Decision Date02 October 1931
CourtU.S. District Court — District of South Carolina
PartiesH. D. & J. K. CROSSWELL, Inc., v. JONES, Collector of Internal Revenue.

Adrian C. Humphreys and Newton K. Fox, both of New York City, and Thomas & Lumkin, of Columbia, S. C., for plaintiff.

Henry E. Davis, U. S. Atty., of Florence, S. C., C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, and Charles K. Hoover and Charles T. Hendler, Sp. Attys., Bureau of Internal Revenue, all of Washington, D. C., for defendant.

GLENN, District Judge.

The plaintiff, a corporation, has brought suit to recover income and excess profit taxes paid for the years 1918, 1919, and 1920. Pertinent provisions are sections 325, 326, 301, and 302 of the Revenue Act of 1918 (40 Stat. 1088, 1089, 1091, 1092). The facts have been stipulated, and there is no need to repeat most of them here. The question for decision is a very narrow one. The plaintiff originated as a partnership; this partnership had purchased certain contracts giving them rights of bottling and selling Coca-Cola in South Carolina. On March 1, 1915, the partnership incorporated itself under the laws of South Carolina with a capital stock of $5,000 par value. The stock of the corporation was issued to the partners and represented chiefly the value of the bottling contracts which the partnership had acquired. Further history of the dealings with the Commissioner of Internal Revenue involved the question of personal service classification as well as the question which is still before the court, namely, certain sections of the Revenue Act of 1917 (40 Stat. 300). The Commission determined the matter against the plaintiff corporation, and the Tax Board affirmed the action of the Commission. See 6 B. T. A. 1315.

The deficiencies were thereafter assessed, together with interest, the same being paid by the plaintiff on December 16, 1927.

The plaintiff duly filed claims for refund of the taxes and interest paid, and, upon rejection thereof by the Commissioner of Internal Revenue, brought this suit.

Recovery is sought in this action on the ground that the plaintiff is entitled to have its invested capital increased for each of the years by reason of a claimed paid-in capital based on the value of the contracts acquired in 1915 for its capital stock of a par value of $5,000.

It is important at the outset to determine the nature of the contracts involved. All of the contracts are similar in nature, and the substance of these contracts is the privilege on the part of the plaintiff corporation to buy from the parent corporation Coca-Cola syrup at an agreed price. It then had a number of subcontracts with the local bottlers who repurchased the syrup from them at a substantial profit. As the country had grown greatly between 1903 and 1915, and as the use of Coca-Cola had steadily increased, it is readily seen that these contracts became very valuable, as a matter of fact, it is stipulated that the value of the principal contract on March 1, 1915, when it was transferred to the new corporation, was $162,000. In that the territory involved included several of the rapidly developing counties in the Piedmont section of South Carolina, the contracts had a very definite and substantial value. In 1917, 1918, and 1919 two enormous army camps were located in the territory involved. The amount of the taxes reflect the substantial value of these contracts.

The question turns around the application of subsection (a) of section 325 of the Revenue Act of 1918. It comes about in this way: Section 326, Revenue Act of 1918, provides that for the purposes of determining the invested capital of a corporation a sharp distinction is made between "tangible" and "intangible property." Section 326 then defines the term "invested capital." The rate of tax provided by section 301 depends upon the ratio of the net income to invested capital. Section 302 provides for the application of certain rates of tax to certain proportions of income, and invested capital is not a factor in the computation. The tax liability of the plaintiff corporation here has been determined under section 302. The plaintiff in this action contends that its invested capital so increased its basis of computation as to obviate the computation of the tax under section 302 and that the tax should have been determined under section 301. It follows, therefore, that the sole question presented for determination by this court may be summed up as follows: "Are the contracts acquired by the Plaintiff while a partnership and turned over to the Plaintiff a Corporation at the date of organization for capital stock in the Corporation tangible property or intangible property." Section 325, Revenue Act of 1918, defines the terms involved.

