Central Motor Co. v. U.S.

• Decision Date: 31 July 1978
• Docket Number: Nos. 76-1469,s. 76-1469
• Parties: 78-2 USTC P 9608 CENTRAL MOTOR COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. CENTRAL CREDIT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. CRUCES CREDIT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. RED ROCK INVESTMENT COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. to 76-1472.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 470

583 F.2d 470

78-2 USTC P 9608

CENTRAL MOTOR COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

CENTRAL CREDIT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

CRUCES CREDIT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

RED ROCK INVESTMENT COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

Nos. 76-1469 to 76-1472.

United States Court of Appeals Tenth Circuit.

Argued and Submitted Aug. 2, 1977.

Decided July 31, 1978.

Kendall O. Schlenker, Albuquerque, N. M. (Charles E. Anderson and Sandra Jo Craig, of Schlenker, Parker, Payne & Wellborn, Albuquerque, N. M., on the briefs), for plaintiffs-appellants.

William S. Estabrook, III, Atty., Dept. of Justice, Washington, D. C. (Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Atty., Dept. of Justice, and Richard W. Perkins, Atty., Dept. of Justice, Washington, D. C., on the briefs), for defendant-appellee.

Before SETH, Chief Judge, and HOLLOWAY and BARRETT, Circuit Judges.

HOLLOWAY, Circuit Judge.

These are consolidated actions brought pursuant to 28 U.S.C. § 1291 for refund of federal income taxes and accumulated earnings taxes for tax years ending in 1966, 1967 and 1968. The companies involved on this appeal are Central Motor Company (Central Motor), Central Credit Corporation (Central Credit), Cruces Credit Corporation (Cruces Credit), and Red Rock Investment Company (Red Rock). Following special verdicts by a jury, judgments were entered denying recovery of the accumulated earnings taxes in question. In another part of the case, tried without a jury, the trial court held that Central Motor was not entitled to deductions taken for contributions to an employees' pension fund under 26 U.S.C. §§ 401(a) and 404(a)(3), and denied recovery of income taxes in question.

On appeal, the major contentions are: (1) the trial court erred in instructing on the accumulated earnings tax issue and the special verdicts rendered by the jury that there were unreasonable accumulations of earnings should be set aside and judgment entered for each appellant taxpayer in the full amount of the claimed refunds for lack of evidence to support any findings of unreasonable accumulations, Inter alia, (2) the trial court's order granting the government's motion to consolidate the cases for trial of the accumulation of earnings issue was erroneous, and (3) the trial judge erred in finding that the pension fund for Central Motor's employees was not operated for their exclusive benefit and in denying recovery for deductions based on Central Motor's contributions to the pension fund.

The factual background and additional issues will be treated as we discuss the appellate contentions.

I

THE ACCUMULATED EARNINGS ISSUE

a. The background of the taxpayer corporations

The Internal Revenue Service in an audit of the appellants determined that each company was liable for accumulated earnings taxes for the three years in question under 26 U.S.C. §§ 531-537. ¹ The taxes assessed under § 531 were paid by the companies and individual refund actions were instituted. The cases were consolidated for trial on motion of the government on the accumulated earnings issue. A jury verdict was rendered in the form of answers to special interrogatories. Their effect was to deny any refund to the taxpayers except Red Rock for 1966. The jury's responses to the special interrogatories established: (1) that each taxpayer (except Red Rock for 1966) ² had permitted its earnings to accumulate beyond "reasonable present and future needs of the business" in each of the years in issue, (2) that tax avoidance with respect to individual shareholders was one of the purposes of such accumulations, and (3) that the amount of earnings and profits unreasonably accumulated for each year was the exact amount computed in the audit and assessed.

The IRS agent who audited the appellant corporations deemed them pursuant to Code § 1561, to be part of a "controlled group." ³ The controlling individual behind the corporations was Mr. Clair Gurley. With respect to all the appellants, Mr. Gurley or his wife owned a substantial amount of the stock during the years in question. ⁴ Mr. Gurley served as president of each company. At trial Mr. Gurley testified that he made the final decision on matters affecting relationships between the companies and that he was the "controlling force" behind the companies. (R.A. II, 354). Briefly, the history of the corporations involved in this appeal is as follows:

Central Motor : This is a Ford dealership in Gallup, New Mexico, around which the activities of the other corporations revolved. Mr. Gurley acquired full ownership of Central Motor in 1935 and incorporated it in 1946. In 1957, Central Motor moved to a building and other property owned by Central Credit. Central Motor is a unique dealership because a large volume of its business involves sales of pickup trucks to Navajo and Zuni Indians. Mr. Gurley estimated that 65-70% Of the sales were to Indians. During the period 1966-75, Central Motor experienced considerable expansion, both in the total volume of business and in the number of people employed. In this period, total sales rose from $2,915,000 to $10,905,000, and the number of employees climbed from 47 to 95.

