Standard Oil Company v. United States

• Decision Date: 05 November 1964
• Docket Number: No. 10,Docket 28822.,10
• Citation: 338 F.2d 4
• Parties: STANDARD OIL COMPANY (NEW JERSEY), Appellant, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Second Circuit

338 F.2d 4 (1964)

STANDARD OIL COMPANY (NEW JERSEY), Appellant, v. UNITED STATES of America, Appellee.

No. 10, Docket 28822.

United States Court of Appeals Second Circuit.

Argued September 28, 1964.

Decided November 5, 1964.

D. Nelson Adams, New York City (Joel J. Cohen, New York City, on the brief), for appellant.

Vincent L. Broderick, Chief Asst. U. S. Atty., for the Southern District of New York (Harry Marselli, Department of Justice, on the brief), for appellee.

Before FRIENDLY, KAUFMAN and MARSHALL, Circuit Judges.

KAUFMAN, Circuit Judge.

This appeal raises interesting questions concerning the construction of the excess profit provisions of the 1939 Internal Revenue Code. Standard Oil Company (New Jersey) brought an action in the United States District Court for the Southern District of New York to recover $2,181,489.88 paid as interest on asserted "potential deficiencies" in its consolidated excess profits tax returns for the years 1943 and 1944. Chief Judge Ryan granted the Government's motion for summary judgment and dismissed the complaint. From the judgment entered upon that order Standard now appeals.

It contends that interest should not have been assessed because an unused excess profits credit carryover from 1941 prevented any deficiency from ever arising on the 1943 and 1944 returns. Standard concedes, however, that it is entitled to this unused excess profits credit carryover from 1941 only if — and this is the crucial "if" in the case — it could deduct alleged "war losses" in computing its 1941 net income for excess profits tax purposes even though it had not claimed those losses in computing its normal income tax for the same year. The District Court held that the taxpayer could not take this inconsistent position and that its choice not to take the war loss deduction for income tax purposes rendered the deduction unavailable in computing excess profits taxes. We agree and therefore affirm the judgment in favor of the Government.

Fundamental to an appreciation of Standard's tax strategy in the years in question, and the Government's view of this strategy, is an examination of the detailed yet mazelike provisions of the World War II excess profits tax. The amount of profits a corporate taxpayer might accumulate without tax was measured by its "excess profits net income" (net income for excess profits purposes being roughly equivalent to net income for normal income tax purposes in a given year) during a pre-war base period (1936-1939). This permitted accumulation was denominated the "excess profits credit." I.R.C. of 1939, §§ 713(e), 711(b) (1). To the extent that a taxpayer in 1941 and subsequent years, had excess profits net income less than the allowable excess profits credit, it was entitled to an "unused excess profits credit." §§ 710(c), 711(a). This unused excess profits credit could be carried forward or carried back two years to later or earlier tax years for the purpose of reducing or eliminating any excess profits tax liability in those years. § 710 (c), as amended by I.R.A. of 1942.

In 1942 war losses were for the first time made deductible for purposes of computing both the ordinary income tax and the excess profits tax. Section 127, added by Revenue Act of 1942, Ch. 619, 56 Stat. 852. Accordingly, Standard's 1941 income tax return, as originally filed, reflected no deduction for war losses. The same was true of the 1941 excess profits tax return filed on a consolidated basis by Standard and its affiliates, which even absent a war loss deduction showed no express profits tax liability. When the war loss deduction did become retroactively available in 1942, the only immediate reaction of the taxpayer was to cause its wholly-owned subsidiary, Standard Oil Company of New Jersey ("Esso"), to file an amended income tax return for 1941 claiming as a deduction $6,801,094.50 in war losses sustained in that year. But parent Standard chose not to claim any such war loss deductions either for 1941 income tax or excess profits tax purposes.

Not until 1944 did Standard finally recognize the war loss deduction provisions with respect to its 1941 tax year. In that year Standard, on behalf of itself and its affiliated companies, filed a consolidated excess profits tax return for 1943, claiming an excess profits carryover from 1941 based in part on alleged war losses of $50,000,000 suffered but not deducted in 1941.¹ The carryover claimed eliminated any excess profits tax liability for 1943. Similarly, Standard's consolidated excess profits tax return for 1944 disclosed no tax liability because of a carryover of unused excess profits credit from 1942 which also arose in part from the alleged $50,000,000 war losses sustained in 1941. Of important significance on this appeal is the fact that Standard, in taking advantage of the unused excess profits credit carryovers, relied on the alleged $50,000,000 war losses even though it had never claimed them as deductions on its 1941 income tax return.

