Noble v. CIR

• Decision Date: 07 November 1966
• Docket Number: No. 20379.,20379.
• Citation: 368 F.2d 439
• Parties: Cornelius G. NOBLE and Pansy H. Noble, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

368 F.2d 439 (1966)

Cornelius G. NOBLE and Pansy H. Noble, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 20379.

United States Court of Appeals Ninth Circuit.

November 7, 1966.

Sherwood & Denslow Green, Madera, Cal., for petitioners.

Mitchell Rogovin, Asst. Atty. Gen., Wm. Friedlandor, Lee A. Jackson, Harry Baum, Donald W. Williamson, Jr., Attys., Dept. of Justice, Washington, D. C., for respondent.

Before CHAMBERS, HAMLEY, and CECIL,^* Circuit Judges.

CECIL, Senior Circuit Judge.

This cause is before the Court on petition for review of a decision of the Tax Court which sustained the determination of income tax deficiencies against the petitioners for the taxable years 1958, 1959 and 1960 in the respective amounts of $2,394.59, $3,716.74 and $4,395.27. Jurisdiction of this Court is invoked under Sections 7482 and 7483 of the Internal Revenue Codes.

Cornelius Noble and his wife Pansy Noble, petitioners herein, are the sole shareholders of a California corporation, known as Noble's Independent Meat Company (hereinafter referred to as the corporation). The corporation upon its organization in 1946 took over the meat packing business which the petitioners had theretofore operated as a sole proprietorship. The business of the corporation is conducted in the State of California where the petitioners reside.

In 1955 the petitioners, individually, loaned to the corporation the sum of $300,000 for the purpose of acquiring additional equipment and to meet operating expenses. The note evidencing the loan was secured by a Deed of Trust on corporate property. Under the terms of the loan agreement, the corporation would make 120 monthly payments of $1761.99 and would pay the balance on the 121st month. The payments were first to be applied to interest at 5¼ per cent per annum and then to the principal. The corporation met all of the interest payments as they became due but was unable to meet all of the payments on the principal.

The deficiencies in question arose out of payments made by the corporation to the petitioners personally or for their benefit in the following amounts: 1958 — $4353.78, 1959 — $5353.42 and in 1960 — $7869.30. These payments were for painting and repairs on the family residence, travel expense, summer residence expenses and other items of a personal nature. These items were charged on the books of the corporation as business expenses.

During the year 1962, the Internal Revenue Service conducted an examination of the corporation's books for its fiscal years ending March 31, 1958 through March 31, 1962, concurrently with the petitioners' returns for the years 1958, 1959 and 1960. While this examination was in progress, it became evident to petitioners that some of the payments made to them personally or for their benefit would be disallowed as business expenses. On May 15, 1962, the board of directors (consisting of the petitioners) of the corporation adopted a resolution¹ to the effect that the amount of any of the personal payments which were disallowed as business expenses would be credited to the obligation of the corporation on its $300,000 note.

In his report of October 12, 1962, the agent of the Internal Revenue Service disallowed the claimed deductions from the corporation's income in the amount of $17576.50, on the ground that they represented personal expenses of the petitioners. The petitioners received the notice of deficiency on February 18, 1963, in which it was determined that the above amount was a taxable dividend. The bookkeeping entry adjusting the corporation's books to reflect credit for the payment of $17576.50, as of May 15, 1962, on interest and principal of the note was made on March 31, 1964.

It was stipulated that at the times the amounts involved here were received by the petitioners or expended on their behalf they were deducted by the corporation as business expenses; that both the corporation and the petitioners intended that they constituted business expenses on the part of the corporation; and that it was not the intention of the petitioners or of the corporation that the payments should constitute salaries, dividends or repayment of the corporation's obligation to the petitioners. During the years in question, the corporation declared no formal dividends although there were profits from which dividends could have been paid.

The facts are not in dispute. They are based on the stipulation of facts by the parties and the uncontradicted testimony of petitioner Cornelius C. Noble. The question before us on this review arises out of conflicting interpretations of the facts.

It is the contention of the Commissioner that when the payments in question, made to or on behalf of the petitioners by the corporation, were disallowed as business expenses of the corporation, they must be treated as constructive dividends from the corporation, and, as such, be taxed as personal income of the petitioners. On the other hand, the petitioners claim that so long as the corporation was justly indebted to them in amounts far in excess of the amount of the payments in question here and was delinquent in payments on the principal of the loan in excess of the amounts here involved, that the corporation and the petitioners are entitled to treat the payments, mistakenly made as business expenses, as a repayment of a portion of the indebtedness. Under such an interpretation of the facts the payments would not constitute dividend income and would not be taxable as personal income of the petitioners.

