Nipoch Corp. v. Commissioner

NIPOCH CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Nipoch Corp. v. Commissioner Docket Nos. 75616, 79775. United States Board of Tax Appeals 36 B.T.A. 662; 1937 BTA LEXIS 674; October 15, 1937, Promulgated *674 A corporation was formed and availed of for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, within the meaning of section 104 of the Revenue Act of 1932. Samuel B. Pack, Esq., and Benjamin M. Kaye, Esq., for the petitioner. DeWitt M. Evans, Esq., and Spaulding F. Glass, Esq., for the respondent. MURDOCK *663 The Commissioner determined deficiencies in income tax of $250,272.51 for the year 1931 and $155,579.34 for the year 1932. The sole issue, common to both proceedings, is whether the petitioner should be taxed under the provisions of section 104 of the Revenue Acts of 1928 and 1932. FINDINGS OF FACT. Ellis P. Earle in the early part of 1923 owned stocks, bonds, real estate, and other property of the approximate value of $7,000,000. His secretary, who took a prominent part in Earle's business affairs, and his attorney advised Earle to form several corporations and turn over the aforesaid property to the corporations. One purpose of transferring the property to the corporations was to simplify*675 the administration of Earle's estate in case he should die. Earle was at that time 63 years of age and was not in good health. He was still living at the time of the hearing. The secretary and the attorney were familiar with and had considered the effect of Federal income tax statutes. The petitioner was organized on May 12, 1923, under the laws of Delaware. It was authorized to issue capital stock of the total par value of $6,000,000. Earle, on June 5, 1923, transferred to the petitioner stocks and bonds having an aggregate market value of $5,452,000, and received in exchange 54,520 shares of the petitioner's stock, each share of the par value of $100. No other stock was ever issued by the petitioner. Earle was the sole stockholder from 1923 through 1932. The securities transferred to the petitioner were principally common and preferred stocks and bonds of domestic corporations. There were a few bonds of the United States and of foreign governments and a few shares of stock of foreign corporations. Earle's basis for gain or loss on these securities was $4,479,712.58. The directors of the petitioner were Earle, his wife, and his attorney. Earle also organized two other*676 corporations at about the same time. He transferred to the one an office building, having a value of $440,000, in exchange for its entire capital stock, and to the other he transferred an apartment house, having a value of $460,000, in exchange for its entire capital stock. He thereafter remained the sole stockholder of those two corporations. The petitioner from 1923 through 1932 sold some of its securities, purchased other securities, and collected the income from the securities *664 which it held. It had only one employee, George C. Martens, who for many years had been employed by Earle in the capacity of secretary, financial adviser, and manager of his business affairs. The duties performed by Martens for the petitioner consisted of keeping its books and records and studying the investment market for the purpose of making changes in the holdings of the petitioner. He also performed general office duties and prepared the income tax returns of the petitioner and of Earle. The securities acquired from Earle in 1923 were set up on the books of the petitioner at their then value, $5,452,000. Those later purchased were entered on the books at cost. The amount of*677 income derived by the petitioner from various sources from 1923 to December 31, 1930, was as follows: Interest $571,061.66 Gain or loss on sales 667,889.73 Dividends, domestic corporations 3,266,623.54 Dividends, foreign corporations 4,750.00 Other income 162.50 Total 4,510,487.43 The petitioner's expenditures, consisting principally of compensation of officers, interest, and taxes, amounted to $267,549.52 during the same period. The amount of income derived by the petitioner from various sources during 1931 and 1932 was as follows: [1932] Interest $70,075.93 $68,738.47 Gain or loss on sales (19,900.23) (486.27) Dividends, domestic corporations 521,202.58 306,522.15 Dividends, foreign corporations 3,500.00 571,378.28 378,274.35 Its expenditures for those years amounted to $70,833.26 and $68,115.71, respectively. The surplus at the end of each year as shown by the books and the distributions made by the petitioner during each of the years 1923 to 1932 were as follows: Year Surplus at end of year Distributions made [1923] $135,291.28 None [1924] 398,841.07 $105,645.00 [1925] 673,621.58 None [1926] 1,092,451.13 54,520.00 [1927] 1,618,693.11 81,780.00 [1928] $2,054,287.22 $163,560.00 [1929] 2,844,270.24 163,560.00 [1930] 3,280,318.70 163,560.00 [1931] 3,663,833.71 109,040.00 [1932] 3,902,445.25 54,520.00 *678 *665 The petitioner's books as of December 31, 1931, and December 31, 1932, showed the following: December 31, 1931 December 31, 1932 Assets Cash $3,427.14 $14,127.51 Accounts receivable: Miscellaneous 875.00 Potter Co 199,941.67 George Peruvian Ochre Co 532,487.67 Bills receivable: Potter Co 100,000.00 100,000.00 Bonds 1,159,588.70 996,860.53 Stocks 9,675,992.79 9,580,412.79 