Opinion
Docket Nos. 12612 12613.
1949-08-30
O. H. DELCHAMPS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.A. F. DELCHAMPS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioners. Homer F. Benson, Esq., for the respondent.
1. The petitioners and their sister, equal partners in a chain grocery business, admitted petitioners' wives as partners, each petitioner contributing two-fifths of his interest to his wife and the sister a one-fifth of her interest to each wife. The admission of the wives as partners was necessary for the purpose of securing bank credit for the business. Held, that the partnership was formed for a valid business purpose with a bona fide intention to form a business partnership.
2. Held, further, that partnership earnings are taxable to the partners in accordance with the partnership agreement. George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioners. Homer F. Benson, Esq., for the respondent.
These proceedings, consolidated for hearing and opinion, involve deficiencies in income and victory tax of O. H. Delchamps and A. F. Delchamps for 1943, in the respective amounts of $84,116.95 and $84,080.38. The year 1942 is involved due to the forgiveness feature of the Current Tax Payment Act of 1943.
The principal issue is whether the respondent erred in his refusal to recognize the validity, for Federal income tax purposes, of an alleged partnership between the petitioners, their wives, and their sister. Petitioners also raise as an issue on the validity of the partnership the contention that, since respondent accepted gift taxes paid with respect to purported gifts of partnership interests, he is thereby estopped to deny the validity of the partnership for Federal tax purposes. If this issue is decided in favor of the respondent, petitioners contend alternatively that a division should be made of the earnings of the business due to personal services and the earnings due to capital, and the wives should be held to be taxable on their share of the earnings due to capital.
Some of the facts are stipulated and are so found. The stipulation filed is incorporated herein by reference.
FINDINGS OF FACT.
The petitioners are individuals, residing in Mobile, Alabama. They filed their individual income tax returns on the cash receipts and disbursements basis for 1942 and 1943 with the collector of internal revenue for the district of Alabama.
Since 1921 both of the petitioners have been engaged in the retail grocery business in Mobile, Alabama. They began modestly with one small store, operating it with their mother and sister on a small amount of family funds. During the 1920's the business expanded, and more stores were added, but the business was never in a strong cash position.
Prior to her marriage to petitioner A. F. Delchamps, Lucile C. Delchamps was employed in Mobile as a secretary and had saved approximately $650, which she turned over to A. F. Delchamps in 1928 to invest in the family business. The business at that time had a net worth of approximately $50,000 and operated seven stores, but was in a close financial position, with most of the current assets being in inventory. The $650 investment in the business by Lucile C. Delchamps was of considerable assistance to the business at that time.
Shortly after Lucile C. Delchamps married petitioner A. F. Delchamps, in 1930, she began doing general office work for the business. She worked on a full time basis for the business about five or six months, drawing some small amounts of cash from the business, but having no regular, fixed compensation. After she ceased working full time for the business, Lucile C. Delchamps continued to perform occasional secretarial services for the business at home and also supervised for about one year the preparation of delicatessen items in her home for sale in the stores. This work was performed without compensation.
During the 1930's the business was operated as a partnership by the petitioners and their sister, Annie M. Delchamps. There was no written partnership agreement. The business was operated successfully and by 1938 was in a strong cash position, having a net worth of over $330,000, current assets of almost $200,000, and current accounts payable of about $50,000. At that time the business operated eleven stores with a net income of over $100,000 a year. Profits were distributed in a ratio of 40 per cent to each of the petitioners and 20 per cent to Annie M. Delchamps.
In 1938 the three partners began an expansion program with the intention of adding more stores to the business. The expansion program was to be paid for by the current funds of the business and by short term loans, but by late in 1940 the program had cost more than was anticipated and the business was in a weakened position with relation to current assets and current liabilities.
In accordance with its usual practice, the business released a semi-annual financial report on December 31, 1940, to local banks and interested credit concerns. This report revealed that, while the business had a net worth of over $400,000, the current liabilities exceeded the current assets. The report created considerable local concern and threatened to impair the local credit reputation of the business.
The three partners began negotiations with local banks to borrow $300,000 to accomplish a long term funding of the business current indebtedness. The local banks refused to lend the money on any agreement signed by the three partners, even if the petitioners' wives signed it, because of the legal interests in petitioners' real property held by their wives, since, under Alabama law, the wives could not become sureties for their husbands' indebtedness. The partners considered but rejected the idea of selling some of the assets of the business or or mortgaging the real property of the business, because of their belief that either of those methods of raising capital would seriously impair the credit the credit standing of the business.
The partners decided that the best solution to their problem of securing the necessary loans from the banks would be to transfer interests in the business to the petitioners' wives and to make them full partners in the business. The loans could then be made and secured by the agreement of the petitioners, their sister, and their wives, who would be liable individually as partners in the business.