The Internal Revenue Code of 1954, Section 61 (Section 61, Title 26, U.S.C.), defines gross income as "all income from whatever source derived, including (but not limited to) the following items: * * * (7) dividends, * * *". Section 316(a) (Section 316(a), Title 26, U.S.C.), defines a dividend as "any distribution of property made by a corporation to its shareholders — (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year * * *."²

Dividends may be formally declared or they may be constructive. The fact that no dividends are formally declared does not foreclose the finding of a dividend-in-fact. Clark v. C. I. R., 9 Cir., 266 F.2d 698; Biltmore Homes, Inc. v. C. I. R., 4 Cir., 288 F.2d 336, cert. den. 368 U.S. 825, 82 S.Ct. 46, 7 L.Ed. 2d 30; Whitfield v. C. I. R., 5 Cir., 311 F.2d 640; Chism's Estate v. C. I. R., 9 Cir., 322 F.2d 956.

"The crucial concept in a finding that there is a constructive dividend is that the corporation has conferred a benefit on the stockholder in order to distribute available earnings and profits without expectation of repayment." 1 Mertens, Law of Federal Income Taxation, Section 9.07. See also Healy v. Commissioner, 345 U.S. 278, 281, 73 S.Ct. 671, 97 L.Ed. 1007; Clark v. C. I. R., supra, 266 F.2d p. 711; Cummins Diesel Sales of Oregon, Inc. v. United States, 9 Cir., 321 F.2d 503.

Clearly, the payments in question here are of the type that would fall in the category of constructive dividends. Likewise, it is equally clear that the payments would have constituted payments on the loan if the petitioners had designated them for that purpose at the time they were made. Dawkins v. Commissioner of Internal Revenue, 8 Cir., 238 F.2d 174; Bailey v. Commissioner of Internal Revenue, 5 Cir., 103 F.2d 448. The question then arises whether after a determination that payments to the sole stockholders were for personal expenses, a subsequent act of the petitioners can convert what would then have been a taxable dividend into a repayment of a prior valid outstanding loan from the sole shareholders to the corporation.

Intention of the parties is not controlling. The fact, as stipulated by the parties, that the corporation and the petitioners did not intend these payments to constitute dividends, is not decisive. We said in Clark v. C. I. R., supra, 266 F.2d p. 711,

"To constitute a distribution taxable as a dividend, the benefit received by the shareholder need not be considered as a dividend either by the corporation or its shareholders, declared by the board of directors, nor other formalities of a dividend declaration need be observed, if on all the evidence there is a distribution of available earnings or profits under a claim of right or without any expectation of repayment." Healy v. Commissioner, supra; Biltmore Homes, Inc. v. C. I. R., supra.

The declared expression of an individual's intent is not binding upon the Commissioner. The Commissioner and the reviewing courts are permitted to fully examine any transaction to determine its economic and financial reality. Bogardus v. Commissioner, 302 U.S. 34, 58 S.Ct. 61, 82 L.Ed. 32; C. I. R. v. Hansen, 360 U.S. 446, 79 S.Ct. 1270, 3 L.Ed.2d 1360; Hatch's Estate v. Commissioner, 9 Cir., 198 F.2d 26; Anderson v. United States, 9 Cir., 232 F.2d 794; Clark v. C. I. R., supra. Even an honestly held belief or expression of intention does not immunize a transaction from the scrutiny of the Commissioner. Lengsfield v. Commissioner of Internal Revenue, 5 Cir., 241 F.2d 508; Earle v. Woodlaw, 9 Cir., 245 F.2d 119, cert. den. 354 U.S. 942, 77 S.Ct. 1400, 1 L.Ed.2d 1537; Sachs v. C. I. R., 8 Cir., 277 F.2d 879, cert. den. 364 U.S. 833, 81 S.Ct. 63, 5 L.Ed.2d 59.

In the case at bar, it is stipulated that the taxpayers made a valid loan to the corporation in 1955 and that the $17,576.50 received by the Nobles was due to a mistake regarding the nature of expenses they incurred. Inasmuch as it is agreed that the expenses for which they were reimbursed were personal in nature, and not connected with the corporate business, the moneys they received were dividends and should have been included in their tax returns. American Properties Inc. v. Commissioner of Internal Revenue, 9 Cir., 262 F.2d 150; Clark v. C. I. R., supra; Cummins Diesel Sales of Oregon, Inc. v. United States, supra.

Petitioners argue against this result by stating...