In re Owl Drug Co.

Decision Date08 September 1937
Docket NumberNo. 480.,480.
Citation21 F. Supp. 907
PartiesIn re OWL DRUG CO.
CourtU.S. District Court — District of Nevada

E. P. Carville, U. S. Atty., of Reno, Nev.

Thatcher & Woodburn, of Reno, Nev., and Clarence A. Shuey and Grant H. Wren, both of San Francisco, Cal., for trustee, George K. Edler.

YANKWICH, District Judge.

The Owl Drug Company, a Nevada corporation, was adjudicated a bankrupt, upon a voluntary petition, on October 10, 1932. On November 2, 1932, George K. Edler was appointed trustee, qualifying on November 28, 1932. He is still so acting. The bankrupt, prior to bankruptcy, operated a chain of retail drug stores in the States of California, Washington, Oregon, Nevada, and Utah. The business of these stores was taken over by the trustee, who conducted them for a time. Under a court order, the trustee sold the business and all its assets, as a going concern, before 1935. The moneys realized from the sale were deposited in various banking institutions, to abide the determination of the validity of the claims filed in the estate. For the year 1935, the moneys earned $9,911.91 as interest. On March 16, 1936, the trustee filed an income tax return with the Collector of Internal Revenue at Reno, Nevada. The sum of $9,911.91 was shown as income, and deductions of $5,262.12 were claimed for administrative expenses during the year and expenditures for printing and stationery, and California sales tax on printing kodak films — both incurred while the trustee was conducting the business of the bankrupt. The trustee paid a tax of $639.35. Contending that the deductions were improper, the Government claims an additional tax of $723.54.

Two questions are up for determination: (1) Was interest on the money received from the sale taxable income? And (2) were the deductions proper?

The problem involved in the taxability of the interest depends for its solution upon the interpretation to be placed upon sections 22 and 52 of the Revenue Act of 1934 (48 Stat. 680, ch. 277 26 U.S.C.A. §§ 22, 52). Section 22 reads:

"§ 22. Gross income.

"(a) General definition. `Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever."

In defining the word "income" in tax statutes enacted under the Sixteenth Amendment to the Constitution, the criterion adopted by the courts has been "the commonly understood meaning of the term." Merchants' Loan & Trust Co. v. Smietanka (1921) 255 U.S. 509, 519, 41 S. Ct. 386, 388, 65 L.Ed. 751, 15 A.L.R. 1305. This has been called the "man on the street" concept of what income is. Paul & Mertens, Law of Federal Income Taxation, 5.02-5.03. "Income" is all "gain derived from capital, from labor, or from both." Stratton's Independence v. Howbert (1913) 231 U.S. 399, 415, 34 S.Ct. 136, 140, 58 L.Ed. 285. In Eisner v. Macomber (1920) 252 U.S. 189, 207, 40 S.Ct. 189, 193, 64 L.Ed. 521, 9 A.L.R. 1570, the court amplified this definition:

"Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word `gain', which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. `Derived — from — capital'; `the gain — derived — from — capital,' etc. Here we have the essential matter: not again accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being `derived' — that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal — that is income derived from property. Nothing else answers the description.

"The same fundamental conception is clearly set forth in the Sixteenth Amendment`incomes, from whatever source derived' — the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution." (Italics added.)

And see United States v. Phellis (1921) 257 U.S. 156, 169, 42 S.Ct. 63, 65, 66 L.Ed. 180.

Interest on money is the fruit of capital — the price paid for its use. It is, therefore, gain derived from capital. Consequently it is income. Income may result from hiring out money as from hiring out persons or things.1

Interest has always been treated as income under the practice of the Internal Revenue Department. The official forms for returns provide places where "interest received" is to be reported as income and "interest paid" be claimed as a deduction.

This much is obvious.

