Opinion
Docket No. 25986.
1951-06-29
JOSEPH B. EASTMAN CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John Enrietto, Esq., for the petitioner. George E. Gibson, Esq., for the respondent.
John Enrietto, Esq., for the petitioner. George E. Gibson, Esq., for the respondent.
Congress in section 101(6) of the Internal Revenue Code did not intend to exempt from taxation a corporation not engaged in education work but operating a commercial competitive business for profit, although its earnings inure solely to the benefit of another corporation, an educational institution falling within section 101(6).
Deficiencies in corporation income taxes, and penalties, for the taxable year August 1, 1947, to December 31, 1947, and for the calendar year 1948 are involved in this case. Deficiencies therein were asserted in the respective amounts of $12,622.92, with penalty of $3,155.73, and $27,112.77. After concession of the penalty issue by respondent, the question presented is whether the petitioner was entitled to exemption from taxation under section 101(6) of the Internal Revenue Code.
FINDINGS OF FACT.
The facts stipulated are so found.
The petitioner is a corporation organized under Delaware law on June 2, 1947, with executive office in St. Louis, Missouri. It had a warehouse located in Des Moines, Iowa. The corporation income tax returns were filed with the collector for the first district of Missouri.
Petitioner was incorporated under the laws of the State of Delaware on June 2, 1947.
Amherst College is an educational institution of higher learning, incorporated and existing under the laws of the Commonwealth of Massachusetts. It was organized in 1821 and is located in Amherst, Massachusetts. At all times material hereto, Amherst College was an organization exempt from Federal income tax under the provision of section 101(6) of the Internal Revenue Code.
Hugh H. C. Weed, an alumnus of Amherst College of the class of 1905, had for many years kept closely in touch with Amherst, and had served on visiting committees.
Weed felt a keen obligation to the college for his own educational opportunities there and sought means of providing the institution with needed funds to carry on its educational work.
He was particularly interested in assisting the Joseph B. Eastman Foundation at Amherst, which was so named in honor of the late Interstate Commerce Commission Member, and Coordinator of Transportation in World War II. The object of the Foundation was to employ a professor in the school of public administration to train men for Government service.
In 1946, while Weed was serving as director in the Middle and Southwest states for the Second Century Fund for Amherst College, the idea occurred to him of acquiring a business enterprise, the income of which would be devoted to the educational activities of Amherst.
This idea was prompted by announcement of the acquisition by New York University of the Ramsey Accessories Corporation, located in Weed's home city of St. Louis, which he heard had been declared tax exempt by the Bureau of Internal Revenue.
Weed, who was president of Carter Carburetor Company, asked some of his associates to keep on the look-out for any such businesses that might be available. Several businesses were considered but plans were not pursued because of further difficulty in obtaining complete ownership or for other reasons.
In the latter part of 1946 or early 1947, the Lally enterprises were brought to Weed's attention.
These enterprises originated as Lally's Service, Incorporated, organized by L. L. Lally under the laws of the State of Iowa on February 8, 1938. On organization, that company purchased the fixed assets and inventories of the Des Moines Branch of United Motors Service and the automotive department of the A. A. Schnedierhahn Company, and thereafter operated as distributor in most of Iowa for automotive parts and accessories and in addition operated a general automobile service garage at 12th and Mulberry Streets in Des Moines, Iowa.
In 1940, L. L. Lally also organized Lally's Nebraska Company under the laws of the State of Nebraska, which thereafter engaged in the business of distributing automotive parts in Omaha, Nebraska.
Towards the end of 1946, the automobile service garage was transferred to a wholly-owned subsidiary known as Lally's Service, incorporated, and the parent's name was changed to Lally's, Incorporated.
The above-mentioned Lally enterprises were taxable business corporations successfully engaged in commercial activities for profit.