If Standard did not already recognize this inconsistency, it certainly learned from the best authority by 1947. For, concededly, when Standard's 1941 income tax return was audited in 1947 the examining agent indicated that he would be willing to allow the deduction of the 1941 war losses in the 1941 returns, subject to substantiation of the $50,000,000 figure. But, Standard elected not to claim the alleged war losses as deductions in computing normal tax net income for 1941 because (1) at the time, an excess profits credit carryback from 1945 was known and more than sufficient to eliminate any excess profits tax in 1943 and 1944 and (2) the election would eliminate any problem in determining and reporting war loss recoveries.

The wisdom of this election, however, was thrown into doubt by an unforeseen decision of the United States Supreme Court. In 1950 the Court, in Manning v. Seeley Tube & Box Co., 338 U.S. 561, 70 S.Ct. 386, 94 L.Ed. 346 (1950), established the doctrine of a "potential deficiency," exposing taxpayers to liability for interest on tax deficiencies even though there was no ultimate liability for the tax upon which the interest was assessed. In short, even if Standard's excess profits tax deficiencies for the years 1943 and 1944 were ultimately eliminated by the carryback of an unused excess profits credit from 1945, the Commissioner of Internal Revenue could nonetheless assess interest on those deficiencies while they remained in Standard's treasury, instead of being available for Government spending.

The Commissioner took advantage of the "potential deficiency" doctrine in 1954 when he audited Standard's excess profits tax returns for 1943 and 1944. He disallowed a portion of the unused excess profits credit carryovers from the years 1941 and 1942, which Standard from the outset had used to eliminate excess profits tax liability for 1943 and 1944. The Commissioner maintained that Standard could not claim war loss deductions in computing the unused excess profits credit because the same deductions had not been taken for income tax purposes. The disallowances created deficiencies in the 1943 and 1944 excess profits tax returns for which the Commissioner assessed interest until the deficiencies abated, on March 15, 1946, by the application of the unused excess profits credit carryback from the year 1945.

But, it was obvious that if a carryover of unused excess profits credit from 1941 were available, it would have eliminated the 1943 and 1944 deficiencies from the outset and thus would have avoided any liability for interest on potential deficiencies. Because Standard believes that it could have relied upon the 1941 war losses in 1943 and 1944 in computing its unused excess profits credit carryover for 1941 even though it did not claim the losses in computing its 1941 income tax, it takes the position that there was never any deficiency in 1943 or 1944, and therefore seeks to recover the interest collected by the Government.

On this appeal neither party disputes the amount of Standard's excess profits credit for 1941. The contest, rather, focuses directly on the amount of excess profits net income for 1941. The issue is whether the 1941 excess profits net income could properly be retroactively reduced by the alleged $50,000,000 war losses, never claimed as deductions by Standard in computing normal-tax net income for income tax purposes, thereby increasing the unused excess profits credits carried over into 1943 and 1944. A resolution of this issue depends in turn upon an examination of Section 711(a), which equates the excess profits net income for 1941, with certain irrelevant adjustments, to the normal-tax net income "for such year." Does such net income equal the amount of gross income less deductions actually taken or gross income less deductions that could have been taken?

Standard's argument, concisely summarized, is that the war loss deduction was required under the statute to be allowed as a matter of law and that its failure to claim the deduction should not operate to deprive it of the benefits conferred by the statute. The Commissioner's mistake of law in failing to allow the war losses on the last applicable date under the Code should, according to this argument, now be rectified by permitting the deduction to be taken in computing 1941 excess profits net income. But, we feel compelled by the plain language of the Code and our common sense understanding of the deduction provisions to reject these contentions.

In defining the concept of a war loss Section 127(a) (2) simply provided that "property * * * shall be deemed to have been destroyed or seized on the date war * * * was declared." But that section by itself did not make war losses deductible; for the permission to do so one must turn to Section 23(f)'s general provision that losses sustained by a taxpayer "shall be allowed" as deductions.²

Standard's entire argument therefore must stand or fall on...