Opinion
No. 32699.
April 19, 1937.
1. TAXATION.
Where manufacturing company constructed building at cost of $54,712.20, against which depreciation of $1,765.10 was charged, and sold building to partnership composed of four directors constituting majority of board of directors and two others for $23,000, in determining taxable income, manufacturing company held entitled to deduct resulting loss, as "loss sustained from disposition of capital asset," since manufacturing company was entirely divested of title to property (Laws 1934, chap. 120, secs. 3, 6, 8, subd. 4).
2. TAXATION.
Trust fund set aside by manufacturing company for purpose of enabling trustees to make loan to company's employees and for purpose of creating amity, good feeling, cooperation, and good will between company and employees held not deductible, in determining taxable income, as "ordinary and necessary expense," where company created trust just few days before it was bound to account to State Tax Commission for income, company reserved right to terminate trust at any time, and company required good security for loans (Laws 1934, chap. 120, secs. 3, 6, 8, subd. 1; sec. 36).
3. TAXATION.
Deduction made in determining taxable income is in fact an "exemption," and exemption must be strictly construed against exemptionist.
APPEAL from the chancery court of Hinds county. HON. V.J. STRICKER, Chancellor.
F.G. Thomas, of Tupelo, for appellant.
Chapter 120, Laws of Mississippi of 1934, is the Act under which the income tax return in question was filed. The act was approved on March 14, 1934, and took effect as of January 1, 1934. Section 8 of the Act provides that "In computing the net income there shall be allowed as deductions: (1) all the ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business." And it is by virtue of this section and the regulations thereon which are interpretative thereof, that the appellant claims allowance of the deduction of the $25,000, which was paid over to the trustees of Tupelo Garment Company Foundation.
Section 8 of the Act further provides that "In computing the net income there shall be allowed as deductions: (4) Losses sustained during the taxable year not compensated for by insurance or otherwise, if incurred in trade or business. Losses sustained from the disposition of capital assets employed in the conduct of the regular trade or business shall be determined by deducting from the cost (or value as of March 16, 1912, if acquired prior to that date) the depreciation sustained and the amount realized therefrom." And it is by virtue of this section and the regulations thereon which are interpretative thereof, that the appellant claims allowance for the deduction of $29,947.10 sustained in the disposition of its capital asset, its building and the lease site upon which the building is located.
The case of Forbes Lithograph Mfg. Co. v. White, Collector of Internal Revenue, 42 F.2d 287, decided by a federal district court of Massachusetts, in June, 1930, involves identically the same proposition that we are now considering, involves the construction of the same regulation which governs this transaction, that is, section 234 (a), subsection (1) of the Federal Income Tax Statute of 1921 and Article 562 of the regulations thereon, said section being identical with the State Income Tax Act of 1934, Section 8 (1), so far as affects the question in this case.
Sugarland Industries v. Comr., 15 B.T.A. 1265; Elgin National Watch Co. v. Comr., 17 B.T.A. 339; Hibbard v. Comr., 5 B.T.A. 464; Colton v. Colton, 127 U.S. 300; Holden v. Circleville L. P. Co., 216 F. 490; Fox v. Fox, 95 N.E. 498; Orr v. Yates, 70 N.E. 731; Poinsett Mills v. Comr., 1 U.S. Board of Tax Appeals Reports, page 6.
We believe that every test required has been met in the establishment, creation, actual operation and in benefits to the corporation of the Tupelo Garment Company Foundation. The fund has a separate and distinct entity from the appellant and, therefore, has a separate taxable entity; the creation thereof was by an instrument of trust which clearly and unmistakably defines the property which was settled by the trust, with clear and unmistakable language as to the benefactors thereunder, and under the practical operations of the trust fund we have shown that the purposes in the creation have been carried out and furthermore that the desired results have been achieved.
