Musselman Hub-Brake Co. v. Com'r of Internal Revenue

• Decision Date: 01 December 1943
• Docket Number: No. 9503.,9503.
• Parties: MUSSELMAN HUB-BRAKE CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

139 F.2d 65 (1943)

MUSSELMAN HUB-BRAKE CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 9503.

Circuit Court of Appeals, Sixth Circuit.

December 1, 1943.

Wayland K. Sullivan, of Cleveland, Ohio (Wayland K. Sullivan and Ray T. Miller both of Cleveland, Ohio, on the brief), for petitioner.

Louise Foster, of Washington, D. C. (Samuel O. Clark, Jr., Sewall Key, Helen R. Carloss, and Newton K. Fox, all of Washington, D. C., on the brief), for respondent.

Before ALLEN, HAMILTON, and MARTIN, Circuit Judges.

HAMILTON, Circuit Judge.

Petitioner, an Ohio corporation, which kept its accounts and made its tax returns on the accrual basis, became currently indebted for the years 1937, 1938 and 1939, inclusive, to its controlling stockholder for patent royalties and interest, which sums it credited on its books. Sometime in February 1938, and for each of the subsequent years here in question, petitioner, on advice of its tax auditor, gave to its creditor within two and one-half months after the close of the tax year, demand promissory notes for the debts.

During all of the tax years petitioner was solvent, and its notes had a cash par value. The creditor stockholder reported in gross income the par value of the notes received by him each year.

Petitioner, in its income and excess profits tax returns for the years 1937 to 1939, inclusive, deducted the respective amounts, which the Commissioner of Internal Revenue disallowed. The United States Tax Court sustained the commissioner and petitioner appeals.

Sections 23(a) (1), (b) of the Revenue Acts of 1936 and 1938, Internal Revenue Code, 26 U.S.C.A. § 23(a) (1), (b), permit deductions from gross income of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business and all interest paid or accrued during the taxable year. Section 24(c) (1) of the Revenue Acts of 1936 and 1938, Internal Revenue Code, 26 U.S.C.A. § 24(c) (1), denies as deductions all expenses allowable under Section 23(a) or interest incurred under 23(b) unless paid within the taxable year, or within two and one-half months after the close thereof.

The question on this appeal is whether, under the facts in this case, Section 24(c) of the Revenue Act of 1936 as amended by Section 301 of the Revenue Act of 1937, prohibits deductions allowable under Section 23(a) (1), (b).

Prior to 1937, all revenue acts made deductible from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business and all interest paid or accrued within the taxable year on indebtedness.

The Joint Committee on tax evasion and avoidance of the 75th Congress found that many corporations credited on their books to their controlling stockholder incurred business expenses and accrued interest and deducted them from gross income without the stockholder including such items in his gross income for the current year, and that the corporation paid the credits to the stockholder in a subsequent year when his net income was low, which resulted in the stockholder shifting his taxable income from a high to a low bracket.

The committee also found that some debtors kept their accounts on an accrual basis and the creditor reported his income on a cash basis which resulted in the debtor taking the deduction in one taxable year and the creditor reporting the income in another. The committee found too that in some cases corporations made credits on their books to their controlling stockholder of items deductible from gross income and such credits were subsequently extinguished with the result that they were at no time reported by the stockholder. (Hearings Before Joint Committee on Tax Evasion and Avoidance, 75th Cong. 1st Sess. pp. 241, 242, Ways and Means Committee Report No. 1546, 75th Cong. 1st Sess. pp. 16, 29.)

In order to protect the revenue and remove inequalities, the Congress passed the statute with which we are here concerned which, in substance, provides that where the relationship between the parties is such that losses from sales or exchanges between them are not deductible or where the creditor is on a cash basis, that accrued expenses and interest are not deductible by a debtor on the accrual basis, unless actually paid within two and one-half months after the close of the debtor's taxable year. The precise language of the provision is found in the footnote.^* The Ways and Means Committee expressed the opinion that hardships, if any, because of the time requirement, would be rare since such debts would normally be paid within the two and one-half months, if incurred in the ordinary course of business. (Report of Joint Committee on Tax Evasion and Avoidance, 75th Cong. 1st Sess. p. 16.)

The purpose of statutory construction is to harmonize the law and save apparently conflicting statutes from ineffectiveness. Burnet v. Guggenheim, 288 U. S. 280, 286, 53 S.Ct. 369, 77 L.Ed. 748.

Taxing statutes must be applied within reasonable limits and construed in the light of their purpose. One designed to prevent tax avoidance may, under some circumstances, be liberally interpreted in favor of the taxpayer by confining its scope to the object of its creation.

It is necessary to read Sections 23 (a) (1) and 24(c) (1) together in order to arrive at the intention of the Congress under the long established rule that the purpose of the enactment is to be deduced from a view of every material part of the statute on the subject. Helvering v. Rebsamen Motors, Inc., 8 Cir., 128 F.2d 584.

We are not here concerned with the rule that deductions are a matter of legislative grace and therefore the taxpayer must bring a claimed deduction clearly within the terms of the statute, because the statutes we are considering all relate to deductions. When Section 23 is applied, the deductions in question are clearly allowable, but for Section 24(c). So, the rule applies that the two sections should be integrated to carry into effect their combined purpose. Anderson v. Pacific Coast S & S Co., 225 U.S. 187, 203, 32 S.Ct. 626, 56 L.Ed. 1047.

Section 24(c) modified the general rule stated in Section 23(a) (1), by prohibiting the deductions allowable under the latter section, unless payments were made within the prescribed period, and the relationship between the debtor and creditor, in the matter of accounting or stock ownership, was as defined in Section 24(c) (2) or (c) (3).

The word "paid" found in Section 24(c) (1) must be defined in its context setting and in the light of the legislative history of the enactment to determine whether, within its meaning, the deduction by the debtor must be paid in cash to the creditor, or made available to him in such form as would require him to include the debtor's deduction in the creditor's gross income. Helvering v. Hutchings, 312 U.S. 393, 396, 61 S.Ct. 653, 85 L.Ed. 909. In the case at bar the creditor made his returns on a cash basis and the debtor made its returns on an accrual basis. The creditor was the owner of a majority of petitioner's voting stock; therefore, the deductions claimed by the petitioner are not allowable unless "paid" as that word is used in Section 24(c) (1).

The rule that words and phrases used in a statute are to be taken and understood in their plain, ordinary and popular sense, is not always to be followed in construing the language of taxing statutes. If it is clear from the purpose of the statute, read in the light of the whole subject to which it relates, that Congress used the words therein in a broad or different sense from that which would ordinarily be attributed to them, such words and phrases must be given the meaning intended by the Congress. Applying this rule and using the keys found in Sections 23 and 24(c) (2) and (3), and the legislative history of 24, to unlock the meaning of the word "paid," it would seem that Congress meant that the debts were paid when the deductions constituted income actually or constructively received by the...