HSD Co. v. Kavanagh, 11251.
| Decision Date | 19 June 1951 |
| Docket Number | No. 11251.,11251. |
| Citation | 191 F.2d 831 |
| Parties | H. S. D. CO. v. KAVANAGH, Collector of Internal Revenue. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Wilber M. Brucker, Detroit, Mich. (John F. Langs, Detroit, Mich., on the brief, R. F. Molyneaux, Detroit, Mich., of counsel), for petitioner.
Francis W. Sams, Washington, D. C. (Theron Lamar Caudle, Ellis N. Slack, and S. Dee Hanson, all of Washington, D. C., Edward T. Kane, Roger P. O'Connor, Detroit, Mich., on the brief), for respondent.
Before HICKS, Chief Judge, SIMONS and McALLISTER, Circuit Judges.
Appellant filed a complaint in the district court, asking for a refund of excess profits tax. It claimed that the amount in question was properly deductible from gross income in computing net income to determine income tax liability, on the ground that it was a contribution to two employees' trusts, which were exempt from taxation. The contributions to the trusts were made during the fiscal year ending April 30, 1944; and it was claimed that they were deductible from appellant's gross income for that year under Section 23(p) of the Internal Revenue Code, and Section 165(a) of the Internal Revenue Code, as amended, 26 U.S.C.A. §§ 23(p), 165(a). The district court held that the contributions were not exempt from taxation, and dismissed the suit.
On appeal, the taxpayer contends that the trial court erroneously refused to permit the issues to be determined by a jury; that the government did not sustain the burden of proof which was upon it; that the evidence did not sustain the court's findings that the taxpayer was not entitled to the deduction for the amounts contributed to the trusts; and that the government was bound by the prior rulings of the Commissioner of Internal Revenue that the trusts had met all requirements entitling them to exemption from taxation and that, accordingly, the contributions to the trusts were properly deductible.
The circumstances giving rise to this controversy are as follows: Appellant company, on April 29, 1942, before commencing certain manufacturing for war needs, executed the two trust agreements in question.
One of the trust instruments, known as the "Employees' Trust," was entered into between appellant company and John F. Langs, Trustee. This was a stock bonus, profit-sharing, and pension plan for hourly-paid employees, to last for ten years, with a possible five-year extension by the Trustee upon the advice, consent, and direction of the Advisory Committee provided for therein. At that time, there were four hourly-paid employees. The corporation was a small company.
The other trust was known as the "Executive Employees' Trust" and was a profit-sharing, stock bonus, and pension plan for the executive officers of the corporation. At that time, there were three such executive officers. The trust was for a five-year period, with a possible five-year extension, at the sole and exclusive direction of John F. Langs, Trustee, provided, however, that the trust would terminate at the death of all of the executive officers. Mr. Langs not only acted as Trustee in each of the trusts, but also was one of an Advisory Board of three members whose duty it was to direct the Trustee's investment of trust funds. Moreover, he was also, during the period in question, the attorney for appellant company.
Both trust agreements contained similar provisions for cash contributions by formula within the amount permitted by statute, subject to appellant company's right to cease making such contributions at any time.
Upon the execution of the trust instruments, appellant company immediately commenced to contribute to the two trusts, and during the three years through April 30, 1944, made the following contributions:
Executive
Employees' Employees' Both
Trust Trust Trusts
Year ended 4-30-42 $15,551.22 $ 5,000.00 $20,551.22
Year ended 4-30-43 2,651.75 2,999.29 5,651.04
Year ended 4-30-44 7,500.47 8,837.32 16,337.79
__________ __________ __________
Totals $25,703.44 $16,836.61 $42,540.051
The Trustee had general powers of control over handling and investing the trust funds. When the contributions were made to the trusts, the Trustee invested them largely in the non-voting stock of appellant company, and also in a certain real estate option. Around this option revolves the principal issue in the case.
