Sancho v. National City Bank of New York, 3538.

• Decision Date: 28 June 1940
• Docket Number: No. 3538.,3538.
• Citation: 112 F.2d 998
• Parties: SANCHO, Treasurer, v. NATIONAL CITY BANK OF NEW YORK.
• Court: U.S. Court of Appeals — First Circuit

112 F.2d 998 (1940)

SANCHO, Treasurer, v. NATIONAL CITY BANK OF NEW YORK.

No. 3538.

Circuit Court of Appeals, First Circuit.

June 28, 1940.

William Cattron Rigby, of Washington, D. C. (George A. Malcolm, of San Juan, P. R., and Nathan R. Margold, of Washington, D. C., on the brief), for appellant.

E. T. Fiddler, of San Juan, P. R., and Andrew Kirkpatrick, of Larchmont, N.Y. (H. S. McConnell and Fiddler, McConnell & Gonzalez, all of San Juan, P. R., on the brief), for appellee.

Before MAGRUDER and MAHONEY Circuit Judges, and PETERS, District Judge.

MAGRUDER, Circuit Judge.

The Butler Act of March 4, 1927 (44 Stat. 1421, 48 U.S.C.A. § 872) amended Section 48 of the Organic Act of Puerto Rico by adding the following:

"That no suit for the purpose of restraining the assessment or collection of any tax imposed by the laws of Puerto Rico shall be maintained in the District Court of the United States for Puerto Rico."

This provision was inserted in the bill by amendment on the floor offered by Senator Bingham, who thus explained its purpose (68 Cong.Rec., p. 5025):

"I will state that the change in the existing law is this: The Organic Act of Porto Rico does not carry to Porto Rico the general statutes of the United States. Consequently, it has been possible and has proved an extremely dangerous thing in the government of Porto Rico for taxpayers to secure an injunction against paying Porto Rican taxes in the court of the United States, in the district court of the United States for Porto Rico; and thereby, instead of following our practice — which is to pay the tax first and then take an appeal — they do not pay the tax at all. They get injunctions against paying the tax; and I have seen in one of the publications the statement that at one time there was over $2,000,000 of uncollected taxes held up by injunction. This amendment is to apply the same rule in Porto Rico that now applies on the continent of the United States."

On April 30, 1938, the National City Bank of New York, hereinafter called the Bank, filed its complaint in the United States District Court for Puerto Rico against the Treasurer of the Territory, praying a decree: "That the defendant Treasurer of Puerto Rico * * * be perpetually restrained and enjoined from attaching, levying upon, embargoing or distraining any property of the complainant The National City Bank of New York, and from taking any step whatsoever for the collection of the income tax" of complainant for the year ending December 25, 1937, in the sum of $41,590.33. By supplemental bill filed March 27, 1939, a decree in similar terms was prayed with respect to income taxes in the sum of $33,886.91 for the year ending December 25, 1938.

On August 7, 1939, the district court entered its final decree in the cause providing:

"That Rafael Sancho Bonet, Treasurer of Puerto Rico, defendant herein, his successor or successors in office, and the agents, employees, and any person acting by and under authority derived from the said defendant or his successors in office, be, and they hereby are, perpetually restrained and enjoined from attaching, levying upon, embargoing, or distraining any property of the complainant, The National City Bank of New York, and from taking any step whatsoever for the collection of the income taxes shown to have been due on the returns filed by the complainant with the defendant for the taxable years ending December 25, 1937, and December 25, 1938, respectively."

From the foregoing decree the Treasurer of Puerto Rico prosecutes the present appeal.

Comparing the prayer of the bill and the terms of the decree with the above-quoted prohibition in the Butler Act, it would seem on the face of it that the decree is in the very teeth of the statute. A heavy burden of persuasion rests upon the Bank to explain how this is not so; we have not been persuaded, but on the contrary think that the court below should have dismissed the bill for lack of jurisdiction.

