Shaw-Walker Company v. CIR

Decision Date13 February 1968
Docket NumberNo. 17268.,17268.
Citation390 F.2d 205
PartiesThe SHAW-WALKER COMPANY, a corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Court of Appeals — Sixth Circuit


John P. Carroll, Jr., New York City, for petitioner, Davis, Polk & Wardwell, New York City, on the brief, Cyrus J. Halpern, J. Anthony Kline, New York City, Edward C. McCobb, Grand Rapids, Mich., of counsel.

Albert J. Beveridge, III, Atty., Tax Division, Dept. of Justice, Washington, D. C., for respondent, Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Attys., Dept. of Justice, Washington, D. C., on the brief.

Before O'SULLIVAN, PHILLIPS and EDWARDS, Circuit Judges.

PHILLIPS, Circuit Judge.

The taxpayer, the Shaw-Walker Company, seeks review of a decision of the Tax Court finding a deficiency of $1,580,366.50 for the taxable years 1955, 1956 and 1957 in accumulated earnings tax under Section 531, Internal Revenue Code of 1954, 26 U.S.C. § 531.1

The Tax Court agreed with the Commissioner in holding that Shaw-Walker had accumulated earnings to such an extent in prior years that failure of the corporation to distribute all of its current earnings as dividends during the three taxable years in question subjected it to liability for accumulated earnings tax on all its earnings in each of those three years. The Tax Court allowed certain accumulated earnings credits under 26 U.S.C. § 535(c), as hereinafter detailed, but failed to credit them against the tax assessed for any of the taxable years in question because of excessive accumulations during prior years. The result was to tax all the net earnings of the taxpayer for each of the taxable years.

The ultimate findings of fact made by the Tax Court were that during each of the taxable years the taxpayer permitted its earnings and profits to accumulate beyond the reasonable needs, including the anticipated needs, of the business and that during each of these years the corporation was availed of for the purpose of avoiding the income tax with respect to its shareholders by permitting earnings and profits to accumulate instead of dividing or distributing them.

The statement of the taxpayer submitted pursuant to § 534(c) of the Internal Revenue Code, 26 U.S.C. § 534(c),2 which is discussed hereinafter, is filed as an appendix to this opinion. For a more complete statement of facts, reference is made to this appendix and to the Memorandum Findings of Fact and Opinion of the Tax Court, T.C. Memo, 1965-309. The facts will be stated here only to the extent necessary to dispose of the issues discussed in this opinion.

Shaw-Walker was founded by two partners in 1899 with an initial capital of $3,500. At its inception the corporation sold card indexes. During the taxable years the corporation manufactured and sold more than 5,000 different products and advertised that it supplied "everything for the office except machines," principally office furniture, filing supplies and filing equipment.

Management and manufacturing headquarters of the corporation are in Muskegon, Michigan. It sells its products through eighteen branch offices and through numerous local office equipment dealers. For the taxable years annual sales ranged from $22 million to $24 million.

The Walker family has managed the corporation's affairs since 1903 and during the taxable years owned approximately 65 to 70 per cent of its common stock. No stock was held by or available to the public. The Tax Court found that Shaw-Walker was managed informally:

"Prior to and during the taxable years the executives located in Muskegon constituted a majority of the board of directors. These executives operated the petitioner by the method of daily consultation since they saw each other almost daily and sometimes many times a day. When matters came up that had to be solved they were able to discuss their problems with L. C. Walker and have a decision made. Thereafter, the decisions and actions of the executives were simply ratified or approved by the board of directors."

The corporation paid the following salaries and dividends to members of the Walker family during the years 1954-1957:

                          L. C. Walker                 Shaw Walker          
                  Year    Dividends Compensation Dividends Compensation
                    1954          $179,171           $25,000          $145,100          $15,000
                    1955           179,721            35,417           145,070           17,083
                    1956           213,195            50,000           174,048           20,000
                    1957           213,845            50,000           174,048           21,667

Dividends also were paid to other members of the Walker family who held stock but were not employed by the corporation.

