposed, that older whiskey appeals to the more lucrative carriage trade, while greener whiskey has a less exacting constituency. Under the circumstances peculiar to this plaintiff’s method of doing business, which may not necessarily apply to other members of the bulk bourbon industry whose procedures may differ in significant respects for all the record shows, we hold that the period from the deposit of the barreled bourbon whiskey in the plaintiff’s warehouses to the time of its withdrawal therefrom constitutes storage rather than manufacturing, even though the whiskey is maturing the while. The necessary consequence of this conclusion is that the whiskey is a finished, salable (though not appetizing) manufactured product at the commencement of its storage.

There is no fixed all-purpose definition of the term “manufacture.” See Duke Power Co. v. Clayton, 274 N.C. 505, 513-514, 164 S.E.2d 289, 295 (1968); 55 C.J.S. Manufactures § 1a (1948). See also the variety in 26 Words and Phrases (1953) under “Manufacture.” Etymologically the term compounds from the latin words “manu” and “facere”, literally, to make by hand. Machinery is metaphorically a mechanized extension of the human hand. In an industrial society manufacturing is no longer represented by the handcrafted products of an earlier cottage industry age, but rather is characterized by the production of goods in quantity through the concentrated employment of multiple labor, much material, and relatively large amounts of capital in the form of structures, divers machines, and abundant finances. Manufacture is not a technical word but has a common, ordinary, but elastic meaning. Sharpe v. Hasey, 134 Wis. 618, 620-621, 114 N.W. 1118, 1119 (1908). Its meaning varies too according to the context in which it is employed. For example, where it is used in a statute which extends or denies the benefits of a license or tax exemption to such classification, or in a customs provision applying a different duty to imported manufactures, it becomes important to apply a liberal or a strict construction according to the legislative purpose of the measure. The dictionary definition is of secondary value in the interpretive process. In the present case, the term is not used in the relevant tax statute, but nevertheless is involved in implementation of the statutory intent.

The most comprehensive judicial analysis of the term “manufacturing” exposed by research is found in In re I. Rheinstrom & Sons Co., 207 F. 119 (E.D.Ky.1913), aff’d 221 F. 829 (C.A. 6), appeal dismissed, 239 U.S. 11, 36 S.Ct. 1, 60 L.Ed. 119 (1915), where in concluding that the elaborate processing of Maraschino cherries constituted manufacturing with regard to establishing creditor priorities under a bankruptcy statute, the court painstakingly sifted and analogized numerous precedents.. Written 60 years ago, no case before or since Rheinstrom has made such a major effort. The message of much of the lengthy discussion there is that the processing and manipulation of agricultural or natural products into a form suitable for sale in the market does not constitute manufacture, so long as the article sold is the processed but recognizable form of the original or natural product, despite the labor and machinery necessary to achieve that result. But where the transformation of the product is too pronounced, and the processing too involved, as in the ease of Rheinstrom’s Maraschino cherries, then the end product may become a manufacture, having abandoned its original characteristics en route.

Thus the roasting, grinding and blending of raw coffee beans for commercial sale was held not to be manufacturing, nor the mixing of several varieties of tea into a blend for sale. People ex rel. Union Pac. Tea Co. v. Roberts, 145 N.Y. 375, 40 N.E. 7 (1895). And the purchase, slaughtering and sale of sheep /and lambs, with byproducts of wool, hides, and rendered tallow (fat being chemically transformed through heat) was held not to be manufacture. “At most, they were merely prepared for market and preserved until sold.” People ex rel. New England Dressed Meat & Wool Co. v. Roberts, 155 N.Y. 408, 412, 50 N.E. 53, 54 (1898). Grass cut into hay, then dried in the open and stored in a warehouse for a month before baling and shipment, in the course of which processing the native starch converted to sugar through natural forces to make a more nutritive fodder, was held not to be manufacture in the context of a customs law imposing a tariff on manufactured imports. Frazee v. Moffitt, 18 F. 584 (N.D.N.Y.1882). The court there found that

* [T]he drying and any conversion of starch into sugar are mere incidents of the necessary cutting to enable it to be stored for food x- * *. Dried apples would not be called a manufactured article, though the apple is peeled and cored and sliced, and dried by exposure to the sun and manipulation. The substance of dried applies is still apples. * * * [18 F. at 587.]