There is nothing in the record which in any wise justifies any assertion that the property did not sell for its reasonable market value, and certainly the mere fact that the property sold for $23,000, when the cost on the books of the company carried the property at a value of $52,947.10 is of no evidentiary value. However, the fact that the stockholders of the appellant have since the date of the sale of the property approved and acquiesced in the sale is strong evidentiary value that the sale price of $23,000 is reasonable and adequate and that the sale was made for good business reasons and was conducive to the best management and policies of the appellant. The impelling motive of the appellant in selling this real estate in order to take the real estate off of its books and to make the corporation more liquid remains by the record unchallenged. There is no evidence, proof or charge that there was any fraud in connection with the sale and as the record shows the entire transaction was strictly a bona fide one. Therefore, under the state of facts, should not the loss have been allowed as a proper item of deduction? We think unquestionably that it should and the right of the appellant to the deduction is amply sustained by the rules and regulations construing the section of the act allowing such deductions and sustained by the overwhelming weight of judicial interpretations regarding such right.
A taxpayer is not bound to fashion his own affairs in such a way as to create a greater tax liability.
Helvering v. Gregory, 69 F.2d 909.
The question of the control which the transferee has over the transferor is of no concern where the sale is a bona fide one, made for cash, but even conceding that the element of control is involved, (in this case not 80% but a mere 21% of ownership) we find cases sustaining our position where the control was absolute or practically so.
Edwards Securities Corp. v. Comr., 30 B.T.A. 918; Fruit Belt Tel Co. Case, 22 B.T.A. 440; David Stewart Case, 17 B.T.A. 604; Budd v. Comr., 43 F.2d 509; Dalton v. Bowers, 287 U.S. 404; Burnett v. Clark, 287 U.S. 410; Jones v. Comr., 71 F.2d 214; Elridge v. Comr., 30 B.T.A. 1322.
J.A. Lauderdale, Assistant Attorney-General, for appellee.
Under the facts in this case the Tupelo Garment Company, appellant, was not entitled to deduct from its gross income for its fiscal year beginning July 1, 1933, and ending June 30, 1934, the sum of $29,947.10 as a loss sustained from the disposition of capital assets employed in the conduct of the regular business of said company.
Unless appellant's claim for a deduction is clearly within the statute, then such claim should be disallowed.
New Colonial Ice Co. v. Helvering, 292 U.S. 435, 78 L.Ed. 1348; Chas. Ilfield Co. v. Hernandez, 292 U.S. 69, 78 L.Ed. 1127; Helvering v. Inter-Mountain Life Ins. Co., 294 U.S. 686, 79 L.Ed. 1227; Jackson Fertilizer Co. v. Stone, 173 Miss. 183.
The contention of the State Tax Commission is that the pretended sale of the property in question by the Tupelo Garment Company to the Tupelo Realty Company was not, in fact, a sale but a mere subterfuge in the guise of valid transactions for the purpose of evading the income tax due by the appellant, and we think that the statement of fact is amply sufficient to sustain this contention.
Helvering v. Gregory, 69 F.2d 809; Wiggins v. Comr., 46 F.2d 743.
Under the facts in this case said corporation was not entitled to deduct from its gross income the sum of $25,000 paid by it to the Tupelo Garment Company Foundation.
It is my contention that this fund is delivered by the corporation to the trustees of the Foundation for the purpose of investment, and that the company may take its principal and income therefrom at any time it sees fit. This is clearly an investment and the fact that the title is in the trustees during the time the principal is earning income for the corporation would make no difference.
Appellant claims that this $25,000 should be deducted from its net income because it is "an ordinary and necessary expense." It is clearly shown by the facts in this record that it was neither ordinary nor necessary, and it must be remembered that these terms are construed most strictly against the taxpayer.
In the case at bar it is shown that appellant operates in four counties and in five municipalities. Neither the population of the municipalities nor the counties is shown. What other employers are doing is not shown. The record shows that the corporation employed about 1221 employees. The necessity for the loans to said employees is not shown. I assume that any modern moneylender would loan money to the employees of this corporation on the same terms and conditions that were imposed by the trust agreement upon the trustees.
The record further shows that the feeling between the laborers and the corporation was good and that the corporation was making enormous and unjustifiable profits out of their labor, and there is no showing that this trust fund was necessary to maintain this fine feeling of fellowship.
American Rolling Mill Co. v. Comr., 41 F.2d 314; Forbes Lithograph Mfg. Co. v. White, 42 F.2d 287.
