Opinion
Docket No. 10629.
1947-12-23
BLUME KNITWEAR, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Sydney A. Gutkin, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
Abandonment by petitioner of profit-sharing plan after one year of operation, upon disapproval by the Salary Stabilization Unit, held, on all the evidence, not to demonstrate lack of bona fides of trust so that it would fail to qualify under section 165(a), Internal Revenue Code. Sydney A. Gutkin, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
By this proceeding petitioner seeks a redetermination of its tax liabilities for its taxable year ended November 30, 1942, as follows:
+-------------------------------------------+ ¦Income tax ¦$1,191.96¦ +---------------------------------+---------¦ ¦Declared value excess profits tax¦2,013.45 ¦ +---------------------------------+---------¦ ¦Excess profits tax ¦8,839.93 ¦ +---------------------------------+---------¦ ¦Total ¦12,045.34¦ +-------------------------------------------+
The problem involved relates to the deductibility of a contribution to ‘an employee's profit sharing plan.‘
FINDINGS OF FACT.
Petitioner is a New York corporation, with its principal office at 1372 Broadway, New York, New York. It filed its return for the period in question with the collector of internal revenue at 110 East 45th Street, New York, New York. The return was on an accrual basis and for a fiscal year ended November 30, 1942.
On November 30, 1942, at a meeting of its board of directors petitioner established a trust known as ‘Blume Knitwear, Inc. Profit Sharing Plan.‘ Abraham Karp, Hyman Besser, and Barnett M. Lerner were named trustees in the instrument. On the same date petitioner's stockholders confirmed the action of the board of directors in creating the trust. Leslie M. Sobo, Lillian S. Rosenbaum, Barnett M. Lerner, and Benjamin Kowal comprised all of petitioner's stockholders.
Petitioner's business was such that the pay of its working employees was low. At the time in question salaries were ‘frozen‘ by Government action and petitioner desired to minimize a turnover in personnel.
The trust instrument of November 30, 1942, recited these facts and expressed the hope of relieving the condition ‘through the giving of its permanent employees a share in its profits.‘ It was also recited that the intention was to make such plan qualify under section 165 of the Internal Revenue Code.
The trust agreement stated that a beneficiary included all employees except those whose compensation was solely in the form of commissions and those whose customary employment was not more than twenty hours a week or not more than five months in a calendar year. The names of qualifying persons were set forth in an attached schedule.
Paragraph 2 of the trust agreement provided that the company, on account of its fiscal year ended November 30, 1942, should pay to the trustees before January 30, 1943, out of its net profits for its fiscal year ended November 30, 1942, an amount equal to 10 per cent of the total compensation paid to all employees who were ‘beneficiaries‘; and that on each succeeding anniversary date until the President's proclamation of the cessation of war hostilities, or on July 1, 1947, whichever was earlier, the company should pay a similar amount if its net profits exceeded $50,000. Should such excess not amount to the 10 per cent, the company was to pay only the amount of the excess.
The trustees agreed to receive, enforce, and disburse the funds in accordance with the terms of the trust; a separate account was to be maintained for each beneficiary; and the trustees were to be confined to legal investments (excluding real estate).
Paragraph 7 provided as follows:
7. The company does not obligate itself to continue to make annual payments to the trust, but reserves the right, in its absolute and unlimited discretion to refrain from making any such annual payment, although it is the present intention of the company to continue to make such payments in accordance with this agreement.