In commenting on this case, Rheinstrom, supra, 207 F. at p. 142, observed that if there is a change made in converting grass into hay,

* * * [I]t is nature and not the farmer that makes the change, and hence the farmer cannot be said to be a maker * * *. He simply manipulates the grass, so that nature can do her work better. * * * [S]o far as there is a making, it is nature which does the making. * * *

Rheinstrom repeats this observation in equivalent language at p. 154. Note the similarity to the aging of whiskey in storage without manipulation or attention, and through the working of natural forces, quite comparable in principle to the sun-drying of apples or the starch-to-sugar metamorphosis in stored hay.

Even though whiskey in storage is, unlike less animate objects, in a state of internal flux and slow betterment while it rests in its congenial surroundings, nevertheless it at all times remains whiskey, and in plaintiff’s practice at any and all times it is a salable if not an agreeably potable product when first it is distilled and barreled. It need not be ready to imbibe in order to be ready for sale. The distiller aims at the wholesaler as his target of sale, the wholesaler at his retailer, and the retailer at the drinker. (In its later life, whiskey is said in jest to have more public enemies and private friends than any known liquid comestible.) Only to the retailer and the consumer is the readiness of the product for normal consumption a matter of immediate concern, for the wholesaler’s interest is primarily in the potential consumer attributes of the basic product, and he buys from the producer on the strength of that potential whether it is achieved at the moment of sale or not.

In Anheuser-Busch Brewing Ass’n v. United States, 207 U.S. 556, 28 S.Ct. 204, 52 L.Ed. 336 (1908), aff’g 41 Ct.Cl. 389 (1906), in ruling that the extensive chemical processing given to imported corks before their use as stoppers in exported bottled beer was not “manufacture” in the meaning of a statute authorizing the deduction (“drawback”) of the duty paid on imported components of exported products, the Supreme Court said at p. 562:

* * * Manufacture implies a change, but every change is not manufacture, and yet every change in an article is the result of treatment, labor, and manipulation. But something more is necessary * * *. There must be transformation; a new and different article must emerge, “having a distinctive name, character, or use.” * * * A cork put through the claimant’s process is still a cork. * * *

Rheinstrom, supra, 207 F. at p. 149, dialectically criticizes this statement in Anheuser-Busch. By transliteration of the cork situation to the whiskey one, whiskey is still whiskey after storage, albeit with a transformation in color, taste and aroma, but surely no more of a transformation than occurred to the AnheuserBusch corks, which were actually given much more manipulation of a “manufacturing” nature than the inert storage treatment accorded the whiskey. Nor was the change made in the corks by manipulation any more pronounced than the transformation in the stored whiskey. In each case the basic substance to which the cork and aging were collateral, namely, beer and whiskey respectively, were manufactured products. In each case the product was changed so it could be used, with this difference: whereas the corks in their pristine imported condition could not be used as corks until thoroughly processed, our plaintiff’s whiskey was usable for the purpose intended by its maker, namely, sale in bulk, at any time after when in raw state it was entered in the barrels, for plaintiff was in the business of bulk sales which did not require the whiskey to be potably aged at the time of sale. Granted that this case is confined to the particular whiskey which the plaintiff did not sell in bulk but held and bottled on its own account for sale in case lots; nevertheless that area of its business was only incidental to its principal business. So far as is disclosed, the plaintiff had no program to set aside a particular portion of its annual production for its own use, but ostensibly left that decision to depend on the amount that was not disposed of to bulk purchasers.

