Clay Sewer Pipe Ass'n v. Com'r of Internal Revenue, 8399.

• Decision Date: 06 December 1943
• Docket Number: No. 8399.,8399.
• Citation: 139 F.2d 130
• Parties: CLAY SEWER PIPE ASS'N, Inc., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

139 F.2d 130 (1943)

CLAY SEWER PIPE ASS'N, Inc., v. COMMISSIONER OF INTERNAL REVENUE.

No. 8399.

Circuit Court of Appeals, Third Circuit.

Argued November 5, 1943.

Decided December 6, 1943.

Robert Guinther, of Akron, Ohio (Slabaugh, Seiberling, Guinther & Pflueger, of Akron, on the brief), for petitioner.

Muriel S. Paul, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, A. F. Prescott, and Louise Foster, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before BIGGS, GOODRICH, and McLAUGHLIN, Circuit Judges.

GOODRICH, Circuit Judge.

The taxpayer, Clay Sewer Pipe Association, Inc., came into being at the behest of several manufacturers in the clay sewer pipe industry in order to promote the sales of vitrified clay sewer pipe over sewer pipes made of other materials. Its formation was suggested to the industry by H. C. Maurer in 1938. Mr. Maurer had had considerable experience as sales manager of a clay sewer pipe company. The plan was to have the industry hire a chief engineer and subordinate who would go out into the various states and by personal contact attempt to expand the use of clay sewer pipe and to prepare and distribute technical literature about clay pipe. It was indicated by Maurer that to develop such a program would probably take at least two or three years. The program was to be paid for by having each member pay .4 of 1 percent on the tonnage it sold, or $.24 per ton. Maurer explained that during the first year the receipts would exceed the expenditures and he told one of the manufacturers that the excess money could be put in a special fund and held until they could "judicially expend" it. Maurer signed pre-incorporation contracts with 19 manufacturers which provided for the formation of a corporation, its purposes¹ as planned, mutual inspection of books and for continuation of the contract for yearly periods unless fifteen days notice of discontinuance were given by any manufacturer. Clay Sewer Pipe Association, Inc. was then incorporated under the laws of Ohio as a "corporation for profit". The articles provided that shares of stock were to be issued only to those who subscribed for and agreed to pay for the services to be performed by the corporation and limited each subscriber to one share. If a shareholder ceased to be a subscriber for the services his share certificate was to be cancelled. Upon liquidation or dissolution, or at the time of any other distribution of surplus of assets, each shareholder was to be entitled to participate in the distribution in proportion to the amount previously paid by him to the corporation for its services. The "Code of Regulations" of the Association provided for "dividends or distributions" on this basis. No money was paid for the capital stock of the Association which was carried on the books at the declared nominal value of $1.00.

The Association established an office in Pittsburgh and proceeded to carry out the original plan. During 1939, as originally predicted, the Association did not do much and had comparatively small expenses. Payments were made by the Association members during that year according to plan. At the end of the year such payments exceeded the expenses.² In its income tax return for 1939, on an accrual basis, the taxpayer reported income of $107,648.18, but reported no tax due on account of deductions it had taken. One of the deductions taken was a "Reserve for future expenses" totalling $32,347.23 with a notation "Income deferred for expenditures for performance of contract services. * * * This amount represents the excess of income received and accrued from expenses paid and incurred representing prepayments and advance billings for services to be performed." The Commissioner disallowed this deduction, and his position was sustained by the Tax Court. This appeal followed.

The taxpayer seeks to sustain its deduction on the broad theory that an excess of receipts over expenditures does not constitute income where the excess must be subsequently expended. Here, it says, it received the money from its members as a prepayment for services and was under an obligation to use the money only in the manner provided in the contract made with its subscribers. This premise, as applied to the facts of the case, does not, however, support the legal conclusion urged.

The test determining the taxability of the payments is whether they were received under a claim of right and without restriction as to their disposition. North American Oil Consolidated v. Burnet, 1932, 286 U.S. 417, 424, 52 S.Ct. 613, 76 L.Ed. 1197. The taxpayer does not contend, and with apparent good reason,³ that mere receipt by a taxpayer on an accrual basis, of money as a prepayment for services to be rendered in future years prevents taxation, as income in the year received. Nor does it deny that the money involved here was received under a claim of right, that is, its contracts with its shareholders. But it does urge that restrictions as to the use and disposition of the income takes it outside the rule of the North American Oil case and the comparable decision in Brown v. Helvering, 1934, 291 U.S. 193, 54 S.Ct. 356, 78 L.Ed. 725.

What are the claimed restrictions? (1) It is pointed out that the original contemplation of the parties was that the excess of the receipts over expenditures in the initial years of the Association was to be judiciously expended and put in a special fund.⁴ Yet neither of these points were incorporated into the formal agreement or elsewhere. The Association was not bound to set up a special fund of such excess. And, certainly the condition of judicious expenditure is common to corporate funds generally. (2) The nature of the interest of the shareholders in the corporate funds is emphasized, that distributions, if any, were to be made in proportion to contributions. But the Supreme Court in the North American Oil case clearly stated, earnings which otherwise meet the test as taxable, remain taxable although the recipient claims he is not entitled to retain them and may be adjudged liable to return their equivalent. See also Brown v. Helvering, supra; Commissioner of Internal Revenue v. Alamitos Land Co., 9 Cir., 1940, 112 F.2d 648, certiorari denied 1940, 311 U.S. 679, 61 S.Ct. 46, 85 L.Ed. 437; Commissioner of Internal Revenue v. Brooklyn Union Gas Co., 2 Cir., 1933, 62 F. 2d 505. This result has obtained even where the taxpayer was required to set up a fund to repay the money at a future date. Cleveland R. Co. v. Commissioner of Internal Revenue, 6 Cir., 1929, 36 F.2d 347 certiorari denied 1930, 281 U.S. 743, 50 S. Ct. 348, 74 L.Ed. 1156. Furthermore, the provisions for distributions by way of dividends or upon dissolution to shareholders did not in any way restrict the use of the money for corporate purposes. Neither the equation for distribution nor the provision that shareholders who withdrew from the Association would receive nothing imposed a limitation on corporate use. In fact, under the latter...