However, section 52 of the Revenue Act of 1934 (26 U.S.C.A. § 52) provided, in part: "Every corporation subject to taxation under this title chapter shall make a return. * * * In cases where receivers, trustees in bankruptcy, or assignees are operating the property or business of corporations, such receivers, trustees, or assignees shall make returns for such corporations in the same manner and form as corporations are required to make returns. Any tax due on the basis of such returns made by receivers, trustees, or assignees shall be collected in the same manner as if collected from the corporations of whose business or property they have custody and control." (Italics added.) Thus, while every corporation subject to taxation must make a return, the return is required of receivers, trustees in bankruptcy, and assignees of corporations, only when they are operating the property or business of the corporation. The effect of an enactment of this character is stated in Paul & Mertens, op.cit., § 39.29: "Receivers, trustees in bankruptcy, and assignees operating the property or business of corporations are required to file returns in the same manner and form as corporations are required to make returns. Whether or not there is such operation is determined by the facts in the particular case. The statute and regulations make a distinction between receivers operating all the property or business of an individual or corporation, and receivers in possession of only part of such property or business. The former type of receiver is required to file a return, the latter is not." And thus the Board of Tax Appeals: "The effect of this section is that receivers, trustees in bankruptcy or assignees who are operating the property or business of corporations `shall make returns for such corporations.'" Trustees of Gonzolus Creek Oil Co. (Dissolved), 12 B.T.A. 310, 322.

The return is obligatory when the trustee continues the bankrupt's business. "Where receivers or trustees continue the business of a bankrupt any income thus earned is taxable under the various federal income tax laws. But where they merely marshal and distribute the assets of the insolvent, there is no income, and hence no income tax is payable." 6 Remington on Bankruptcy (1923) § 2978 (Italics added.) And see Gilbert's Collier on Bankruptcy 4th Ed. (1937) § 1297.

The trustee must operate all the property of the bankrupt. Burnet v. North American Oil Consol. (C.C.A.) 50 F.(2d) 752; Trojan Oil Co. (1932) 26 B.T.A. 659; Commissioner v. Owens (C.C.A. 10, 1935) 78 F.(2d) 768. When he does, the income is, in truth, that of the corporation. He makes the return "for the corporation." However, as under the Bankruptcy Act the property of the bankrupt vests in the trustee, the Supreme Court has held that the income is not the income of the bankrupt corporation, but "of the trustee, and was subject to income and excess profits tax only if the statutes authorized the assessment of the tax against him." Reinecke v. Gardner (1928) 277 U.S. 239, 241, 48 S. Ct. 472, 473, 72 L.Ed. 866. (Italics added)

Prior to 1916, no such provision existed in the revenue acts. And courts, on the basis of the principle stated, in Reinecke v. Gardner, supra, held uniformly that receivers operating the property of corporations were not subject to this tax. See Pennsylvania Steel Co. v. New York City Ry. Co. (C.C.A. 2, 1912) 198 F. 774; Scott v. Western Pacific Ry. Co. (C.C.A. 9, 1917) 246 F. 545; United States v. Whitridge (1913) 231 U.S. 144, 34 S.Ct. 24, 58 L.Ed. 159.

Since 1916 (39 Stat. 756) the yearly revenue acts have contained provisions identical with the one under consideration. Their object is to reach a new source of income taxation, not reached before. But income from that source is not available, unless all the conditions imposed by the section coexist. The most fundamental one is that the receiver, trustee in bankruptcy, or assignee must be "operating the property or business" of a corporation, and all of it.

To "operate" means to put into, or to continue in operation or activity, to manage, to conduct, to carry out or through. This is both the ordinary and the legal definition of the word. See Webster's New International Dictionary; 6 Words and Phrases, First Series (1904) pp. 4989 et seq.; 3 Words and Phrases, Second Series (1914) pp. 743 et seq.; 5 Words and Phrases, Third Series (1929) pp. 629 et seq.; 2 Words and Phrases, Fourth Series (1933) pp. 864 et seq. The new Shorter Oxford English Dictionary defines it as follows: "To direct the working of, to manage, conduct, work (a railway, business, etc.); to carry out, direct to an end (an undertaking etc.; chiefly U.S. 1880." Volume II, p. 1374.

The operation of a business implies its conduct and management not sporadically, but continuously over a...

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