Opinion
No. K-255.
May 8, 1933.
1. J.E. Ervine Co. was during the period involved in this suit a partnership composed of J.E. Ervine and J.E. Bishop, having its principal place of business at Houston, Tex. It was organized in 1904, and dealt in grain, real estate, oil leases, and royalties. Its partnership agreement was oral, the partners agreeing that they would share equally in the profits of the business, the capital to be owned by them in proportion to the amounts each contributed thereto. In the latter part of 1927 or early part of 1928 the firm name was changed from J.E. Ervine Co. to Ervine Bishop.
2. J.E. Ervine Co. made and filed with the collector of internal revenue for the First district of Texas a partnership income tax return on form 1065, for the taxable year 1917, showing thereon net income in the sum of $20,712.42, and a partnership excess-profits tax return on form 1102, for the calendar year 1917, showing thereon net income subject to excess profits tax in the amount of $23,551.38.
3. The Commissioner of Internal Revenue recomputed the excess profits tax of the plaintiff excluding from plaintiff's invested capital the amount of $98,309.07, representing the net cost paid out of partnership funds for eleven-sixteenths interest in certain land, the remaining five-sixteenths interest in which was owned by the sister of one of the two partners and the brother of the other. As the result of this decrease in invested capital, the Commissioner found to be due from the plaintiff excess profits taxes amounting to $6,117.37, to which was added a penalty of $183.66, and interest of $170.19, making a total deficiency of taxes, penalty, and interest amounting to $6,471.22.
4. The taxes, penalty, and interest were assessed against the plaintiff by the Commissioner of Internal Revenue, and said amount was paid to the collector of internal revenue by the plaintiff as follows: April 25, 1923, $444.23; May 29, 1923, $6,026.99.
5. After the payment of the taxes, penalty, and interest, the plaintiff on May 31, 1923, filed with the collector a claim for refund of $6,026.99 excess profits taxes for the year 1917 on the grounds that the disallowance as invested capital of the partnership investment in the lands in question was erroneous, and stating in part as follows:
"The additional assessment of $6,117.37 is based upon a disallowance of the value of certain lands owned by the partnership as invested capital and as follows:
"J.E. Ervine Co., a partnership composed of J.E. Ervine and J.E. Bishop, own an eleven-sixteenths interest in certain lands which will hereafter be further described, the remaining five-sixteenths interest is owned by Mrs. J.E. Scott and Mr. H.W. Bishop. In the general partnership the interests of Mr. Ervine and Mr. Bishop are equal, but in this particular land the eleven-sixteenths interest held by the partnership is distributed to the partners, seven-sixteenths to J.E. Ervine and four-sixteenths to J.E. Bishop."
6. A part of the land involved in this suit, known as the Nolan tract, consisting of about 5,000 acres of farming and prairie lands, was purchased in 1909, four-sixteenths interest therein being acquired by Mrs. J.E. Scott, Mr. Ervine's sister, one-sixteenth by H.W. Bishop, Mr. Bishop's brother, and the remaining eleven-sixteenths being paid out of partnership funds. The partnership not having sufficient funds to purchase the entire tract, Mrs. J.E. Scott and H.W. Bishop were invited to take an interest. It was agreed between the two partners that the capital accounts and expenses and profits in connection with this land were to be on the basis of seven-sixteenths to Mr. Ervine and four-sixteenths to Mr. Bishop. At the time the land was purchased, the deeds were made to Mr. Ervine; later part of the land was sold, and, the purchaser having defaulted, title to the land was recovered in 1916 through court proceedings, when the deed was made to J.E. Bishop and J.E. Ervine. Both the original purchase and the reacquirement were reflected on the books of the partnership in accordance with the proportions above stated. The amount paid out of partnership funds for the reacquirement of the eleven-sixteenths interest in this part of the Nolan tract was $55,567.19, and the amount paid out of said funds as the cost of the eleven-sixteenths interest in the remainder of the Nolan tract was $20,735.00. This land was more valuable in 1917 than in 1909. The remainder of the land involved in this suit, a lot in San Antonio, was acquired in 1913 at a cost of $69,520. Eleven-sixteenths of this amount, or $47,795, was paid out of partnership funds, and the transaction was reflected on the books of the partnership in the same proportions of interest as in the case of the Nolan tract, referred to above.