It was next provided that the trustees were to pay to each beneficiary one-fifth of the net amount of principal and income accumulated in the trust on his behalf one month after the President's proclamation, or July 1, 1947; one-fourth of the balance remaining 13 months thereafter; one-third of the balance remaining 25 months thereafter; one-half of the balance remaining 37 months thereafter, and the balance remaining 49 months thereafter. It was stated that a person who was a beneficiary on the day of the first payment should not cease to be a beneficiary for any cause, and that after the effective date ‘the trustees may in their discretion, accelerate the payments hereinabove provided for in the case of one or more of the beneficiaries.‘
Paragraphs 9, 10, 11, and 12 of the instrument provided:
9. If any beneficiary, prior to one month after the President's proclamation, shall leave the service of the company, of his own volition, or shall be dismissed because of unsatisfactory service (of which the trust committee
shall be the sole judge), he shall thereupon cease to be a beneficiary, and his right or privilege to participation in this trust, to any of the payments made by the company to the trust, or to any income share shall immediately cease and determine and the company shall make no further payment to the trustees on his behalf. All amounts credited to such beneficiary's account shall thereupon become the property of the trust and shall be held by the trustees for the sole additional benefit of the then remaining beneficiaries; each beneficiary to the extent of his ratable share, which share shall be determined as of the date following the day when such retiring beneficiary shall have ceased to be employed by the company, and shall be credited to the accounts of the beneficiaries. Such additional amounts, so credited to the remaining beneficiaries, shall thereafter be treated in the same way for all purposes, as if they were company payments to the trust.
Defined as a committee comprised of one representative of nonmanagement personnel, one representative of the management, and a third party chosen to act with them— their determinations to be upon a vote of the majority.
10. Upon due proof of the death of any beneficiary, before the time when he becomes entitled to his entire share of the trust fund, the trustees shall pay to the personal representatives of such deceased beneficiary, the amount credited such beneficiary's account, computed up to and including the date of such beneficiary's death.
11. Should a beneficiary be dismissed from the service of the company through no fault of his own, with an entirely satisfactory record (of which the trust committee shall be the sole judge), he shall be treated for all purposes as a beneficiary who has died while in the company's employ, except that the payment shall be made to such beneficiary in lieu of his personal representative.
12. If the company shall ;hereafter, in its sole discretion, grant a leave of absence to any employee because of sickness, induction into military service, or other good reason, and shall certify that fact to the trustees, the trustees shall thereupon pay to such employee the amount credited to his account in such installments as the trustees shall see fit.
It was further provided that the trustees had the full power to resolve any ambiguities or omissions in the agreement; that successor trustees were to be appointed by the company.
Paragraph 19 provided:
19. The company by resolution of its directors may amend this trust by (a) extending it to other employees of the company who have not been covered hereby or (b) otherwise altering, amending or modifying this agreement, or changing the trustees; provided, however, that no such extension, amendment, modification, or alteration hereof shall be made which shall in any way adversely affect any beneficiary, take away any amounts or benefits to which he is entitled, or in any way diminish the same, or which shall divert any part of the corpus or income of this trust to purposes other than for the exclusive benefit of the beneficiaries; provided, further, that no alteration, amendment or modification hereof shall be made which shall affect the duties of the trustees without their written consent.
The right to amend to make the agreement conform to the requirements of section 165 of the Internal Revenue Code was reserved in paragraph 21.
The arrangement, as outlined above, was communicated to petitioner's employees by means of a notice which was read to them at a meeting and posted on a bulletin board at the office of the company.
On January 28, 1943, petitioner paid $15,253.40 to the trustees under the trust set up by the above described instrument.
At the time of the adoption of the plan, petitioner was advised by the New York office of the Salary Stabilization Unit that contributions to a profit-sharing plan which qualified under section 165 did not constitute ‘salary‘ or ‘wages,‘ within the purview of the antiinflation law. Thereafter, in early 1943, press releases indicated that The salary Stabilization Unit had changed its position, and in reply to a letter of May 5, 1943, from petitioner's counsel, respondent, by letter of July 2, 1943, advised that contributions to profit-sharing plans required approval of his office. Respondent further advised that where the provisions of the profit-sharing trust were such that the employees' contributions were payable to the employees only in the event of retirement at a suitable age, death, or disability, or after a fixed period of time, not less than ten years, the distribution over a period of years thereafter, ‘for example, 10 per cent per annum for 10 years,‘ his office would approve contributions to a qualifying plan. The letter, in effect, advised that the profit-sharing plan and the trust did not comply with the provisions of the Act of October 2, 1942, as amended, and the regulations promulgated thereunder relating to salary stablization.
By letter dated July 6, 1943, petitioner's counsel advised it of respondent's ruling and proposed that the plan might be amended to conform to the requirements.