On March 31, 1941, the net worth of the three-way partnership was $465,782.74, which was divided between the partners as follows:
+----------------------------------------+ ¦ ¦Capital ¦Profits ¦ +------------------+----------+----------¦ ¦ ¦investment¦subject to¦ +------------------+----------+----------¦ ¦ ¦ ¦withdrawal¦ +------------------+----------+----------¦ ¦A. F. Delchamps ¦$100,000 ¦$86,140.73¦ +------------------+----------+----------¦ ¦O. H. Delchamps ¦100,000 ¦68,327.96 ¦ +------------------+----------+----------¦ ¦Annie M. Delchamps¦100,000 ¦11,314.05 ¦ +------------------+----------+----------¦ ¦Total ¦300,000 ¦165,782.74¦ +----------------------------------------+
The unwithdrawn distributable profits were carried forward on the books of the partnership as loans of the old partners to the business. The $300,000 of capital investment in the old partnership was carried forward as invested capital in the new partnership. Each of the petitioners gave his wife two-fifths of his one-third interest in the capital of the business, and Annie M. Delchamps gave to each of the two wives one-fifth of her one-third interest in the business. After the gifts were completed, each of the petitioners, their wives, their sister owned a one-fifth interest in the total capital of the business.
In the gift tax returns filed by the petitioners and their sister, the gifts were valued at $20,000 for each one-fifteenth interest in the business. Respondent, however, disputed the values assigned to the gifts by the petitioners and Annie M. Delchamps. He assigned values to the gifts based upon his capitalization of the average annual earnings of the business for a three-year period. The disputed gift tax liability was settled by agreement assigning a value of $40,200 to each one-fifteenth interest in the business, instead of the $20,000 value reported in the gift tax returns, thus giving primary weight to the earning power of the business. The gift tax deficiencies determined by respondent on the basis of the agreed values were paid in full by the three donors.
By oral agreement, a new five-way partnership was formed on April 1, 1941, with each member of the new partnership having an equal share in the capital investment and earnings of the business. An agreement was then entered into on June 13, 1941, with two local banks for the business to borrow $300,000, evidenced by ten promissory notes bearing 5 per cent interest, payable quarterly over a six-year period. The notes were secured by an agreement of the five partners that they would continue to hold without encumbrance the real property used in the business and owned individually and as partners in the business by them and that they would give a mortgage on the property to the banks at any time the banks considered )it necessary. The money loaned by the banks was used by the partners to refinance the current indebtedness of the business, thereby considerably improving its current financial position and credit standing.
On February 19, 1942, the petitioners, their wives, and Annie M. Delchamps entered into a written partnership agreement which provided that the business would be continued as an equal five-way partnership, with all partners sharing equally in profits and losses and having equal powers to write check on partnership bank accounts or to execute notes, contracts, or other instruments for the partnership. The petitioners and Annie M. Delchamps were to give all their time to the business and to receive salaries in addition to their respective shares of partnership profits.
In the operation of the partnership business, petitioner A. F. Delchamps was in charge of the general operations and sales of the business, receiving a salary of $7,500 per year; petitioner O. H. Delchamps was in charge of purchasing, warehousing, and distribution of the merchandise, receiving a salary of $7,500 per year, and Annie M. Delchamps was in charge of accounting and office work, receiving a salary of $5,000 per year. The partnership agreement was revised on October 1, 1943, when the capital interest of each of the five members of the partnership was increased from $60,000 to $150,000. Following formation of the partnership, the banks, business houses, employees, and public were informed that the wives were partners in the business. The wives were thereafter accepted and treated as partners in the business.
Lucile C. Delchamps, the wife of petitioner A. F. Delchamps,, and Virginia S. Delchamps, the wife of petitioner O. H. Delchamps, made regular withdrawals of partnership income, as follows:
+------------------------------------------------------------+ ¦Fiscal year ended—¦Lucile C. Delchamps¦Virginia S. Delchamps¦ +------------------+-------------------+---------------------¦ ¦3-31-42 ¦$3,442.74 ¦$2,036.06 ¦ +------------------+-------------------+---------------------¦ ¦3-31-43 ¦9,860.88 ¦9,790.39 ¦ +------------------+-------------------+---------------------¦ ¦3-31-44 ¦58,779.77 ¦60,588.65 ¦ +------------------+-------------------+---------------------¦ ¦3-31-45 ¦80,537.82 ¦85,538.73 ¦ +------------------+-------------------+---------------------¦ ¦1-31-46 ¦73,145.59 ¦67,684.99 ¦ +------------------------------------------------------------+
The income distributed to the petitioners' wives was used by them as they saw fit and was not used to support their families or turned over to the petitioners.
The partnership of the petitioners, their wives, and Annie M. Delchamps was formed for a business purpose with a bona fide intention to form a real and true business partnership for all purposes.
