In re Miller's Auto Supplies, Inc.

• Decision Date: 13 July 1987
• Docket Number: Adv. No. 86-0148S.,Bankruptcy No. 84-02233K
• Parties: In re MILLER'S AUTO SUPPLIES, INC. Debtor. Max SCHWARTZ, Trustee, Plaintiff, v. COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF REVENUE, Defendant.
• Court: United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Eastern District of Pennsylvania

75 B.R. 676 (1987)

In re MILLER'S AUTO SUPPLIES, INC. Debtor Max SCHWARTZ, Trustee, Plaintiff, v. COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF REVENUE, Defendant.

Bankruptcy No. 84-02233K, Adv. No. 86-0148S.

United States Bankruptcy Court, E.D. Pennsylvania.

July 13, 1987.

David Fishbone, Philadelphia, Pa., for plaintiff/trustee.

Prince Atlee Thomas, Deputy Atty. Gen., Com. of Pa., Philadelphia, Pa., for defendant.

OPINION

DAVID A. SCHOLL, Bankruptcy Judge.

The matter before the Court is an adversarial proceeding in which the Trustee for the Debtor, Miller's Auto Supplies, Inc., seeks to avoid certain payments made to the Commonwealth of Pennsylvania, Department of Revenue (hereinafter referred to as "the Commonwealth") by the Debtor as preferential transfers pursuant to 11 U.S.C. § 547. The precise issue we must decide is whether monies collected for retail sales taxes and employer withholding taxes by the Debtor pursuant to state statutes requiring same is the equivalent of a trust, where there is no evidence as to whether the monies had been segregated from the general funds of the Debtor. If a trust has been properly established, the funds are not property of the Debtor's estate and, thus, payment of these funds would not be subject to avoidance as preferential transfers.

We find that the Commonwealth failed to show that the monies paid to it had been segregated; and, since we hold such segregation or tracing of funds is necessary to demonstrate the establishment of a trust, we find that the payments in question are property of the estate and, as such, were the subject of, avoidable preferences pursuant to § 547.

We are presenting our Opinion in narrative form because the parties have submitted this matter for resolution on a designated record consisting of a Stipulation of Facts filed on April 28, 1987. Consequently, we need make no factual findings and we will make reference to only such stipulated facts as are necessary to explicate our decision. Pursuant to our Order of April 29, 1987, the parties were accorded the opportunity to file briefs, the Trustee on or before May 15, 1987, and the Commonwealth on or before June 5, 1987, and we considered these in making our decision.

The Debtor filed a Voluntary Petition under Chapter 11 of the Bankruptcy Code on July 10, 1984. The case was converted to a Chapter 7 case on March 26, 1985, at which time Max Schwartz was appointed Trustee for the Debtor.

On February 2, 1984, the President of the Debtor Corporation signed a "Deferred Payment Agreement" with the Commonwealth, agreeing to make monthly payments on account of past-due retail sales taxes and employer withholding taxes. Pursuant to this Agreement, the Commonwealth received three payments from the Debtor totalling $118,205.29, all of which were received after April 13, 1984. April 11, 1984, represents the ninetieth (90th) day prior to the filing of the Chapter 11 petition. In addition to the foregoing, the parties have stipulated to facts which would make out all of the requirements of § 547(b)¹ except that the parties disagree as to whether the payments were property of the estate such that § 547 would be applicable to these transfers.

The Commonwealth contends that the payments received were trust funds established pursuant to state law which had been collected and held by the Debtor on behalf of the state. The pertinent statutory provisions upon which the Commonwealth relies are as follows:

72 P.S. § 7225 (Pennsylvania Sales Taxes) —

All taxes collected by any person from purchasers in accordance with this article and all taxes collected by any person from purchasers under color of this article which have not been properly refunded by such person to the purchaser shall constitute a trust fund for the Commonwealth and such trust shall be enforceable against such person, his representatives and any person (other than a purchaser to whom a refund has been made properly) receiving any part of such fund without consideration, or knowing that the taxpayer is committing a breath of trust;. . . .

72 P.S. § 7320 (Pennsylvania Personal Income Tax)—

Every employer required to deduct any withholding tax under this article is hereby made liable for such tax. For purposes of assessment and collection, any amount required to be withheld and paid over to the department and any additions to tax penalties and interest with respect thereto, shall be considered the tax of the employer. All taxes deducted and withheld from employees pursuant to this article or under color of this article shall constitute a trust fund for the Commonwealth and shall be enforceable against such employer, his representative or any other person receiving any part of such fund.

