B & L FARMS CO. v. United States, Civ. No. 63-323.

• Decision Date: 19 February 1965
• Docket Number: Civ. No. 63-323.
• Citation: 238 F. Supp. 407
• Court: U.S. District Court — Southern District of Florida
• Parties: B & L FARMS CO. and May Spach, Edwin L. Hubbard and John Nicholas, as Trustees in Bankruptcy for B & L Farms, Co., Plaintiffs, v. The UNITED STATES of America, and Laurie W. Tomlinson, Defendants.

238 F. Supp. 407

B & L FARMS CO. and May Spach, Edwin L. Hubbard and John Nicholas, as Trustees in Bankruptcy for B & L Farms, Co., Plaintiffs, v. The UNITED STATES of America, and Laurie W. Tomlinson, Defendants.

Civ. No. 63-323.

United States District Court S. D. Florida, Miami Division.

June 25, 1964.

On Rehearing February 19, 1965.

Edwin L. Hubbard, Coral Gables, Fla., W. G. Ward, Miami, Fla., for plaintiffs.

Wm. A. Meadows, Jr., U. S. Atty., Lavinia L. Redd, Asst. U. S. Atty., Miami, Fla., for defendants.

FULTON, District Judge.

This is a tax refund suit whereby the plaintiffs seek to recover income taxes in the amount of $162,538.73, which were paid for the taxpayer's fiscal year ending July 31, 1956.

Plaintiffs contend that the taxpayer suffered a net operating loss for the fiscal year ending July 31, 1959, which loss was sufficient in amount to justify the claimed refund. Plaintiffs rely on the "carry-back" provisions of Section 172 of the Internal Revenue Code of 1954.

The case was submitted on the pleadings and the briefs of counsel. The parties agreed to an extensive stipulation of facts, which stipulation is incorporated herein by reference. The following is a brief summary of the pertinent facts.

Plaintiff, B & L Farms Co., is a corporation which was formerly engaged in a farming business in Dade County, Florida, and which incurred and paid federal income taxes for its fiscal year ending July 31, 1956. On August 1, 1958, the company filed a petition in this Court for a Plan of Arrangement under Chapter XI of the Bankruptcy Act. The attempt to work out the arrangement was unsuccessful, however, and the company was adjudicated to be a bankrupt in this Court on June 26, 1959, upon petition of several of the creditors. The adjudication of bankruptcy occurred approximately five weeks prior to the end of the company's 1959 fiscal year. May Spach, Edwin L. Hubbard and John Nicholas were appointed as trustees in bankruptcy for the company. They continue to serve in this capacity.

B & L Farms Co. was incorporated in 1949. From that date until said bankruptcy, the company engaged in the production and packing of tomatoes and other produce. For tax purposes, the company kept its books and reported its income on a cash receipts and disbursements basis. It calculated and reported its income on a fiscal year basis, commencing August 1st of each year and ending on July 31st of the next year.

The company prospered through its 1956 fiscal year, but thereafter it encountered difficulties caused by adverse weather conditions. Upon adjudication in bankruptcy, the farming operations of the company terminated. The company's packing house and machinery were not operated by the trustees, but these assets were subsequently sold by the trustees, in a package deal with other property.

During the 1959 fiscal year, prior to bankruptcy, the company incurred an indebtedness of $2,459,618 in the purchase of fertilizer, insecticides and other items necessary for its farming operations. This trade account indebtedness remained unpaid at the time of the bankruptcy adjudication. Claims based on this indebtedness were subsequently filed in the bankruptcy proceedings. A considerable portion of such claims were paid by the trustees, but such payment to these creditors did not occur until after the end of B & L Farms Co.'s 1959 fiscal year.

It is uncontroverted that the company did suffer a considerable net operating loss in the 1959 fiscal year, even apart from any of the items in dispute in this lawsuit. In fact, the sum of $162,538.73, which the company paid as federal income taxes for the 1956 fiscal year, is the adjusted tax payment for that year, computed after applying a net operating loss "carry-back" from 1959 which the government conceded. What the present case involves, therefore, is the contention by plaintiffs that the law permits a still larger net operating loss computation for the 1959 fiscal year

Plaintiffs contend that a larger net operating loss for fiscal year 1959 can be established, because of the transfer of all corporate assets to the trustees on June 26, 1959, by any one of the following deductions:

(1) Deduction under 26 U.S.C. § 162 for business expenses due to the trade account indebtedness incurred during fiscal year 1959.

(2) Deduction under 26 U.S.C. § 165 for a business loss because of the divestiture of the bankrupt's assets to the trustees.