Total 10,939,883.63 11,423,830.17 Liabilities Accounts payable 1,352,049.92 1,597,383.42 Miscellaneous 1.50 Chatham-Phenix Bank 472,000.00 472,000.00 Capital stock 5,452,000.00 5,452,000.00 Surplus 3,663,833.71 3,902,445.25 Total 10,939,883.63 11,423,830.17 The total market value of the stocks and bonds owned by the petitioner was $6,042,898.72 on December 31, 1931, and $5,605,740.38 on December 31, 1932. Most, if not all, of those stocks and bonds were listed securities. The item of bills receivable, $100,000, shown as an asset on the balance sheets, supra, represents a loan, originally made to Earle by the petitioner to purchase certain real estate, which was thereafter assumed by one of the other Earle corporations*679 when it acquired the real estate from Earle. The items of $199,941.67 and $532,487.67 represent amounts paid by the petitioner to brokers on behalf of two other Earle corporations. Those companies carried margin accounts with brokers which were opened in 1929 and which the petitioner guaranteed in December 1931. In 1932 the broker insisted that the margin on the one account be increased and that the other account be closed. The petitioner thereupon borrowed the money from the brokers and endorsed the brokers' checks to the two other Earle companies, and the latter deposited the checks and issued their own checks to the brokers. The item of $472,000, shown as a liability on the balance sheets, supra, represents a loan made by the Chatham-Phenix Bank to the petitioner prior to 1931. The items of accounts payable, $1,352,049.92 for 1931 and $1,597,383.42 for 1932, represent indebtedness due by the petitioner to brokers on its own margin accounts, which was incurred prior to 1931. A computation of the surplus of the petitioner, on the basis of the market value of its securities at the close of each year and the book figures of all other items shown on its balance sheets, *680 results in a *666 deficit of $1,128,849.06 at December 31, 1931, and a deficit of $1,069,087.69 at December 31, 1932. A computation, made in the same way, together with a reduction of the petitioner's capital from $5,452,000 to $4,479,712.58 (the transferor's basis for the securities transferred in 1923) results in a deficit of $156,561.64 at December 31, 1931, and a deficit of $96,800.27 at December 31, 1932. The petitioner filed consolidated income tax returns with three other Earle corporations for the years 1923 to 1928. It filed separate returns for the years 1929 to 1932. Its returns for the years 1931 and 1932 were filed with the collector of internal revenue for the second district of New York. The petitioner paid Federal income taxes of $230.96 for 1923, $12,240.43 for 1924, $40,714.67 for 1926, $34,142.89 for 1929, and $421.72 for 1930. It paid no tax in 1925. The tax liability on the consolidated returns was $23,896 for 1927 and $14,804.21 for 1928, but the evidence does not show the proportion thereof allocable to or paid by the petitioner. In its income tax return for 1931 the petitioner reported a loss of $20,147.56 and no tax due, and in its return for*681 1932 it reported a loss of $16,890.61 and no tax due. Earle filed individual income tax returns for the years 1919 to 1932. He did not report in his returns for the years 1931 and 1932 any of the undistributed profits of the petitioner. He paid no Federal income taxes for the years 1919, 1920, 1921, 1923, and 1932. The amounts of such taxes paid by him in other years were as follows: Year Amount [1922] $30,257.06 [1924] 1,295.02 [1925] 11,737.24 [1926] 2,988.69 [1927] 7,373.37 [1928] $12,182.38 [1929] 9,249.95 [1930] 502.73 [1931] 852.96 The respondent determined deficiencies of $250,272.51 for 1931 and $155,579.34 for 1932, which resulted in part from increasing income as provided in section 104(c) by the amount of the dividends of $521,202.58 and $310,158.64 received respectively in 1931 and 1932. The petitioner was a mere holding or investment company. The petitioner was formed and availed of for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. OPINION. MURDOCK: The pertinent statutory provisions are as follows: *682 SEC. 104. ACCUMULATION OF SURPLUS TO EVADE SURTAXES. (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and *667 paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 * * *. (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax. See section 104 of the Revenue Acts of 1928 and 1932. Substantially similar provisions are found in the earlier acts. 1 See section 220 of the Revenue Acts of 1918, 1921, 1924, and 1916. Both parties argue separately the questions (1) whether the petitioner was formed, and (2) whether it*683 was availed of, for the purpose described in the statute. The respondent contends that the taxes in controversy are due if the corporation was either formed or availed of for the purpose mentioned. The respondent finds support for his contention in the statute, which uses the word "or." But the point need not be decided in this case. The Commissioner has determined that section 104 applies. His determination is presumed to be correct until the contrary appears from the evidence. Thus the evidence must be examined to see whether or not it is sufficient for the petitioner's purpose. After paying no Federal income taxes for the years 1919, 1920, and 