Alvord v. CIR

• Decision Date: 26 April 1960
• Docket Number: No. 7984.,7984.
• Citation: 277 F.2d 713
• Parties: Ellsworth C. ALVORD and Katharyn W. Alvord, Husband and Wife, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Fourth Circuit

277 F.2d 713 (1960)

Ellsworth C. ALVORD and Katharyn W. Alvord, Husband and Wife, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 7984.

United States Court of Appeals Fourth Circuit.

Argued January 7, 1960.

Decided April 26, 1960.

Harry L. Brown, Washington, D. C. (Ellsworth C. Alvord, Alvord & Alvord, Washington, D. C., and Noel T. Dowling, New York City, on brief), for petitioners.

Carter Bledsoe, Attorney, Department of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., and Lee A. Jackson and Grant W. Wiprud, Attorneys, Department of Justice, Washington, D. C., on brief), for respondent.

Before SOPER, HAYNSWORTH and BOREMAN, Circuit Judges.

HAYNSWORTH, Circuit Judge.

The question is whether a citizen of the United States, who owns a majority of the stock of a foreign personal holding company, is taxable under § 337 of the 1939 Code¹ on his share of the undistributed net income of the corporation during years in which the United States effectively prohibited the distribution of such income. In holding that he was,² we think the Tax Court adopted a too literal and an erroneous interpretation of the statute.

Brief reference to the background, fully set forth in the opinion of the Tax Court, is necessary to an understanding of the context in which the question arises.

Background — The Patenotres

Eleanor and Raymond Patenotre, mother and son, were citizens of France owning substantial assets in this country. At the critical times, most of these assets were held by J. P. Morgan & Co. in an agency account or under certain escrow agreements which the Patenotres executed to secure payment of their United States income tax obligations. In addition, E. F. Hutton & Co., held in New York the assets, principally securities, of Hekor Investment Holding Company, Ltd., a Canadian corporation, and Raymond Patenotre was the owner of 95% of Hekor's outstanding stock.³ Hekor's assets and Raymond Patenotre's Hekor stock were also involved in arrangements effected in 1949 to secure payment of the Patenotre tax obligations.

In 1943, there was a jeopardy assessment of income tax, penalties and interest claimed to be due by Eleanor Patenotre for the calendar year 1930 in the aggregate amount of $2,836,961.43. Thereafter, from time to time, deficiencies of income tax, with penalties and interest, for succeeding years were asserted against Eleanor and, in later years, against Raymond Patenotre.

In 1947, the Patenotres came to the United States. Under applicable regulations, they were not allowed to depart from the United States until they had paid all of their tax obligations to the United States or made arrangements, satisfactory to the United States, for their payment. In October 1949, an arrangement was effected through the Chief of the Alien Tax Division of the Bureau of Internal Revenue under which, (1) Eleanor's liabilities for income taxes for 1930, including penalties and interest, were settled by the payment of $2,000,000 out of the Morgan & Co. agency account, (2) though tax liens had been filed with both Morgan & Co. and Hutton & Co., the Patenotres were permitted to withdraw $500,000 from the agency account at Morgan & Co., (3) after paying the two items aggregating $2,500,000, Morgan & Co. was to hold the remaining Patenotre assets in its possession under an escrow agreement directing and obligating it to apply those assets in payment of the Patenotre tax liabilities for the years 1931-1949 when those tax liabilities were finally determined, and (4) Raymond Patenotre executed an assignment to the District Collector of all of his interest in the stock of Hekor and in Hekor's assets as additional security for the payment of the 1931-1949 tax liabilities of the Patenotres.

When these security arrangements were effected in 1949, the claims, actual and in contemplation, of the United States against the Patenotres for taxes, penalties and interest for the years 1931-1948 aggregated approximately $3,023,000.⁴ At that time the Patenotres filed tentative returns for 1949. Raymond reported a 1949 tax liability of approximately $21,000 which he attempted to pay with a check on Morgan & Co. Morgan would not honor the check, however, because of the still outstanding tax lien of which it had notice. Later a deficiency for 1949 in the amount of $85,000 with a penalty addition of $21,000 was asserted against Eleanor. As finally determined Eleanor's tax liability for 1949 was $56,105.83 and Raymond's $2,972.65.