OPINION.
LE MIRE, Judge:
The principal issue here presented for decision is whether, during the taxable years 1942 and 1943, Lucile C. Delchamps and Virginia S. Delchamps were equal partners with their husbands and Annie M. Delchamps in a partnership doing business as the Delchamps Grocery Co. Respondent determined that they were not and taxed the income distributed to them to them husbands, the petitioners here.
In the determination of whether the validity of the partnership here involved should be recognized for Federal tax purposes, the ultimate question for decision is whether the partnership is real within the meaning of the Federal revenue laws. That is, we must determine upon consideration of all the facts whether the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. Commissioner v. Tower, 327 U.S. 280; Commissioner v. Culbertson, 337 U.S. 733.
It is now well settled that transactions between members of a family which affect tax questions must be closely scrutinized to determine whether they are really what they purport to be, or whether they are merely shifts in tax incidence through superficial changes of ownership which have no real effect upon the economic relation of the members of the family to the income. Commissioner v. Tower, supra; Lusthaus v. Commissioner, 327 U.S. 293; Helvering v. Clifford, 309 U.S. 331.
In the case the petitioners and their sister had owned and operated a family grocery business as a partnership for a number of years. In the course of a program of business expansion their financial resources were overstrained and what had been a relatively strong position, so far as current assets and current liabilities were concerned, became a hazardous position for the business, with current liabilities exceeding current assets. The business was sound and had a net worth of over $400,000, but was in need of immediate loans to refinance current liabilities. The partners rejected both proposed plans of selling part of the business assets and of mortgaging the business properties when they were advised that either course would impair the credit standing of the business. Since the petitioners' wives owned interests in the real property used in the business, but could not be liable under Alabama law for their husbands' debts, a satisfactory loan agreement, even with the wives' signatures, could not be worked out with the banks. The petitioners and their sister thereupon decided that the most satisfactory solution to the credit problem confronting the business was to form a new partnership which would include the wives as full partners, making them liable individually as partners in the business for the debts of the business to the full extent of their own property and interest in the real property used in the business.
Pursuant to that decision, each of the petitioners gave to his wife a share in the business amounting to two-fifths of his interest, or two-fifteenths of the entire business. Annie M. Delchamps gave to each of the two wives one-fifth of her interest in the business, or one-fifteenth of the entire business. After these transfers were completed, the new five-way partnership was created, with each of the five partners holding an equal one-fifth interest in the business. A satisfactory loan agreement was then made with the banks and the business was substantially refinanced by putting its current obligations on a long term basis.
The purpose informing the partnership was the reasonable and necessary one of securing substantial loans from the banks in order to make the current financial position of the business more secure and to protect the credit standing of the business. Although other means might have been employed to accomplish this purpose, the partners in good faith believed that the formation of the partnership was the most advantageous one for the business. The accomplishment of this purpose is a fact which may not be disregarded. Hartz v. Commissioner, 170 Fed.(2d) 313; certiorari denied, 337 U.S. 733.
Gifts of interest in a business to their wives by taxpayers might be mere superficial transfers of ownership made solely to save income taxes by dividing earned incomes, thus violating the principle axiomatic in tax law that income must be taxed to him who earns it. However, in this case, gifts of interests in the business were made to the petitioners' wives by Annie M. Delchamps, as well as by the petitioners themselves. It could not be said that the transfers of interests by her to the two wives were mere superficial transfers of ownership within the family groups. Those transfers were complete and irrevocable transfers of interests from without the family groups. They can not be disregarded for tax purposes. It should also be noted that Lucile C. Delchamps had invested both capital and services of her own in the business in prior years, for which she was not otherwise fully compensated.
While the personal services of the wives during the years here involved may not have amounted to sufficient participation in the business to support a finding that a bona fide partnership was created, we conclude from all the facts that a bona fide partnership was well established on the grounds of contributions of capital and credit. There was a real and true intention to create a bona fide partnership to make the resources of the two wives available for the support of the credit position of the business. The partnership must be recognized as real within the meaning of the Federal revenue laws. Hartz v. Commissioner, supra.
Having concluded that the partnership is valid for tax purposes, we do not concern ourselves with the sufficiency of the wives' contributions of capital or services to justify the shares of partnership earnings distributed to them. Any reallocation of partnership earnings among the partners contrary to that provided for in the partnership agreement would amount to the making of a new contract for the partners. That action is beyond the province of this Court, in the absence of any patently unreasonable agreement by them. Woosley v. Commissioner, 168 Fed.(2d) 330; Canfield v. Commissioner, 168 Fed.(2d) 907.
Any determination of the alternative issues raised by petitioners is unnecessary in view of our determination that the partnership was valid for Federal tax purposes.
Decisions will be entered for the petitioners.