Milton Dairy Co. v. Willcuts

• Decision Date: 25 September 1926
• Docket Number: No. 7235.,7235.
• Citation: 15 F.2d 814
• Parties: MILTON DAIRY CO. v. WILLCUTS, Collector of Internal Revenue.
• Court: U.S. Court of Appeals — Eighth Circuit

15 F.2d 814 (1926)

MILTON DAIRY CO. v. WILLCUTS, Collector of Internal Revenue.

No. 7235.

Circuit Court of Appeals, Eighth Circuit.

September 25, 1926.

Ira C. Oehler, of St. Paul, Minn. (Haydn S. Cole and Frederic D. McCarthy, both of St. Paul, Minn., on the brief), for plaintiff in error.

John R. Wheeler, Sp. Atty., Internal Revenue Bureau, of Washington, D. C. (Lafayette French, Jr., U. S. Atty., and L. W. Scott, Asst. U. S. Atty., both of St. Paul, Minn, and A. W. Gregg, Gen. Counsel, Bureau of Internal Revenue, of Washington, D. C., on the brief), for defendant in error.

Before SANBORN, Circuit Judge, and WOODROUGH and SCOTT, District Judges.

SANBORN, Circuit Judge.

The plaintiff, the Milton Dairy Company, was liable to pay and paid income and excess profits taxes for the fiscal year ending February 28, 1919, and also for the fiscal year ending February 28, 1920, which it claimed were excessive to the amount of $1,804.19, and it seeks by this action to recover this amount from the defendant, the collector.

Pursuant to the established methods of ascertaining the amount of its income and excess profits taxes, it made a return and statement of the income for each of these two years, and deducted therefrom the "invested capital" of section 326 (a) of the Revenue Act of 1918, 40 Stat. pp. 1058, 1092, 1093 (Comp. St. § 63367/16i). The Congress by that act specified the items that might lawfully be thus deducted, and declared them to be parts of the "invested capital" of that act. Therefore the increase of this "invested capital" necessarily decreased the taxable income and the tax, and the decrease of this "invested capital" increased the taxable income and tax, of the plaintiff for each of these years.

Section 326 (a), so far as relevant to the question in this case, provided:

"That as used in this title the term `invested capital' for any year means * * *

"(1) Actual cash bona fide paid in for stock or shares;

"(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares; * * *

"(3) Paid-in or earned surplus and undivided profits, not including surplus and undivided profits earned during the year."

The plaintiff had a net income of $11,489.26 in the fiscal year ending February 28, 1918, which remained undivided and undistributed in use in its business during the years 1919 and 1920, and a net income of $22.908.14 in the fiscal year ending February 28, 1919, which remained undivided and undistributed in use in its business during the year 1920. In making its return and statement of its income and profits for the fiscal year 1919, it stated and claimed this $11,489.26 undivided profits as part of its "invested capital" of that year; and in making its return and statement of its income and profits of the year 1920, it stated and claimed this $22,908.14 undivided profits as part of its "invested capital" of that year. The Commissioner of Internal Revenue disallowed these claims, and these disallowances resulted necessarily in an increase of the plaintiff's income and excess profits taxes for the fiscal years 1919 and 1920 by $1,804.19, which it paid under protest and brought this action to recover.

The only justification for these disallowances is the fact that in the fiscal year 1917 the plaintiff sustained a disastrous operating deficit in the conduct of its business, which depleted its prior capital $70,296.12; and this declaration in Regulations 45, article 838: "There can, of course, be no earned surplus or undivided profits until any deficit or impairment of paid-in capital due to depletion, depreciation, expense, losses, or any other cause has been made good;" and the fact that Holmes on Federal Taxation, page 728 of the 1919 edition, and page 1057 of the 1922 edition, prints the substance of this article 838 in the words thereof.

On the other hand, however, article 860 of Regulations 45, Revised, declares that "capital or surplus actually paid in is not required to be reduced because of an impairment of capital in the nature of an operating deficit, except where there has been directly or indirectly a liquidation or return of their investment to the stockholders, in which case full effect must be given to any liquidation of the original capital."

The argument in support of the Commissioner's ruling and his decision in this case is that the allowance and the deduction of undivided profits of any fiscal year is conditioned by an excess of the value of the assets of the taxpayer over its liabilities at the end of that fiscal year, and the practical effect of the imposition of such a condition is to exclude and except from the benefit of the deduction of "undivided profits," as part of the "invested capital" of section 326 (a) in the process of computing their taxable income and excess profits, all taxpayers of income and excess profits the value of whose assets through operating deficits or...