Noteman v. Welch
| Decision Date | 16 January 1939 |
| Docket Number | 7195,7196.,Law No. 7186 |
| Citation | 26 F. Supp. 437 |
| Parties | NOTEMAN et al. v. WELCH, Former Collector of Internal Revenue (three cases). |
| Court | U.S. District Court — District of Massachusetts |
Hale & Dorr and Lawrence E. Green, all of Boston, Mass., for plaintiffs.
John A. Canavan, U. S. Atty., and C. Keefe Hurley, Asst. U. S. Atty., both of Boston, Mass., and George H. Zeutzius, Sp. Asst. to Atty. Gen., for defendant.
The plaintiffs in the above named three actions which have been consolidated for trial, the facts, except for the amounts involved, being similar in each case, seek to recover the sums of $3,579.07, $13,381.65, and $8,528.60, respectively, with interest from October 4, 1937, representing the corporate surtaxes, penalties, and interest assessed against and collected from them as trustees of the National Loan Society of Malden, the National Loan Society of Boston, and the National Loan Society of Cambridge, hereinafter called the taxpayers, upon the undistributed adjusted net incomes of the latter for their respective fiscal years ending September 30, 1935.
These Societies are associations organized under declarations of trust in accordance with the laws of the Commonwealth of Massachusetts, and under the provisions of 26 U.S.C. § 1696, 26 U.S.C.A. § 1696, are corporations for tax purposes.
The taxes, interest, and penalties were assessed and collected from the plaintiffs as a result of a determination of the Commissioner of Internal Revenue that the above named associations were personal holding companies and subject to surtax under the provisions of Section 351 of the Revenue Act of 1934, 48 Stat. 751, 26 U. S.C.A. § 331.
Section 351 reads as follows:
Statements of fact and conclusions of law appearing herein are intended to meet the requirements of Rule 52 of the new Federal Rules of Civil Procedure, 28 U.S. C.A. following section 723c.
On December 6, 1935, the taxpayers filed their corporate income tax returns on Form 1120 for the fiscal year ending September 30, 1935, reflecting tax liabilities which were paid. No returns were filed by the taxpayers on Form 1120-H prescribed to be filed under the conditions referred to in Treasury Regulations 86, Article 351-8.
On August 12, 1937, the Commissioner of Internal Revenue notified the taxpayers of deficiencies in surtax under Section 351 of the Revenue Act of 1934 and surtax penalties for failure to file a personal holding company return (Form 1120 -H). The taxpayer filed a waiver of restrictions on the assessment and collection of the deficiencies, assenting to their immediate assessment and collection. On September 7, 1937, the Commissioner prepared returns on Form 1120-H in accordance with the proposed deficiencies. On September 17, 1937, the surtax deficiencies, interest, and penalties were assessed and paid by the taxpayers. A claim for refund was filed on October 6, 1937, on these grounds: (1) That the taxpayers were not subject to the provisions of Section 351 of the Revenue Act of 1934 for the fiscal years in question and that no taxes were due upon their undistributed adjusted net incomes; (2) that Section 351 cannot be constitutionally applied (under the provisions of the Fifth Amendment, Const.U. S.C.A.) to impose the surtax set forth therein upon the taxpayers; and (3) that whether the Commissioner was correct or not in determining the deficiencies and imposing the surtaxes, the penalties were imposed without authority of law. These claims were rejected and the suits are properly before this Court.
It was stipulated between the parties that during the tax years in question more than 50 per cent in value of the outstanding stock of the plaintiff companies was owned directly or indirectly by and for not more than five individuals, and the only remaining question left for decision on this phase of the case is whether at least 80 per cent of the gross income of the taxpayers for the tax years in question was derived from "interest" as used in Section 351, supra.
The gross and only income of the taxpayers for the tax years in question was derived from payments received on loans made by the taxpayers and is reflected in item 7 of their tax returns opposite the designation "Interest on loans, notes, etc.," where all the words following the word "interest" are stricken out and the words "and charges for Small Industrial Loans" substituted, so as to read: "Interest and charges for Small Industrial Loans."
It is argued by the taxpayers that their income — what they received for the use of the money loaned — was a composite of and several into (1) interest; and (2) charges or expenses of making, servicing, and collecting the loans, and the latter consisted of such a proportion of the whole that far less than 80 per cent of their income was derived from "interest" as used in Section 351 and consequently they were not subject to the taxes in question.
This brings us to the question as to what is the meaning of the word "interest" as used in Section 351.
These associations did business under the provisions of Chapter 140, Massachusetts General Laws (Ter.Ed.), commonly known as the "Small Loans Act," Section 96, which reads as follows:
Section 100 of this Act reads as follows:
The plaintiffs contend that the word "interest" as used in the Massachusetts statute to designate the amount licensed loan agencies may charge, is a much more comprehensive term than as defined in Treasury Regulations 86 (infra). They argue the term "interest" as used in that statute designating what they may charge for the use of money means (1) "pure interest," and (2) "charges for making, servicing, and collecting loans," which latter may be divided into seven classifications, viz.: (1) investigation of borrower and security; (2) closing of loans, papers, etc.; (3) servicing and collecting loans; (4) license and reports to State Banking Department and Public Relations; (5) advertising to secure loans; (6) bad debts; and (7) general expenses.
Through expert testimony and other witnesses they maintained the percentage of the income received to be allocated to six of these specifications (excluding general expenses referred to in Item 7, consisting chiefly of salaries, taxes, one-third of the management fees, legal fees and disbursements, and small miscellaneous expenses), would amount to about 42.8 per cent of their gross income and if deducted less than 80% of the income of the taxpayers was derived from "interest" as used in Section 351.
It was stated in the case of Cuneo v. Bornstein, 269 Mass. 232, 236, 168 N.E. 810, that the purpose of the "Small Loans Act" was to prohibit the unlicensed business of making small loans and to prevent an excessive rate of interest on such loans and that the statute was passed as a protection to the borrower. The Court in this case speaks of the total amount to be charged borrowers as the "rate of interest" on the loans.
Section 100 of Chapter 140 of the Massachusetts General Laws (Ter.Ed.) in authorizing the Commissioner of Banks to fix the rate of interest on loans, says he "shall have due regard to the amount of the loan, and the nature of the security, and the time for which the loan is made." The evidence of the taxpayers showed that the Commissioner in fixing the rate of interest in accordance with this Section took into account the expense of advertising and auditing, bad debts, depreciation of furniture, fixtures and equipment, insurance,...
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Noteman v. Welch
...stock "was owned, directly or indirectly, by or for not more than five individuals". In this appeal from the District Court's decision (26 F. Supp. 437), granting judgment for the Collector, the taxpayer contends that the court should have found, on the evidence, that more than 20 per cent ......