Commissioner of Int. Rev. v. Obear-Nester Glass Co.

• Citation: 217 F.2d 56
• Decision Date: 15 November 1954
• Docket Number: No. 11140.,11140.
• Parties: COMMISSIONER OF INTERNAL REVENUE v. OBEAR-NESTER GLASS COMPANY.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

217 F.2d 56 (1954)

COMMISSIONER OF INTERNAL REVENUE v. OBEAR-NESTER GLASS COMPANY.

No. 11140.

United States Court of Appeals Seventh Circuit.

November 15, 1954.

H. Brian Holland, Asst. Atty. Gen., Tax Division, Melva M. Graney, Ellis N. Slack, Sp. Assts. to the Atty. Gen., for petitioner.

William R. MacGreevy, Henry C. Lowenhaupt, St. Louis, Mo., for respondent, Lowenhaupt, Mattingly, Chasnoff & Stolar, St. Louis, Mo., of counsel.

Before DUFFY, Chief Judge, MAJOR and SWAIM, Circuit Judges.

SWAIM, Circuit Judge.

The respondent, Obear-Nester Glass Company, a Missouri corporation whose principal place of business is in Illinois, brought suit against the Hartford-Empire Company for treble damages under the federal anti-trust laws. 15 U.S.C.A. § 1 et seq. The Hartford-Empire Company eventually paid petitioner $1,000,000 in full settlement of the claim. The parties agree that one-third of the settlement represents respondent's actual damages but not a recovery of capital, while the remainder represents punitive (treble) damages recoverable under the antitrust laws.

Of this recovery, respondent insists that it should be required to pay income tax on only the one-third received in settlement for actual damages incurred. The Commissioner claimed that the entire $1,000,000 was taxable as income: the amount representing punitive damages as well as that for actual damages. The Tax Court overruled the Commissioner and held that only the amount recovered for actual damages was taxable. Obear-Nester Glass Co. v. Commissioner of Internal Revenue, 20 T.C. 1102. From the Tax Court's decision the petitioner appeals to this court.

There is no dispute over the facts. The only question before us is whether or not punitive damages awarded under the federal anti-trust acts constitute gross income within the definition of that term found in Section 22(a) of the Federal Income Tax Law, 26 U.S.C.A. § 22(a).

Before the Sixteenth Amendment Congress could not levy a direct tax without apportionment among the states. Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429, 15 S.Ct. 673, 39 L.Ed. 759, Id., 158 U.S. 601, 15 S.Ct. 912, 39 L.Ed. 1108. The Amendment allows a tax on "income" without apportionment, but an unapportioned direct tax on anything that is not income would still, under the rule of the Pollock case, be unconstitutional.

Since 1940 the Tax Court has held that punitive damages are not income, while the Commissioner has continued to tax them as such. The Tax Court's position was originally based on Central R. Co. of New Jersey v. Commissioner of Internal Revenue, 3 Cir., 79 F.2d 697, 101 A.L.R. 1448, a case not involving punitive damages. In that case the corporate taxpayer, in a settlement of an action brought to recover profits made by a fiducial employee in transactions by him in a conspiracy to defraud the taxpayer, received more than $450,000. The court held that this recovery was not taxable as income. Its decision was based on the definition of income in Eisner v. Macomber, 252 U.S. 189, 207, 40 S.Ct. 189, 193, 64 L.Ed. 521; that income is "`gain derived from capital, from labor, or from both combined'". The court in the Central Railroad case felt that the recovery there was derived from neither capital nor labor.

In Highland Farms Corporation v. Commissioner of Internal Revenue, 42 B. T.A. 1314, 1322, the Board of Tax Appeals, for the first time, held that punitive damages were not income, giving no reason other than the Central Railroad case. This holding was followed in Glenshaw Glass Co. v. Commissioner of Internal Revenue, 18 T.C. 860, 868, and William Goldman Theatres, Inc., v. Commissioner of Internal Revenue, 19 T.C. 637. These two cases were considered together and affirmed in one opinion, 3 Cir., 211 F.2d 928. On the surface the authorities seem to be unanimous that punitive damages do not constitute income, but while these cases were being decided another doctrine was becoming established.