By letter dated July 14, 1943, the Salary Stabilization Unit informed petitioner's counsel that specific rulings would be issued upon application on the question of the retroactive effect of the respondent's position that ‘contributions to profit-sharing trusts constitute salary increases requiring approval.‘ The advice was that such rulings would be issued only to those companies which specifically indicated their intention to discontinue payments to the trust.
On July 15, 1943, petitioner's counsel wrote it that, if it would discontinue making payments to the trust, it was thought that approval would be obtained for the plan for the taxable year in question. He inquired whether petitioner wished to discontinue the trust or to amend it to conform to the requirements laid down by respondent.
Under date of September 29, 1943, by action of its board of directors, petitioner discontinued the making of further payments to The blume Knitwear, Inc., profit-sharing plan. In the minutes of the meeting at which such action was taken it was provided that payments already made should be retained by the trustees.
By letter dated October 26, 1943, petitioner's attorney was advised of approval of payments made by petitioner ‘prior to January 31, 1943, on the profit-sharing trust created by such company, are not in contravention of the Act of October 2, 1942, * * * as amended, and the Regulations promulgated thereunder, as amended.‘
Under date of November 30, 1944, petitioner's board of directors amended its profit-sharing plan to provide that the amount of compensation upon which the 10 per cent was to be reckoned should include compensation accrued as well as paid.
Paragraph 7 of the agreement was further amended to provide that the company could discontinue making payments to the trust ‘whenever the board of directors determines that such discontinuance is required because of business necessity.‘
Paragraph 8 was amended to provide that after the President's proclamation ‘the trustees shall have the power to accellerate (sic) the payments hereinabove provided for in the case of any beneficiary who is found by the trust committee to be in need of such payment for his, or his family's support.‘
Paragraph 9 was amended to read as follows:
(a) If a beneficiary shall be discharged from the service or employ of the company because of dishonesty or the commission of a crime punishable by law, he shall thereupon cease to be a beneficiary, and his right or privilege to any payment to the trust by the company, or to any amount credited to, or accrued for the credit of, his account shall thereupon cease and determine; and the company shall make no further payment to the trustees on his behalf or with respect to his compensation.
(b) If a beneficiary, prior to one (1) month after the President's proclamation, shall leave the service of the company, of his own volition, he shall thereupon cease to be a beneficiary, and his right to participation in this trust or to any payment to the trustees by the company shall thereupon cease and determine, and the company shall make no further payment to the trustees on his behalf or with respect to his compensation; except that he shall be entitled to, and shall not forfeit such portion of his account (up to one hundred (100%) per cent thereof) as equals twenty (20%) per cent times the number of full years that he has been a beneficiary hereunder. Such portion of his account shall be paid at the time and in the manner provided for by Paragraph 8 hereof.
(c) In the case of any forfeiture by a beneficiary of any or all of his account, the amount so forfeited shall become the property of the trust, and shall be held by the trustees and used for the reduction of the immediately following payment to the trust required to be made by the company, or if the company has discontinued the making of further contributions pursuant to Paragraph 7 hereof, the amount so forfeited by a beneficiary shall be credited to the remaining beneficiaries who are such on the immediately succeeding anniversary date hereof, each in such proportion as the then current compensation of such remaining beneficiary bears to the total compensation of all such remaining beneficiaries.
Paragraph 10 was amended to read as follows:
Upon due proof of the death of any beneficiary before the time when he becomes entitled to ;is share of the trust fund, the trustees shall pay to the person selected by the beneficiary (by designation in writing to the trustees to receive the same, which designation may be changed by the beneficiary at any time prior to his death by written notice delivered to the trustees), the amount credited to such deceased beneficiary's account, computed up to and including the date of such beneficiary's death. If the person so selected by the beneficiary be not then living, or no designation has been made hereunder, the payment shall be made to the personal representative of such beneficiary.