61 PA.CODE § 34.2(d) (applies to Pennsylvania Sales Taxes)

Accounting for an handling tax collections. All taxes collected by a vendor from purchasers . . . shall constitute a trust fund for the Commonwealth. Since the vendor is a trustee with respect to the taxes he has collected, the keeping of records which clearly reflect his performance of his responsibilities is basic to this fiduciary relationship. The act, in recognition of this, requires that a vendor shall remit the amount of tax due or the amount actually collected, whichever is greater.

(1) Physical segregation of tax where collections are not shown on sales memoranda or cash register tapes.

The act provides that a vendor must adopt some method of segregating tax from sales receipts and record such in accordance with proper accounting and business practices . . .

(i) If a vendor keeps full-time memoranda of sales showing the amount of tax due and the amount charged to the purchaser . . ., he shall not be required to physically segregate his tax collection from sales receipts or create other records of tax collections of individual sales.

(ii) If a vendor uses a register which lists each tax collection on a tape retained by the vendor, or if he makes such a list or record manually and retains it for departmental audit, he shall not be required to physically segregate his tax collections. . . . The fact that tax collections are not physically segregated from sales receipts shall not be deemed a waiver of the Department\'s procedural rights to enforce the trust which exists with respect to tax collections.

The Commonwealth further asserts that since state law does not require the segregation of funds, 61 PA.CODE § 34(d)(1)(ii), to establish a trust, and since the Trustee adduced no facts to support its contention that payments were made from the ordinary accounts of the Debtor and were not trust funds, the Commonwealth should prevail.

The Trustee counters with the argument that a trust is not established without segregation of funds, and that it was the Commonwealth who failed to carry its burden with respect to the tracing of funds. Both parties cite to an earlier decision of this Court, In re American International Airways, Inc., 70 B.R. 102 (Bankr.E.D.Pa. 1987) (hereinafter referred to as "AIA"), in which we held that where a debtor has segregated funds and established a trust for the United States for the payment of federal excise and withholding taxes pursuant to 26 U.S.C. § 7512(b), payment of such funds to the United States is not an avoidable preferential transfer. However, we also thusly indicated therein that, where funds had not been segregated, an avoidable preference occurs:

To successfully make a claim to specific funds which would otherwise be distributed to all creditors, a creditor is obliged to make a strong showing of not only the creation of a trust, but also the tracing of the specific funds against which a trust is allegedly imposed in the possession of the debtor and/or a trustee. In this way, the imposition of special priorities and secret liens which are anathema to the principle of equal distribution in a bankruptcy proceeding will be kept to a minimum. Id. at 105.

We are now confronted with the very issue which was previewed in AIA. We hold that the burden is upon the creditor to trace the funds against which a trust is being asserted and, if it fails to do so, no claim to specific funds will be permitted.

The majority of the cases which have considered the issue of whether a trust fund has been established for the purpose of determining avoidable preferences in bankruptcy cases have arisen under 26 U.S.C. § 7501(a) and concerned federal taxes (hereinafter referred to as "§ 7501 trusts").²

The seminal case concerning enforcement of a § 7501 trust against a Debtor is United States v. Randall, 401 U.S. 513, 91 S.Ct. 991, 28 L.Ed.2d 273 (1971). Randall interpreted the Bankruptcy Act, which the Code was enacted to supersede in 1978. In Randall, the debtor-in-possession was ordered to maintain a separate bank account for payroll taxes pursuant to 26 U.S.C. § 7501(a). The debtor withheld taxes from the wages of its employees, but did not deposit the taxes in a segregated account as it was required to do. After the estate was liquidated, the Internal Revenue Service (hereinafter referred to as "IRS") argued that the withheld taxes were not property of the estate but rather were subject to a § 7501 trust. The Supreme Court held that enforcement of such a trust would defeat the express priorities of the Bankruptcy Act. 401 U.S. at 518. After an analysis of the Act, the Court concluded that the legislative development of bankruptcy laws "(1) marks a decline in the grant of a tax preference to the United States and (2) marks an ascending priority for costs and expenses of administration." Id. at 517, 91 S.Ct. at 994. The Court further stated that "the statutory policy of subordinating taxes to costs and expenses of administration would not be served by creating or enforcing trusts which eat up an estate, leaving little or nothing for creditors and court officers whose goods and services created the assets." Id. at 518, 91 S.Ct. at 995. We are bound by, and fully agree...