Commissioner of Int. Rev. v. San Carlos Milling Co., 6914.

• Citation: 63 F.2d 153
• Decision Date: 13 March 1933
• Docket Number: No. 6914.,6914.
• Parties: COMMISSIONER OF INTERNAL REVENUE v. SAN CARLOS MILLING CO., Limited.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

63 F.2d 153 (1933)

COMMISSIONER OF INTERNAL REVENUE v. SAN CARLOS MILLING CO., Limited.

No. 6914.

Circuit Court of Appeals, Ninth Circuit.

February 6, 1933.

Rehearing Denied March 13, 1933.

G. A. Youngquist, Asst. Atty. Gen., and Sewall Key and Morton K. Rothschild, Sp. Assts. to Atty. Gen. (C. M. Charest, Gen. Counsel, and John D. Foley, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., of counsel), for petitioner.

George E. Cleary, of New York City, for respondent.

Before WILBUR and SAWTELLE, Circuit Judges, and CAVANAH, District Judge.

SAWTELLE, Circuit Judge.

The taxpayer is a domestic corporation organized under the laws of the territory of Hawaii, with its principal office at Honolulu, T. H. Its principal place of business is in the municipality of San Carlos, province of Negros Occidental, Philippine Islands, where it operates a sugar mill for the manufacture of raw sugar from sugar cane, under a contract or contracts with certain planters who supply the sugar cane. These contracts will be discussed fully hereinafter. By the terms of the contracts, the taxpayer received as compensation for its milling services in the manufacture of the sugar 40 per cent. of the raw sugar manufactured from the cane supplied by the planters. The Commissioner of Internal Revenue determined that the sugar so received by the taxpayer under these contracts was income, because the contracts with the planters constituted a sale of the sugar to the taxpayer and therefore the taxpayer was not entitled to the benefits of section 262 (a) of the Revenue Act of 1921 (42 Stat. 271) in computing its tax for the year 1923. This determination was reversed by the Board of Tax Appeals (24 B. T. A. 1132), which held that the taxpayer was entitled to the benefits of section 262 (a) because the contracts constituted merely a bailment of the sugar and not a sale thereof. From this decision, the Commissioner has appealed.

The statute in question is as follows:

"Sec. 262. (a) That in the case of citizens of the United States or domestic corporations, satisfying the following conditions, gross income means only gross income from sources within the United States —

"(1) If 80 per centum or more of the gross income of such citizen or domestic corporation (computed without the benefit of this section) for the three-year period immediately preceding the close of the taxable year (or for such part of such period immediately preceding the close of such taxable year as may be applicable) was derived from sources within a possession of the United States; and

"(2) If, in the case of such corporation, 50 per centum or more of its gross income (computed without the benefit of this section) for such period or such part thereof was derived from the active conduct of a trade or business within a possession of the United States. * * *"

No question is raised as to the applicability of this statute if it be determined that the contracts between the taxpayer and the planters constituted a bailment of the sugar rather than a sale. If the milling contracts with the planters constituted a bailment, the sugar received by the taxpayer as compensation for its milling services under the contracts was income received within a possession of the United States, and therefore entitled to the benefits or exemption of the statute; but, if the contracts constituted a sale of the sugar to the taxpayer rather than a bailment, then the proceeds from the sale thereof was not income derived from sources within a possession of the United States, but was income received in the United States, because practically all of the sugar was sold in the United States, and consequently the benefits of the statute could not be invoked.

The sole question for our consideration, therefore, is whether the intention of the taxpayer and the planters, as disclosed by the contract for the transfer of the sugar cane to the taxpayer to be manufactured into sugar, was to constitute the transaction a sale of the sugar to the taxpayer or merely a bailment thereof.

"Where articles are delivered by one person to another who is to perform labor upon them or to manufacture them into other articles for the former, the transaction is a bailment notwithstanding the articles are to be returned in altered form. But if the person by whom the articles are received may deliver in return articles which are not the product of those received the transaction is in effect a sale. So, where wheat is delivered to a miller to be ground and returned in the form of flour, the transaction constitutes a bailment, even, according to some authorities, though the flour returned is not to be ground from the identical wheat delivered; but where wheat is delivered to a miller to be paid for in flour, there is a sale. Likewise, where yarn is delivered to be paid for in cloth woven therefrom, it is a sale. But it has been held that a transaction is not converted into a sale by reason of the fact that the manufacturer is to receive a share in the manufactured article by way of compensation." 6 C. J. 1096.

"The substance of the agreement, and not its form or the particular expressions employed in it, is controlling, and the intention of the parties must be ascertained from the terms of their contract." Id., 1088.

With these rules in mind, we find that the following is substantially the agreement of the parties:

In 1911, Alfred D. Cooper, the taxpayer's agent in the Philippine Islands, entered into a contract with a number of planters in the Philippines to construct a sugar mill and maintain it for a period of thirty years, provided that the planters agreed to furnish the mill with a certain amount of sugar cane for a like period. This contract was later assigned to the taxpayer. Under the terms of the contract, the taxpayer agreed to construct and operate a railroad for use in transporting sugar cane, sugar, and fertilizer to the plantations of the growers free of charge to the planters. It also agreed to take delivery of all cane grown by the planters, properly loaded on cars at points along its railway, and to haul the cane free of...