Paragraph 11 was amended to read as follows:
11. In any case in which the employment of a beneficiary ceases for a reason other than provided for by Paragraph 9(a) or (b), he shall thereupon cease to be a beneficiary with respect to further company payments to the trust, but the trustees shall pay to such beneficiary the amount credited to his account, computed to and including the date he is so dismissed or leaves the company's employ as the case made be; provided, however, that such payment shall not be at a time or times earlier, or in a manner other than as provided for by Paragraph 8 hereof, unless such beneficiary should be found by the trust committee to be in need of such payment for his, or his family's support; in which case, such payment may be made immediately to the extent of 20% of such beneficiary's account; one year after such initial payment, further payment may be made to the extent of 25% of the balance so remaining; two years after such initial payment, further payment may be made to the extent of 33 1/3% of the balance so remaining; three years after such initial payment, further payment may be made to the extent of 50% of the balance so remaining; four years after such initial payment, further payment may be made to the extent of the balance of such beneficiary's account.
Paragraph 12 was amended to read as follows:
12. If any beneficiary is inducted into military service, it shall be construed that such beneficiary is continuing in the employ of the company during such leave; and in such event, such beneficiary shall not lose any benefits to which he may be entitled hereunder.
New paragraphs, numbered 24 and 25, were added as follows:
24. In no case shall stockholders of the company, who own directly or indirectly more than 10% of the capital stock of the company, be entitled to receive in the aggregate an amount in excess of 30% of the company's contribution in any one year. If their aggregate amount computed without reference to the limitations of this paragraph exceeds such 30%, then the excess over such 30% shall be credited to the beneficiaries of the company other than such stockholders, in such proportion as any beneficiary's compensation bears to the total compensation of all such other beneficiaries. In any case where the limitations imposed by this paragraph are operative, each such stockholder shall received such proportion of such 30% as the amount of his credit without reference to the limitations imposed by this paragraph, bears to the total credits of all such stockholders computed without reference to the limitations hereof.
25. This trust shall be irrevocable and no part of the corpus or income thereof shall ever revert, or be refunded, to the company; all payments thereto being for the exclusive benefit of the employees beneficiaries thereof and their beneficiaries.
The amendments were stated to be effective as of January 1, 1944.
On January 2, 1945, a letter from the Commissioner to petitioner stated as follows:
You were advised by letter dated December 7, 1944, that your profit-sharing plan did not meet the requirements of Section 165(a) of the Internal Revenue Code, as amended, for the reasons set forth therein.
After a conference held in this office on December 21, 1944, with your representative, Mr. Sidney A. Gutkin, there were submitted amendments to your profit-sharing plan, duly executed on December 21, 1944, with the request that this office consider the plan as now amended.
Your plan has been considered in connection with the said amendments and it is the opinion of this office that such plan, as amended, now meets the requirements of Section 165(a) of the Internal Revenue Code, as amended, and that the trust established as a part thereof is entitled to exemption under such provision of the Code.
Contributions made to the trust will be allowable as deductions from gross income in accordance with Section 23(p) of the Internal Revenue Code, as amended, subject, however, to verification upon examination of your return.
By letter dated May 9, 1945, respondent withdrew his approval of January 2, 1945, and advised petitioner that:
The information now available in this office indicates that certain pertinent facts were not disclosed. It appears that the plan was discontinued by resolution of your Board of Directors dated September 29, 1943, so that the amendments to the trust dated November 30, 1944, were made after the termination of the plan.
Your plan has now been consideration (sic) in connection with the additional information now available in this office, and it is the opinion that the plan fails to meet the requirements of Section 165(a) of the Internal Revenue Code, as amended. Since your profit-sharing plan does not meet the requirements of Section 165(a) of the Internal Revenue Code, as amended, the trust which is a part thereof, is not entitled to exemption under such section.
During the fiscal year ended November 30, 1942, petitioner had 48 employees, 45 of whom were beneficiaries under the plan. Of the 45 employees covered by the plan, 4 were officers who were the sole stockholders of the company, and were supervisors, and one was a supervisor, not a stockholder or officer. The 4 officers each held 25 per cent of the stock of the company. During the fiscal year ended November 30, 1942, the total compensation paid the employees regarded as beneficiaries was $152,533.95, of which $113,000 was paid to the 4 officer-stockholders.
Of the 45 employees, including the 4 officers, 19 had over 1 year's service, 26 had over 5 months' service, and 18 had less than 6 months' service.
At the time of the adoption of the plan, petitioner intended that it be continued in accordance with its terms, and no early discontinuance was contemplated.