7. The total cost of the eleven-sixteenths interest in all the land involved herein was $124,097.19, against which there was an indebtedness of $25,788.12, leaving $98,309.07, which amount the Commissioner of Internal Revenue excluded from plaintiff's invested capital.
8. During the existence of the partnership, neither of the partners had any business dealings outside of the partnership; the only property owned by Mr. Ervine, other than his interest in the partnership, was his home and some property left to him by his mother, and the only property owned by Mr. Bishop, other than his interest in the partnership, was his home. The partnership was held out to the public as such, and it was generally known to persons with whom they did business that it was a partnership. They frequently borrowed money for the account of the partnership, issued partnership notes, secured partnership loans by pledging various assets, including their interest in the Nolan tract, and in deferred purchase-money notes received from the sale of the lot in San Antonio the two tracts involved herein. The entire eleven-sixteenths interest in all the land was liable for the partnership debts. The income from said land went into partnership income, and was so reported on income tax returns. Statements furnished banks for the purpose of securing partnership credit listed the eleven-sixteenths interest in the land as a partnership asset. The partnership had other transactions, such as oil leases and royalties, aside from the real estate transactions involved in this suit.
9. There was filed with the Commissioner of Internal Revenue on February 20, 1923, a power of attorney, whereby J.W. McCullough, of Houston, Tex., was appointed agent and attorney in fact of the plaintiff in all matters respecting its federal tax liability for the year 1917.
10. The Commissioner of Internal Revenue on January 26, 1924, wrote plaintiff as follows:
"Your claim for refund of $6,026.99, excess-profits tax, for 1917, has been examined and is rejected.
"The claim is based on the statement that the examining officer eliminated from invested capital $98,309.07, which represents eleven-sixteenths of the value of land owned by J.E. Ervine and J.E. Bishop, individual members of the partnership of J.E. Ervine Company, together with Mrs. J.E. Scott and W.H. Bishop.
"Inasmuch as the property is not exclusively owned by J.E. Ervine Company, it does not constitute invested capital of the partnership and income and expenses in connection with the property should not be considered in the computation of the partnership's income.
"The rejection indicated above will officially appear on the next schedule to be approved by the Commissioner."
Said rejection appeared on Schedule No. 2069, dated January 17, 1924.
11. On January 26, 1925, plaintiff filed with the solicitor of internal revenue a sworn statement of facts relating to its claim for refund, and, after reciting that the claim had been rejected on inadequate grounds, asked the solicitor for a consideration of its claim and his conclusions thereon.
12. J.W. McCullough on November 9, 1925, wrote the solicitor of internal revenue as follows:
"You will recall my visit with you in Washington the latter part of September, at which time I endeavored to secure information as to the status of our pending claim in the J.E. Ervine Company case, file IT:R: CC 3 — MAH, and my letter to the Solicitor dated January 26, 1925, which was written after a conference with you and one of your associates.
"As stated to you verbally, Messrs. J.E. Ervine Company feel that an injustice has been done them and are inclined to test their rights in the courts, and it was on this account that I felt privileged to discuss the matter with you in the hopes that litigation could be avoided. We have now waited about as long as we can under the law, and in order to protect our rights, if we have any, will have to begin action, as I understand it, within the near future. Therefore, if it is possible for you to give me your conclusions in this matter I assure you such action will be greatly appreciated. * * *"
The solicitor replied on November 16, 1925: "This will acknowledge your letter in the matter of J.E. Ervine Company, in which I have taken up with Mr. Marrs, who has the case in charge, an early determination of the decision of the office. I hope that we can give you something definite in the near future."
