Commissioner of Internal Revenue v. Whitney

• Decision Date: 11 August 1948
• Docket Number: Dockets 20877-20889.,No. 233-245,233-245
• Citation: 169 F.2d 562
• Parties: COMMISSIONER OF INTERNAL REVENUE v. WHITNEY and other consolidated cases.
• Court: U.S. Court of Appeals — Second Circuit

169 F.2d 562 (1948)

COMMISSIONER OF INTERNAL REVENUE v. WHITNEY and other consolidated cases.

Nos. 233-245, Dockets 20877-20889.

Circuit Court of Appeals, Second Circuit.

August 11, 1948.

Montgomery B. Angell, of New York City (Lucius A. Buck, of New York City, on the brief), for respondents-petitioners.

Hilbert P. Zarky, Sp. Asst. to Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., and Sewall Key and Lee A. Jackson, Sp. Assts. to Atty. Gen., on the brief), for petitioner-respondent.

Before SWAN, CLARK, and FRANK, Circuit Judges.

CLARK, Circuit Judge.

For many years the partnership of J. P. Morgan & Co. carried on a general banking business in New York City in the firm name, and in Philadelphia under the name of Drexel & Company. In the latter part of 1939 the partners decided that their New York business should be incorporated as a trust company, and arrangements to that end — which involved also the complete separation of the Philadelphia business — were completed in March, 1940. On March 29, the State Superintendent of Banks issued a certificate authorizing J. P. Morgan & Co. Incorporated to transact the business of a trust company in New York City. The following day, Saturday, March 30, a special meeting of the directors of the corporation was held. The directors were the thirteen partners of the firm. At this meeting a resolution was adopted authorizing the corporation to purchase the assets and to assume the liabilities and obligations of the firm as set forth in a Bill of Sale and Agreement presented to the meeting. The Bill of Sale and Agreement was executed by the firm, the thirteen individual partners, and the corporation on that date. By it "the Firm and each of the Partners, respectively," sold and transferred to the new banking corporation all title to the firm "assets, rights and properties," detailed by schedule and of the aggregate agreed value of $597,098,131.87, against the assumption by the corporation of liabilities to depositors and others of $584,832,737.78. The difference of $12,265,394.09 was paid to the firm; then it (less the sum of $55,073.01 contributed to the corporation under circumstances stated below) was deposited to the accounts in the bank of the thirteen firm members in the proportionate amounts of their interests in the partnership. Among other provisions of the Bill of Sale and Agreement was a promise by each of the partners not to engage in any banking or other business in New York City or elsewhere under the name of J. P. Morgan & Co., or any other similar name, except as an officer, director, or employee of the bank. A stockholders' meeting the same day approved the action of the directors and confirmed the execution and acceptance by the bank of the Bill of Sale and Agreement. The partners owned 72.9 per cent of the corporate stock and their relatives owned an additional 5.3 per cent. The bank opened for business on Monday, April 1, while the affairs of the partnership were wound up by the settlement of accounts of March 30, 1940.

In the assets transferred by the firm to the corporation certain securities then showed a gain in value over their cost, while others showed a loss. The amounts of such capital gains and losses are not in dispute; but the treatment of them with respect to the 1940 income taxes of the thirteen firm members is. In computing the net income of each of the thirteen partners, the Commissioner included the capital gains, but disallowed the capital losses on the basis of I.R.C. § 24(b) (1) (B), 26 U.S.C.A.Int.Rev.Code, § 24(b) (1) (B). Judge Leech, however, in a decision reviewed by the full Tax Court without dissent, held that the section did not prohibit deduction of these losses — being "partnership losses" — and therefore directed their allowance. 8 T.C. 1019. The Commissioner's petitions for review in each of the thirteen cases raise therefore the question as to the appropriate construction of this statutory provision.

For consideration of this question it is not necessary to set forth the details of each partner's interest or of other relevant facts, particularly as they are stated in the opinion below.¹ For all the partners the short-term capital losses aggregated $1,598,871.01; and the long-term capital losses, after applying the percentages applicable in 1940 under I.R.C. § 117 (b), 26 U.S.C.A.Int.Rev.Code, § 117(b), amounted to $1,230,368.01. The taxpayers' cross-petitions bring up separate issues concerning the disallowance by the Tax Court of losses claimed upon certain securities in default contributed by the firm to the corporation; we shall postpone discussion of this phase of the appeal until later.

