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Frank Lyon Co. v. United States Case Brief

Case Summary

Frank Lyon Co. v. the United States, 435 U.S. 561, is a U.S. Supreme Court case of 1978, during which the eligibility to tax deductions was reviewed in the context of a sale and lease back agreement between a bank and a Frank Lyon Corporation. The Worthen Bank admitted being non-feasible to complete its building construction and engaged in the sales and lease back agreement with Frank Lyon Co. to sell the building and then lease it back from the new owner.

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Upon the agreement was signed, the bank was “obligated to pay rent equal to the principal and interest payments on petitioner’s mortgage” with an opportunity to repurchase the building” (Library of Congress, n. d., p. 561). The petitioner, Frank Lyon Co., claimed deductions deprecations. Following the claim, the Commissioner of Internal Revenue did not meet the request and did not allow the deductions explaining it by the idea that Frank Lyon Co. was not the owner of the building. Therefore, the company was not entitled to receive deductions because the sala and lease back transaction was a mere financing transaction (Library of Congress, n. d.). The case was taken to the Supreme Court, which held that the petitioner had the right to obtain tax deductions.

Facts

Frank Lyon Co. was a company operating in the sphere of interior furnishings. Worthen Bank was a state bank participating in the Federal Reserve System (Library of Congress, n. d.). A third party was involved, which was the New York Life insurance company that provided long-term financing for the project (Kavulich, 1979). Worthen Bank had an intention to complete the construction project but could not succeed due to financial constraints. Worthen Bank initiated a sale and lease back agreement with Frank Lyon Co., sold the building to Lyon, and then leased it for the term of 25 years with the right to extend or repurchase. Worthen paid rent; Frank Lyon Co. accrued rent at the end of the financial year 1969 and filed for a tax deduction. Commissioner denied deduction stating that Frank Lyon Co. was not a title owner of the building.

Tax Issues and Analysis

Despite the three-party nature of the case, the court considered it a two-party case where Worthen Bank and Frank Lyon Co. In terms of the federal tax system, the claimed transactions within the sale and lease back agreement were considered mortgage loans, and the lease relationship between the two parties was analyzed, where they act as lessee and lessor, respectively. According to Kavulich (1979), the sale and lease back agreement implied that the transactions would result in the same economic positions for both parties as they were before the agreement. Thus, an “economically genuine lessor-lessee relationship … will permit the tax benefits to flow to the lessor” (Kavulich, 1979, p. 622). The lessor entered the agreement with an intention to obtain tax benefits, which is why it is imperative for Frank Lyon Co. to file for tax deductions. Therefore, since Frank Lyon Co. was exposed to the risks and the losses due to deprecations, the tax procedures involved the petitioner, not the bank, who now was merely a lessee.

The overall sale and lease back agreement’s aim is multifaceted and allows companies to pursue their financial, economic, and developmental goals. However, as stated by Rashty (2018), one of the main benefits of the sale and lease back transaction initiative is the ability to “transfer the tax ownership and related benefits to the buyer-lessors” (p. 54). Similarly, Ashiya (2015) states that “taxation by itself does not favor the seller/lessee” (p. 92). Therefore, the tax benefits are a legal attribute of Frank Lyon Co. that is eligible for the tax deduction, that holding that was achieved in the Supreme Court.

An Overview of Sale Lease Back Transactions

The arrangement of sale and lease back transactions provides mutual benefits for the two parties entering the agreement. As stated by Deo (2018), the lease agreement allows for obtaining the right to use the property “in return for a series of specified future payments over a definite period” (p. 10). In the case of Frank Lyon Co. v. the United States, the Worthen Bank used the building in possession of the owner, Frank Lyon Co., with an obligation to pay rent and fro 25 years. Such agreements allow the companies to eliminate some items of property or real estate from their financial statement sheets but to continue using them (Deo, 2018). In such a manner, due to the non-feasible status, Worthen sold the building and therefore transferred the rights for taking tax deductions to the title owner, who is Frank Lyon Co.

Conclusion

Summarizing the case, one should reiterate that Frank Lyon Co. v. the United States, 435 U.S. 561, was ruled by the Supreme Court of the United States on the matter of tax deduction eligibility of the parties engaged in the sale and lease back agreement concerning a bank building. Since Worthen Bank sold the building to Frank Lyon Company and then signed a lease, the status of the title owner was transferred to Frank Lyon Co. According to the federal tax issues and legal considerations related to the sale and lease back agreements, the title owner and lessor was entitled to tax deductions.

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References

Ashiya, N. (2015). Determinants of potential seller/lessee benefits in sale-leaseback transactions. International Real Estate Review, 18(1), 89-112.

Deo, P. (2018). Sale and leaseback revisited. Journal of Accounting and Finance, 18(5), 10-22.

Library of Congress. (n. d.). U.S. Reports: Frank Lyon Co. v. United States, 435 U.S. 561 (1978) [PDF file]. Web.

Kavulich, J. J. (1979). Income tax – three-party sale-leasebacks – true leases or financing techniques? Frank Lyon Co. v. United States, 435 US 561 (1978). Western New England Law Review, 1(3), 601-622.

Rashty, J. (2018). An analysis of the new sale and leaseback guidance. The CPA Journal, 88(9), 52-56.

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