13. On January 12, 1926, the solicitor wrote J.W. McCullough Company asking for certain information as follows:
"1. Whether the property (farm land, lots, etc.) in question, was purchased with the capital or surplus funds of the partnership J.E. Ervine and Company.
"2. If said property was purchased with the surplus of said partnership, in which partnership Messrs. J.E. Ervine and J.E. Bishop are equal partners, why were not the interests in said property taken on the same basis?
"3. Would it be possible for the taxpayer to explain why the interests in said property were divided as follows:
"`Mr. J.E. Ervine, partner, seven-sixteenths.
"`Mr. Ervine's sister (Mrs. J.E. Scott), four-sixteenths.
"`Mr. J.E. Bishop, partner, four-sixteenths.
"`Mr. Bishop's brother (Mr. H.W. Bishop), one-sixteenth.
"4. Has the taxpayer any further evidence on the question as to whether and when the property under discussion was paid in to the partnership?"
The plaintiff on February 24, 1926, replied to the foregoing communication, answering categorically and fully the questions propounded.
14. Plaintiff again wrote the solicitor on November 8, 1926, as follows:
"Under date of February 24, 1926, we replied to your communication dated January 12th, your file SOL:R. It was our hope that with the information which was furnished, your office would be able to advise us of your conclusions. While in Washington last June our Mr. McCullough called at your offices and discussed, in a general way, the matter with your Mr. Marrs, and was promised something definite from you within thirty or sixty days from that date. We have not received this advice.
"As explained to your assistant, Mr. Fox, our object in coming to you with this case is to avoid the expense and inconveniences of a suit, preferring to submit all of the facts upon which we would rely in the event of a suit, to you for careful review; and, upon the assumption that your good offices can be used to avert litigation as well as defend the Government, after suit is begun, we will be largely, if not altogether, influenced by your conclusions. We feel the tax involved which was assessed and collected from this company was determined as the result of a misunderstanding of the facts in the case, and therefore we sought permission to present these to you and secure your conclusions after review."
On April 22, 1927, the solicitor replied:
"Reference is made to your letter of November 8, 1926, in which you ask to be advised of the conclusion reached by this office on your request for the reconsideration of a claim for refund filed by you for the taxable year 1917, which was rejected by the Income Tax Unit. The basis of the Unit's action is set forth in its letter dated October 13, 1924.
"In this connection you are informed that this office has given the case careful consideration in connection with your communication of February 24, 1926. This communication does not, however, contain any further or additional evidence than was already before this office when the letter of October 13, 1924, was written to you. This office has, therefore, decided that you have not presented such additional evidence as will warrant a reversal of the action taken by the Income Tax Unit. The case has, therefore, been returned to the Unit with advice to that effect."
15. The Commissioner of Internal Revenue wrote plaintiff on June 2, 1927, as follows:
"Reference is made to a letter from your representative, Mr. J.W. McCullough, dated February 24, 1926, in reply to office letter of January 12, 1926, relative to the rejection of your claim for refund of income taxes assessed for the year 1917.
"Your claim is based upon the statement that there should be included in the invested capital for the year 1917 the amount paid for farm lands by the members of the partnership.
"In office letter dated January 26, 1924, the claim was rejected, and in a letter dated October 13, 1926, your representative, Mr. McCullough, was advised that the evidence submitted did not prove to the satisfaction of this office that the partners, Messrs. J.E. Ervine and J.E. Bishop, paid to the partnership for interest and shares their respective seven-sixteenths and four-sixteenths individual interest in certain real estate.
"You are advised that the statements contained in the letter of February 24, 1926, have been considered. Since no additional evidence was contained therein, the action previously taken is sustained."
William Warfield Ross, of Washington, D.C. (Clarence A. Miller, of Washington, D.C., on the brief), for plaintiff.
