California and Hawaiian Sugar Refin. Corp. v. United States

Decision Date05 December 1962
Docket NumberNo. 287-59,287-59
Citation311 F.2d 235
PartiesCALIFORNIA AND HAWAIIAN SUGAR REFINING CORPORATION, Limited v. The UNITED STATES.
CourtU.S. Claims Court

Marion B. Plant, San Francisco, Cal., for plaintiff.

Warren R. Wise, Washington, D. C., with whom was Asst. Atty. Gen., Louis F. Oberdorfer, for defendant. Edward S. Smith and Philip R. Miller, Washington, D. C., were on the brief.

DAVIS, Judge.

The California and Hawaiian Sugar Refining Corporation sues for a refund of income taxes and interest which it was required to pay for 1953. In the view we take, the case involves two separate but related issues. The first is whether processing and floor stock taxes paid by the plaintiff in 1934 and 1935 under the Agricultural Adjustment Act of 1933, and refunded to it in 1953 after the invalidation of that statute, are a return of capital or taxable income. The second issue relates to the deductibility of legal and expert-witness fees incurred in securing the refunds.

Plaintiff is, and has been for approximately 30 years, an agricultural marketing cooperative engaged in refining and marketing the sugar of its patrons, who are Hawaiian sugar cane growers. Until January 1, 1952, plaintiff was exempt from federal income taxation under the laws then in effect. For taxable years beginning on or after that date, plaintiff and other cooperatives similarly situated became subject to the qualified system of federal income taxation established by Section 101(12) of the Internal Revenue Code of 1939, as amended, to the extent they retained unallocated income earned during the tax year. Under that section an "exempt" cooperative is taxed on its income, whether or not derived from patronage, except that the cooperative is allowed deductions from gross income for amounts paid during the year as dividends upon its capital stock, and for amounts paid or allocated to patrons. The cooperative must include in its taxable income both patronage income and income not derived from patronage which it retains and does not allocate to the accounts of its patrons.

During 1934 and 1935, while it was exempt from all federal income taxes, the plaintiff paid the processing taxes and floor stock taxes imposed by the Agricultural Adjustment Act of 1933, 48 Stat. 31. On January 6, 1936, in United States v. Butler, 297 U.S. 1, 56 S.Ct. 312, 80 L.Ed. 477, the Supreme Court declared unconstitutional the taxes imposed by the 1933 Act. In 1939, under a special statute permitting suit, the plaintiff filed two proceedings in the Tax Court for refund of the processing taxes, and a suit in this court for refund of the floor stock taxes. Decisions of the Tax Court dismissing the actions for refund of the processing taxes were set aside by the Ninth Circuit, and the cases were remanded for further consideration. California & Hawaiian Sugar Refining Corp. v. Commissioner, 163 F.2d 531 (C.A.9, 1947), cert. denied, 332 U.S. 846, 68 S.Ct. 350, 92 L.Ed. 417 (1948). In January 1953, stipulated judgments were entered for the plaintiff in the two Tax Court cases, and the following October the Government accepted plaintiff's offer to compromise the Court of Claims case. Pursuant to the stipulated judgments and the compromise, the plaintiff received during 1953 (after it had become subject to federal income taxation) refund payments of processing and floor stock taxes totalling $970,507.41, and payments of interest totalling $1,042,624.02. It did not pay or allocate any portion of these refund payments, or the interest, to its patrons.

When it filed its income tax return for the taxable year ending December 31, 1953, the plaintiff included as income the interest received with respect to the refunded taxes, but did not include as income the principal amounts of the refunds. During 1953 the plaintiff had properly accrued $269,372.46, incurred for legal and expert-witness fees in conjunction with the refund litigation. It deducted this entire amount on its return as an ordinary and necessary business expense.

In 1959, the Commissioner of Internal Revenue proposed, and ultimately assessed, a deficiency in 1953 income taxes of $499,163.85, plus interest, based upon the inclusion of the principal amount of the processing and floor stock tax refunds in gross income. In the alternative, the Commissioner proposed that, assuming the refunds of the principal amount of the taxes were not includible in gross income, the legal and expert-witness fees should be prorated between the tax refunds and the interest received thereon, and that only the portion of the fees allocable to the recovery of interest (which works out to $139,510.69) should be allowed as a deduction. The plaintiff paid the deficiency of $499,163.85, together with interest of $139,403.47, and in due course filed this suit to recover those payments.