Sec. 24(b) (1) (B) prohibits any deduction, in computing net income, for losses from sales or exchanges of property — except in the case of distributions in liquidation — between an individual and a corporation whose stock is more than 50 per cent owned by or for him.² Our problem is shortly whether this provision includes or excludes partnership holdings. The provision was originally enacted in 1934 as § 24(a) (6) (B); it then included, in addition to the present prohibition, only those between "members of a family." It reached substantially its present form in 1937, § 301, when there were added to the prohibited groups: two personal holding companies with stock ownership of more than 50 per cent in or for the same individual; the grantor and fiduciary of any trust; the fiduciaries of two trusts from the same grantor; the fiduciary and beneficiary of any trust. Among rules for the determination of stock ownership are subds. (B) and (C) of I.R.C. § 24(b) (2), providing that an individual shall be considered as owning "the stock owned, directly or indirectly, by or for his family," and "the stock owned, directly or indirectly, by or for his partner" (the first, B, dating from 1934, and the second, C, from 1937). Further, as is well known, a partnership is not taxable; the individual partners are liable in their individual capacity for both individual income and their respective shares of partnership income computed according to the statutory rules. I.R.C. §§ 181-183, 26 U.S.C.A.Int.Rev.Code, §§ 181-183.

When these detailed statutory provisions are read against the background of the legislative history and the problem as it was presented to the Congress in 1934, we cannot feel that there can be any serious doubt as to the legislative intent or any substantial ground for believing that Congress intended to leave so large a loophole — almost as large as the one it was trying to close — from its prohibition against deductible losses upon transfers between closely related persons or groups. Indeed, the only thing which would give us pause is the unanimous decision of the Tax Court, whose expert view is always entitled to respectful consideration.³ We cannot avoid believing that it has become entangled in the jurisprudential aspects of so-called legal "entities" to such an extent as to cause it to overlook the real meaning and purpose of these enactments. In fact they had not then been so authoritatively explained as is now the situation since the more recent decision of the Supreme Court in McWilliams v. C.I.R., 331 U.S. 694, 67 S.Ct. 1477, 91 L.Ed. 1750, 170 A.L.R. 341, which we cite below. The circumstances under which a jural aggregate — admittedly the status of a partnership under the federal revenue laws and the Uniform Partnership Act — may become a jural entity are fascinating in their possibilities for semantic dispute. But this should not be allowed to go so far as to draw all teeth from a statute carefully directed at what the legislative body viewed as the evil of "tax evasion." We may come back to this jurisprudential debate to discuss briefly some of the suggestions urged upon us; but first and most important must be a consideration of the statute itself against its background.

The statute was passed as a part of the dramatic investigations of and legislative attack upon "tax evasion" which developed as a concomitant of the great loss in security values from 1929 on to the date of the legislation. The volume of realized losses in such investments and the question of realization itself provoked legislative attention. For the investigation in which this very firm prominently appeared had brought out that it was possible for taxpayers to go through the form of realization of a loss by a transfer where the economic attributes of ownership were retained. This we pointed out in dealing with the special restrictions made by this same general legislation upon the offset of partnership capital losses against individual capital gains in reversing the deductions allowed in 3 T.C. 1217 to a partner of this firm. Commissioner of Internal Revenue v. Lamont, 2 Cir., 156 F.2d 800, certiorari denied 329 U.S. 782, 67 S.Ct. 203, 91 L.Ed. 671. Whether or not the Congress went further than a fair adjustment of equities would require whether in truth it may be "shocking to the sense of justice," as the taxpayers assert, that capital gains be taxed and losses disallowed, is not for us to say. At least, however, the legislative approach is understandable against this background. But it would hardly be understandable were we to consider the purpose to be to permit just that form of realization of a loss condemned in an individual whenever it was done through the simply added legal device of the partnership, and particularly when this would leave untouched the more spectacular cases which the investigation of the Senate Committee on Banking and Currency had brought to public attention. Commissioner of Internal Revenue v. Lamont, supra, 156 F.2d at page 803.

The only reason for such a differentiation suggested by the Tax Court or by the taxpayers is the difficulty "of determining the bona fides" of transactions showing large tax losses between members of families and between individuals and the corporations they controlled. No reason is...