Mead Corporation v. Commissioner of Internal Rev.

• Decision Date: 29 November 1940
• Docket Number: No. 7019.,7019.
• Parties: MEAD CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

116 F.2d 187 (1940)

MEAD CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.

No. 7019.

Circuit Court of Appeals, Third Circuit.

November 29, 1940.

COPYRIGHT MATERIAL OMITTED

Edward G. Ince and Robert McDougal, Jr., both of Chicago, Ill., and Theo. W. Brazeau, of Wisconsin Rapids, Wis., for petitioner.

Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Carlton Fox, Sp. Assts. to Atty. Gen., for respondent.

Before BIGGS, CLARK, and JONES, Circuit Judges.

JONES, Circuit Judge.

The pending petition brings on for review a decision of the Board of Tax Appeals determining a deficiency in tax against the petitioner corporation for the year 1931 in the amount of the additional tax authorized by Sec. 104(a) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 26 U.S.C.A. Int.Rev.Acts, page 375. The tax there prescribed is 50% of the net income of "any corporation * * * formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed". This tax is in addition to the regular income tax to which corporations in general are subject and is levied upon the offending corporation's taxable net income as augmented in the manner provided by Sec. 104(c).

In the present case, the petitioning corporation's sole shareholder was another corporation which, as such, was not subject to surtax (Sec. 12, Revenue Act of 1928, 26 U.S.C.A. Int.Rev.Acts, page 352). However, the Board of Tax Appeals found that the petitioner was formed or availed of for the purpose of preventing the imposition of the surtax upon the individual owners of the stock of the parent corporation which owned the entire capital stock of the petitioner. Thereupon the Board concluded, as a matter of law, that the individual shareholders of the parent or holding corporation were the shareholders of the subsidiary (the petitioner) within the intent and meaning of Sec. 104(a) of the act and that, accordingly, the petitioner was liable for the additional tax. The Board of Tax Appeals rested its decision squarely upon its construction of the statute, holding that the term "its shareholders" as used in Sec. 104(a) is sufficiently broad to include, in the case of a subsidiary corporation, the stockholders of the parent or holding corporation. The opinion of the Board (a bare majority joining in the decision) was undoubtedly provoked by the elaborate scheme adopted and carried out by the parties interested in the petitioner in an obvious effort to minimize their own liability for income taxes as the facts disclose.

Prior to 1931, George W. Mead, his wife and their three children owned or controlled a majority of the issued and outstanding common stock of the Consolidated Water Power & Paper Company, a Wisconsin corporation. In that year, pursuant to a plan devised by Mead's lawyers and tax consultants, he caused three Delaware corporations to be formed, viz., the G. W. Mead Securities Corporation, the S. W. E. Corporation and the Mead Corporation (the petitioner). A variety of transfers ultimately found Mead, his wife and their children the owners of all of the common and preferred stock of the Securities Corporation (Mead and his wife holding the common and their children the preferred), the Securities Corporation the owner of the entire capital stock of the Mead Corporation, and the Mead Corporation the owner of so much of the Consolidated Water Power & Paper Company stock as the Meads had actually owned outright. The S. W. E. Corporation, having served its purpose in the course of the transfers and being no longer useful, was dissolved.

In addition to the Power Company stock which Mead had owned outright, he had purchased, under a contract of January 3, 1927, from one Witter, his brother-in-law, a large block of Power Company stock. This stock, together with the Meads', constituted control of the Power Company. Under the contract of purchase, Mead had given Witter his interest bearing notes payable serially over a period of ten years. The Witter stock, which was transferred to Mead at the time of his purchase, was delivered to Witter as collateral security for Mead's purchase-money notes. At that time Mead had indicated his desire to form a corporation to hold all of the Meads' Power Company stock and Witter assented. However, nothing definite was done to that end until 1931 when the matters hereinabove referred to were undertaken.

The Mead Corporation on the day following its acquisition of the Power Company stock, which the Meads had owned outright, assumed Mead's obligation to Witter under the contract of purchase and took title to the unreleased Witter stock. New certificates for the stock were issued to the Mead Corporation and delivered by it to Witter as collateral security for the payment of the balance due on Mead's notes. Witter did not, however, release Mead from his personal liability on the notes.