Following liquidation of Central Credit in 1969, the buildings occupied by Central Motor were sold to Mr. Gurley's son and son-in-law. Central Motor then purchased the building from them in 1974. At the time of trial Central Motor was in the process of constructing a new facility which was expected to be completed in a few months. The cost of $500,000-600,000 for the new facility was being financed by Mr. Gurley himself.

In fiscal 1975 Central Motor elected to take sub-chapter S tax status so that its income at the time of trial was being taxed directly to the shareholders (including Mr. Gurley).

Central Credit : Central Credit was incorporated by Mr. Gurley in January, 1956. The nature of its business was limited to ownership of the original land and buildings which were rented to Central Motor Company. During its existence, the only acquisition beyond the original Central Motor building was a body shop in 1961. Central Credit was liquidated in 1969 as a consequence of the audit by the IRS. (R.A. II, 363).

Cruces Credit : Cruces was incorporated in 1947 in Las Cruces, New Mexico. Initially, Cruces was a finance company serving a car dealership in Las Cruces, Mesilla Motor Company, in which Mr. Gurley had a part ownership. Mr. Gurley's interest in Mesilla Motors was sold by him and Cruces Credit became dormant for several years. Cruces was revived in the late 1950s as a source of financing sales by Central Motor. Mr. Gurley stated that the sole customer of Cruces has been Central Motor. Cruces was liquidated in 1972 because of the audit. (R.A. II, 377).

Red Rock : Red Rock was incorporated in March, 1959, by Mr. Gurley's son and son-in-law, Patrick Gurley and John Schuelke. It was used as a car leasing agency until November, 1961. At that time, it was sold to Mr. Gurley, who used it as a financing company for vehicles sold by Central Motor. Red Rock was still in existence at the time of trial.

Credit Investment Company : Credit Investment is not an appellant, but serves as a depository for the pension fund of Central Motor's employees. During the period 1966-68, Credit was principally owned by Mr. Gurley's son and son-in-law. It was incorporated in 1961 after a distribution of a trust which Mr. Gurley had established for his children. Credit Investment is involved in the car financing business.

b. The general principles governing liability under § 531 for accumulated earnings.

Pursuant to Code § 532, the accumulated earnings tax of § 531 is imposed if a corporation was "formed or availed of for the purpose of avoiding the income tax with respect to its shareholders . . . by permitting (its) earnings and profits to accumulate instead of being divided or undistributed." Thus, there are two elements to the imposition of the tax: (1) intent to avoid shareholder taxes, and (2) unreasonable accumulation of earnings and profits. The taxpayers here attack the findings of unreasonableness of their accumulations of earnings but not the jury's findings that there were tax avoidance motives. ⁵

The Supreme Court has recently stated the rationale for the imposition of the tax in Ivan Allen Company v. United States, 422 U.S. 617, 624-25, 95 S.Ct. 2501, 2504, 45 L.Ed.2d 435, as follows:

Because of the disparity between the corporate tax rates and the higher gradation of the rates on individuals, a corporation may be utilized to reduce significantly its shareholders' overall tax liability by accumulating earnings beyond the reasonable needs of the business. Without some method to force the distribution of unneeded corporate earnings, a controlling shareholder would be able to postpone the full impact of income taxes on his share of the corporation's earnings in excess of its needs . . .

In order to foreclose this possibility of using the corporation as a means of avoiding the income tax on dividends to the shareholders, every Revenue Act since the adoption of the Sixteenth Amendment in 1913 has imposed a tax upon unnecessary accumulations of corporate earnings effected for the purpose of insulating shareholders.

In ascertaining the reasonableness of accumulations of earnings, each business must be assessed in light of its own particular requirements. Cheyenne Newspapers, Inc., v. Commissioner, 494 F.2d 429, 432 (10th Cir.). Reasonableness of provisions made for business needs is necessarily for determination by those concerned with management of the business. Henry Van Hummell, Inc. v. Commissioner, 364 F.2d 746, 749 (10th Cir.), cert. denied, 386 U.S. 956, 87 S.Ct. 1019, 18 L.Ed.2d 102. Whether a corporation has accumulated its earnings and...