It is not enough to show that for some reason or other the tax is not lawfully due. Obviously the prohibition against injunctions is not limited to cases where in the court's view the tax is properly owing and where there would be no occasion for an injunction anyway. Congress has said, in effect, that even assuming the tax is not lawfully due, the taxpayer must pay first and litigate afterwards. This is no doubt awkward and inconvenient from the taxpayer's point of view. But the disadvantage to the taxpayer is considered to be outweighed by the need of protecting the public revenue against the very real danger that collection of taxes properly payable may be postponed by injunction pending protracted litigation. The inconvenience to the taxpayer is the same regardless of the ground of his claim that the tax is not legally due — whether he asserts that the taxing act is unconstitutional, or that by proper construction it does not cover him, or that a deduction allowed by law has been disallowed, or (as the Bank contends in the case at bar) that the tax should be considered in effect as having already been paid by virtue of a credit properly allowable for overpayments in previous years.

A quite condensed statement of the complicated facts will suffice to indicate the nature of the present controversy.

Complainant is a national banking association, organized under the laws of the United States, with its principal office in New York City, and various branch offices established in the Island of Puerto Rico under the provisions of 12 U.S.C.A. § 601. For many years it had been the practice of the New York office of the complainant to supply funds to its Puerto Rican branches whenever necessary for local operations. From 1930 to 1935 the Puerto Rican branches customarily credited the New York office with an item designated as "interest" on the funds so provided. On the basis of these book entries the Puerto Rican branches, in filing their annual income tax returns, under the insular income tax act, for the years ending December 25, 1930-35, inclusive, deducted the amount entitled "interest paid" to the New York office as an expense of the local business. Other than this item the Bank took no deduction in its annual income tax return to the Treasurer of Puerto Rico for any of its expenses outside of Puerto Rico allocable to its Puerto Rican income.

For each of the years 1930 to 1935, inclusive, the Puerto Rican branches also filed with the Treasurer, at his request and upon forms furnished by him entitled "Annual Return of Income Tax Withheld at the Source", separate returns showing the item entitled "interest paid" by the Puerto Rican branches to the New York office. Upon the theory that this so-called "interest" was income derived by the New York office from Puerto Rican sources, the Treasurer required the Bank to pay income taxes "withheld at the source" at the rate of 12½% on this item of "interest". (§§ 22, 35, Income Tax Act of 1924, Laws of Puerto Rico 1925, pp. 460, 484, hereinafter described by a shorthand expression as the "withholding tax".) These taxes were paid by the Bank for the years 1930 to 1934, inclusive. The payments were not made as a result of deficiency assessments, but were in the amounts shown to be due according to the returns filed by the taxpayer. However, at the time each of these payments was made the Bank advised the representative of the Treasurer authorized to receive payments of income taxes, that the Bank was not subject to any tax on account of such "interest" and that the payments were made under protest; and the Bank further caused this protest to be noted on the back of the receipts issued by the Treasurer in acknowledgment of such payments.

The reason assigned for designating this charge as "interest" was that it was in conformity with accounting practices under 12 U.S.C.A. § 604,¹ requiring that the accounts of branches be kept as though they were separate institutions. The amount of "interest" paid by the Puerto Rican branches to the head office of the Bank did not represent an exact computation of the cost of head office funds used by the Puerto Rican branches, but was merely an approximation required for intra-bank accounting purposes.

Thereafter, within four years of the date of each of the above payments of taxes withheld at the source, the Bank filed with the Treasurer claims for credit or refund, pursuant to Section 64(b) of the Income Tax Act of 1924, Laws 1925, p. 526. The Treasurer has denied each of these claims for credit or refund.

In the fall of 1936, the Treasurer commenced an extended reinvestigation of the income tax questions relating to the Bank, particularly with respect to this item of so-called "interest". Numerous conferences took place between the Treasurer and his subordinates, and representatives of the Bank, and the books of the Bank were reexamined by officials of the Treasury Department.

While this reinvestigation was proceeding, on February 17, 1937, the Treasurer served notice on the Bank of the levy of income tax deficiency assessments for the tax years 1933, 1934, and 1935, based on the rejection by the Treasurer of the deduction taken by the Bank, in its returns for those years, of the "interest paid" to the New York office by the Puerto Rican branches. The ground taken was that these payments were not really interest but were merely intra-company transactions.

During the course of the negotiations the Bank maintained that though this item of "interest" was not properly deductible as such, the Bank was entitled in lieu thereof to a deduction of the extra Puerto Rican cost to the head office of furnishing the Puerto Rican branches with operating funds. The Bank proposed to the Treasurer a formula for determining the cost of these funds. This formula was approved by the Treasurer. A tentative agreement was reached to the effect that the Bank would for income tax purposes be regarded as a single corporate entity (as indeed it was),...