Gutierrez v. Comm'r of Internal Revenue

• Decision Date: 18 December 1969
• Docket Number: Docket No. 5958-66.
• Citation: 53 T.C. 394
• Parties: SILVIO GUTIERREZ, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

53 T.C. 394

SILVIO GUTIERREZ, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5958-66.

Tax Court of the United States.

Filed December 18, 1969.

Herrick K. Lidstone and Carl B. Cordes, for the petitioner.

James Q. Smith and Stanley J. Goldberg, for the respondent.

Petitioner became a resident alien on Mar. 1, 1961, and held this status through Dec. 31, 1961. His foreign personal holding company operated on a fiscal year ended Aug. 31, 1961. Held, that under sec. 551(b), I.R.C. 1954, the portion of the taxable income of the foreign personal holding company allocable to that part of its fiscal year during which petitioner was a nonresident alien is not includable in petitioner's gross income for 1961 as undistributed foreign personal holding company income. Marsman v. Commissioner, 205 F.2d 335 (C.A. 4, 1953), reversing18 T.C. 1 (1952) on this issue, followed. Held, further, that in determining the taxable income of the foreign personal holding company, petitioner has failed to establish that the company was entitled to a deduction for a reasonable addition to a reserve for bad debts.

OPINION

DAWSON, Judge:

Respondent determined a deficiency of $88,146.71 in the income tax of petitioner for the year 1961.

In his reply brief respondent has conceded that accrued bond interest of. $52,751.31 need not be included in the gross income of either petitioner or Gulf Stream Investment Co., Ltd., his foreign personal holding company. Thus, the two issues remaining for decision are: (1) Whether under section 551(b), I.R.C. 1954,¹ petitioner, a resident alien, must include in his gross income the entire amount of Gulf Stream's undistributed foreign personal holding company income for its fiscal year ended August 31, 1961, or only 184/365 of such income, where petitioner did not become a resident of the United States until March 1, 1961; and (2) whether Gulf Stream is entitled to a deduction of $16,007 for alleged bad debts or to a reserve therefor. The determination of these issues will also affect the amount which petitioner may deduct for medical expenses under section 213.

The facts of this case have been fully stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Silvio Gutierrez (herein called petitioner) has been at all times and is now a citizen of Venezuela. He was a resident of Venezuela at the time he filed his petition in this case.

Petitioner filed his Federal income tax return for 1961 with the district director of internal revenue for the Manhattan District of New York. The return was prepared on a cash receipts and disbursements basis for the calendar year.

Prior to March 1, 1961, petitioner was a nonresident alien of the United States. Petitioner became a resident alien of the United States on March 1, 1961.

Gulf Stream Investment Co., Ltd., a Bahamian corporation, was incorporated on September 1, 1951, and derived all of its income from investments during its fiscal year ended August 31, 1961. Petitioner was Gulf Stream's sole stockholder for the entire 1961 fiscal year and through December 31, 1961.

Gulf Stream at all relevant times maintained its books on the accrual method of accounting and on the basis of a fiscal year ending September 1 which for purposes of this case shall be considered a fiscal year ended August 31.

Gulf Stream's profit and loss statement for the fiscal year ended August 31, 1961, contained a figure of $94,045 for loans to five Venezuelan individuals. The statement also creates a reserve of $16,007 for ‘doubtful loans.’ Notes signed by the five persons show that the loans were made on February 1, 1960, and were due on February 1, 1961. No principal or interest was paid on any of these loans through August 31, 1968.

The report of Gulf Stream's auditors dated March 30, 1962, stated that they had not received direct confirmation of the loans from the borrowers. Although the notes provided for extension of the loans, none was ever extended.

In 1961 petitioner paid $639.85 for medicines and drugs and $1,329.90 for other medical and dental expenses for himself and his family.

On his 1961 Federal income tax return petitioner reported Gulf Stream's taxable undistributed income for the year ended August 31, 1961, as $113,645.50. Petitioner now seeks to reduce this amount by $16,007, the amount of the reserve for bad debts which appears on Gulf Stream's income statement. On his return petitioner also included in his income only that ratable portion (184/365) of Gulf Stream's income which was earned after he became a resident alien.