In 1950, these tax claims were substantially increased. By an amended answer in a pending proceeding in the Tax Court involving Raymond's income tax liabilities for the years 1934-1940, the Commissioner increased his claim of deficiencies of tax and penalties from $324,789.48 to $1,267,167.01. The tax claims for the years 1931-1949, however, were known to be inflated, for income items totalling approximately $2,700,000 had been charged to both Eleanor and Raymond, and taxes thereon had been assessed to each of them.

Raymond Patenotre died in 1951, and thereafter estate tax liabilities were asserted as well as accruing liabilities for income taxes for the years 1950-1953. As finally determined in 1955, however, there was no estate tax liability and the income tax liabilities for the years 1950-1953 were relatively small and inconsequential.

In November 1955 a settlement of all of the Patenotre tax liabilities was agreed upon. This resulted in the termination of pending Tax Court proceedings by stipulation and an administrative determination of the income tax deficiencies for years not before the Tax Court. For the years 1931 through 1953 the unpaid income tax liabilities of Eleanor, Raymond and Raymond's estate, thus determined, aggregated $1,287,266.53. Of that amount $1,210,021.57 was attributable to the years 1931-1948; $52,654.65 to the year 1949 and $18,166.48 to the years 1950-1953. There were also penalty additions with respect to the years before the Tax Court of $269,108.07.

With interest on the deficiency for each year, the settlement required a total payment of $2,343,843.52. An advance payment of $2,200,000 had been made out of the account at Morgan & Co. in December 1954. The balance of $143,843.52, which included interest to the date of payment, was paid out of the same account on November 30, 1955. Thereupon, the escrow agreement under which Morgan had held the Patenotre assets since 1949, the assignment of the Hekor stock and assets and all notices of tax liens were cancelled.

The Taxpayer and the Hekor Stock

The taxpayer, Ellsworth C. Alvord, is a practicing attorney in Washington, D.C. He had represented the Patenotres and had advanced funds to them. Early in 1949, Raymond acknowledged that he was indebted to Alvord, on account of such services and advances, in an amount approaching $700,000. He agreed to pledge his Hekor stock to secure this indebtedness. This pledge, apparently, was not effected, or it was released, for the stock was subsequently assigned to the District Collector as additional security for the payment of the Patenotre tax obligations.

Later in 1949, however, after the security arrangements for payment of the Patenotre tax liabilities had been effected, Patenotre agreed to sell his Hekor stock to Alvord for which Alvord was to cancel the Patenotre indebtedness to him and to pay $475,000⁵ in cash. Patenotre agreed to obtain a release of the Hekor stock and the assets of that company from the claims of the United States. Promptly after that was accomplished, final settlement was to be had.

Though the cash portion of the purchase price was not paid until 1956 and though the assignments to the District Collector and the tax liens were in effect until late 1955, it is agreed that Alvord became the owner of Patenotre's Hekor stock in September 1951. Thereafter, he was the owner of 9,500, or 95%, of the 10,000 shares of Hekor stock outstanding.

When Alvord acquired the Hekor stock, and thereafter until November 1955, the United States had control, and was in active charge, of Hekor's assets and its financial affairs. It was exercising these powers under Patenotre's assignment and its tax lien. Without the permission of the United States, Hekor's directors were without power to declare and pay a dividend to the stockholders.

In November 1951, Alvord requested permission to declare and pay at the end of the year a dividend in the amount of Hekor's estimated "Supplement P net income."⁶ This request was refused by the Chief of the Alien Tax Division upon the grounds that (1) the Hekor stock had been assigned to the United States as security for the income tax liabilities of the Patenotres for the years 1931-1949; (2) Hekor, itself, had substantial unpaid tax obligations, and (3) Raymond Patenotre having died, there probably would be substantial estate taxes for which the United States had a statutory lien upon Raymond's assets (presumably the 9,500 shares of Hekor's stock).

Alvord responded contentiously, but he made the point that the tax claims against the Patenotres were substantially less than the value of the assets held in escrow by Morgan for their payment,⁷ and he "assumed" that the denial of his request relieved him of any obligation to report on his individual return his share of Hekor's undistributed Supplement P net income.

In 1952, there was a stipulation pursuant to which Hekor paid, subject to redetermination, $128,700.67 on account of deficiencies of income tax, personal holding company surtax and penalties. On motion made in 1956, it was determined that this payment resulted in an over-payment of $101,636.66. In 1952, however, interest amounting to some $68,000 had been paid upon the conditionally determined deficiencies asserted against Hekor. This interest payment, with other deductions, left Hekor with no Supplement P net income for 1952.

In November 1953, Hekor's Board of Directors declared a dividend in an amount equal to...