Monte Appel, Asst. Atty. Gen. (John A. Rees, of Washington, D.C., on the brief), for the United States.
Before GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Action by J.E. Ervine Co. against the United States.
Judgment for plaintiff.
This case having been heard by the Court of Claims, the court, upon the report of a commissioner and the evidence, makes the following special findings of fact:
Two issues are presented in this case: (1) Whether the net cost to plaintiff of the eleven-sixteenths interest in the real estate in question should have been included in plaintiff's invested capital for the year 1917; and, if so (2) whether the plaintiff's suit was barred by the statute of limitations on the date of the filing of its petition, May 29, 1929.
The definition of "invested capital" applicable to the year 1917 is found in section 207 of the Revenue Act of 1917 ( 40 Stat. 300, 306): "(a) In the case of a corporation or partnership: (1) Actual cash paid in, (2) the actual cash value of tangible property paid in other than cash, for stock or shares in such corporation or partnership, * * * and (3) paid in or earned surplus and undivided profits used or employed in the business, exclusive of undivided profits earned during the taxable year. * * *"
The facts show that J.E. Ervine and J.E. Bishop organized a partnership in 1904, under the firm name of J.E. Ervine Co. From that time until and during the year 1917 the partnership dealt in grain, real estate, oil leases, and royalties, sharing equally in the profits of the business. During the existence of the partnership, neither partner had any business dealings outside the partnership. The only property owned by Mr. Ervine, outside the partnership property, was his home and some property inherited from his mother, and the only property owned by Mr. Bishop, other than his interest in the partnership, was his home. They frequently borrowed money for the account of the partnership, issued partnership notes, secured partnership loans by pledging partnership assets, including their interest in the real estate involved. The income from the real estate went into the partnership income, and was so returned on their income tax returns. Statements furnished to the banks for the purpose of securing partnership credit listed their eleven-sixteenths interest in the real estate.
The Commissioner of Internal Revenue in rejecting the claim for refund said:
"* * * The claim is based on the statement that the examining officer eliminated from invested capital $98,309.07, which represents eleven-sixteenths of the value of land owned by J.E. Ervine and J.E. Bishop, individual members of the partnership of J.E. Ervine Company, together with Mrs. J.E. Scott and W.H. Bishop.
"Inasmuch as the property is not exclusively owned by J.E. Ervine Company, it does not constitute invested capital of the partnership, and income and expenses in connection with the property should not be considered in the computation of the partnership's income. * * *"
The record leaves no room for doubt that the partnership owned an eleven-sixteenths interest in the real estate, and that its net cost to the partnership was $98,309.07. This interest was purchased with partnership funds. Its acquisition was a partnership transaction, and the interest was employed exclusively in the partnership business. It was, as we have seen, pledged for partnership loans, listed as a partnership asset in statements furnished to banks for credit purposes, and was liable at all times for the partnership debts. That title to the eleven-sixteenths interest was held in the individual names of the partners in unequal proportions is immaterial, in view of the fact that the whole of the interest was regarded by them and treated by them as an asset of the partnership. When the eleven-sixteenths interest in the Nolan tract was originally acquired in 1919, the deeds were made to Mr. Ervine, later part of the tract was sold, and, the purchaser having defaulted, title to the same was recovered through court proceedings in 1916, when the deed was made to the individual partners. Both the original purchase in 1909 and the reacquirement in 1916 were reflected on the books of the partnership in accordance with the proportion of the then invested capital of the respective partners in the business, and were paid out of partnership funds. The proof is uncontradicted that the eleven-sixteenths interest of the partnership in the real estate had been purchased out of the earned surplus and undivided profits of the partnership. It clearly constituted a part of plaintiff's invested capital, and should have been included as such in the computation of its tax liability for the year 1917. The contention that, because the property was not owned exclusively by the partnership, the value of its undivided interest therein does not constitute invested capital, is not supported by any authority, and we think is without merit.