The issue of whether whiskey aging in barrels subsequent to the distillation process was “work in process” has been considered in three recent cases. The first was Jack Daniel Distillery v. United States, 379 F.2d 569, 180 Ct.Cl. 308 (1967). The question arose in a somewhat different context than the instant one, specifically how the distiller’s inventory of whiskey in barrels was to be valued at the time of sale of all the distiller’s assets. The plaintiff in Jack Daniel contended that, once distilled, the whiskey was a distinct product, and that even while aging the whiskey could not be fairly valued without taking into account the prospective value of the right to bottle the whiskey product under the Jack Daniel label. ' The Internal Revenue Service contended that the aging whiskey in barrels was still “work in process”; and that until it had aged the requisite length of time it was not yet the distinct whiskey product identified under the Jack Daniel label. Thus the defendant argued that the tangible asset, aging whiskey in barrels, should be valued without addition of the value of the right to affix thereto the intangible label. The Court of Claims rejected defendant’s contentions. The court agreed that the whiskey in barrels had some characteristics of “work in process”, in that the distiller allowed it to age a certain number of years before bottling it for sale; nonetheless the court found that the whiskey in barrels was unlike “work in process” in many respects. The parties had agreed that Jack Daniel whiskey was, when sold at retail, a distinct product unlike any other whiskeys, including bourbon whiskeys. The court found that the distinct qualities of the Jack Daniel product were generated at the time of the actual distilling process, prior to the barrelling of the whiskey. The aging or maturing of the whiskey was a natural process that did not add anything to the Jack Daniel whiskey that was unlike other whiskeys. The barreled product, while aging, was a “product” that had an ascertainable liquidation value whether or not it had aged to the point at which the distiller normally bottled it. Thus the court found that the whiskey in barrels did not fit the usual concept of “work in process”; and the court agreed with the plaintiff in Jack Daniel that the whiskey was already a distinct product that could not fairly be valued, even on the first day in barrels, without considering the value of the right to use the distinctive Jack Daniel label. It would seem that the factual analysis in Jack Daniel would a fortiori support plaintiff’s position in Heaven Hill, since the instant plaintiff’s whiskey, while it may have its devoted clientele, is not substantially unlike other bourbon whiskeys but is considered a salable product even in the raw state. In Jack Daniel it was not disputed that the distiller held all of its whiskey until aged a specified amount of time, and sold all of the whiskey under its own label as a distinct whiskey product. In the present case, the fact that plaintiff sells almost all of its whiskey in bulk at virtually any point in the time during which the whiskey is aging, two-thirds of it within the first year of storage, and that it holds some whiskey at least 4 years for bottling under its own label, would seem to reflect consumer preferences rather than the distiller’s desire to create a distinct “aged whiskey” product.

A somewhat different result from that of Jack Daniel, was reached by the Tax Court in George L. Schultz, 50 T.C. 688 (1968) aff’d per curiam, 420 F.2d 490 (3d Cir. 1970), a case relied on here by defendant. In Schultz, the taxpayer purchased as an investment whiskey certificates covering numerous barrels of raw whiskey which he left in the possession of the distiller, originally planning (by his own admission) to leave the whiskey in storage until it had aged 4 to 5. years (although he ultimately sold it at a loss somewhat earlier). The court expressed its opinion that the storage of the whiskey while aging constituted part of the manufacturing process, albeit the aging process was a natural one not caused or aided by human instrumentality. The actual holding of the Tax Court, however, was that since the taxpayer had admittedly originally sought to acquire 4-year old whiskey, the storage and related expenses constituted part of the costs of acquisition of the capital asset, i. e., 4-year old (or older) bourbon. Thus, the Tax Court held that the storage costs should be capitalized rather than deducted annually as expenses. Despite the assertions of defendant to the contrary, the Schultz case is readily distinguishable from the facts of the instant case. The taxpayer in Schultz was not in the bourbon business or industry, but was an admitted speculator engaged in a limited investment transaction ; and his original intent was to hold the whiskey until it had aged at least 4 years for sale at that time. Indeed, in affirming in Schultz, the Court of Appeals for the Third Circuit stressed that they were affirming on the facts of that case. Further, Schultz has since been distinguished as above in a case involving a distributor of bourbon whiskey, see Van Pickerill & Sons, Inc. v. United States, 445 F.2d 918, 921-922 (C.A. 7, 1971).

An issue closely analogous to ours was considered by the United States Court of Appeals for the Seventh Circuit in Van Pickerill & Sons, Inc., supra. There the taxpayer was a wholesale liquor dealer who was also the exclusive distributor in certain counties of southern Illinois of a particular brand of bourbon whiskey. Taxpayer would purchase raw or “white” whiskey from the distiller, but the seller-distiller would retain possession of the whiskey in barrels in his warehouse until it had aged 4 or 5 years to conform to consumer tastes. The seller-distiller would pass on the storage costs, insurance charges, and ad valorem taxes assessed by the State of Kentucky, to the buyer-wholesaler on a regular basis. The taxpayer consistently deducted these assessments annually as expenses, but the Commissioner of Internal Revenue determined that this method of accounting did not clearly reflect taxpayer’s income, under section 471 of the Code. The Commissioner argued that the aged whiskey ultimately sold by the taxpayer was a different product from the raw whiskey initially purchased; thus the storage and related costs should be added to the cost of the goods at the time of sale rather than deducted annually. The court rejected the Government’s contentions in affirming the (unreported) decision of the trial court in favor of the taxpayer. There, as in the instant case, the expert accounting testimony on both sides, taken as a whole, supported both accounting methods as clearly reflecting income, without indicating that either was the “best” method.