As contended by appellant the general rule is that a corporation and its stockholders are deemed separate entities. However, there are exceptional situations where it otherwise would present an obstacle to the due protection or enforcement of public or private rights.
United States v. Lehigh Valley R. Co., 220 U.S. 257, 55 L.Ed. 458; Chicago, M. St. P.R. Co. v. Minneapolis Civic Commerce Assn., 247 U.S. 490, 62 L.Ed. 1229; Southern P. Co. v. Lowe, 247 U.S. 330, 62 L.Ed. 1142; Gulf Oil Corp. v. Lewellyn, 248 U.S. 71, 63 L.Ed. 133.
In the case at bar a majority of the directors of the Tupelo Garment Company, a majority of the trustees of the Foundation, and practically all of the stockholders of the Tupelo Realty Company, are one and the same persons, and in addition to this, said persons controlled a large majority of the stock at the alleged stockholder's meeting.
The income tax act provides that charitable donations made by individuals in an amount limited by statute may be deducted from their gross income. There is no such provision in reference to corporations. In fact, it seems to be generally conceded that a corporation cannot make a deduction of a charitable donation from its gross income.
Consolidated Gas, E.L. P. Co. v. U.S., 65 Ct. Cl. (Fed.) 252, 278 U.S. 612, 73 L.Ed. 537, 49 Sup. Ct. Rep. 18; Niles Bement Pond Co. v. U.S., 281 U.S. 357, 74 L.Ed. 363, 50 Sup. Ct. Rep. 251; Sweet v. U.S., 66 Ct. Cl. 654.
The record in the case at bar does not show that any donation or any charitable work was done. The record affirmatively shows that all funds invested were loaned at interest on good security. However, even though we should concede that the trustees did donate a part of this fund to needy employees of the corporation, it is clear that the corporation could not have made such donations directly and deducted the amount so paid from its gross income. What it cannot do directly, it cannot do indirectly, and the fact that the trust agreement recites that the corporation is not acting as a philanthropist but merely making the expenditures for the benefit of its business would not in any way change the situation. In other words, the court will look to the instrument itself and the requirements thereof rather than to the declarations of the corporation made in its own interest.
Appellant, the Tupelo Garment Company, engaged in the business of manufacturing shirts, filed with the State Tax Commission its income tax report for its fiscal year beginning July 1, 1933, and ending June 30, 1934, as provided by chapter 120, Laws of 1934. In this report it deducted the sum of $25,000 paid by it to a foundation or trust fund, and the sum of $29,970.10, claimed by it as a loss sustained on the sale of certain buildings and land. After these deductions were made the appellant reported and paid on a net income of $107,577.96. The State Tax Commissioner declined to allow the deductions above mentioned, and assessed additional taxes thereon in the sum of $3,296.82. The appellant then prosecuted an appeal to the full commission, as provided by law. The commission concurred in the findings made by the commissioner and approved the additional assessment, whereupon the garment company filed its petition in the chancery court of Hinds county, with a bond as provided by law. The case was tried on that petition, answer thereto denying that the appellant was entitled to the deductions, and an agreed statement of facts. The chancery court declined to allow either deduction; approved and confirmed the assessment made by the State Tax Commission, and rendered a decree against the Tupelo Garment Company, and its surety, for the tax and interest, amounting to $3,746.28. From that decree the Tupelo Garment Company prosecutes an appeal here.
Chapter 120, Laws of 1934, is known as the Income Tax Act. Section 3 of said chapter levies a tax "upon the entire net income of every resident individual, corporation, association, trust or estate, in excess of the credits provided." Section 6 defines "net income" as the gross income, as defined thereunder, less the deductions allowed. Section 7 defines the term "gross income" and provides that certain enumerated items shall be exempt from taxation. The deductions allowed are as follows:
"Sec. 8. In computing the net income there shall be allowed as deductions:
"(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. . ..
"(4) Losses sustained during the taxable year not compensated for by insurance or otherwise, if incurred in trade or business. Losses sustained from the disposition of capital assets employed in the conduct of the regular trade or business shall be determined by deducting from the cost (or value as of March 16, 1912, if acquired prior to that date) the depreciation sustained and the amount realized therefrom."
