Citation206 F. Supp. 330
Decision Date12 June 1962
Docket NumberNo. 331-61.,331-61.
CourtU.S. District Court — Southern District of California

206 F. Supp. 330

UNITED STATES of America, Defendant.

No. 331-61.

United States District Court S. D. California, Central Division.

June 12, 1962.

206 F. Supp. 331

Butterworth & Smith, Edward L. Butterworth, Los Angeles, Cal., Dempsey, Thayer, Deibert & Kumler, Albert L. Burford, Jr., Los Angeles, Cal., for plaintiff.

206 F. Supp. 332

Francis C. Whelan, U. S. Atty., Lillian W. Wyshak, Asst. U. S. Atty., Los Angeles, Cal., for defendant.

MATHES, District Judge.

Plaintiff company brings this action, pursuant to 28 U.S.C. § 1346(a) (1) and § 7422(a) of the Internal Revenue Code of 1954 26 U.S.C. § 7422(a), for a refund with interest of Federal income taxes paid for the period July 1, 1956, through December 31, 1957, claiming that membership fees received by plaintiff during that period were improperly taxed as "income" by the Commissioner of Internal Revenue.

The evidence adduced at trial reveals no substantial controversy as to the material facts, which may briefly be stated as follows. Plaintiff, known generally as "Fedco", was incorporated under the laws of California as a nonprofit corporation see Cal.Corp.Code § 9200 in August of 1949 and, during the period in question, was engaged in the sale of consumer goods at discounted retail prices to its members and their guests at five store and warehouse locations in Southern California. Membership was limited chiefly to government employees.

In return for a fee of two dollars, each qualified applicant received a non-assessable and non-transferable life-membership certificate entitling him, inter alia, to enter plaintiff's premises and make purchases at a "discount". No further or periodic payments were called for, since membership for life was acquired by payment of the initial two-dollar fee, subject, however, to revocation "for any cause deemed sufficient" by a two-thirds vote of the Board of Directors.

Regular members, comprising the bulk of the membership, were entitled under plaintiff's by-laws to vote for the election of directors, "all of whom shall be life members of the organization". Each member was also entitled to receive a pro rata share of all corporate assets remaining at the time of liquidation or dissolution. Upon the death of a member, the membership fees were refundable at the option of the estate of the deceased; and, unless refunded, the decedent's spouse would succeed to all privileges of membership, excepting only "the right to vote or hold office or serve on the Board of Directors of this Corporation".

As ground for the refund claimed, plaintiff contends that the membership fees in question constituted a "contribution to the capital" of the corporation within the meaning of § 118 of the Internal Revenue Code of 1954 26 U.S.C. § 118, or were received "in exchange for stock" pursuant to § 1032(a) of the Internal Revenue Code of 1954 26 U.S. C. § 1032(a); and that, in either case, such fees were exempted from inclusion in plaintiff's gross income. Plaintiff further urges that the membership fees cannot, in any event, be deemed income under the Federal Constitution, since the capital nature of the transactions precludes treating them as "income" within the scope of the Sixteenth Amendment; and so any Federal tax upon these fees would be subject to the further Constitutional requirement that direct taxes must be "apportioned among the several States" U.S.Const. art. I, § 2, cl. 3, and "in Proportion to the Census" U.S.Const. art. I, § 9, cl. 4.

In reply, defendant insists that the membership fees must be declared as "income", since they constituted nothing more in substance than payment for services to be rendered. See Int.Rev. Code of 1954, § 61(a) (1), 26 U.S.C. § 61(a) (1). In the alternative, defendant further contends that, should such fees not be characterized as "income", then the Government would, in all events, be entitled to recoupment pursuant to § 362(c) (2) of the Internal Revenue Code of 1954 26 U.S.C. § 362(c) (2), resulting from a corresponding basis-reduction of depreciable property, namely, "furniture, fixtures, equipment, and leasehold improvements" acquired by plaintiff with the proceeds of the fees.

The term "gross income" has been defined as "all income from whatever source derived". Int.Rev.Code of 1954, § 61(a), 26 U.S.C. § 61(a). "And the Supreme Court has given a liberal

206 F. Supp. 333
construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted." Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 99 L.Ed. 483 (1955)

One such exemption is found in § 118 (a) of the Internal Revenue Code of 1954, which provides that "In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer". This provision, without counterpart in any prior Code, was enacted to codify then-existing law as to contributions made by groups or individuals without proprietary interest in a corporation, since in many cases such contributions could neither be deemed gifts nor payments for services, and therefore should not be taxable as income. See: H.R.Rep.No.1337, 83rd Cong., 2d Sess. at p. a38 (1954); S.Rep. No. 1622, 83rd Cong., 2d Sess. at pp. 18-19 (1954); U.S.Code Cong. and Admin. News 1954, pp. 4042, 4648. Indeed, Treasury Regulation § 1.118-1 26 C.F. R. § 1.118-1 declares that "the exclusion § 118 does not apply to any money or property transferred to the corporation in consideration for goods or services rendered * * *".

