EASTERN GAS & FUEL A. v. Commissioner of Internal Rev., 3732.

• Decision Date: 29 May 1942
• Docket Number: No. 3732.,3732.
• Citation: 128 F.2d 369
• Parties: EASTERN GAS & FUEL ASSOCIATES v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — First Circuit

128 F.2d 369 (1942)

EASTERN GAS & FUEL ASSOCIATES v. COMMISSIONER OF INTERNAL REVENUE.

No. 3732.

Circuit Court of Appeals, First Circuit.

May 29, 1942.

John E. McClure, of Washington, D. C. (Maude Ellen White and Miller & Chevalier, all of Washington, D. C., and J. Rex Dibble and Miller, Chevalier, Peeler & Wilson, all of Los Angeles, Cal., on the brief), for petitioner.

Samuel H. Levy, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and J. Louis Monarch, A. F. Prescott, and Joseph M. Jones, Sp. Assts. to Atty. Gen., J. P. Wenchel, Chief Counsel, and Rollin H. Transue, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., on the brief), for Commissioner.

Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.

MAHONEY, Circuit Judge.

In this petition for review the taxpayer has appealed from a decision of the Board of Tax Appeals which sustained a determination of the Commissioner of Internal Revenue disallowing as deductions in the petitioner's income tax returns for the years 1934, 1935 and 1936, certain amounts paid as taxes to the Commonwealth of Massachusetts. The principal issue which confronts us is whether these amounts are deductible under the applicable provisions of the Revenue Acts of 1934 and 1936, namely Sections 23(a), (c) and (d).¹ 48 Stat. 680 (1934); 49 Stat. 1648 (1936) 26 U.S.C.A. Int.Rev.Acts, pages 671, 827, § 23 (a, c, d).

The petitioner, Eastern Gas and Fuel Associates, was organized on July 18, 1929, under the laws of the Commonwealth of Massachusetts and had as one of its objects the acquisition of the preferred and common shares of the Massachusetts Gas Companies, Connecticut Coke Company and Philadelphia Coke Company. The Massachusetts Gas Companies, a voluntary association, was organized on September 25, 1902. Under the Massachusetts' income tax law, Gen.Laws Mass.1921, Ch. 62, Section 1,² provision was made for the taxation at 6% of dividends on transferable shares in partnerships, associations or trusts. An exception was made if the partnership, association or trust furnished proof that at least two-thirds of its property was taxed within the Commonwealth and filed an agreement to pay the Commonwealth annually a tax of 6% of the income derived from its property.

In compliance with this law the Massachusetts Gas Companies furnished the required proof that at least two-thirds of its property was taxable within the Commonwealth and filed an agreement to pay the annual tax of 6% of its income. In accordance with the agreement which was in force from 1916 throughout 1929, the Massachusetts Gas Companies paid the tax to the Commonwealth of Massachusetts. The petitioner never filed such an agreement and never paid such a tax.

The petitioner in its declaration of trust provided in part:

"Article 23. C. This trust will, out of the balance of the net profits or surplus remaining after all dividends accrued on the Prior Preference to the preceding quarterly dividend day have been paid or declared and set aside for payment, refund to each holder of Prior Preference, or arrange for the payment of, any Massachusetts income tax in respect of dividends on the Prior Preference received by such holder, to an amount not exceeding six per cent (6%) of such dividends, or refund or arrange for the payment of any personal property tax of the Commonwealth of Pennsylvania or any municipality or sub-division thereof in respect of the ownership of Prior Preference, not exceeding four (4) mills on each dollar of taxable value of Prior Preference held by such holder (all such refunding or payment as well as any similar refunding or payment hereinafter or in votes or resolutions of the Trustees provided in respect of the Preferred Stock, being in this Article 23 referred to as `reimbursement for taxes') — all in such manner and under such regulations as the Trustees may from time to time prescribe.

* * * * *

"Article 23. I. Holders of Preferred shall be entitled pro rata out of the balance of the net profits or surplus remaining after all dividends accrued on the Preferred to the preceding quarterly dividend day have been paid or declared and set aside for payment to such reimbursement for taxes, if any, as may have been established for the particular series in such manner and under such regulations as the Trustees may from time to time prescribe."

