Hall v. CIR

• Citation: 294 F.2d 82
• Decision Date: 19 July 1961
• Docket Number: No. 18247.,18247.
• Parties: Jesse E. HALL, Sr., and Rhoda O. Hall, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

294 F.2d 82 (1961)

Jesse E. HALL, Sr., and Rhoda O. Hall, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 18247.

United States Court of Appeals Fifth Circuit.

July 19, 1961.

Donald P. Moyers, John H. Conway, Jr., Tulsa, Okl., Martin, Logan, Moyers, Martin & Hull, Tulsa, Okl., of counsel, for petitioners.

Charles K. Rice, Asst. Atty. Gen., Hart H. Spiegel, Chief Counsel, Rollin H. Transue, Atty., I. R. S., Washington, D. C., Lee A. Jackson and Arthur I. Gould, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before RIVES, BROWN and WISDOM, Circuit Judges.

RIVES, Circuit Judge.

The facts in this tax deficiency case are fully and carefully stated in the opinion of the Tax Court reported at 32 T. C. 390, and may be here summarized with extreme brevity. Prior to 1947 petitioner Hall was engaged, in a small way, in manufacturing equipment he had designed for the cementing of oil wells. In March of 1947 the Gulf Oil Company, convinced of the merit of petitioner's products, placed an order with him for over $500,000 worth of equipment to be delivered in Venezuela. At that time petitioner was doing business as a sole proprietorship — Weatherford Company of Weatherford, Texas. Enormous profits were to be anticipated by the Weatherford Company from the sale of petitioner's equipment to Gulf, and from the future sales which would doubtless follow successful utilization of petitioner's devices by Gulf. For example, an item which cost $1.75 to produce sold for $28.60, another costing $2.65 sold for $55. On July 8, 1947 there came into being the Weatherford Spring Company of Venezuela, C.A. (hereinafter called the Spring Company). On July 14, 1947 the Weatherford Company contracted for the Spring Company to act as Weatherford's sole representative and distributor for all foreign countries, including Venezuela, and to sell to the Spring Company all articles manufactured by the Weatherford Company at "cost plus ten per cent." By this device the enormous profits which would have been realized by the Weatherford Company on its foreign sales were shifted almost totally to the Venezuelan corporation.

The Commissioner has determined, and the Tax Court agreed, that it is necessary to allocate the income of the Spring Company for the years 1947 and 1948 to petitioner Hall "in order to prevent evasion of taxes or clearly to reflect his income." Section 45, I.R.C.1939, 26 U. S.C.A. § 45. The statute provides that income may be reallocated "in any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests * * *."

According to the Commissioner, petitioner Hall both "owned" and "controlled" the Spring Company within the meaning of the statute. On the question of ownership the Commissioner showed the following. From July 1947 to February 1948, of the 250 shares in the Spring Company, 248 were recorded in the name of the petitioner Hall, 1 share in the name of his son Elmer, and 1 share in the name of James E. Berry.¹ From February 1948 to August 1948, the record stock ownership was the same, except that one of petitioner Hall's shares was transferred to Juan A. Perea. From August 1948 onward, no shares were recorded in the name of petitioner Hall, 248 recorded in the name of Elmer Hall, and 1 each in the names of James E. Berry and Juan A. Perea. Petitioner Hall supplied all of the investment capital for the Spring Company ($8,000). Sales proceeds of the Spring Company were received by petitioner in Weatherford, Texas, where he had virtually free and unlimited use of the funds. Checks drawn on the Spring Company account in Weatherford, Texas, had to be countersigned by the petitioner. Hall carried the cash account of the Spring Company on his own books as an asset. The Spring Company maintained an office in petitioner's building in Weatherford, Texas. The employee of the Spring Company situated there received her general instructions from petitioner and, in fact, the petitioner on occasion told her what price to charge the ultimate purchasers on equipment that the Spring Company bought from Weatherford for sale to foreign customers.

