John Kelley Co v. Commissioner of Internal Revenue Talbot Mill v. Same

• Decision Date: 07 January 1946
• Docket Number: 47,Nos. 36,s. 36
• Citation: 90 L.Ed. 278,326 U.S. 698,326 U.S. 521,66 S.Ct. 299
• Parties: JOHN KELLEY CO. v. COMMISSIONER OF INTERNAL REVENUE. TALBOT MILL v. SAME
• Court: U.S. Supreme Court

326 U.S. 521

66 S.Ct. 299

326 U.S. 698

90 L.Ed. 278

JOHN KELLEY CO.

v COMMISSIONER OF INTERNAL REVENUE. TALBOT MILL

v. SAME.

Nos. 36, 47.

Argued Oct. 11, 1945.

Decided Jan. 7, 1946.

As Amended Jan. 28, 1946.

Mr. Frank J. Albus, of Washington, D.C., for petitioner John Kelley co.

Mr. Melville F. Weston, of Boston, Mass., for petitioner Talbot Mills.

Mr. J. Louis Monarch, of Washington, D.C., for respondent.

Mr. Justice REED delivered the opinion of the Court.

These writs of certiorari were granted to examine the deductibility as interest of certain payments which the taxpayer corporations made to holders of their corporate obligations. Although the obligations of the two taxpayers had only one striking difference, the noncumulative in one and the cumulative quality in the other of the payments reserved under the characterization of interest, the Tax Court (formerly the Board of Tax Appeals, 56 Stat. 957, 26 U.S.C.A.Int.Rev.Code, § 1100; only its present name will be used herein) held that the payments under the former, the Kelley Company case, were interest and under the Talbot Mills were dividends. The Circuit Court of Appeals reversed the Tax Court in the Kelley case and another circuit affirmed the Talbot Mills decision.¹ On account of the diversity of approach in the Tax Court and the reviewing courts, we granted certiorari.

In the Kelley case, a corporation, all of whose common and preferred stock was owned directly or as trustee by members of a family group, was reorganized by authorizing the issue of $250,000 income debenture bearer bonds, issued under a trust indenture, calling for 8% interest, non-cumulative. They were offered only to shareholders of the taxpayer but were assignable. The debentures were payable in twenty years, December 31, 1956, with payment of general interest conditioned upon the sufficiency of the net income to meet the obligation. The debenture holders had priority of payment over stockholders but were subordinated to all other creditors. The debentures were redeemable at the taxpayer's option and carried the usual acceleration provisions for specific defaults. The debenture holders had no right to participate in management. Other changes not material here were made in the corporate structure. Debentures were issued to the amount of $150,000 face value. The greater part, $114,648, was issued in exchange for the original preferred, with six per cent cumulative guaranteed dividends, at its retirement price and the balance sold to stockholders at par, which was eventually paid with sums obtained by the purchasers from common stock dividends. Common stock was owned in the same proportions by the same stockholders before and after the reorganization.

In the Talbot Mills case the taxpayer was a corporation which, prior to its recapitalization, had a capital stock of five thousand shares of the par value of $100 or $500,000. All of the stock with the exception of some qualifying shares was held by members, through blood or marriage, of the Talbot family. In an effort to adjust the capital structure to the advantage of the taxpayer, the company was recapitalized just prior to the beginning of the fiscal year in question, by each stockholder surrendering four-fifths of his stock and taking in lieu thereof registered notes in aggregate face value equal to the aggregate par value of the stock retired. This amounted to an issue of $400,000 in notes to the then stockholders. These notes were dated October 2, 1939, and were payable to a specific payee or his assignees on December 1, 1964. They bore annual interest at a rate not to exceed 10% nor less than 2%, subject to a computation that took into consideration the net earnings of the corporation for the fiscal year ended last previous to the annual interest paying date. There was, therefore, a minimum amount of 2% and a maximum of 10% due annually and between these limits the interest payable varied in accordance with company earnings. The notes were transferable only by the owner's endorsement and the notation of the transfer by the company. The interest was cumulative and payment might be deferred until the note's maturity when 'necessary by reason of the condition of the corporation.' Dividends could not be paid until all then due interest on the notes was satisfied. The notes limited the corporation's right to mortgage its real assets. The notes could be subordi- nated by action of the Board of Directors to any obligation maturing not later than the maturity of the notes. For the fiscal year in question the maximum payment of 10% was made on the notes.

