Kerr-Cochran, Inc. v. Commissioner of Internal Rev.

• Decision Date: 11 March 1958
• Docket Number: No. 15479.,15479.
• Citation: 253 F.2d 121
• Parties: KERR-COCHRAN, Incorporated, a Nebraska Corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

253 F.2d 121 (1958)

KERR-COCHRAN, Incorporated, a Nebraska Corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15479.

United States Court of Appeals Eighth Circuit.

March 11, 1958.

COPYRIGHT MATERIAL OMITTED

James D. Conway Hastings, Neb., for petitioner.

Harry Marselli, Atty., Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Ellis N. Slack and Lee A. Jackson, Attys., Dept. of Justice, Washington, D. C., with him on the brief), for respondent.

Before SANBORN, WOODROUGH and JOHNSEN, Circuit Judges.

JOHNSEN, Circuit Judge.

The Commissioner determined deficiencies of $35,621.01 and $25,727.93, for the years 1949 and 1950, in petitioner's income taxes. The Tax Court upheld the deficiencies, and the matter is before us on petition for review.

The deficiencies represented surtaxes imposed under the provisions of 26 U.S. C.A.Int.Rev.Code of 1939, § 102(a), that "There shall be levied, collected, and paid for each taxable year * * * upon the net income of every corporation * * * if such corporation * * * is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders * * * through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax * * *", at rates set out in the section.

This provision subjects a corporation to a special tax of a penalty nature, whenever it has undertaken or allowed itself to be used in any taxable year to accumulate earnings or profits of that year for the purpose of enabling its shareholders to escape the taxes of a distribution. And even though a part of these earnings or profits could reasonably have been made the basis of accumulation, all thereof that is not distributed may be subjected to the penalty tax under § 102 of the 1939 Code, if the motive prompting the accumulation is the avoiding of taxes to the shareholders. 7 Mertens Law of Federal Taxation, Rev.Ed., § 39.25. Nor is it necessary to the imposing of the penalty tax that the avoiding of taxes to the shareholders be the sole purpose behind the accumulation; "it is sufficient if it is one of the determinating purposes". World Pub. Co. v. United States, 10 Cir., 169 F.2d 186, 189; Trico Products Corp. v. Commissioner, 2 Cir., 137 F.2d 424, 426.

A prima facie test and presumption have been allowed the Commissioner and the Tax Court for establishing purpose in accumulation — that of whether the accumulation is one that is beyond the reasonable needs of the business. There is an express legislative provision that "The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary". Code of 1939, § 102(c).

It will be noted that the basis of the prima facie test and presumption under the statute is "reasonable needs of the business", and not managerial desires or ambitions as a matter of requiring examination at that stage of the question of good faith or absence of intent to aid stockholders. Without regard to actual motive, the statute permits a purpose to violate § 102 to be presumed, when any accumulation of earnings and profits is found, on objective evaluation, to have been engaged in, for the taxable year, beyond the reasonable needs of the business. And this presumption, when established, is made to have a special nature and effect, in that § 102(c) allows it to become determinative or conclusive of purpose to avoid surtax upon shareholders, unless the corporation undertakes and is able to prove by a clear preponderance of the evidence the absence of such purpose.

In making it workably possible for the presumption to be established, the courts have taken the view that the term "reasonable needs of the business", as used in the statute, was meant to have a practical and objective basis and so to entitle the Commissioner and the Tax Court to look only at the immediate needs of the business¹ — "need associated with the business in hand". See McCutchin Drilling Co. v. Commissioner, 5 Cir., 143 F.2d 480, 482; Wilson Bros. & Co. v. Commissioner, 9 Cir., 124 F.2d 606, 609; World Pub. Co. v. United States, D.C.Okl., 72 F.Supp. 886, 894, affirmed 10 Cir., 169 F.2d 186.

Immediacy of need may involve operational expediencies or growth requirements, which are realistically manifest in the corporation's situation, and which are conventionally related to such a measure of accumulation as their source. But immediate need does not go farther than direct and present apparency. It does not, under § 102(c) of the 1939 Code, reach to visionary hopes or ambitions, nor does it compel blind acceptance of marked sweeps from previous rudder course, just because they have been undertaken. The Tax Court has the right, as a basis for setting up the presumption under the statute, to engage in judgment of its own on projections or expansions in the corporation's enterprise or facilities, whether resting in plan or undertaking, which seem to represent business anachronism in the corporation's situation, or which appear to constitute fiscal artificiality in making earnings accumulation their source — thus casting on the corporation the burden of demonstrating that no purpose to avoid surtax upon shareholders has been involved in the accumulation.