On June 16, 1942, the company, which had been holding this option to purchase the plant occupied by it in Detroit, transferred it to the Trustee, in his capacity as Trustee for the Executive Employees' Trust, for the sum of $500.00 in cash. This cash had been contributed to the trust by appellant company. Later, on July 30, 1942, the Trustee paid the additional sum of $4,451.95 as the balance of the down payment on a land contract running from the owner to the Trustee. Thereafter, the Trustee made monthly payments of $400.00 through November, 1944, the total sum paid by him up to that time amounting to $16,151.95.
On November 15, 1944, the Trustee sold his vendee's interest in the property to a third party, and on April 2, 1945, he received therefor the sum of $30,396.16, which gave the Executive Employees' Trust a net profit on this land contract transaction of $14,244.21.
Two officers of the corporation, who, among other beneficiaries of the Executive Employees' Trust, were, with their wives, owners of all the outstanding Class A stock of appellant company, which was the voting stock. They were also the owners of 31% of the outstanding Class B nonvoting stock.
As a result of contributions by appellant company to the trusts, on April 30, 1945, the Executive Employees' Trust had assets consisting of investments by the Trustee in Class B stock of appellant, of $48,800.00; insurance contracts of $5,380.11; and cash in the amount of $1,235.74. On the same date, the Hourly-Paid Employees' Trust had assets consisting of investments in Class B stock of $11,200.00; and cash in the amount of $1,604.51.
On April 30 1945, therefore, the Executive Employees' Trust had assets of $55,415.85, and the Hourly-Paid Employees' Trust had assets of $12,804.51.
During the period from April 29, 1942 through April 30, 1945, the Executive Employees' Trust realized a net profit of $31,838.28; the Hourly-Paid Employees' Trust, during the same period, realized a net profit of $73.00 — and later, in 1947, a dividend of $672.00 was received by this trust. The statements of assets and liabilities of the Executive Employees' Trust, as of April 30, 1945, showed the interest of four active participants to be $55,415.85. The interest of the participants above mentioned was noted to be subject to the forfeiture limitations and conditions of the trust agreement. All forfeitures reverted to the trust for the remainder of the employees therein. The statement of assets and liabilities of the Hourly-Paid Employees' Trust, as of April 30, 1945, showed the interest of one active participant to be $2,508.74; the interest of one inactive participant, $822.00; the interest of two participants transferred to Executive Employees' Trust, $3,000.00; the interest of participants due to forfeiture previously occurring to be allocated, $1,215.10; and forfeitures to be applied as a reduction on the company's current year's contribution, $5,258.67. It was noted that the foregoing interest of the participants was subject to the forfeiture limitations and conditions of the trust agreement.
During the years in question, there were four participating employees in the Executive Employees' Trust; there were twenty-three Hourly-Paid Employees in the other trust.
All of the foregoing facts were agreed to by the parties in a written stipulation filed in the case.
This case involves the fiscal year ended April 30, 1944. It is, therefore, governed by Section 23(a) and (p) of the Internal Revenue Code, Section 121 (a) of the Revenue Act of 1942, and Section 165(a) of the Internal Revenue Code, Section 162(b) of the Revenue Code of 1942.
Section 23(a), as thus amended, provides that in computing net income, there shall be allowed as deductions all ordinary and necessary expenses paid or incurred during the taxable year in carrying on the business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. Section 23(p), as above amended, provides that in computing gross income, contributions made by an employer to or under a stock bonus or profit-sharing plan shall not be deductible under subsection (a), but shall be deductible, "if deductible under subsection (a) without regard to this subsection," under subsection (p). Contribution, therefore, to such an employees' trust, in order to be deductible, must meet the requirements of Section 23(a) as to reasonableness with regard to compensation paid; it must also meet the requirements of Section 23(p) in order to be deductible thereunder; and one of the conditions set forth in Section 23(p) is that the trust, in respect to which the deductions are made, must meet the requirements of Section 165(a).
Section 165(a) (2) and (4) of the Internal Revenue Code, Section 162 of the Revenue Code of 1942, 26 U.S.C.A. § 165, provides that employees' trusts are exempt from income tax:
"(2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees or their beneficiaries;
* * * * * *
"(4) if the contributions or benefits provided under the plan do not...
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