Sportwear Hosiery Mills v. Commissioner of Int. Rev.

• Decision Date: 25 June 1942
• Docket Number: No. 7922.,7922.
• Citation: 129 F.2d 376
• Parties: SPORTWEAR HOSIERY MILLS v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

129 F.2d 376 (1942)

SPORTWEAR HOSIERY MILLS v. COMMISSIONER OF INTERNAL REVENUE.

No. 7922.

Circuit Court of Appeals, Third Circuit.

Argued April 7, 1942.

Decided June 25, 1942.

COPYRIGHT MATERIAL OMITTED

George E. H. Goodner, of Washington, D. C. (Helen Goodner, of Washington, D. C., on the brief), for appellant.

Bernard Chertcoff, Sp. Asst. to Atty. Gen., Samuel O. Clark, Jr., Asst. Atty. Gen., and J. Louis Monarch, Sp. Asst. to Atty. Gen., for appellee.

Before BIGGS, JONES, and GOODRICH, Circuit Judges.

GOODRICH, Circuit Judge.

The petitioner, a corporation with principal place of business in Pennsylvania, seeks review of the action of the Board of Tax Appeals affecting its liability for income and unjust enrichment taxes for the year 1936. There are three questions involved.

The first has to do with the correctness of the Commissioner's action regarding the deduction made for salary for Fannie Goldberg, secretary of the corporation. She became the owner in 1936 of 1/3 of the common and 2/9 of the preferred stock of the company. She was thereafter voted $125 per week salary. This amount, so far as concerns a deduction for tax purposes, was reduced by the Commissioner as excessive. The Board of Tax Appeals upheld the Commissioner. The taxpayer, of course, had the burden of persuasion upon the point that the Commissioner was wrong.¹ The Board heard the evidence and reached a conclusion sustaining him. It is well settled that the reasonableness of such allowance is a question of fact² and equally clear that a conclusion of fact is binding upon us if supported.³ We have read the testimony set out in the petitioner's appendix. No good purpose would be served by repeating it. It is sufficient to say that the conclusion of the Board is not to be disturbed upon this point.

The second question concerns the construction of § 14(c) (1) of the Revenue Act of 1936. Section 14⁴ imposes a graduated surtax on undistributed corporate profits. The amount of the tax depends upon the excess of the adjusted net income (net income minus a credit for normal tax and other credits, not relevant here) over the undistributed net income (adjusted net income minus a credit for dividends paid and other credits, not material here) and as this increases, the tax due decreases.⁵

The problem in this case is concerned only with the effect of a paragraph providing for a "Specific credit". Section 14(c) (1) provides:

"(1) Specific credit. If the adjusted net income is less than $50,000, there shall be allowed a specific credit equal to the portion of the undistributed net income which is in excess of 10 per centum of the adjusted net income and not in excess of $5,000, such credit to be applied as provided in paragraph (2)."⁶

Despite taxpayer's argument that the meaning of this paragraph is clear, we think an ambiguity is apparent: namely, whether the clause "not in excess of $5,000" modifies "the portion of the undistributed net income" or the entire clause which precedes it. This ambiguity we must resolve to reach a decision in this case.

Treasury Regulation 94, Article 14-3 adopts the first view.⁷ The Commissioner followed this construction and allowed the taxpayer a specific credit of $3,416.84 on its adjusted and undistributed net incomes of $15,831.62. The two were identical in this case for no dividends were declared for the tax year in question. The taxpayer adopts the alternative view and claims a credit of $5,000.⁸ The only question involved in this part of the case is which of the two views is the one to be followed.

The question is by no means free from difficulty. The Treasury Regulation cannot, of course, change the law, but where two interpretations are possible, as here, the administrative view counts for something. Fawcus Machine Co. v. United States, 1931, 282 U.S. 375, 378, 51 S.Ct. 144, 75 L.Ed. 397. A majority of the Board of Tax Appeals in this case, supported the Commissioner's interpretation. So does a square decision of the 6th Circuit. Black Motor Co., Inc., v. Commissioner of Internal Revenue, 6 Cir., 1942, 125 F.2d 977, petition for rehearing denied, April 6, 1942. Apart from authority, we think that the construction offered by the Commissioner leads to more consistent results and presumably, therefore, is within the Congressional intent. A construction is unreasonable when it produces an absurdity,⁹ and some of the results of applying the taxpayer's construction are at least incongruous. For example:

A corporation with an adjusted net income of $50,000 is not entitled to a specific credit. If its undistributed net income is also $50,000, its tax under § 14 would be $10,250. If the corporation's adjusted and undistributed net incomes were one cent less or $49,999.99, it would fall within § 14(c) (1). Under the taxpayer's construction the tax would be $9,250 or $1000 less; under that of the Commissioner, $10,250.¹⁰ The specific credit would be $5000 and 0 respectively.