The first issue is whether the principal amount of the processing and floor stock taxes refunded to the plaintiff in 1953 is income for that year or a nontaxable return of capital. The plaintiff contends that because it derived no income tax benefit from the payment of the unconstitutional taxes in 1934 and 1935, by reason of its status at that time as an agricultural cooperative wholly exempt from federal income taxation, the refunds should be recognized as a nontaxable return of capital in 1953. We believe this position is correct.

An established principle, under the general provision of the Internal Revenue Code of 1939 (Section 22(a)) taxing "gains, profits, and income * * * from any source whatever," is that a refund of taxes illegally collected in prior years is not taxable income in the refund year unless the taxpayer had previously obtained a tax benefit on account of those taxes. Theoretically, a recovery of monies wrongfully exacted by the government is not income at all but a return of capital funds illegally taken from the taxpayer; where, however, the taxpayer has utilized the original impost to reduce income taxes, it is fair "to take taxpayer at its word" (see Ben Bimberg & Co., Inc. v. Helvering, 126 F.2d 412, 414 (C. A. 2, 1942), cert. denied, Ben Bimberg & Co. v. C. I. R., 317 U.S. 641, 63 S.Ct. 32, 87 L.Ed. 516) and to consider the refund as a new gain. This general justification for the tax benefit rule (in the present type of case) was spelled out by this court in Perry v. United States, 160 F.Supp. 270, at p. 271, 142 Ct.Cl. 7, at p. 9 (1958), involving the refund to a taxpayer of charitable contributions which he had made in prior years, where the court, speaking through Judge Whitaker, said that "the return to the taxpayer of the property he had tried to give away cannot possibly be considered as income — he merely got back his own property. It cannot possibly be considered as income, except on the ground that he had deducted from his income the amount contributed in each year, thus reducing his taxes." In the same case, Judge Madden, in a dissent on another point (joined by Judge Laramore), remarked (at p. 12 of 142 Ct.Cl., at p. 273 of 60 F.Supp.) that "one does not ordinarily acquire taxable income by collecting a debt, or by a refund of taxes which he never should have had to pay. The reason that the money was regarded as taxable in the special cases referred to was that, once having used the taxes paid or the bad debt as a tax deduction, the prospect of recovery was, for income tax purposes, written off, though as a legal claim it still existed. Having been written off, the later realization of the claim was, again for tax purposes, like a windfall to the taxpayer, and within the broad definition of taxable income."

This principle is reflected in the many cases holding a refund of taxes includible in the taxpayer's income of the recovery year where a prior tax benefit of some sort has been found,1 but not in its absence.2 The same theory underlay subsection (b) (12) of Section 22 of the 1939 Code (added in 1942) which provided that income attributable to the recovery during the taxable year of bad debts, taxes, or delinquency amounts, for which a deduction had been allowed in a prior taxable year, would not be included in gross income to the extent that the prior year's deduction had not resulted in a reduction of the taxpayer's income tax. In short, where there was no prior tax benefit, the recovery was to be excluded from gross income.3

The terms of Section 22(b) (12) do not apply to the present case because this taxpayer, being then exempt from federal income taxation, neither made a deduction nor received a credit for the taxes when it paid them in 1934 and 1935. But it does not follow that, by extending legislative relief in certain categories of these tax refund cases, Congress intended that comparable recoveries not mentioned in the amendment should be included in gross income. See Dobson v. Commissioner, 320 U.S. 489, 506, 64 S.Ct. 239, 88 L.Ed. 248; Tuttle v. United States, 101 F.Supp. 532, 122 Ct.Cl. 1 (1951); Perry v. United States, supra, 160 F.Supp. 270, 142 Ct.Cl. 7, (1958); Birmingham Terminal Co. v. Commissioner, 17 T.C. 1011, 1014 (1951); Treas.Reg. 118 § 39.22(b) (12)-1.4 As the Government itself recognized in Treasury Regulation 118 with respect to this very statutory exception, it is wholly appropriate, where a piece of corrective legislation simply applies a general principle to a particular area, to continue to apply the same principle in like areas left untouched by the Congress. In other words, if taxpayer's transaction is found on principle to be a return of capital, there is nothing in Section 22(b) (12) requiring or suggesting that it must now be included in gross income.

We can rightfully go back, then, to the general postulate that a refund of taxes illegally collected is not to be treated as income unless the taxpayer has previously received a tax benefit. In the cases which have characterized the refund as income, the taxpayer benefitted under the income tax laws by taking an effective...

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