The court noted that the taxpayer’s method of accounting for these expenditures was widely used in the trade. As for the Government’s “matching” theory, the same as the one urged in the instant case, the court stated:

* * * [I] t appears that the decision by the Commissioner is more an expression of preference for capitalizing these charges rather than a determination that taxpayer’s consistent use of its methods will not reasonably reflect income in the long run. * * * [Id. at 921.]

The court distinguished Schultz, supra, on the basis that that case involved a one-time speculator in bulk bourbon rather than one regularly engaged in the trade. The court concluded:

We realize that taxpayer’s inventory of unbottled aging whiskey has some characteristics of work in progress. Yet, the applicable Code section and regulations appear designed to afford taxpayers the type of flexibility exercised * * * [by this taxpayer]. [Id. at 922.]

While the decision in Van Pickerill is not binding on this court, the reasoning of that case is entirely persuasive, and is not distinguished merely because that taxpayer was a wholesaler and the instant plaintiff is a distiller.

With this preface as background, three principal reasons occur why the storage of plaintiff’s whiskey did not amount to manufacture or production. In the first place, during its storage the whiskey was having nothing done to it to promote or create its aging; instead it was doing something to itself through natural forces. If this is an epigrammatic formula it is also true, and it corresponds to the situation of the hay which, during storage, is through natural forces converting its starch into sugar to enhance its utility. As with the hay, no manipulation by labor or material occurs to the whiskey during storage which is the efficient cause of the chemical change taking place in the product. The pot is being stirred by the invisible hand of nature.

Second, in the plaintiff’s scheme of things the storage phase is intermediate between the distillation and barreling stage on the one end, and the sale or disposition stage on the other. This intermediate aging stage is more closely identified with the sales phase than with the manufacturing phase, for when the plaintiff places its newly filled barrels of raw whiskey in its warehouses it is symbolically placing its merchandise on the shelves of its shop for sale as a finished product. Once it is barreled and stored it awaits sale, and various factors may affect its salability, including supply and demand, age, source, quality, reputation of its maker, etc. These are only selling factors. With the plaintiff the sale of nonpotable raw whiskey in bulk is its business raison d’etre, and its bottling of its own whiskey on its own account is a minor sideline.

Third, is the concept expressed in Van Pickerill & Sons, Inc., supra, that where, as in this case, the correct tax status of the disputed costs is closely in balance and they can reasonably be considered not to be part of production or manufacturing, and the taxpayer has consistently so treated' them, the Code and the applicable regulations authorize that treatment.

As a general proposition, a taxpayer is not restricted to using any particular method of accounting. Section 446(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 446(a) (1970). However, section 446(b) of the Code provides in pertinent part:

* * * [I]f the method [of accounting] used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.

With particular reference to inventories, section 471 of the Code provides:

Whenever in the opinion of the Secretary or his delegate the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary or his delegate may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income, (emphasis added).

Turning to the regulations prescribed by the Internal Revenue Service, section 471 of the Code is discussed at 26 C.F.R. § 1.471-2 (1972). Subsection (a) of the regulation reiterates that inventory accounting must conform “as nearly as may be” to the best accounting practice in the industry, and must clearly reflect income. Subsection (b) provides the following guidelines:

It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with §§ 1.471-1 through 1.471-9. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income, (emphasis added).