We believe that the meaning ascribed to § 14(c) (1) by the Treasury Regulations is the more reasonable. By it the specific credit decreases proportionately as the adjusted net income approaches the $50,000 limit and the undistributed profit tax approaches uniformly, not by leaps and bounds, the tax at the $50,000 level.¹¹

The petitioner supports its construction by two major arguments. First, it maintains that under the interpretation urged by the Commissioner, every corporation, regardless of the size of its undistributed net income is alloted up to $5,000 of that income for taxation at 7%.¹² If Congress had intended this result, it could, so runs the argument, easily have so provided. But it did not.

But the taxpayer oversimplifies the effect of the supposed intent of Congress. If we look for a moment at the Commissioner's interpretation, it becomes apparent that it produces an additional result which would not have been accomplished had Congress worded § 14(c) (1) in the manner petitioner speaks of. The illustrations in footnote 11 show that as the adjusted net income approaches $50,000, the specific credit decreases. By § 14(c) (2) (A), the specific credit is deducted from the undistributed net income. Thus, the final amount of undistributed net income subject to surtax rates depends, in part, upon the amount of the specific credit. Since the surtax rates are graduated, § 14(b), that is higher as the undistributed net income increases, the lower the specific credit, the greater is the portion of undistributed net income subject to those higher surtax rates. Thus, although $5,000 is always taxed at 7%, the respective amounts of its components (the specific credit and 10% of the adjusted net income), which admittedly are variable, determine the final surtax rates applicable, and hence, the total tax.

Secondly, the taxpayer argues that its construction in allowing a larger specific credit effectuates the intent of Congress to favor small corporations; that under the Regulations the specific credit is determined without regard to the undistributed net income.¹³ This argument is ingenious but is less forceful when it is borne in mind that Congress did not make the rate of the tax to be paid dependent upon the amount of undistributed net income alone. We believe that the sought for Congressional purpose would be better attained if, as the corporation's adjusted net income approached $50,000, the specific credit decreased. This result is obtained under the Regulations. However, under the taxpayer's construction, any corporation with an undistributed net income of $5,555.55 and thus necessarily an adjusted net income of at least the same amount, or anywhere in excess of that sum, would have a specific credit of $5,000.¹⁴ It may be conceded that the specific credit is computed independently of the undistributed net income. But it cannot be overlooked that the specific credit is but one of the factors which determines the final amount of the tax. The size of the undistributed net income, although usually not a real factor in arriving at the specific credit, is very important in the determination of tax liability. After all, the total effect of § 14 is to determine the amount of the tax to be paid, and as such its subdivisions define the separate components to be considered together in arriving at the final result.

On this question, therefore, we agree with the conclusion of the Commissioner, the Board of Tax Appeals, and the Sixth Circuit.

The third point involves petitioner's liability under § 501(a) (2) of the Unjust Enrichment Act.¹⁵ That section imposes a tax "equal to 80 per centum of the net income from reimbursement received by such person from his vendors of amounts representing Federal excise-tax burdens included in prices paid by such person to such vendors, to the extent that such net income does not exceed the amount of such Federal excise-tax burden which such person in turn shifted to his vendees." The primary purpose of this act was to tax the profits realized in the form of refunds as a result of the Agricultural Adjustment Act¹⁶ being declared unconstitutional,¹⁷ in those cases where the taxpayer had passed the processing tax on to his vendees.¹⁸

In 1936 petitioner was paid back by its vendors the amount of $15,030.34 on cotton yarn it had previously purchased. Petitioner filed an unjust enrichment return, but reported no tax liability. The Commissioner determined a deficiency in tax of $1,314.37 on unjust enrichment in the amount of $2,737.29. Of this sum $954.74 represented payments from one concern, Clyde Fabrics, received through its broker, the Palmetto Yarn Corporation and $1,417.23 from another, the Johnston Mills Company. These payments do not appear to have been made pursuant to contract.¹⁹ The Board of Tax Appeals sustained the Commissioner's determination.²⁰

Petitioner, on appeal to this Court, pressed the same three contentions it had raised before the Board. We shall consider them in order.

First. Pe...