Sala v. Commissioner of Internal Revenue

• Decision Date: 18 December 1944
• Docket Number: No. 7.,7.
• Citation: 146 F.2d 228
• Parties: SALA v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

146 F.2d 228 (1944)

SALA v. COMMISSIONER OF INTERNAL REVENUE.

No. 7.

Circuit Court of Appeals, Second Circuit.

December 18, 1944.

Richard J. Cronan and M. Robert Gallop, both of New York City (George Trosk, of New York City, of counsel), for petitioner.

Morton K. Rothschild, of Washington, D. C., Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Sp. Asst. to Atty. Gen., for respondent.

Before L. HAND, AUGUSTUS N. HAND, and CHASE, Circuit Judges.

L. HAND, Circuit Judge.

This appeal is from an order of the Tax Court, assessing against the petitioner a deficiency in income tax for the year 1935. For a number of years she had been the sole shareholder in two companies, each owning a large building in the City of New York: One called the Broadex Realty Corporation, and the other Ideal Investing, Inc. Until 1928, her husband was president of both these companies, and managed their business; and she had no part in that management. In that year he died, insolvent, and in order to pay his debts she applied in 1930 to her uncle, one Bache, a banker, for a loan. He agreed to arrange one for her from a bank, if she would put the control of all her affairs in his hands. She assented, and he got the loan, which his firm guaranteed — Bache himself receiving the shares of the two companies as security. Bache then entrusted the general financial conduct of the companies to his lawyer, Nathan, who prepared the resolutions, which we shall mention; but Bache himself had charge of the actual management of the buildings. The two together selected and elected all the officers of the companies.

Between 1927 and 1932, the petitioner had borrowed from the Broadex Company about $760,000, and nearly $1,25,000 from the Ideal Company — $2,000,000 in all — these loans being carried on the companies' books as accounts receivable. On January 15, 1935, Nathan had the directors of the Broadex Company pass a resolution, "that the account receivable of this corporation against Countess Sala be carried in the balance sheet at not exceeding $260,422.62, and that the residue shall be presently written off as uncollectable, but no claim of a deductible loss for income or other tax purposes shall be made by reason thereof." On December 24th of the same year, Nathan had the directors of the Ideal Company pass a resolution in substantially the same terms, except that the amount was $543,787.18. Following these resolutions the accounts receivable against the taxpayer was carried at $500,000 on the books of the Broadex Company, and at $700,000 on those of the Ideal Company. The taxpayer never had any part personally in these "write-downs"; and the testimony showed that they were made to avoid carrying the accounts at what was thought to be a false value, thus giving possible color to the assessment against the companies of penalty taxes for their failure to declare dividends.

In April, 1938, Nathan had the directors of both companies adopt a resolution that the account be "written off as of December 31, 1937, as presently uncollectable, and be eliminated from the balance sheet," but that this should not "constitute the forgiveness" of the debtor, or "impair" the companies' rights. On the other hand, on October 13th of the same year, Nathan had resolutions passed rescinding the earlier resolutions of that year, and restoring the accounts against the taxpayer, in full, "regardless of the judgment of this Board" as to their "collectibility." Upon this state of facts the Commissioner declared that the "write-downs" of 1935 made available to the taxpayer dividends to the extent of the earnings of the two companies in that year, and taxed her accordingly. The Tax Court affirmed this ruling, and she appealed.

The question is whether by the resolutions of 1935 the corporations released the taxpayer's debts in the amount of $1,200,000. Three circuits¹ have held that, if they did, taxable income...