Service Bolt & Nut Co. v. C.I.R.

• Decision Date: 29 December 1983
• Docket Number: Nos. 82-1619,82-1620 and 82-1621,s. 82-1619
• Citation: 724 F.2d 519
• Parties: 84-1 USTC P 9127, 5 Employee Benefits Ca 1184 SERVICE BOLT & NUT CO., Profit Sharing Trust, Service Bolt & Nut of Akron, Inc., Profit Sharing Trust, Service Bolt & Nut of Pennsylvania, Inc., Profit Sharing Trust, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 519

724 F.2d 519

84-1 USTC P 9127, 5 Employee Benefits Ca 1184

SERVICE BOLT & NUT CO., Profit Sharing Trust, Service Bolt &amp Nut of Akron, Inc., Profit Sharing Trust, Service Bolt & Nut of Pennsylvania, Inc., Profit Sharing Trust, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 82-1619, 82-1620 and 82-1621.

United States Court of Appeals Sixth Circuit.

Argued Oct. 4, 1983.

Decided Dec. 29, 1983.

John P. Rice, Jr., argued, Cleveland, Ohio, for petitioners.

Kenneth W. Gideon, Chief Counsel, I.R.S., Robert A. Bernstein, John A. Dudeck, Jr. argued, Glenn L. Archer, Jr. and Michael L. Paup, Tax Div., Dept. of Justice, Washington, D.C., for respondent.

Before KENNEDY and CONTIE, Circuit Judges, and PECK, Senior Circuit Judge.

JOHN W. PECK, Senior Circuit Judge.

The principal issue raised by this appeal is one of first impression, namely, whether income received by profit sharing trusts qualified under Sec. 401 of the Internal Revenue Code, 26 U.S.C. Sec. 401, ¹ from their limited partnership interests constituted unrelated business taxable income under Sec. 512. Other issues raised by this appeal include whether the taxpayers were liable for additions to tax under Sec. 6651(a)(1), whether the Commissioner of Internal Revenue was estopped from assessing the deficiencies and additions to tax at issue after abating an initial, erroneously imposed assessment, and whether the taxpayers were entitled to attorneys' fees under the Equal Access to Justice Act (EAJA), 28 U.S.C. Sec. 2412(b).

In a decision announced May 20, 1982, the Tax Court held against the taxpayers on all issues. 78 T.C. 812 (1982). We affirm.

I.

The three taxpayers, Service Bolt & Nut Co. Profit Sharing Trust (SBN Trust), Service Bolt & Nut of Akron, Inc. Profit Sharing Trust (Akron Trust), and Service Bolt & Nut of Pennsylvania, Inc. Profit Sharing Trust (Penn Trust), were established as profit sharing trusts qualified under Sec. 401(a) by Service Bolt & Nut Co., Inc. (SBN Co.), Service Bolt & Nut of Akron, Inc. (SBN Akron), and Service Bolt & Nut of Pennsylvania, Inc. (SBN Penn), respectively. At all times relevant, each trust claimed tax exempt status under Sec. 501(a).

On July 1, 1974, a number of events relevant to this case occurred. SBN Co. created two wholly-owned subsidiaries: Service Bolt & Nut of Lorain, Inc. (SBN Lorain) and Service Bolt & Nut of Cleveland, Inc. (SBN Cleveland). SBN Co. immediately divested itself of the subsidiaries by selling its stock in them to a third party. SBN Lorain and SBN Cleveland each established a qualified profit sharing plan and trust: Service Bolt & Nut of Lorain, Inc. Profit Sharing Trust and Service Bolt & Nut of Cleveland, Inc. Profit Sharing Trust, respectively. SBN Co., SBN Akron, SBN Penn, SBN Lorain, and SBN Cleveland each subscribed as the general partner to the articles of one of five partnerships created under the Ohio Uniform Limited Partnership Act, Ohio Rev.Code Sec. 1781.01 et seq. ² Each corporation sold its inventory to the partnership in which it was the general partner and caused that partnership to sell limited partnerships totalling ninety percent of the interest in the partnership to the profit sharing trusts established by the other Service Nut & Bolt corporations. ³

As limited partners, the trusts did not participate in the management of the partnerships and their liability was limited to the amount of their capital contribution. The partnerships engaged actively in the wholesale fastener distribution business.

For the taxable year ending September 30, 1975, SBN Trust received from its partnership interests gross income of $88,318.46 and net income of $75,692.00. SBN Trust did not file a tax return for the taxable year ending September 30, 1975.

For the taxable year ending December 31, 1974, Akron Trust received from its partnership interests gross income of $105,102.52 and net income of $26,219.00. For the taxable year ending December 31, 1975, Akron Trust received from its partnership interests gross income of $13,927.49 and net income of $12,927.00. Akron Trust did not file a tax return for either year.