After the completion of the incorporations and the transfers and assignment to which we have referred, Mead became president, treasurer and a director of both the Mead Corporation and the Securities Corporation, his two sons becoming the other officers and directors of both corporations. Neither corporation conducted any business. The activities of the Mead Corporation (except for a bank stock investment in relief of a personal undertaking of Mead) consisted of its receipt of dividends on the Power Company stock, payment of interest and principal on account of the obligations for the Witter stock, payment of dividends to its sole stockholder, the Securities Corporation, and the payment of the expenses incident to the creation and organization of the three Delaware corporations and the effectuation of the plan of transfers. The Securities Corporation's sole activity was its receipt of dividends from the Mead Corporation and its payment of dividends on its own stock to the holders thereof, the members of the Mead family. Mead's ascribed purpose for the roundabout transfer of the Power Company stock was that the Meads' entire holdings of Power Company stock might be placed in one control and that the transfers might be consummated under the reorganization provisions of the Revenue Act of 1928, Sec. 112, 26 U.S.C. A. Int.Rev.Acts, page 377, so as not to determine a taxable gain to the Meads by reason thereof. However, the further use of both the Securities Corporation and the petitioner for the continued holding and control of the Power Company stock did serve to reduce very considerably the liability of Mead and his wife for taxes on ordinary income. The effect on the income tax liability of the Mead children was negligible.

The Board of Tax Appeals found that "The petitioner was formed and availed of for the purpose of avoiding the imposition of surtax upon members of the Mead family, particularly George W. Mead and his wife, Ruth W. Mead". As that finding is supported by substantial evidence, it may not now be disturbed. Helvering v. National Grocery Co., 304 U.S. 282, 58 S.Ct. 932, 82 L.Ed. 1346. Nor would we be disposed to find otherwise were it within our power to do so. Whatever other motives Mead may have had in forming the holding companies to retain and exercise the Mead family's former ownership and control of the Power Company stock, his desire to reduce his own and his wife's liability for income tax was uppermost. Nevertheless, the question presented by the record in this case is not whether the Meads should be subjected to additional taxes as being the substantial owners of the Power Company stock and, as such, accountable for the income therefrom whether distributed to them or not. The respondent made no claim that the ostensible reorganization was a mere device to relieve the Meads of tax liability or that they are still the substantial owners of the Power Company stock, wherefore the entities of both the petitioner and the Securities Corporation should be disregarded. The question here is simply whether the petitioner is subject to the additional tax prescribed by Sec. 104(a).

The statute, by its terms, lays the tax upon a corporation which prevents, in the manner denounced by the act, the imposition of the surtax upon "its shareholders". The words are plain and it is from them that the intent of Congress is to be derived. United States v. Standard Brewery, 251 U.S. 210, 217, 40 S.Ct. 139, 64 L.Ed. 229; Adams Express Co. v. Commonwealth of Kentucky, 238 U.S. 190, 199, 35 S.Ct. 824, 59 L.Ed. 1267, Ann.Cas. 1915D, 1167; Bate Refrigerating Co. v. Sulzberger, 157 U.S. 1, 87, 15 S.Ct. 508, 39 L.Ed. 601. Shareholders of a corporation, in the usual and ordinary acceptation of the term, are the holders of its stock as the record owners thereof. Treasury Regulation 74, Art. 543, interpreting Sec. 104 of the Revenue Act of 1928, so recognizes.¹ The possessive pronoun "its" which, in Sec. 104(a), limits and thus identifies the "shareholders" whose freedom from surtax the corporation shall not serve except it be penalized, refers to the corporation made subject to the tax. It is the taxpayer corporation which is forbidden to accumulate its "gains and profits" for the purpose of preventing the imposition of the surtax upon its shareholders. However, in the present case, no amount of accumulation of gains and profits or failure to distribute surplus would relieve the petitioner's sole stockholder of liability for surtax. That shareholder, being a corporation, was not subject to surtax. Revenue Act of 1928, Sec. 12. Hence the statute, by its terms, does not apply to the facts of the instant case. To say that the term "its shareholders" means not only the corporation's actual shareholders but also the shareholders of its shareholders would be to add to the statute something that is not there and to give it an effect which its plain words do not compel. This we may not do. "To supply omissions transcends the...