Petitioner, during the period involved herein, had no other type of employees' plan.
OPINION.
OPPER, Judge:
Petitioner's position that the present issue is limited to whether petitioner's ‘profit-sharing plan‘ complied with Internal Revenue Code, section 165(a), seems to be supported by the opening statement of counsel and by the apparent agreement thus developed as to the scope of controversy. As originally presented, the two questions were whether there has been compliance with any requirements of permanence inherent in section 165(a), and whether the benefits of the trust were so preponderantly weighted in favor of the corporate officers that it could not be said that it was for ‘the exclusive benefit‘ of its employees.
Since the latter objection is not pressed in respondent's brief, we regard the only issue requiring consideration as that of permanence.
SEC. 165. EMPLOYEES' TRUSTS.(a) EXEMPTION FROM TAX.— A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees—(1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and(2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees, shall not be taxable under section 161, but the amount actually distributed ormade available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25(a).
Granting in this respect the applicability to the year before us of respondent's regulations, as amended almost two years later, T.D. 5278, 1943 C.B. 478, on the theory that they were either properly made retroactive or were merely declaratory of the interpretation at all times required, the most that can be said is that the abandonment of the plan after one year ‘for any cause other than business necessity‘ was ‘evidence that the plan from its inception was not a bona fide program * * * 9‘
‘The term 'plan’ implies a permanent as distinguished from a temporary program. While the employer may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, if the plan is abandoned for any cause other than business necessity within a few years after it has taken effect, this will be evidence that the plan from its inception was not a bona fide program for the exclusive benefit of employees in general. Especially will this be true in the case of a pension plan under which pensions were fully funded for the highly paid employees or others in favor of whom discrimination is prohibited under section 165(a), and which was abandoned soon after the pensions for such favored employees had been provided. The permanency of the plan will be indicated by all of the surrounding facts and circumstances, including the likelihood of the employer's ability to continue contributions as provided under the plan. In the event a plan is abandoned, the employer should promptly notify the Commissioner, stating the circumstances which led to the discontinuance of the plan.‘ (T.C. 5278, 1943 C.B. 478, 481, amending Regulations 103, sec. 19.165(a)(1)-1.)Testimony of petitioner's president.
Granting further in respondent's favor that the circumstances causing the decision to abandon the plan were not a ‘business necessity,‘ and therefore that its abandonment constitutes the evidence to which the regulations refers, we are, nevertheless, called upon to examine the operative facts to ascertain whether this evidence, which certainly can not be conclusive, is sufficiently rebutted so that on the whole record the burden imposed upon the petitioner of proving a ‘bona fide plan‘ is sustained.
The testimony shows that the reason for the abandonment of the plan was an outgrowth of petitioner's purpose in creating it. Viewing as improbable the approval by the Salary Stabilization Unit of percentage increases in salaries to all of petitioner's employees if these were to be paid in cash, the profit-sharing plan in question was chosen in order on the one hand to assure ultimate additional payments to the employees and on the other to postpone the actual payments until a five-year period at the conclusion of the war. It was petitioner's understanding that such, a plan would be acceptable to the Salary Stabilization Unit and it was in fact agreed to by the employees.
Upon submission to the Salary Stabilization Unit, after payment to the trust of the profits computed for the first year of operation, the plan was disapproved as to any future payments, but petitioner was advised that if it were to discontinue the plan the payment already made would be permitted to remain undisturbed. An alternative requiring amendment of the plan to call for a longer waiting period ‘would not be acceptable to the employees. ‘4
The conclusion appears to us inescapable that these circumstances leading to the abandonment of the plan after the main purpose originally envisaged was found to be impossible of fulfillment demonstrate that on the whole record there was a bona fide program for the exclusive benefit of employees in general.
We think that under these circumstances the bona fides of petitioner's program for the exclusive benefit of its employees in general is not overcome by the mere fact of abandonment when the reasons therefore have been adequately shown and explained. Assuming, as we have done, the necessity that a profit-sharing plan must have a fair degree of permanence and continuity, we are nevertheless of the opinion that any such requirement has here been met.
Decision will be entered under Rule 50.