For the taxable year ending December 31, 1974, Penn Trust received from its partnership interests gross income of $102,799.41 and net income of $15,475.00. Penn Trust did not file a tax return for the taxable year ending December 31, 1974.

On September 6, 1977, each trust received from the Office of the Internal Revenue Service (IRS) a "30-day letter" which proposed to tax the trust on the income it had received from its limited partnership interests. On October 17, 1977, on the basis of the "30-day letter", but without statutory authorization, ⁴ the Commissioner assessed income taxes and additions to tax against each trust.

Following the granting of extensions of time for filing a written protest, the District Director of the IRS at Cleveland, Ohio received on December 16, 1977, a timely protest, a request for a National Office Conference, and a request for technical advice from each trust. These requests were forwarded to the Washington, D.C. office of IRS on January 20, 1978 and the trusts were so advised by letter.

On August 9, 1978, John B. Eldred, Chief, Technical Staff, wrote John P. Rice, Jr., attorney for the trusts, on behalf of the District Director of IRS and enclosed for Rice's information copies of the National Office's response to the request for technical advice. Eldred also informed Rice in writing that "[t]his rationale will be included as a part of the statutory notices to be issued at an early date with respect to the above trusts." ⁵

Eldred subsequently requested the IRS Cincinnati Service Center to adjust the October 17, 1977 assessments "due to the assessment having been made in error." Eldred also notified the Center that a statutory notice was being prepared and would be issued at an early date. On January 8, 1979, the Center abated the assessments and so notified each trust. On November 1, 1979, IRS issued statutory notices of deficiency to each trust.

On December 6, 1979, Rice informed IRS by letter that, on the basis of the January 8, 1979 abatement, the trustees of Penn Trust had disbursed all funds in the trust to the beneficiaries. Rice also informed IRS that the other trusts had received a statement of adjustment.

On January 29, 1980, each trust filed a petition in the Tax Court for a redetermination of the assessed deficiencies. The cases were consolidated and submitted on a stipulated statement of facts. In its decision, the Tax Court sustained the determinations of the Commissioner and held that the trusts received unrelated business taxable income in their capacity as limited partners, that the trusts were liable for additions to tax under Sec. 6651(a)(1), that the Commissioner was not estopped from reassessing taxes and additions to tax after abating the initial, erroneously imposed tax, and that the trusts were not entitled to attorneys' fees under the EAJA. The trusts, contending that the Tax Court erroneously resolved each issue, filed this appeal.

II.

In sustaining the deficiencies assessed by the Commissioner, the Tax Court adopted the Commissioner's contention that, absent one narrow exception not relevant here, neither the language of the controlling sections of the Code nor the policies underlying those sections warranted treatment of a tax exempt trust's income from its limited partnership interests different from that of a tax exempt trust's income from its general partnership interests. The Tax Court held that both general and limited partnership interests could produce unrelated business taxable income.

The argument that the trusts advance on appeal is the same as that presented to the Tax Court. Briefly summarized, the argument runs as follows: As the legislative history shows, the purpose of the tax on unrelated business income is to prevent unfair competition by otherwise nontaxable trades and businesses with their taxable counterparts. The language of Sec. 512(a)(1), ⁶ which provides a general definition of the term "unrelated business taxable income", indicates that a tax exempt organization's income from an unrelated trade or business would be taxable only where the organization actively engages in the management, operation, and control of the trade or business. Accordingly, income from a limited partnership interest to the trust would not be taxable because a limited partnership interest is a passive investment that does not permit the trust to actively engage in the management, operation or control of the partnership. This conclusion is corroborated by the use in Secs. 512(c) ⁷ and 513(b) ⁸ of the term "member", the natural, ordinary and familiar referent of which, it is argued, is a general partner. Finally, although Sec. 512(c) has never been judicially interpreted, the interpretation of the section proposed by the trusts is similar to the interpretation of the Philadelphia Net Profits Tax by the Superior Court of Pennsylvania. Freedman v. Tax Review Board, 212 Pa.Super. 442, 243 A.2d 130 (1968), aff'd by an equally divided court, 434 Pa. 282, 258 A.2d 323 (1969).

We conclude that this line of argument is meritless. Nothing in the language of the Code sections at issue nor in the purpose of the statute as expressed in its legislative history compels a determination that an exempt trust's income from a limited partnership should be excluded from the computation of the trust's unrelated business taxable income.

Turning to the statutory language, we believe the trusts' reliance on Sec. 512(a)(1) to be misplaced. Although Sec. 512(a)(1) provides a general definition of "unrelated business taxable income", Sec. 512(c) establishes a special rule for the computation of an exempt organization's unrelated business taxable income received from its partnership interests. This rule expressly provides that an exempt organization can be taxed on its share of the income received from a...