The payments in question on corporate obligations were for the years in the Kelley case, 1937, 1938 and 1939; in the Talbot Mills case for the year 1940. Both corporations deducted the payments as interest from their reports of gross income under statutory sections and regulations set out in the footnote.² The applicable statutes and regulations were identical for all periods. The Commissioner asserted deficiencies because the payments were considered dividends and not interest.

There is not present in either situation the wholly useless temporary compliance with statutory literalness which this Court condemned as futile, as a matter of law, in Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, 97 A.L.R. 1355. The demonstrated possibility of sales by the holders of the obligations to persons other than stockholders alone proves the differentiation. As material amounts of capital were invested in sock, we need not consider the effect of extreme situations such as nominal stock investments and an obviously excessive debt structure.

From the foregoing statements of facts, if appears that the characteristics of all the obligations in question and the surrounding circumstances were of such a nature that it is reasonably possible for determiners to reach the conclusion that the secured annual payments were interest to creditors in one case and dividends to stockholders in the other case. In the Kelley case there were sales of the debentures as well as exchanges of preferred stock for debentures, a promise to pay a certain annual amount, if earned, a priority for the debentures over common stock, the debentures were assignable without regard to any transfer of stock, and a definite maturity date in the reasonable future. These indicia of indebtedness support the Tax Court conclusion that the annual payments were interest on indebtedness. On the other hand, in the Talbot Mills case, the Tax Court found the factors there present of fluctuating annual payments with a two per cent minimum, the limitation of the issue of notes to stockholders in exchange only for stock, to be characteristics which distinguish the Talbot Mills notes from the Kelley Compoany debentures. Upon an appraisal of all the facts, the Tax Court reached the conclusion that the annual payments by Talbot Mills were in reality dividends and not interest.

We think these conclusions should be accepted by the Circuit Courts of Appeals and by ourselves. Judicial review of Tax Court decisions depends upon the Internal Revenue Code, Section 1141(c) Powers (1), 26 U.S.C.A.Int.Rev.Code § 1141(c)(1). It reads:

'To affirm, modify, or reverse. Upon such review, such courts shall have power to affirm or, if the decision of the Board is not in accordance with law, to modify or to reverse the decision of the Board, with or without remanding the case for a rehearing, as justice may require.'

It is only recently that we gave careful consideration to the problems of review of Tax Court decisions. Dobson v. Commissioner, 320 U.S. 489, 64 S.Ct. 239, 88 L.Ed. 248. That opinion emphasized that our interpretation of Congressional purpose, in enacting the statute, just quoted for judicial review of Tax Court decisions, was that Congress intended to leave to the final determination of the Tax Court all issues which were not clear-cut questions of law.

The provisions for review are the same now as they were when enacted in 1926. Congress, and all others interested, were then well aware of the difficulties in drawing a line between questions of fact and questions of law.³ The legislation was upon a subject, the collection of the revenue, in which federal administrative finality had been given wide scope.⁴ The Tax Court was originally established to 'secure an impartial and disinterested determination of the issues involved,'⁵ so that the taxpayer and the Government would have an independent review of the position of either on tax demands before payment of the tax or foreclosure of an asserted deficiency. Two years later its success was recognized by committee commendation and the enlargement of the finality of its decisions from 'prima facie evidence of the facts contained therein' to reviewability only 'if the decision of the oard is not in accordance with law'⁶ As to the mischief which the limitation of the scope of judicial review was to cure, we find only the words of the committee reports.⁷ Without a clearer description by Congress of the intended line to separate reviewability of the Tax Court decisions from non-reviewability, courts must interpret the review statute, as best they can, to accomplish the declared Congressional purpose of adequate control of administrative action without substituting judicial opinion for that of the Tax Court upon the evidence. Note 7, supra.

The illustrations in the report, note 7, supra, are legal questions without doubt, except the possibility that the words 'application of the statute or any regulatio having the force of law' may be thought to give a reviewing court power to pass upon the Tax Court's conclusion from the primary or evidential facts. So that in the present cases, it might be said to be a question of law as to whether the primary facts adduced made the payments under consideration dividends or interest. But we think such conclusion gives inadequate weight to the...