Section 36 of the act provides that: "The rules and regulations issued by the treasury department of the United States government relative to the interpretation of the federal income tax statute of 1921 shall, in so far as applicable, be used in the construction of this statute."
The Tupelo Garment Company, hereafter called the Garment Company, had outstanding shares of stock of the value of $193,507 for the fiscal year here involved. The net income thereof was $162,505.06, including the contested deductions. In that year it made a little more than 83 per cent. of its entire outstanding capital. The Garment Company had a board of directors consisting of seven members, four of whom were R.F. Reed, W.B. Fields, J.P. Hunter, and R.W. Reed. These four men, together with two others, formed a partnership known as the Tupelo Realty Company in the latter part of June, 1934, and a few days later the partnership was incorporated under the same name. The stockholders of this corporation were the same as the partners in the partnership. The Tupelo Realty Company issued $2,200 worth of stock, and 99 per cent. of it was owned by four stockholders — the four above-named directors of the Garment Company.
At a meeting of the directors of the Garment Company on June 19, 1934, the four directors above named, who constituted a majority of the board, resolved to sell the buildings and to create a foundation fund, and called a special meeting of the stockholders for June 26, 1934. In 1934 the Tupelo Garment Company completed its factory building which was used then and now in manufacturing its products. The building cost $54,712.20, against this depreciation in the sum of $1,765.10 was charged, leaving a net cost, or value, of $52,947.10. At the special meeting of the stockholders R.F. Reed reported for the directors that they had received an offer of $23,000 cash for a sale of the buildings and improvements, real estate and lease contracts covering the company plant in Tupelo. The stockholders authorized the directors to accept the proposition and to negotiate for the lease of such property from the purchaser. At the same meeting the stockholders also authorized the establishment of the foundation or trust fund, a copy of which was before them, and the payment of $25,000 thereto.
Before June 30th the directors sold the buildings as authorized, and executed the trust and paid $25,000 to the trustees thereof as directed. At the regular meeting of the stockholders on July 10, 1934, the board affirmed and approved both transactions. The sale of the real estate, buildings, and improvements, occasioned a loss of more than $29,000. The deed to the partnership, Tupelo Realty Company, is in regular form, as is also the deed from the partnership to the corporation, Tupelo Realty Company, and so far as this record discloses the Tupelo Garment Company was entirely stripped and divested of the title to the property under consideration.
It is shown in the agreed statement of facts that the Tupelo Garment Company operated plants at Tupelo, New Albany, Booneville, Baldwyn, and Fulton in this state, and it appears to have been its policy not to own real estate, because at the other points mentioned it did not own any real estate but leased buildings for its purposes.
The Garment Company immediately leased from the Tupelo Realty Company the buildings and real estate, formerly owned by it, for a rental of $500 a month or $6,000 a year, and this lease has been continued. At the meetings of the stockholders and directors the four directors above mentioned controlled in shares of stock and proxies a majority of the votes; they also owned 99 per cent. of the stock of the realty corporation which received the deed to the real estate here in question. For the year 1934 the real estate and buildings involved were assessed for taxes in the city of Tupelo and in the county at a value of $3,500, and thereafter the Tupelo Realty Company was assessed on the same property at a valuation of $7,500.
1. After the entire sale had been completed, the stockholders again ratified and approved this immense loss on a practically new building, so that, there is no possible theory upon which this court can hold that the stockholders were defrauded. The stockholders of the Garment Company had the right to decide that it was not good business policy for it to own buildings; they may have considered that probably no other corporation in the city of Tupelo would desire to lease the buildings in controversy. The record does not disclose what depreciation the use of the building would cause, nor what the cost of its maintenance, including taxes and insurance, would be in the future. The record shows that the purchase price, $23,000, was paid by the Tupelo Realty Company; that it secured the money from a bank in Tupelo, and within a month borrowed $22,000 of the $25,000 set aside by the Garment Company for the foundation or trust fund. We do not think the fact that the four directors bought the building can militate against the sale and the effectual vesting of the title. The Garment Company divested itself thereof entirely. The fact that the Garment Company sold the buildings to its directors, under these circumstances, does not in law destroy or avoid the sale.