In Park & Tilford Distillers Corp. v. United States, 107 F.Supp. 941, 123 Ct.Cl. 509, the United States Court of Claims held that "insider profits," awarded under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S. C.A. § 78p(b), were taxable to the recipient corporation as income. The same holding was made in General American Investors Co. v. Commissioner of Internal Revenue, 2 Cir., 211 F.2d 522. Section 16(b) of that Act provides that directors, officers or persons owning ten per centum or more of the stock of a corporation shall turn over to the corporation any profit made on any purchase and sale of stock of said corporation made within a six-month period. Its obvious purpose is to protect "outside" shareholders from "insiders" who could use their superior knowledge of and control over the corporation's future plans to make personal profits by short term dealings in its securities. To effectuate this policy the Act provides that the profits so made shall be turned over to the corporation. The prime purpose of the Act is punitive, to discourage dealings of this type by persons having inside information as to the affairs of the corporation. Clearly the purpose is not compensatory. Damage to the remaining stock is not a prerequisite to recovery.

In William Goldman Theatres, Inc., 19 T.C. at page 641, the court tried to distinguish these cases from the punitive damages cases by saying that "* * the taxpayer did not receive the money in payment of punitive damages, but pursuant to a statute which provided that certain profits realized by corporate insiders under circumstances there present should `inure to and be recoverable by' the corporation." Admittedly the facts are different, but the Tax Court has not pointed to any distinction that would justify a difference in treatment as to taxation of the two types of gain. On appeal the Court of Appeals also tried to distinguish the two doctrines. Commissioner of Internal Revenue v. Glenshaw Glass Co., and Commissioner v. William Goldman Theatres, Inc., 3 Cir., 211 F.2d 928, 932. The court cited the concurring opinion of Judge Murdock in General American Investors Co. v. Commissioner, 19 T.C. 581, 587, which pointed to the language of Section 16(b) saying that "any profit realized" shall be paid to the corporation. Judge Murdock apparently considered "insider profits" taxable, not as windfalls, but as "profits." The respondent, in effect, makes the same argument when he claims that Section 16(b) operates on a trust fiction. The fallacy in this contention was clearly shown in the opinion on the appeal, General American Investors Co. v. Commissioner, 2 Cir., 211 F.2d 522, 524. The court there said:

"Perhaps reluctant to take a position seemingly inconsistent with prior decisions of the Tax Court, which relied heavily upon the Eisner v. Macomber definition and upon Central R. Co. of New Jersey v. Commissioner citation, the concurring judges below took the view that these payments were `profits,\' because Section 16(b) provided that `any profit realized\' under the circumstances here present `shall inure to and be recoverable by the issuer.\' But this reasoning will not bear analysis. These payments were not `profits\' to petitioner, although they represented `profits\' realized by the director and the stockholder."

We agree with the Second Circuit that awards under Section 16(b) do not represent profits to the corporation which receives them.

We are unable to reconcile the taxability of "insider profits" with the non-taxability of punitive damages. We could, of course, point out the factual difference between the two situations, but we are unwilling to rest a decision on words alone when they express no rational distinction for purposes of taxation. As a result, we can only view the problem presented by this appeal as one upon which the authorities are in conflict.

The respondent contends that a tax on punitive damages would be unconstitutional because punitive damages are not income and, thus, not within the Sixteenth Amendment. The first question is: which definition of income is controlling, that of Congress or that of the Supreme Court? Since the judiciary is traditionally charged with the responsibility of interpreting the Constitution, we shall assume, for the purposes of this decision only, that, because the Sixteenth Amendment is limited to income, Congress may not tax directly without apportionment that which the Supreme Court does not so define.

The conflict centers around two different interpretations of the definition of income in Eisner v. Macomber, supra. In Central R. Co. of New Jersey v. Commissioner, 3 Cir., supra, the case upon which the nontaxability of punitive damages is based, the court treated the definition as if the Supreme Court had intended it to be all inclusive. Since the gain involved in that case did not fall within the definition it could not be income and was, therefore, not taxable. In General American Investors Co. v. Commissioner, 2 Cir., supra, the court thought that the Supreme Court did not intend that the definition be all inclusive. The court there admitted that the gain involved did not fall within the Eisner definition but it nevertheless held that it was taxable income.

In Eisner v. Macomber the Supreme Court was faced with the problem of distinguishing between a capital gain and income derived from capital. Having made the distinction the Court wanted to establish which was taxable and which was not. For this purpose it looked to a definition in Webster's International Dictionary, which had already been repeated in two cases, that income was gain derived from capital or labor. The Court was not primarily interested in defining income according to its source, but wanted to show that income attributable to capital must be derived from capital, and, therefore, an increase in capital which could not be separated from it was not income. The borrowed definition served its purpose in separating the gain...