The claim for refund was first disallowed by the Commissioner of Internal Revenue on January 17, 1924. The two-year limitation provided in section 3226 of the Revised Statutes as amended (26 USCA § 156) for instituting suit on this action expired on January 17, 1926. The petition was filed on May 29, 1929, and, if the statute of limitations be held to run from January 17, 1924, the plaintiff's right to maintain suit is barred. The plaintiff, however, contends that the Commissioner of Internal Revenue, subsequent to his disallowance of the claim for refund on January 17, 1924, reopened and reconsidered the same, and that the limitations on plaintiff's right to institute and maintain suit began to run on June 2, 1927, the date on which the Commissioner, after reconsideration, finally notified plaintiff that the action previously taken in respect to the claim for refund was sustained.
Although the statute makes no specific provision for the reopening and reconsideration of a claim for refund that has been disallowed by the Commissioner, the long-continued practice of the Treasury Department has been to reopen and reconsider claims disallowed in a proper case within the time allowed by the statute for bringing suit, and the regulations (T.D. 3240, October 31, 1921, 5 C.B. 313) provide for reconsideration. The authority of the Commissioner to reopen and reconsider a claim for refund that has been disallowed has been recognized by the court in Mobile Drug Co. v. United States (D.C.) 39 F.2d 940, and McKesson Robbins, Inc., v. Edwards (C.C.A.) 57 F.2d 147. In these cases it was held, and we think properly, that, when the Commissioner enters upon a reconsideration of the merits of a case, his decision for the purpose of the statute of limitation for bringing suit is in abeyance until he has reached his final conclusion. The statute impliedly gives the Commissioner the authority to reopen and reconsider his action in disallowing a claim for refund, in order to correct any errors or mistakes that may have been made in such action, if he does so within the period allowed by the statute for bringing suit upon his first action. There is nothing in the statute which prohibits the Commissioner from reopening and reconsidering a claim for refund that has been disallowed, and the purpose of the statute in requiring that the Commissioner be given an opportunity to correct any errors or mistakes that may have been made in the decision of a case before suit is brought is sufficient to sanction a new hearing and a reconsideration by the Commissioner of his decision disallowing a claim. The question for decision is whether the Commissioner did in fact reopen and reconsider the refund claim subsequent to its disallowance by him on January 17, 1924, and within the time when he had the authority to take such action.
The plaintiff on January 26, 1925, within the two-year period following the rejection of the refund claim, filed with the solicitor of the Bureau of Internal Revenue a sworn statement of facts relating to its rejected claim for refund. This sworn statement of facts was filed with the solicitor after an authorized agent of plaintiff had held a personal conference with bureau officials in reference to the matter. On November 9 following, plaintiff's attorney in fact wrote the solicitor, referring to the two previous conferences held with him in respect to the pending claim, also calling his attention to the letter and statement of facts in reference thereto filed on January 26, 1925, and stating that information as to the solicitor's conclusion in the matter would be greatly appreciated. The solicitor replied on November 16, 1925, saying: "This will acknowledge your letter in the matter of J.E. Ervine Company, in which I have taken up with Mr. Marrs, who has the case in charge, an early determination of the decision of the office. I hope we can give you something definite in the near future."
On January 12, 1926, the solicitor again wrote plaintiff's attorney in fact requesting specific information and propounding four interrogations bearing directly upon the claim. The plaintiff on February 24, 1926, replied directly to this letter, and furnished the solicitor full and detailed information in respect to the matter inquired about.
On November 8, 1926, plaintiff again wrote the solicitor, saying: "Under date of February 24, 1926, we replied to your communication dated January 12th, your file SOL:R. It was our hope that with the information which was furnished, your office would be able to advise us of your conclusions. While in Washington last June our Mr. McCullough called at your offices and discussed, in a general way, the matter with your Mr. Marrs, and was promised something definite from you within thirty or sixty days from that date. We have not received this advice."
