Hawaiian Freight Forward v. Commissioner of Int. Rev.

• Decision Date: 19 June 1952
• Docket Number: No. 12965.,12965.
• Citation: 196 F.2d 745
• Parties: HAWAIIAN FREIGHT FORWARDERS, Ltd. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Ninth Circuit

196 F.2d 745 (1952)

HAWAIIAN FREIGHT FORWARDERS, Ltd. v. COMMISSIONER OF INTERNAL REVENUE.

No. 12965.

United States Court of Appeals, Ninth Circuit.

May 7, 1952.

As Amended on Denial of Rehearing June 19, 1952.

Louis Janin, Harold E. Haven and Melvin H. Morgan, all of San Francisco, Cal., for petitioner.

Ellis N. Slack, Acting Asst. Atty. Gen., A. F. Prescott, Melva M. Graney, Irving Axelrad, Sp. Assts. to the Atty, Gen., for respondent.

Before: DENMAN, Chief Judge, and STEPHENS and BONE, Circuit Judges.

DENMAN, Chief Judge.

This is a petition to review a decision of the Tax Court affirming a decision of the Commissioner of Internal Revenue that the petitioner, a Hawaii corporation, had a deficiency in its tax return for its 1943 and 1944 fiscal years. The Tax Court held that the taxpayer must report its 1943 and 1944 excess profits income under the invested capital method of 26 U.S.C. § 714 rather than the income method of § 713 because the taxpayer had not qualified itself for the latter treatment under the relevant portions of 26 U.S.C. § 740 by showing that it or a qualified "component corporation" was in existence during the base period of 1936-40.

The petitioner was organized on March 14, 1940, to acquire the business of a partnership engaged in the freight forwarding business. This business in partnership form had first been organized in 1937 with two active partners, Leffel and Ballentyne, and one inactive partner, Schnack. Their interests were in shares of 33/67 and 24/67 and 10/67, respectively. On March 8, 1940, six days before the corporation was organized, Schnack withdrew from the partnership, taking $8,000 for his capital interest and accumulated profit. Each of the remaining partners had a 50% interest in whatever was left. The certificate of dissolution required to be filed by Hawaiian law was filed on July 2, 1940, stating that the partnership was dissolved on March 14, the day that the corporation was organized. After March 8 when Schnack withdrew, Leffel and Ballentyne carried on the business until March 14 when they each became 50% shareholders in the successor corporation. The transfer of assets to the corporation was not completed until April 1 because much of the freight business was in transit between Honolulu and Chicago.

The Tax Court held that the predecessor partnership, existing from 1937 to March 8, 1940 with three partners, did not qualify as a "component corporation" within the meaning of 26 U.S.C. § 740 (b) (5)¹ and § 740(a) (1) (D).² The petitioner claims that this decision is error because the Tax Court overlooked the fact that this partnership was an entity under the Hawaiian law or the agreement of the parties; and thus, the entity, originally composed of three men, continued unabated after Schnack's withdrawal until the corporation was formed.

On this petition to review, the government takes the position that the predecessor partnership of the taxpayer existed only between March 8, 1940 and March 14, 1940 and that the three-man partnership existing before March 8, 1940 was a different partnership for the purposes of the revenue code. Consequently, the predecessor partnership was not in existence before January 1, 1940. This conclusion is based on the argument that when Schnack withdrew from the three-man partnership, either a new partnership or a proprietorship was formed, with only two men as members. Thus, the taxpayer here is faced with a dilemma: if it argues that the three-man partnership continued unabated until the corporation was formed, the test of identity of interest prescribed in § 740(a) (1) (D) and § 112(b) (5) is not met since after incorporation, Leffel and Ballentyne will have different percentage interests in the business. Or if a new partnership or proprietorship was formed after March 8 and prior to incorporation, then the second partnership from March 8-14 is the "component corporation" rather than the first partnership of three men and the earnings experience of the latter during the base period of 1936-40 cannot be utilized.³

But on the taxpayer's theory, there is no dilemma since it argues that Hawaiian law makes a partnership an entity and that, in any event, the agreement of the parties made this partnership a continuing entity. Thus, it is like a corporation and will continue without any outward change as far as outsiders are concerned despite any changes in the membership. Thus, the date that partnership assets were transferred to the corporation is the only date on which the identity of interest test may be applied and it is met on that date. And if there is a single partnership up until the time of incorporation, there is no problem of a second partnership being an "acquiring corporation" of a first partnership.

The answer to the problem must lie then in the answer to the question whether the taxpayer's theory that Hawaiian law or the agreement of the parties makes this partnership an entity can be applied to this problem of federal taxation. Assuming this statement of the Hawaiian law to be correct, and the agreement of the parties to be as stated, we are of the opinion that they are not controlling on this question for two reasons.

(A) In construing this legislation, we are required to accept that construction which will make this income tax law uniform in its application throughout the states and territories. As was stated by the Supreme Court in Lyeth v. Hoey, 305 U.S. 188, at page 194, 59 S.Ct. 155, at page 158, 83 L.Ed. 119:

"In dealing with the meaning and application of an act of Congress enacted in the exercise of its plenary power under the Constitution to tax income and to grant exemption from that tax, it is the will of Congress which controls, and the expression of its will, in the absence of language evidencing a different purpose should be interpreted `so as to give a uniform application to a nationwide scheme of taxation.\' Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74, 77 L.Ed. 199. Congress establishes its own criteria and the state law may control only when the federal taxing act by express language or necessary implication makes its operation dependent upon state law. Burnet v. Harmel, supra. See Burk-Waggoner Oil Assn. v. Hopkins, 269 U.S. 110, 111, 114, 46 S. Ct. 48, 70 L.Ed. 183; Weiss v. Wiener, 279 U.S. 333, 337, 49 S.Ct. 337, 73 L.Ed. 720; Morrissey v. Commissioner, 296 U.S. 344, 356, 56 S.Ct. 289, 80 L.Ed. 263. Compare Crooks v. Harrelson, 282 U.S. 55, 59, 51 S.Ct. 49, 75 L.Ed. 156; Poe v. Seaborn, 282 U.S. 101, 109, 110, 51 S.Ct. 58, 75 L.Ed. 239; Blair v. Commissioner, 300 U.S. 5, 9, 10, 57 S. Ct. 330, 81 L.Ed. 465."

If we should follow the Hawaiian law here, the result would be different from that obtaining in states which have adopted the Uniform Partnership Act in which the partnership is treated, similarly to common law, as not a juristic entity. Williams v. McGowan, 2 Cir., 152 F.2d 570, 162 A.L.R. 1036.

As to the agreement of the parties, the taxpayer claims that the three original partners made an agreement like that in Ransohoff's Inc. v. C. I. R., 9 T.C. 376, for the partnership to continue no matter what happened to individual partners. The Tax Court found here, however, that when Schnack withdrew there was no intent in the remaining partners to have the partnership continue and this finding is supported by evidence that prior to Schnack's withdrawal, an understanding had been reached between Leffel, Ballentyne and a third party to operate the freight forwarding business.

(B) The application of an entity theory to the partnership in this situation is barred by the statement of Congressional policy in the Revenue Code. It is of underlying significance that Congress in § 740(a) (1) (D) does not deal with the partnership as an entity. That section makes the test of § 112(b) (5) expressly applicable. The "person" transferring property in a taxfree exchange under § 112(b) (5) may be a partnership.⁴ Assuming this to be so, Congress does not spell out in that section whether or not a partnership is to be treated as a juristic entity for that section. The Commissioner has taken the position that...