1921, Earle was required to pay $30,257.06 for the year 1922. Earle and his advisers began to make plans for the organization of the petitioner at or about the time that his return for the year 1922 was due. Three corporations were formed and to these Earle transferred practically all of his fortune. The petitioner received about 77 percent of Earle's fortune in June 1923. Most of the income from the property transferred to the petitioner was in the form of dividends not ordinarily taxable to a corporation. Thus it must have been*684 obvious to Earle and his advisers that the result of the transfer of this property from Earle to the petitioner would be a substantial reduction in the taxes on the income from the property. Such was the result of the transfer. Martens, who was familiar with the circumstances surrounding the formation of the petitioner, was the only one who gave direct testimony as to the purpose for which the petitioner was formed. He testified that he was familiar with Federal income tax statutes at that time but thought that the formation of the petitioner would not have any effect upon income taxes because the petitioner could follow the practice, resorted to by Earle in prior years, of selling securities at a loss in order to wipe out income. Since most of the dividends to be received by the petitioner would form no part of its taxable income under normal circumstances, it is obvious that its *668 dividend income would not have to be wiped out by losses. Furthermore, Earle had not been able to wipe out his income for 1922, and it is difficult to see how anyone could have reasonably anticipated in 1923 that the petitioner would sustain losses equal to its taxable income in subsequent*685 years. Martens further testified that the petitioner and the other two corporations were incorporated for the purpose of simplifying the administration of Earle's estate after his death. A finding has been made that that was one of the purposes in incorporating. But such a purpose is, of course, not inconsistent with another purpose to reduce income taxes by having the corporation accumulate its gains and profits rather than distribute them to Earle. Earle did not testify. No officer of the petitioner testified. Purpose, being a state of mind, is always difficult to determine in a proceeding like this. Subsequent events may aid. The gains and profits of the petitioner, instead of being divided or distributed, were accumulated during the years following its incorporation in amounts far beyond the reasonable needs of its business. The result was that its shareholder was saved from the imposition of a large amount of surtax over a period of years. The record considered as a whole warrants the conclusion that this corporation was formed for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains or profits to accumulate*686 instead of being divided or distributed. The Commissioner has been sustained in applying section 104 and its predecessors in a number of cases. But in each of those cases there has been a finding that the corporation was "availed of" within the taxable year for the purpose described in the statute. No case has come to our attention where the Commissioner has been sustained solely on the ground of the purpose for which a corporation was "formed." However, in at least two cases there are statements to indicate that that purpose alone would be sufficient. , affirming ; . Although it is quite obvious that for a number of years following its organization the petitioner was availed of for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, the situation in this connection for the taxable years 1931 and 1932 is somewhat peculiar. The petitioner in every year of its existence had a substantial amount of income. The*687 dividends which it paid effected a distribution of only a small part of its income. The result was that it accumulated a substantial surplus. The reasonable needs of the business neither required nor justified the accumulation of gains or profits in the amount shown on *669 its books. Those books show that it had a surplus in excess of $3,500,000 during each of the years 1931 and 1932. The book surplus resulted from the fact that the petitioner carried its securities at cost. However, the market value of those securities had declined to such an extent that the actual value of its assets was substantially less than the amount of its liabilities, including the par value of its outstanding stock. The petitioner argues that under such circumstances a corporation could not possibly be availed of during the taxable year for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains or profits to accumulate instead of being divided or distributed. The argument is that it would actually have no accumulation of gains of profits whatsoever and any distribution to its shareholders would be a distribution of capital. See*688 ; cf. ; ; sec. 34, General Corporation Law of New Jersey, as amended in 1929. However, a similar situation existed in the case of Rands, Inc., and the Board held that the corporation was availed of within the year for the purpose described in the statue. Reviewed by the Board. Decision will be entered for the respondent. Footnotes 1. In the acts prior to that of 1924, the words "or investment" did not appear in (b). ↩