"Sec. 325. (a) That as used in this title —

"The term `intangible property' means patents, copyrights, secret processes and formulae, good will, trade-marks, trade-brands, franchises, and other like property;

"The term `tangible property' means stocks, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than intangible property."

It is very evident that, if we adopt a historical or scientific classification of property, these contracts must be held to be intangible. The difficulty arises by reason of the fact that the Revenue Act of 1918 repudiates the commonly accepted meanings of the words "tangible" and "intangible property," and sets up a classification by its own terms. The act practically says that the distinctions between tangible and intangible property which have been recognized by legal history and the science of jurisprudence are not satisfactory for revenue purposes. And therefore a new classification must be established. The government naturally contends that these contracts are intangible, and fall under the description "all other like property." The plaintiff contends that these contracts are not like the specific classes of property set out in the definition of intangible property, and that therefore they fall under the phrase "other property other than intangible property." In short, the plaintiff contends that the general language is used in the definition of tangible property, and before any type of property can come under the classification of intangible property it must be a patent, copyright, a secret process, formulæ, good will, trade-mark, trade-brand, franchise, or some property which possesses those characteristics similar to the list just enumerated. Undoubtedly, logic would require us to look first to the characteristic which is common to all of the terms used in the first part of the section. Unless the property under scrutiny possesses in a marked way the outstanding characteristics which are common to all of these classes of property, we could not say that it was "other like property." What, then, is the common characteristic of all of these terms? We think that the common characteristic is protection by some special statutes. For example, patents are protected by the statutes and government administration. Copyrights are likewise protected. So with secret processes and formulæ, which are in many cases required to be registered with state authorities. Good will has a definite and accepted meaning for taxation purposes well recognized by the law. Trade-marks and trade-brands are likewise protected by statute and principles of common law. In all of these is the element of governmental privilege and protection, and Congress must have had this idea in mind when grouping these terms together.

The government most earnestly contends, however, that these contracts are very similar to franchises, and that, as the word "franchise" is the last term used, the phrase "other like property" has a special reference to the term "franchise." We agree that the term "franchise" has been loosely applied to a few business relations which do not enjoy special government or legal protection. But the term "franchise" is used much more commonly and more accurately to describe special privileges granted by some governmental unit. This meaning of the word "franchise" has been recognized by the court. For example, we find a franchise defined:

"`Franchise' is a word of extensive signification. It is a liberty or privilege. In England, under the common law, a franchise was a gem in the royal diadem. It was also a certain privilege inherent to the crown, and subsisted in the hands of a subject by grant from the King. It was therefore defined to be a `royal privilege in the hands of a subject.' In this country the people not only have all the rights and privileges of English subjects, but they have secured all the rights and privileges of the crown. State v. City of Topeka, 2 P. 587, 589, 30 Kan. 657. * * *

"The ordinary signification of the word `franchise,' as defined by Webster, is a particular privilege or right granted by a prince or sovereign to an individual or to a number of persons; an exemption from a burden or duty to which others are subject. Central R. & Banking Co. v. State, 54 Ga. 401, 409.

"A franchise is generally understood to be a special privilege emanating from the sovereign power of the state, owing its existence to a grant, or to prescription presupposing a grant. Board of Trade of Chicago v. People, 91 Ill. 80, 82; Chicago City R. Co. v. People, 73 Ill. 541, 547; Hazelton Boiler Co. v. Hazelton Tripod Boiler Co., 28 N. E. 248, 137 Ill. 231; State of New Jersey v. Wright, 6 S. Ct. 907, 908, 117 U. S. 648, 29 L. Ed. 1021; Lincoln St. Ry. Co. v. City of Lincoln, 84 N. W. 802, 808, 61 Neb. 109.

"A franchise is a grant of a right or privilege to an individual or a corporation by the government or sovereign power. People of the State of New York v. New York, L. E. & W. R. Co., 2 N. Y. Civ. Proc. R. 82, 89." Words and Phrases, First Series, Vol. 3, page 2929.

In the light of these considerations, let us examine these Coca-Cola contracts...

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