We are reluctantly compelled to hold under section 8, subdivision (4) of chapter 120, Laws of 1934, that the loss of $29,970.10 was one sustained from the disposition of capital assets employed in the conduct of the regular business of said company. It is not unusual that individuals decide to sell property at a loss as a business policy rather than continue ownership thereof. The fact that in this case the Garment Company voluntarily suffered this immense loss does not alter the fact of the loss; it only arouses suspicion. If we undertook to view the sale here as a gift of more than $29,000 to the Tupelo Realty Company we would be foreclosed, because the reported and recited purchase price of $23,000 is a substantial sum, and such a conclusion might lead to the taxation of all large or substantial losses, which the statute does not seek to accomplish.
2. The court below disallowed the claimed deduction of $25,000, which was paid over by the Garment Company to a foundation fund. The claim for this deduction is based on subdivision (1) of section 8 of the act, which allows "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."
The instrument creating the trust or foundation, too lengthy to set forth herein, set aside $25,000 for the purpose of enabling the trustees named therein to make loans to the company's employees for meeting emergencies arising, and unforeseen events, requiring and demanding financial aid, etc. The preamble, in almost eloquent language, recited that the company's success would depend upon the happiness of its employees; that the instrument was created in order to stimulate the esprit de corps of the employees, and that its purpose was to create amity, good feeling, co-operation and good will between the company and its employees. The instrument provided for five trustees to be elected annually by the board of directors of the Garment Company, three of whom had to be directors of the Garment Company, one an employee thereof, and one a disinterested person. The title to the funds turned over to the trustees was absolutely vested in them, subject to the conditions and limitations contained in the instrument. The trustees were authorized to invest the funds with the view of deriving the best possible income, considering the safety of such investments; they were the sole judges of the character, amount, and security of such investment. Section 18 of the instrument is as follows: "Out of any amount of the principal of the fund the Trustees may cause to be made loans and advances, to the employees of the Trustor in good standing, and primary consideration shall be given to such loans and advances, and to charge for such loans or advances such interest or interest rates as they may deem best and proper not repugnant to law, such loans to be secured as amply as possible considering the situation and need of the borrower and the emergency arising requiring such a loan or advance. The Trustees may make such loans or advances to the Trustor's employees upon open note or evidence of debt, without security upon obtaining the signature as co-maker or endorser of at least two other of such employees in good standing, which would reasonably assure repayment thereof."
The trustees were required to use the income arising from their investments to keep the corpus of the estate unimpaired and to pay the necessary expenses of administering the fund, and from any remaining income they were authorized to take care of the needs of indigent employees, to render financial aid and assistance to employees in good standing. They were also empowered to enlarge and increase the fund. The board of directors of the trustor was authorized to remove any trustee who did not conform to the judgment of the majority. There is an expression of hope that the funds of the foundation might be converted into an employees pension fund or an employees relief fund, and in the event such could be done, the trustees were authorized to so change it.
Section 27 of the instrument is as follows: "This trust may be terminated at any time by action taken by the Board of Directors of the Trustor, and upon notice given to the Trustees, they shall surrender and turn over to the Trustor all funds, property and assets of every kind and character, owned and held in any way connected with or related with this trust, and shall execute any and all instruments, documents and papers necessary to effectually make such transfer."
Section 28 authorized the board of directors of the trustor to alter, amend, change, or repeal any of the terms and conditions, rules and regulations and provisions of the trust, or add new and additional or amended terms and conditions thereto.
In the agreed statement of facts it is shown that many employees had availed themselves of the opportunity to borrow from this fund, and many loans had been made, ranging in amount from a few dollars up to as much as $250, and that the creation of the foundation had increased the loyalty and amity of the employees.
The creation of this foundation and the setting aside of the fund occurred within one week of the time when the Garment Company had to account to the state for its income. As above stated, only a few days after the foundation was created the trustees loaned $22,000 to the Tupelo Realty Company.