Substantial dividends were paid to stockholders for the years immediately prior to 1954:

                                     Earnings of the
                                      Company After
                  Year Ended          Federal Income          Dividends
                    June 30               Taxes              Distributed
                     1946               $  195,030             $163,523
                     1947                1,406,620              402,657
                     1948                1,514,757              397,670
                     1949                1,463,724              590,529
                     1950                1,448,207              638,534
                     1951                1,580,796              635,884
                     1952                1,604,558              576,857
                     1953                1,377,589              638,901

Between the taxable years ended June 30, 1946, and June 30, 1957, the company's earnings after taxes were $18,385,892 and during those years it distributed $6,833,631 in dividends.

The following data is also relevant:

                of Net Income
                Net Taxable (after
                Year Income Less Earnings   taxes) Distributed
                Ended Provision Dividends Retained in as
                June 30   for Taxes  Distributed the Business  Dividends 
                   1955         $1,460,655.77     $629,646.70      $  831,009.07        43.1
                   1956          2,490,240.09      792,604.57       1,697,635.52        31.8
                   1957          2,519,342.72      856,071.51       1,663,271.21        33.9

The Tax Court found that it was the taxpayer's policy to finance its growth out of its retained earnings and that the last time Shaw-Walker owed money to a bank was in 1938.

Unless a corporation can prove to the contrary by a preponderance of the evidence, the fact that its earnings and profits are permitted to accumulate beyond the reasonably anticipated needs of the business is determinative of the purpose to avoid the income tax in applying the accumulated earnings tax. 26 U.S.C. § 533(a).3 If the taxpayer is able to prove that it accumulated all or any part of its earnings to meet its reasonable business needs, this amount is allowable as a credit against its accumulated earnings tax. 26 U.S.C. § 535(c). Upon receipt of the Commissioner's proposed notice of deficiency, the taxpayer may submit a statement of the grounds (together with facts sufficient to show the basis thereof) upon which it relies to show that the accumulations were for its reasonable business needs. When a § 534(c) statement is filed by the taxpayer in proper form to meet the requirements of the statute, the burden of proving that earnings and profits were accumulated beyond the reasonable needs of the business shifts to the Commissioner. 26 U.S.C. § 534(a).4

Although the fact that the corporation was availed of for the proscribed purpose may be proved by the accumulation of earnings and profits beyond its reasonably anticipated business needs, the purpose to avoid shareholder income tax may also be proved by other circumstances:

"(2) The existence or nonexistence of the purpose to avoid income tax with respect to shareholders may be indicated by circumstances other than the conditions specified in section 533. Whether or not such purpose was present depends upon the particular circumstances of each case. All circumstances which might be construed as evidence of the purpose to avoid income tax with respect to shareholders cannot be outlined, but among other things, the following will be considered:
"(i) Dealings between the corporation and its shareholders, such as withdrawals by the shareholders as personal loans or the expenditure of funds by the corporation for the personal benefit of the shareholders.
"(ii) The investment by the corporation of undistributed earnings in assets having no reasonable connection with the business of the corporation (see § 1.537-3), and
"(iii) The extent to which the corporation has distributed its earnings and profits."
Treas.Reg. § 1-533-1.

The issues of whether accumulations are beyond the reasonable needs of the business and whether a corporation has been availed of for the proscribed purpose present questions of fact. The Tax Court's findings of fact may be set aside on review only if they are clearly erroneous. Helvering v. National Grocery Co., 304 U.S. 282, 58 S.Ct. 932, 82 L.Ed. 1346; Kirlin Corp. v. C. I. R., 361 F.2d 818 (6th Cir.).

1) Burden of Proof

One of the issues to be determined is whether the § 534(c) statement filed by the taxpayer (appendix hereto) was sufficient to shift to the Commissioner the burden of proving that all or any part of the net earnings and profits were permitted to accumulate beyond the reasonably anticipated needs of the business.

Prior to the trial the taxpayer filed a motion asking the Tax Court to determine that its statement satisfied the requirements of § 534(c) and that the Court determine that the burden of proof had shifted to the Commissioner. The Tax Court denied this motion and ruled that "the interests of both parties as well as that of the Court will best be served by allowing this question to be disposed of at or after trial." 39 T.C. 293.

In the hearing before the Tax Court the Commissioner contended that Shaw-Walker's § 534(c) statement was...

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