In his attempt to counteract the effect of this overwhelming body of evidence, petitioner takes the position that the Spring Company was in fact owned 50% by his son Elmer and 50% by James E. Berry.² The only evidence of this purported agreement is the oral testimony of the parties themselves. There was no writing to corroborate the existence of such an agreement. The Tax Court noted that, "We do not doubt that Berry had some interest in Spring Co. in addition to a straight salary arrangement but on the record here we have been unable to find that Berry owned one-half of the Spring Co. stock." This amounted to finding that the evidence was not sufficient to show that Berry owned a substantial interest in Spring Company, and it is an understatement to say that such a finding is not clearly erroneous. In the face of the Government's mountain of evidence of the ownership of Spring Company by petitioner, plus the presumption of correctness which accompanies determinations of the Commissioner,³ the burden was clearly on the petitioner to come forward with some explanation if he was to avoid a reallocation under Section 45. Petitioner chose to sustain his burden by oral testimony of the parties that Berry was a 50% owner of the Spring Company. This claim was rejected and its rejection was a pure credibility determination. His chosen defense having failed, the petitioner cannot now complain that the Tax Court should have found that, even if Berry's interest in Spring Company was not 50%, it was substantial enough to avoid petitioner Hall's being properly termed the "owner" of Spring Company within the meaning of Section 45. Where in the record is there evidence on which the Tax Court could have found that Berry's interest was "substantial"? Petitioner's position was 50%. The only evidence of this was the purported oral agreement. The Tax Court found that no such agreement existed. The record is barren of any other evidence that Berry had a "substantial" interest in the Spring Company.⁴

Questions of ownership aside, we think that the finding that petitioner Hall was in "control" of the Spring Company during the tax years in question cannot be set aside as clearly erroneous. In addition to the evidence summarized above, which goes both to ownership and to control, the Commissioner is here supported by Section 29.45-1 of Regulation 111, which provides in part: "A presumption of control arises if income or deductions have been arbitrarily shifted." In this case most of the income which would have been realized by Hall as sole proprietor of the Weatherford Company was shifted to Spring Company. As evidence of "arbitrariness," the Government points to the fact that Hall had theretofore paid a 20% commission to an unrelated third party for both selling and servicing. The "cost plus 10%" agreement with Spring Company granted to that company a commission for sales and servicing in excess of 90%. Petitioner accounts for this fantastic commission being paid to the Spring Company by again referring to James E. Berry. Hall argues that Berry's services were so essential to the continuation of the business that it was necessary to give Spring Company a 90% commission on sales and to give Berry a 50% interest in the Spring Company in order to induce Berry to ally himself with Hall. This argument, farfetched on its face, borders on the incredible when one considers that the record is devoid of any evidence that Berry was in any way uniquely qualified to service Hall's equipment.⁵

As for the services which Spring Company was to render Weatherford Company in return for the 90% commission, it appears that Spring Company did not have selling or servicing facilities in any foreign country other than Venezuela. Moreover, it appears that when servicing was needed on equipment in use in Kuwait, Hall sent his son George, an employee of Weatherford Company, to service the equipment, even though Spring Company purported to be the exclusive servicing agent for all the equipment sold in foreign countries. In view of this evidence, we cannot find that the Tax Court was clearly erroneous when it held that income was arbitrarily shifted from Weatherford Company to Spring Company.⁶

We conclude that the finding that Hall was the owner or in control of Spring Company was not so clearly erroneous as to require reversal by this Court.

There is also at issue in this case the deductibility of a sum of $316,784.38 by Weatherford Company as an ordinary and necessary business expense. When the Spring Company was set up, it was agreed that all sales made subsequent to August 7, 1947 would be credited to its account. As of that date considerable equipment had already been shipped to Venezuela, but had not yet been installed. As to this equipment, Spring Company agreed to assume the responsibility for servicing it. The charge for the servicing of this equipment was $316,784.38. This figure was arrived at by taking the cost of this undelivered equipment, adding 10% of the cost figure to it, and deducting this cost plus 10% figure from the total sales price. Thus, the "servicing" fee, in effect, transferred to Spring Company the profit Spring Company would have made had it originally sold the undelivered equipment.

The Commissioner's determination of nondeductibility is presumptively correct and cannot be overcome without positive evidence that the amount claimed to be deductible is reasonable. Commissioner of Internal Revenue v. Smith, 5 Cir., 1960, 285 F.2d 91. Under the Cohan rule, Cohan v. Commissioner, 2 Cir., 1930, 39 F.2d 540, the Commissioner allowed a deduction of $22,500. We sustain the decision of the Commissioner and the Tax Court on...