United States v. Tillinghast, 321.
| Decision Date | 20 January 1932 |
| Docket Number | No. 321.,321. |
| Citation | 55 F.2d 279 |
| Parties | UNITED STATES v. TILLINGHAST et al. |
| Court | U.S. District Court — District of Rhode Island |
Henry M. Boss, Jr., U. S. Atty., of Providence, R. I., and C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, and Frederick W. Dewart, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., for complainant.
Hinckley, Allen, Tillinghast, Phillips & Wheeler and Edwards & Angell, all of Providence, R. I., for respondents.
This is an action in equity, brought by the United States to recover the sum of $118,773.14, against the former stockholders, and the representatives of such as have deceased, of the Crefeld Waste & Batting Company, for income and excess profits taxes alleged to be due and owing to the government from that corporation for the year 1917. All the assets of this corporation were distributed to the respondents and the corporation dissolved prior to the bringing of this suit and subsequent to the accrual of the tax, if any, alleged to be due.
The Crefeld Waste & Batting Company, which will hereafter be referred to as "Crefeld," was a Rhode Island corporation, which engaged in the business of manufacturing and dealing in cotton and woolen waste. In 1905, apparently for the purpose of developing its business in the southern textile states, Crefeld caused to be organized the South Atlantic Waste Company under the laws of the state of North Carolina. Of the 1,000 shares of the capital stock of this corporation, which were issued of a par value of $100 each, Crefeld acquired 788 shares. The remaining 212 shares were held by various individuals.
Some five years later, and between March, 1910, and May, 1911, the South Atlantic Waste Company was in need of additional capital to carry on its business. This, to a total amount of $365,000, Crefeld loaned to South Atlantic, taking in evidence thereof the promissory notes of that corporation. These notes were all payable either upon demand or in three months.
Shortly thereafter there arose the consideration of a so-called plan of reorganization of the financial structure of South Atlantic and its relations with the northern company. At a meeting of the Crefeld stockholders on May 22, 1911, a reorganization plan was approved. This plan proposed that Crefeld should surrender to South Atlantic the notes evidencing the indebtedness of $365,000, provided the treasurer of South Atlantic could obtain for cancellation the 212 additional shares which were outstanding so that the same could be reissued to Crefeld. This plan was carried out, and, with the exception of a few directors' shares, the entire capital stock of South Atlantic stood in the name of Crefeld. At the close of that year, as of December 30, 1911, Crefeld wrote off its books this intercompany account by debiting its profit and loss account and crediting bills receivable. Corresponding entries, after the so-called reorganization had been acted upon and during the same year, were made on the books of South Atlantic.
In March of 1912, when the company came to file its annual net income return for the year 1911, it deducted the $365,000 as a loss, evidently regarding the obligations released as either uncollectable or as an unrecoverable capital contribution to its then wholly owned subsidiary. This deduction was disallowed by the Commissioner of Internal Revenue, and an additional tax, arising from this disallowance, of $602.17 was assessed against, and paid by, Crefeld. This was done in the summer of 1917. Shortly thereafter Crefeld, not being permitted to take this loss as for the year 1911, undertook to unscramble the eggs of the reorganization and restore upon its books the charge of $365,000 against South Atlantic and in turn crediting its profit and loss account, making at the same time the following entry: "Notes of South Atlantic Waste Company determined by United States Internal Revenue Department to have been improperly charged off in 1911 as follows: Individual notes listed."
It does not appear that the notes in question were redelivered by South Atlantic to Crefeld.
Following this action, and in the same year, Crefeld brought suit in the state courts of Rhode Island against South Atlantic ostensibly on these notes. Judgment was entered for South Atlantic in this suit on December 4, 1917, on the ground, among others, that the notes were barred by the statute of limitations. On December 12, 1917, Crefeld again charged off the $365,000 with similar entries, as before, but accompanied by the following notation: "Invalidity of the following notes of the South Atlantic Waste Company as per judgment of the Superior Court, Providence County, State of Rhode Island, December 4, 1917: Individual notes listed."
During the same month Crefeld also sold its entire stock holdings in South Atlantic for the sum of $49,700. There is no evidence that this sale was not bona fide or that it did not represent the then full market value of the stock of the subsidiary company.
Somewhat before the consummation of these steps Crefeld had begun the liquidation and distribution of its assets to its stockholders. This liquidation and distribution of assets was completed by December 31, 1918. At no time thereafter did the company possess any assets. In November, 1923, the corporation was formally dissolved and its charter surrendered under the laws of the state of Rhode Island.
On March 29, 1918, Crefeld filed with the collector of internal revenue at Hartford, Conn., a return on form 1031 designated as corporation income tax return for the calendar year 1917. This return, made after the sale of its South Atlantic stock, showed deductions in excess of the total gross income. The largest of these deductions reflected the loss claimed by Crefeld because of its unrecovered investment in South Atlantic.
Many more facts could here be stated to illuminate the ramifications of this action. To do so, however, would necessitate repetition resulting from the necessary recapitulation of those pertinent to each of the several issues to be separately considered.
Certain of the defenses raised would, if sustained, determine the whole cause of action. Others are partial defenses only, and raised by way of reduction of the amount of recovery in event the major contentions be not sustained. Each of these defenses, whether complete or partial, will be here dealt with, to the end that, in event of appeal, the controversy in its entirety may be before the court for final disposition. Succinctly stated, the various defenses interposed raise the following questions:
(1) Should the suit be dismissed because of lack of authority or sanction by the Commissioner of Internal Revenue?
(2) Is the action barred by limitation?
(3) Has the complainant established its case in so far as it is based upon the disallowance of the deductions taken by Crefeld because of the losses arising from advances to South Atlantic?
(4) Were certain rentals, paid and first agreed upon in 1917, in respect to an occupancy during prior years, properly deductible by Crefeld in the year paid?
(5) Were certain switching charges paid in 1917, but for services rendered prior thereto, deductible in the year paid?
(6) In event of recovery by the complainant, would the respondents severally be entitled to set off any part of the personal taxes already paid by them on reported profits received in the distribution of Crefeld's assets, which profits would be reduced by any recovery allowed the complainant?
These questions will be considered in the order stated.
The first issue raised is predicated upon the alleged noncompliance by the government with the requirements of section 3214, Rev. St. (26 USCA § 143), the relevant part of which is as follows: "No suit for the recovery of taxes, or of any fine, penalty, or forfeiture, shall be commenced unless the Commissioner of Internal Revenue authorizes or sanctions the proceedings."
Under date of November 17, 1925, D. H. Blair, then Commissioner of Internal Revenue, sent to the United States Attorney for the District of Rhode Island the following letter:
On November 24 the United States attorney, in compliance with this direction, instituted in this court a suit, the bill of complaint in which appears as United States Exhibit 14 in this action. It involved the same subject-matter as the present action, and was brought against the same respondents here appearing, or their predecessors in interest. This suit was dismissed on November 19,...
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