Thus, the question of whether a payment to a corporation constitutes a "contribution to the capital of the taxpayer", within the meaning of § 118, is held to turn not only upon what is given or gained in return for the payment, but also upon the motive or purpose and intent of the person making the payment. See: Brown Shoe Co. v. Commissioner, 339 U.S. 583, 591, 70 S.Ct. 820, 94 L.Ed. 1081 (1950); Detroit Edison Co. v. Commissioner, 319 U.S. 98, 102-103, 63 S.Ct. 902, 87 L.Ed. 1286 (1943); cf. Edwards v. Cuba Railroad, 268 U.S. 628, 632-633, 45 S.Ct. 614, 69 L.Ed. 1124 (1925). And these criteria have been applied even in cases where the "contribution" of a fixed amount has been found to be at least part-payment for services. See: Teleservice Co. of Wyo. Val. v. Commissioner, 254 F.2d 105 (3rd Cir.), cert. denied, 357 U.S. 919, 78 S.Ct. 1360, 2 L.Ed.2d 1364 (1958); Denver & Rio Grande Western Railroad Co., 32 T.C. 43, 45-46 (1959), aff'd, 279 F.2d 368 (10th Cir.1960); Warren Television Corp., 17 CCH Tax Ct.Mem. 1053 (1958); cf. United Grocers, Ltd. v. United States, 186 F.Supp. 724 (N.D.Cal.1960).

Here plaintiff concedes that the dominant purpose of applicants for membership in "Fedco" has been to "buy merchandise at pretty good prices"; and it is plain that payment of the membership fees in return for this privilege constituted primarily payment for a direct benefit and service to the members and, as such, was not exempt from taxation as a "contribution to * * * capital" under § 118. Cf.: Brown Shoe Co. v. Commissioner, supra, 339 U.S. at 591, 70 S.Ct. at 94 L.Ed. 1081; Community T.V. Ass'n v. United States, 203 F.Supp. 270, 272-274 (D.Mont.1962).

On the other hand, it is equally clear that any gain to plaintiff from receipt of membership fees is not taxable as income, if received "in exchange for stock" of the corporation within the meaning of § 1032(a). The inquiry turns, then, to whether plaintiff's membership certificates, issued in return for the membership fees, evidence "stock" as the term is employed in § 1032.

In this connection, it is first to be noted that plaintiff's memberships were deemed by the California Commissioner of Corporations to be securities under the State Corporate Securities Law see Cal. Corp.Code § 25008; and, subsequent to incorporation, plaintiff applied for and received an official permit from the State Commissioner to issue the membership certificates involved herein see Cal. Corp. Code §§ 25500-25515. But it is to be borne in mind, nonetheless, that "The definition of words used in federal tax statutes is governed by federal law" Cunha's Estate v. Commissioner, 279 F.2d 292, 296, (9th Cir.1960), cert. denied, 364 U.S. 942, 81 S.Ct. 460, 5 L.Ed. 2d 373 (1961); for:

"It is the will of Congress which controls, and the expression of its
206 F. Supp. 334
will in legislation, in the absence of language evidencing a different purpose, is to be interpreted so as to give a uniform application to a nationwide scheme of taxation. * * * State law may control only when the federal taxing act, by express language or necessary implication, makes its own operation dependent upon state law". Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74, 77 L. Ed. 199 (1932); see Lyeth v. Hoey, 305 U.S. 188, 193-194, 59 S.Ct. 155, 83 L.Ed. 119 (1938).

Inasmuch as no definitive Federal statutory language exists in the present instance, and no compelling Federal statutory implication can be found, which directs application of State law in defining the word "stock", neither the findings of the State Commissioner, nor the pronouncements of Cal.Corp.Code §§ 103 and 115, that "shareholder" and "shares of stock" include membership in nonstock corporations, can be controlling here. Accordingly, it is the duty of this Court to apply Federal law and give the term "stock" its "ordinary meaning", consistent with the policy and purpose of § 1032. Cf. Little's Estate v. Commissioner, 274 F.2d 718, 727 (9th Cir.1960); see United West Coast Theatres Corp. v. South Side Theatres, 86 F.Supp. 109, 112 (S.D.Cal.1949).

Ownership of shares — "stock" — in a corporation has been characterized as "an individual interest giving the stockholder a right to a proportional part of the dividends and the effects of the corporation when dissolved, after payment of its debts". First National Bank of Boston v. Maine, 284 U.S. 312, 329-330, 52...

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