Indeed, radical changes in the business of a corporation, on the basis of an accumulation of earnings and profits, may themselves be capable, without regard to the presumption of § 102(c), of pointing toward a violation of the statute, or, as Treasury Regulation 111, Sec. 29.102 — 3 expresses it, "may afford evidence of a purpose to avoid the surtax".

In the establishment of the presumption of § 102(c), whether a corporation has accumulated earnings and profits for a taxable year beyond the reasonable needs of its business, or whether it otherwise, from nondistribution, has been availed of for the purpose of enabling its shareholders to avoid surtax, is essentially a question of fact for the Tax Court's determination on the whole of the particular situation. Helvering v. National Grocery Co., 304 U.S. 282, 58 S.Ct. 932, 82 L.Ed. 1346; Helvering v. Chicago Stock Yards Co., 318 U.S. 693, 63 S.Ct. 843, 87 L.Ed. 1086; Wilkerson Daily Corp. v. Commissioner, 9 Cir., 125 F.2d 998, 1000; Medical Arts Hospital v. Commissioner, 5 Cir., 141 F.2d 404, 405; W. H. Gunlocke Chair Co. v. Commissioner, 2 Cir., 145 F.2d 791, 796.

While, as suggested above, the question of reasonable needs of a business primarily involves consideration of objective factors, these are not generally of such absoluteness on their face as to make the answer to the question a matter of law. Nor is the task of the Tax Court simply one of choosing and aggregating the various objective elements. Practical evaluation of the whole situation involves an exercised, proper business judgment — but with that judgment being entitled to have as part of its background the realities which have prompted the statute, and not being required to be exercised on the basis of the plenariness within which management otherwise has the right to have its actions unquestioned. The function of exercising judgment and making evaluation within these bounds is as to § 102(c) exclusively the Tax Court's. Helvering v. National Grocery Co., 304 U.S. 282, 58 S.Ct. 932, 82 L.Ed. 1346.

For these reasons, a considered finding of the Tax Court under § 102(c), that earnings or profits have in a particular situation been permitted to accumulate beyond the reasonable needs of the business, when there is nothing in the record to indicate improper process in consideration, may not be overturned by a Court of Appeals, if there exists on the evidence as a whole substantial probative substance, whether direct or circumstantial, as a basis for it. Egan v. Commissioner, 8 Cir., 236 F.2d 343; Bride v. Commissioner, 8 Cir., 224 F.2d 39; Smoot Sand & Gravel Corp. v. Commissioner, 4 Cir., 241 F.2d 197; Beckton, Dickinson & Co. v. Commissioner, 3 Cir., 134 F.2d 354; McCutchin Drilling Co. v. Commissioner, 5 Cir., 143 F.2d 480; K O M A, Inc. v. Commissioner, 10 Cir., 189 F.2d 390.

The task of appraising need and adjudging reasonableness in relation thereto as to a particular situation of accumulation is ordinarily not an easy one, even under the practicality allowed the Tax Court by the immediacy doctrine discussed above. Margins of relativeness for making evaluation will almost always exist in the immediate objective factors surrounding the corporation's action. In these circumstances, it is only natural that the Tax Court should turn to and oftentimes find its general persuasion becoming crystallized by some aspect of conduct or policy on the part of the corporation, in dealing with its funds, or even in other respects, which is out of character with reality in business need or immediacy thereof, as a basis of accumulating earnings for the taxable year involved.

Thus, the fact that the corporation is advancing or loaning money to stockholders may come to have a special crystallizing significance in the Tax Court's evaluation of the overall elements of some particular situation. See United Business Corporation v. Commissioner, 2 Cir., 62 F.2d 754, 755. The same may be true in other situations of the fact that the corporation is making investments in outside securities. See J. M. Perry & Co. v. Commissioner, 9 Cir., 120 F.2d 123, 126. Similarly, may a use of earnings and profits to buy property for rental and revenue purposes, without any proximateness to the corporation's regular business, tend to persuade in some situations that accumulation is being engaged in beyond the reasonable needs of the business, as related to the statutory object of encouraging stockholder distributions.

These are merely examples of special...