The record discloses that after the payment of expenses and all deductions, save those two involved in this case, the garment company made a net income for that fiscal year in excess of 25 per cent. of the amount of wages paid the employees. There is no evidence tending to show that other employers of labor in this state have created similar foundations, nor can we say that such an expenditure has become "usual and ordinary" in this state. However, section 36 of the income tax act provides that the rules and regulations adopted in the enforcement of the federal income tax statute of 1921 shall, in so far as applicable, be used in the construction of the statute.
The United States Board of Tax Appeals has held that foundations or trusts established by employers for pensions or hospitalization of employees are usual and ordinary expenses when created in good faith, and has allowed deductions therefor. Sugarland Industries v. Commissioner, 15 B.T.A. 1265; Elgin National Watch Co. v. Commissioner, 17 B.T.A. 339; Hibbard, Spencer, Bartlett Co. v. Commissioner, 5 B.T.A. 464, and Forbes Lithograph Manufacturing Co. v. White (D.C.), 42 F.2d 287. Therefore, we would be reluctant to say as a matter of law that such an appropriation, made in good faith for the establishment of a foundation for the benefit of the employees, would not be "usual and ordinary expense." Neither would we be willing to say that this court would discourage the initiation of a plan similar to the one here involved, because it is apparent that such recognition of the employees by such a trust would tend to enhance the value of their services by creating in them a spirit of gratitude and amity toward the employer. If it be true that this is the first corporation in this state to follow the course of recognizing employees as human beings, and at the same time increasing the value of the man power employed by it through more efficient service, we do not think this fact alone should stay the court from approving this deduction on the ground that the expenditure is not "usual and ordinary." However, granting that such a trust could be created, and granting that this trust, in so far as its stipulations and purposes are concerned, contains all the elements requisite to establish a trust, and conceding that the employees of this Garment Company would be cestui que trusts, still we are of the opinion that the deduction in this case cannot be allowed. We must consider that the Garment Company created the fund just a few days before it was bound to account to the State Tax Commission for its income, and that at the same time it had made a sale of its real estate at a considerable loss. We must also consider the fact that the Garment Company reserved the right to terminate the trust at any time its board of directors saw fit, without regard to the cestui que trusts, the increased necessity for the maintenance thereof, any conditions that might exist, the success of carrying out the objects of the trust, and without the consent of the trustees of the foundation. The mere fact that a trust may be terminated by the trustor is not controlling, but all the facts which we have set forth convince us that the entire record does not clearly show that this deduction should be allowed.
In many of the cases we have examined similar to the one here involved, it has been provided that a trust may be terminated by the agreement of the trustees named in the trust and the trustor. Forbes Lithograph Manf. Co. v. White, supra; Elgin National Watch Co. v. Commissioner, supra, and Hibbard, Spencer, Bartlett Co. v. Com'r, supra. We take into consideration the fact that this trust could be operated two ways, one for the benefit of the cestui que trusts, and the other for the benefit of the trustor by relieving itself of the tax on the corpus of the trust. Lending money to those people over whom it had a very close supervision and requiring good security indicates to us clearly that in spite of the eloquent language ostensibly creating a permanent valid trust, the trustor had an eye to investment for its own benefit rather for the benefit of its employees; and this seems to be true because the trustor had the reserved power to terminate the trust at any time.
In order to allow this deduction we would have to say that the right thereto clearly appears, for such a deduction is in fact an exemption, and exemptions must be strictly construed against the exemptionist. Jackson Fertilizer Co. v. Stone, 173 Miss. 183, 162 So. 170. We are of the opinion that the idea of an investment was predominant by the terms of the trust.
The claim for the loss in the sale of the buildings and grounds is allowed as a proper deduction. The claim for the establishment of the foundation is disallowed, and the case is remanded to the lower court for a decree to be entered in accordance with the views herein set forth.
Affirmed in part; reversed in part and remanded.
CONCURRING OPINION.
I concur in the disallowance of the exemption claimed on the $25,000 placed by the appellant in the trust fund, set forth in the main opinion; but solely on the ground that the trust was revocable at the appellant's pleasure, resulting in its having the power, if it desired, to revoke the trust immediately, thereby reacquiring the $25,000 and any accretions earned therefrom by the trustees. Had the trust been irrevocable, I am not prepared to say that the exemption claimed because of its creation should not be allowed.