1. Amount of Undistributed Foreign Personal Holding Company Income Includable in Petitioner's Gross Income.— Respondent has included in petitioner's gross income for 1961 all of Gulf Stream's taxable income for its fiscal year ended August 31, 1961. In doing so, respondent has relied on a literal interpretation of section 551(b),² which includes in petitioner's gross income the amount he would have received if Gulf Stream had distributed its 1961 taxable income as a dividend on August 31, 1961.

Petitioner disagrees with respondent's determination on the ground that he was a nonresident alien until March 1, 1961, and that income earned by his foreign personal holding company before that date should not be taxed. He does not question the power to tax such income. He simply argues that Congress did not intend to tax it.

The foreign personal holding company provisions originated in section 201 of the Revenue Act of 1937.³ They were designed as a response to the rapidly growing problem of foreign ‘incorporated pocketbooks.’ Citizens and residents normally subject to the taxing power of the United States were postponing or avoiding taxation through the use of foreign holding companies not directly within the jurisdiction of our tax laws.⁴ Under the new provisions the corporate income was reached by taxing the U.S. shareholders as if the income had been received by them as dividends.

Prior to March 1, 1961, petitioner was a nonresident alien, wholly free of U.S. jurisdiction over citizens and resident aliens. He was not avoiding U.S. taxes; he was not subject to them. He argues that his entry into this country should not bring his previously earned income within the scope of a provision aimed at preventing U.S. citizens and residents from avoiding tax.

Petitioner also argues that section 551(b), at least under certain circumstances, ‘clearly contemplates allocation of a foreign personal holding company's income between the period when a United States group existed and the period during which a United States group did not exist.’ If petitioner had been a resident alien prior to March 1, 1961, and had returned to Venezuela on that date, he would be taxable only on Gulf Stream's income up to that point. Thus petitioner maintains that the fact that his period of residency occurred in the last half of the Gulf Stream's fiscal year, instead of the first half, does not warrant a different result.

Finally, petitioner contends that section 551(b), if literally construed, operates merely as a trap for the unwary. It was within petitioner's power to cause a distribution of Gulf Stream's income from September 30, 1960, to March 1, 1961, before he became a resident alien subject to our jurisdiction. Under those circumstances the income would not have been taxed as undistributed foreign personal holding company income. It is therefore asserted that Congress did not intend to tax only the unwary, particularly if they are aliens unfamiliar with our tax laws.

Section 551(b) taxes undistributed foreign personal holding company income to the citizen or resident who holds the shares on ‘the last day in which a United States group * * * existed.’ He is taxed on all the company income from its fiscal year unless the U.S. group ceased to exist before the end of that year. In taxing the last holder on earnings for the full year, the provision avoids the problem of allocating earnings to various taxpayers when the shares have changed hands. The successive shareholders are able to adjust their transactions to reflect the anticipated tax. Compare section 1373(b) which taxes the last-day shareholder of a subchapter S corporation. Although neither the legislative history of section 551(b) nor that of section 1373(b) contains any discussion of the attributed yearend dividend device, the effect is indicative of a purpose to collect the total tax from one taxpayer rather than from many. Use of the device in otherwise unrelated sections negates the likelihood that it serves some purpose peculiar to foreign personal holding companies. It thus appears that petitioner has indeed been snared in statutory language directed not at newly arrived resident aliens, but rather at a situation where the shares have changed hands.

We find petitioner's arguments appealing, even though this is not an issue of first impression for this Court. In an identical case we chose to follow the equivalent language of section 337(b) of the 1939 Code. Mary A. Marsman, 18 T.C. 1, 6-9 (1952). Our decision was reversed by the Court of Appeals for the Fourth Circuit, which noted that a literal interpretation of section 337(b) would produce the same result if the taxpayer had become a resident alien for only the last day of the year. The Court of Appeals said: ‘We cannot attribute to the Congress of the United States the intent to accomplish such an extraordinary result.’ Marsman v. Commissioner, 205 F.2d 335 (C.A. 4, 1953).

Petitioner contends that by enacting the 1954 Code without changing the relevant language Congress has given its approval to the opinion of the Fourth Circuit. However, we find nothing in the legislative history of the reenactment to indicate that Congress was aware of either Marsman opinion.

Since the Marsman reversal we have persisted in our literal approach to section 337(b), the predecessor of section 551 (b). Se...