(3) Deduction under 26 U.S.C. § 167 for a sudden obsolescence loss because of the abnormal retirement of the depreciable packing house and machinery at the time of the bankruptcy.

It is conceded that any one of these deductions, if valid, would be sufficient in amount to permit the refund claimed in this case.

CLAIM UNDER SECTION 162

Plaintiffs' claim for a deduction for business expenses under 26 U.S.C. § 162 raises the immediate problem that the creditors for such expenses did not receive actual payment until after the close of the company's 1959 fiscal year. This deduction provision, Section 162, provides in part:

"There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."

A general rule for determining appropriate tax years is stated in 26 U.S.C. § 461, which provides in part:

"The amount of any deduction or credit allowed by this subtitle shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income."

Since the company was on the cash basis method of reporting, the government argues that the company can not claim a Section 162 deduction, under the applicable statutes, because the claimed business expenses were not "paid" during the 1959 fiscal year.

The plaintiffs contend that the business expenses were properly deductible in fiscal 1959 because the adjudication of bankruptcy occurred in that year and because the concurrent divestiture of the bankrupt's assets for distribution to the creditors constituted "payment" on account of such deductible debts at the time of such divestiture.

Plaintiffs' theory of payment by divestiture in bankruptcy can not be sustained under the law. It is a general principle of tax law that a deduction must be established by the express provisions of the statute. White v. United States, 305 U.S. 281, 59 S.Ct. 179, 83 L.Ed. 172 (1938). In the present case, Section 162 uses the word "paid". It has been held in a similar context that the word "paid" means "to liquidate a liability in cash." P. G. Lake, Inc. v. Commissioner, 148 F. 2d 898 (5th Cir. 1945). This definition can be broadened to include "cash or its equivalent"; but that is as far as the courts will go. Helvering v. Price, 309 U.S. 409, 60 S.Ct. 673, 84 L.Ed. 836 (1940). The unfortunate fact for plaintiffs in the present case is that the creditors of the taxpayer simply did not receive actual payment for their claims, in the strict sense required by the law, during the 1959 fiscal year.

It is true that payees receiving payment by check are deemed to have been "paid" for tax deduction purposes, even though the actual cash may not be received until the following tax year. 2 Mertens, Section 12.54. However, a check is a specific negotiable claim which is treated in the business world as the equivalent of cash. This is far different from the claims which the creditors of B & L Farms Co., had upon the adjudication in bankruptcy.

Plaintiffs recognize that they can not save their claim under Section 162 by any open theory of "constructive payment." The concept of constructive payment has been applied occasionally in the check-payment cases, but it has received little favor elsewhere, because of the reluctance of the courts to expand the legislatively-declared scope of such deductions. 2 Mertens Sections 10.18, 12.53-12.59; P. G. Lake v. Commissioner, supra; Vander Poel v. Commissioner, 8 T.C. 407 (1947).

Plaintiffs deny that they need to rely on a "constructive payment" theory; they assert instead that they can show actual payment by virtue of the status of the bankruptcy trustees in this matter. Plaintiffs take the position that the unconditional transfer of assets to the trustees was in effect payment to the creditors at that time. This position is apparently based on the theory that the trustees were to all intents and purposes merely collection agents for the creditors. This contention is obviously untenable because bankruptcy trustees do not represent the creditors alone. They must protect the interests of the bankrupt and provide for the payment of administrative costs. During the 1959 fiscal year, which is the crucial year in the present case, the trustees did not have any fixed duty to pay over any specific amounts to any particular creditors.

Plaintiffs cite the case of Stanton v. Commissioner, 36 B.T.A. 112 (1937), which has some language which can be construed to support plaintiffs' position. However, the Stanton case involved a transfer to non-bankruptcy trustees, who actually paid the creditors in the year for which the tax deduction was allowed. Regardless of its language, therefore, the holding in Stanton is of no help to plaintiffs.

While no bankruptcy cases have been found squarely on point on the "payment" issue, there are analogous cases which support the denial of the Section 162 deduction. It has been held that an individual who transfers business assets to a corporation is not entitled to claim "payment" of his deductible business liabilities at the time of such transfer, even though the transferee assumed such liabilities and subsequently did pay them. Arthur L. Kniffen, 39 T.C. 553 (1962); Doggett v. Commissioner, 275 F.2d 823 (4th Cir. 1960); Citizens Nat. Trust & Savings Bank of Los Angeles v. Welch, 119 F.2d 717 (9th Cir. 1941). The same result should follow in the present case.

CLAIM UNDER SECTION 165

Plaintiffs anticipated that Section 162 might be...