The solicitor replied to this letter on April 22, 1927, and said: "In this connection you are informed that this office has given the case careful consideration in connection with your communication of February 24, 1926. This communication does not, however, contain any further or additional evidence than was already before this office when the letter of October 13, 1924, was written to you. This office has, therefore, decided that you have not presented such additional evidence as will warrant a reversal of the action taken by the Income Tax Unit. The case has, therefore, been returned to the unit with advice to that effect."
Thereafter, on June 2, 1927, the Commissioner of Internal Revenue notified plaintiff by letter that the previous action in rejecting the claim for refund was sustained. The Commissioner said:
"Reference is made to a letter from your representative, Mr. J.W. McCullough, dated February 24, 1926, in reply to office letter of January 12, 1926, relative to the rejection of your claim for refund of income taxes assessed for the year 1917. * * *
"You are advised that the statements contained in the letter of February 24, 1926, have been considered. Since no additional evidence was contained therein, the action previously taken is sustained."
When the Commissioner, upon application made after a decision disallowing a claim, enters upon the consideration of the merits of a case in the manner in which he did in this instance, and later renders a final decision thereon, the taxpayer has two years thereafter under section 3226 of the Revised Statutes as amended (26 USCA § 156) within which to bring suit. The facts in this case sustain the contention that the Commissioner, subsequent to his disallowance of the claim for refund on January 17, 1924, reopened and reconsidered the same, and that his final decision in the matter was in abeyance until June 2, 1927, the date on which he notified the plaintiff that the action previously taken by him was sustained.
Where the Commissioner, after the disallowance of a claim for refund, merely answers letters of inquiry, or refuses and denies an application for reconsideration without going into the case or reconsidering it on its merits, it cannot be held that there has been a reconsideration of the case. Hickman v. United States (D.C.) 47 F.2d 328. In the present case the Commissioner did far more than to refuse or deny an application for reconsideration and more than to reassemble and re-examine the files of his office to ascertain whether there was any basis for plaintiff's request to have the case reopened and reconsidered. He received and considered a sworn statement of facts submitted by the plaintiff in support of his request for a reconsideration of the claim. Not only that, but plaintiff was assured both by letter and in personal interviews with the solicitor and other officials of the Bureau that Mr. Marrs was in charge of the case and that an early decision was hoped for. Further and more important, the plaintiff was called upon by the Bureau on January 12, 1926, to furnish certain specific and highly pertinent information in reference to the claim, which information he promptly furnished. This information was requested of the plaintiff within less than a week of the time his right to institute suit on the disallowed claim of January 17, 1924, would expire. Plaintiff undoubtedly had every reason to believe that the rejected claim for refund was then being considered by the Bureau upon the merits. It would be an unreasonable and exceedingly harsh rule that would require plaintiff to go to the expense of employing counsel and instituting suit to protect against the running of the statute at a time when the Bureau was calling for and considering additional information in reference to his claim. He had a right to suppose that final decision of the Commissioner would be upon the merits of his claim, as we think it was. Furthermore, the Commissioner's letter of June 2, 1927, notifying plaintiff that the previous action of the Commissioner in rejecting the claim was sustained, explicitly stated, "You are advised that the statements contained in the letter of February 24, 1926, have been considered. * * *"
The facts in the instant case bring it within the rule announced in Mobile Drug Co. v. United States, supra, and McKesson Robbins, Inc., v. Edwards, supra. We hold, therefore, that the Commissioner of Internal Revenue reopened and reconsidered plaintiff's claim for refund, and that the statute of limitations on the right to bring suit began to run from June 2, 1927, the date of his final decision in the matter.
The plaintiff is entitled to recover, and it is ordered that judgment be entered in accordance with our conclusion of law.
BOOTH, Chief Justice, did not hear this case on account of illness and took no part in its decision.