Of the regulatory provisions cited in the above quoted paragraph, defendant relies on 26 C.F.R. § 1.471-3(c) (1972), which provides in general terms that the cost of an inventory includes “(1) the cost of raw materials and supplies entering into or consumed in connection with the product, (2) expenditures for direct labor, (3) indirect expenses incident to and necessary for the production of the particular article * *

The statutory scheme strongly reflects a congressional intent to allow flexibility to taxpayers in accounting for expenditures, especially where, as here, the expenditure cannot with assurance be described as a production cost. If the substantial expert accounting testimony presented by both parties at trial shows anything, it shows that highly qualified professional accountants can differ radically as to the “best” method of accounting for the costs at issue here. It is undisputed that plaintiff has consistently followed its present practice of expensing the storage costs since its incorporation in 1946. Section 1.471-2 (b) of defendant’s own regulations, quoted supra, explicitly provides that consistency is to be given the greatest weight in determining whether a particular method of inventorying clearly reflects income. The expert testimony on both sides conceded that either method here, plaintiff’s or that urged by defendant, is in accord with generally accepted principles of accounting. That plaintiff’s method does conform to generally accepted accounting principles is entitled to at -least some probative weight. See John Wanamaker Philadelphia, Inc. v. United States, 359 F.2d 437, 441, 175 Ct.Cl. 169, 177 (1966). It is also undisputed that defendant accepted plaintiff’s method of accounting for these expenditures on its returns from 1946 through 1961. As this court stated in Kennecott Copper Corp. v. United States, 347 F.2d 275, 303, 171 Ct.Cl. 580, 628 (1965).

The fact that the Commissioner of Internal Revenue is not estopped by previous action in relation to similar expenditures from applying a different treatment to the expenditures in the instant case does not mean that his earlier action or similar outlays is wholly without significance.
* * * The question is not estoppel of the Commissioner, but the persuasiveness of prior experience in determining the classification of the * * * expenditures [at issue] as expenses * * *. (emphasis added).

It has also been squarely held in this court that storage expenditures similar in nature to those at issue here can be deducted as expenses rather than added to inventory costs or costs of acquisition of capital assets. Higgins v. United States, 75 F.Supp. 252, 110 Ct.Cl. 204 (1948) (storage costs of turpentine).

Taken as a whole, the expert accounting testimony on behalf of plaintiff does not urge that plaintiff’s method of accounting for the costs is the only or the best method of treating these expenditures ; rather it indicates that both methods are in accord with generally accepted accounting principles; that both methods are widely used in the bourbon distilling industry; and that either or both methods will clearly reflect income over a time if consistently applied. The testimony on behalf of the defendant does not undermine these basic propositions, but rather urges that adding the costs to inventory costs is better under the “matching” theory, which in turn reflects a “trend toward realism.” Yet the latter testimony seems to reflect not what the best accounting practice in the industry actually is, but rather reflects the preference of the defendant’s accounting witnesses, and the Internal Revenue Service, for what the best accounting practice should be. Fairly considered, there is not much to choose from between these opposing points of view, and the determination defendant urges be made would not seem to be appropriate for this court based only on a preference of the Internal Revenue Service. This being so, the better view is to rely on the flexible approach evidencd in the Code, and resolve the issue in favor of the instant plaintiff since, if there is doubt as to the production-related status of the expenses involved, the plaintiff’s position is certainly reasonable and substantial and has been long and consistently maintained. Cf. Cincinnati, New Orleans and Texas Pac. Ry. v. United States, 424 F.2d 563, 191 Ct. Cl. 572 (1970).

The mere fact that, as our findings show, “each bourbon whiskey of a different age, or year’s production, is a qualitatively different and unique product”, does not contradict this conclusion. Many products which are the same for common-sense, over-all, and tax purposes can be called “qualitatively different and unique” for marketing or chemical purposes. Proper tax treatment need not be dominated by such a description. The equi-balance of the accounting evidence, the reasonableness of plaintiff’s position, and the consistency of its treatment of the disputed costs outbalance this simple characterization of each year’s bourbon as different.

Since plaintiff has established the correctness of its position, it follows that it is entitled to recover a tax refund in the full amount of its claim ($65,071.76), with interest thereon as provided by law.

       This opinion incorporates the greatest part of the opinion prepared by Trial Commissioner C. Murray Bernhardt, with modifications and additions by the judges.

      . Defendant prefers to use its private label of “maturation period” for this phase, and to term as “maturation costs” the associated expenses rather than the here synonymous terms of storage or carrying charges. Any of the terms are applicable. Names do not change nature.

      . The Third Circuit stressed that the entire transaction had to be considered, that storage and like charges are normally deductible as ordinary expenses but “they are not deductible where they are incurred as an integral part of a capital transaction”, and that the Tax Court’s determination “that the pre-payments here made were incurred as part of a capital transaction is essentially a factual determination” which was not clearly erroneous.