Helvering v. American Dental Co

• Decision Date: 01 March 1943
• Docket Number: No. 303,303
• Citation: 87 L.Ed. 785,63 S.Ct. 577,318 U.S. 322
• Parties: HELVERING, Commissioner of Internal Revenue, v. AMERICAN DENTAL CO
• Court: U.S. Supreme Court

318 U.S. 322

63 S.Ct. 577

87 L.Ed. 785

HELVERING, Commissioner of Internal Revenue,

v AMERICAN DENTAL CO.

No. 303.

Argued Jan. 5, 6, 1943.

Decided March 1, 1943.

Mr. Samuel H. Levy, of Washington, D.C., for petitioner.

Mr. John E. Hughes, of Washington, D.C., for respondent.

Mr. Justice REED delivered the opinion of the Court.

This writ of certiorari brings here for review the question of the taxability, as income, of rent and interest on accounts owed by the taxpayer which were cancelled by its creditors.

The taxpayer, a corporation, respondent here, owed certain past due bills for merchandise. This indebtedness was represented by interest bearing notes. Interest upon these notes had been accrued for the years prior to 1937 and deducted in the taxpayer's income tax returns, to the amount of $11,435.22. In November, 1936, the creditors agreed to cancel all interest accruing after January 1, 1932. The first entry on the taxpayer's books which records the cancellation appears in December 1937, the tax year here involved, when over $16,000 was credited.

The taxpayer in December, 1933, also owed back rent amounting to $15,298.99. This back rent had been accrued as an expense. A new lease was negotiated at that time and the lessor promised to make an adjustment of the accumulated obligation. The following April the lessor advised the taxpayer that he would accept $7500 in payment of the back rent and would cancel the rest. The reduced sum was paid in February, 1937, by cash and notes which were met the same year. In 1937 the first entries were made on both the lessor's and the taxpayer's books, showing the partial forgiveness of the back rent,

The date of the book entries of the cancellations and the deduction of the interest for the whole of 1936 by the taxpayer led the Board of Tax Appeals to uphold the Commissioner's determination that the cancellation of all items of indebtedness involved here took place in 1937. This determination is accepted by us. Wilmington Trust Co. v. Helvering, Commissioner, 316 U.S. 164, 168, 62 S.Ct. 984, 986, 86 L.Ed. 1352.

The taxpayer credited the total amount of the cancelled debts, $25,219.65 to earned surplus.¹ It did not return any of the sum as taxable income. No proof appears of the insolvency of the taxpayer before or after the cancellation. Its balance sheets show assets exceeding liabilities at the opening and close of 1937 with net assets greater than the asserted adjustment of income. Under these circumstances the Commissioner increased the taxpayer's reported income by $19,234.21, the sum of the items of the cancelled indebtedness which the Board of Tax Appeals found had served to offset income in like amounts in prior years. The taxpayer had accrued the rent and interest in former years. No claim for additional taxes is made by the Commissioner.

The taxpayer sought a redetermination on the ground that the cancellations were exempt gifts and that it was not enriched beyond the tax advantages gained by the deductions in former tax returns. The Board of Tax Appeals found that the cancellations were not gifts, concluded that the tax benefits in dollars obtained by the deductions of former years did not limit the 1937 tax springing from the cancellation and affirmed the Commissioner's determination of deficiency. American Dental Co. v. Commissioner of Internal Revenue, 44 B.T.A. 425. The Court of Appeals reversed on the ground that the cancellations constituted exempt gifts. 7 Cir., 128 F.2d 254. On account of a variety of views in the circuits as to the taxability of similar adjustments of indebtedness, we granted certiorari.² 317 U.S. 612, 63 S.Ct. 59, 87 L.Ed. —-.

The applicable statutory provisions are Section 22(a) and (b)(3) of the Revenue Act of 1936.³ The general definition of gross income has varied little in the successive revenue acts, and, from the earliest, gifts have been excluded by substantially identical statutory language. Act of October 3, 1913, 38 Stat. 166. The Treasury Department Regulations 94, relating to the Revenue Act of 1936 Art. 22(a)-14, covered cancellation of indebtedness.⁴ This regulation first appeared in Regulations 86 under the 1934 Act. It marked a change in the Treasury's concept of the tax effect of debt forgiveness. The old article as it appeared in Regulations 77, relating to the 1932 act, read in part:

'If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income.'⁵

The same language appeared in the former Regulations.⁶

In fields closely related to the cancellation of indebtedness which we are considering here, this Court has treated gains in net assets as income. In United States v. Kirby Lumber Co., 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131, the taxpayer purchased its own bonds at a discount. It was held taxable on the increase in net assets which resulted.⁷ This holding was confirmed by Helvering v. American Chicle Co., 291 U.S. 426, 54 S.Ct. 460, 78 L.Ed. 891. See, also, Commissioner v. Coastwise Transp. Corp., 1 Cir., 71 F.2d 104. Forfeiture or surrender of a lease by which the lessor gains property or money makes such gain taxable. Helvering v. Bruun, 309 U.S. 461, 60 S.Ct. 631, 84 L.Ed. 864; Hort v. Commissioner, 313 U.S. 28, 61 S.Ct. 757, 85 L.Ed. 1168. The narrow line between taxable bonuses and tax free gifts is illuminated by Bogardus v. Commissioner, 302 U.S. 34, 58 S.Ct. 61, 82 L.Ed. 32, on the one side and upon the other by Noel v. Parrott, 4 Cir., 15 F.2d 669, as approved in Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 730, 49 S.Ct. 499, 504, 73 L.Ed. 918.

Normally cancellations of indebtedness occur only when the beneficiary is insolvent or at least in financial straits. Possibly because it seems beyond the legislative purpose to exact income taxes for savings on debts, the courts have been astute to avoid taxing every balance sheet improvement brought about through a debt reduction. Where the indebtedness has represented the purchase price of property, a partial forgiveness has been treated as a readjust- ment of the contract rather than a gain. Hirsch v. Commissioner, 7 Cir., 115 F.2d 656; Helvering v. A. L. Killian Co., 8 Cir., 128 F.2d 433; Gehring Publishing Co., Inc., v. Commissioner, 1 T.C. 345. Where a stockholder gratuitously forgives the corporation's debt to himself, the transaction has long been recognized by the Treasury as a contribution to the capital of the corporation. Regulations 45, Art. 51, through to Regulations 94, Art. 22(a)-14. Commissioner v. Auto Strop Safety Razor Co., Inc., 2 Cir., 74 F.2d 226.⁸

The uncertainties of the effect of the remission of indebtedness on income tax brought about legislation to clarify the problems. The Chandler Bankruptcy Act of June 22, 1938, instituted adjustments deemed desirable.⁹ The provisions of Chapter X of the Bankruptcy Act relating to corporate reorganizations are typical. They declare that no income should be recognized 'in respect to the adjustment of the indebtedness of a debtor' under reorganization proceedings, Section 268, 52 Stat. 904, provided that the basis of the property should be reduced correspondingly as specified in Section 270 as amended July 1, 1940, 54 Stat. 709, 11 U.S.C.A. § 670. The basis requirements do not appear throughout the sections, e.g., Chapter XV, 11 U.S.C.A. § 1200 et seq. The Revenue Act of 1939¹⁰ amended the Internal Revenue Code, Sections 22(b) and 113(b), 26 U.S.C.A. Int.Rev.Code §§ 22(b), 113(b), so as to extend similar relief to all corporate taxpayers 'in an unsound financial condition.'¹¹

It was provided that Section 215 should not apply to any discharge of indebtedness occurring prior to the enactment of the Revenue Act of 1939. No further explanation for this limitation appears beyond the language of the House Report:

'The amendments made by section 215 of the bill are applicable only to taxable years beginning after December 31, 1938. They are not applicable to discharges of corporate indebtedness occurring prior to the date of the enactment of the bill. They are also not applicable to a discharge occurring in any taxable year beginning after December 31, 1942. They likewise do not apply to any discharge of corporate indebtedness occurring in any proceeding under section 77B, or under chapter X or XI, of the Bankruptcy Act of 1898, as amended, since such discharges are governed by other provisions of law.' P. 25.

The Revenue Act of 1942, 56 Stat. 811, Section 114, 26 U.S.C.A. Int.Rev.Acts, amended Section 22(b)(9) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code § 22(b)(9), so as to make the exclusion from gross income of income arising from discharge of indebtedness applicable generally to all corporations, whether or not financially sound.¹²

In the light of these views upon gain, profit and income, we must construe the meaning of the statutory exemption of gifts from gross income by Section 22(b) (3). The broad import of gross income in Section 22(a)¹³ admonishes us to be chary of extending any words of exemption beyond their plain meaning. Cf. Heiner v. Colonial Trust Co., 275 U.S. 232, 235, 48 S.Ct. 65, 66, 72 L.Ed. 256; United States v. Stewart, 311 U.S. 60, 63, 61 S.Ct. 102, 104, 85 L.Ed. 40. Gifts, however, is a generic word of broad connotation, taking coloration from the context of the particular statute in which it may appear. Its plain meaning in its present setting denotes, it seems to us, the receipt of financial advantages gratuitously.

The release of interest or the complete satisfaction of an indebtedness by partial payment by the voluntary act of the creditor is more akin to a reduction of sale price than to financial betterment through the purchase by a debtor of its bonds in an arms-length transaction. In this view, there is no substance in the Commissioner's differentiation between a...