On August 6, 1929, the Board of Trustees by resolution established a series of preferred stock known as 6% cumulative preferred stock, a part of which reads as follows:

"(b) Reimbursement for taxes shall be by refunding to each holder of Preferred, or arranging for the payment of, any Massachusetts income tax in respect of dividends on the Preferred received by such holder, to an amount not exceeding six per cent (6%) of such dividends, or by refunding or arranging for the payment of any personal property tax of the Commonwealth of Pennsylvania or any municipality or subdivision thereof in respect of the ownership of Preferred, not exceeding four (4) mills on each dollar of taxable value of Preferred held by such holder, such reimbursement for taxes to be made in such manner and under such regulations as the Trustees may from time to time prescribe."

Thereafter, on August 14, 1929, the petitioner sent to the holders of the common and preferred shares of Massachusetts Gas Companies a prospectus in which it made the following offer:

"Eastern Gas and Fuel Associates will reimburse Massachusetts holders of the Prior Preference and the 6% Cumulative Preferred Stocks for any Massachusetts income taxes paid with respect to any dividends thereon up to but not exceeding 6%. In the absence of any request to the contrary Eastern Gas and Fuel Associates will pay the Massachusetts income taxes on dividends of these stocks so that dividends to Massachusetts holders will be free of tax in that respect."

The petitioner took up with the Commissioner of Corporations and Taxation of the Commonwealth of Massachusetts the matter of paying the tax imposed by Section 1, Chapter 62, supra, and an agreement was entered into whereby Old Colony Trust Company, of Boston, would act as trustee to pay the tax on the dividends received by the inhabitants of Massachusetts from the petitioner. On December 4, 1929, the petitioner addressed a letter to the Commissioner of Corporations and Taxation setting forth the arrangement whereby the Old Colony Trust Company, as trustee, under the agreement of December 3, 1929, was to pay the taxes on the dividends and this agreement was approved by the Commissioner of Corporations and Taxation.

In 1934, 1935 and 1936, taxes imposed by the Commonwealth of Massachusetts on the dividends of the holders of petitioner's preferred shares residing in Massachusetts and subject to such tax, were paid in the sums of $101,926.52, $99,801.13 and $95,926.38, respectively. The petitioner claimed these amounts as deductions in its income tax returns for the respective years as taxes paid to the Commonwealth of Massachusetts. These deductions were disallowed by the Commissioner and his action was affirmed by the Board of Tax Appeals. The petitioner made the alternative contention before the Board that if the sums in question were properly disallowed as deductions, the respondent erred in understating the adjusted declared value of its capital stock for excess profits tax purposes for the years in question. The petitioner does not rely upon this alternative contention in its brief and we give it no further consideration.

The Board decided that the amounts herein in question are not deductible as ordinary and necessary business expenses within the meaning of Section 23(a) for the reason that the payments made as taxes to the Commonwealth of Massachusetts upon the dividends received by the shareholders of the petitioner came from earnings or profits. No contrary contention was made by the petitioner as to the source of these payments. The Board concluded that since such payments are within the statutory definition of a dividend, 26 U.S.C.A. Int.Rev. Code, § 115³ (Internal Revenue Acts 1934, 1936) therefore, "it is immaterial whether the shareholder could have required payment if there had been no earnings or profits".

We agree with the Board that the Commissioner properly disallowed the claimed deductions on the ground that the payments made were added dividends but we cannot assent to its reasoning. In our opinion the question whether payments are made out of net earnings or surplus is not decisive of the issue. The controlling question is, was the payment of these taxes an enforceable obligation against the petitioner which had to be paid in any event regardless of the existence of surplus or net profits, or was the payment a part of the dividend structure of the petitioner. Cf. Wiggin Terminals, Inc., v. United States, 1 Cir., 1929, 36 F.2d 893, 896, 898. There is no disagreement as to the facts before us and since a determination of the issue depends upon the construction of documentary evidence, we are free to disregard the reasoning of the Board and place our own interpretation upon the evidence in question. United States v. South Georgia Railway Co., 5 Cir., 1939, 107 F.2d 3.

The petitioner makes the contention that it could not have obtained the consent of the shareholders of the Massachusetts Gas Companies to exchange their stock for its shares unless it had promised them that it would pay their taxes. Further, it contends that this was a promise entirely separate from the trust indenture, which provides for the payment of taxes upon the dividends, and, since this was an annual charge which had to be paid in order to acquire and maintain the income producing property, it, therefore, was a necessary and ordinary business expenses. The cases cited in support of this position assume the question in issue because enforceable obligations were found to exist in them. They are not controlling unless the petitioner can...