Weed investigated them and concluded that an automotive parts and service business would be a desirable acquisition. He believed that such business would be depression proof and would require little capital outlay. L. L. Lally, the principal owner and head of the Lally enterprises, was not well and all of the stock of his companies was available.
In 1946 Weed discussed his project with Charles W. Cole, the president of Amherst College, Paul Weathers, its treasurer, George Pierce, chairman of the Finance Committee, and with other members of the Finance Committee. The above-named were also members of the Board of Trustees of Amherst College.
At the suggestion of some of the officials and trustees, Weed then discussed the project with Charles Rugg, who was serving as counsel for the college, who cautioned that the college must be insulated from any liabilities that might be incurred in connection with the operation of the business.
Weed discussed this proposal with members of the Finance Committee of the Board of Trustees of Amherst College. For the purpose of earning funds to be used by the college for its operations, it was concluded that Weed would undertake negotiations for the acquisition of the Lally enterprises so long as Amherst College would not be required to incur obligations or to assume risks in connection with the operation of said enterprises.
Weed then caused petitioner to be incorporated with a certificate of incorporation which granted broad powers to engage in business and which provided in pertinent part at follows:
THIRD: This corporation is organized exclusively for charitable, scientific, literary and/or educational purposes and no part of its income or property shall inure to the private benefit of any stockholder, director, or officer, or any individual or corporation other than Amherst College, of Amherst, Massachusetts. It shall not in any way directly or indirectly engage in carrying on propaganda or otherwise attempt to influence legislation. The specific objects and purposes proposed to be transacted, promoted or carried on by it are to do any or all of the things hereinafter mentioned, as fully and to the same extent as natural persons might or could do, and in any part of the word, viz:
(a) To distribute to Amherst College, for the use and benefit of Amherst College, such part of its property and/or its net income as the directors of the Corporation may determine.
EIGHTH: * * * (f) No director of the Corporation shall receive any compensation for his services as such, but he shall be reimbursed for all expenses incurred by him in connection with the management and administration of the affairs and business of the Corporation.
(g) No stockholder shall at any time be entitled to dividends on his shares; nor shall he at any time be entitled to any of the profits or assets of the Corporation. In the event of the liquidation, dissolution, or winding up of the Corporation, whether voluntary, involuntary or by operation of law, except as may otherwise be provided by law, the directors of the Corporation shall, after payment of all creditors, distribute the assets of the Corporation to Amherst College for the use and benefit of itself.
TENTH: The Corporation reserves the right, by vote of the holders of two-thirds of its outstanding shares, to amend, change, or repeal any provision contained in this Certificate in the manner now or hereafter prescribed by statute, PROVIDED, however, that any such action shall not divert any of the income or property of the Corporation, after payment of creditors, for purposes other than those specified in paragraph THIRD of this Certificate.
Petitioner's total authorized, issued, and outstanding capital stock consists of 10 shares of the par value of $100 each issued on June 4, 1947, to record holders as follows:
(1) Hugh H. C. Weed— 8 shares
(2) his daughter, Phoebe Weed O'Reilly— 1 share
(3) his daughter, Catherine Weed Wilkins— 1 share
In payment for said shares, Weed paid $1,000 to petitioner from his personal funds.
At all times material hereto the members of the board of directors of petitioner have been as follows:
(1) Hugh H. C. Weed
(2) Phoebe Weed O'Reilly
(3) Catherine Weed Wilkins
At all times material hereto the officers of petitioner have been as follows:
+-------------------------------------+ ¦President ¦Hugh H. C. Weed ¦ +--------------+----------------------¦ ¦Vice-President¦Phoebe Weed O'Reilly ¦ +--------------+----------------------¦ ¦Secretary ¦Catherine Weed Wilkins¦ +-------------------------------------+
After incorporation had been completed, Weed notified Weathers, treasurer of the Board of Trustees of Amherst College of that fact. Weed also supplied Weathers with a certified copy of the articles of incorporation of petitioner and declared to Weathers that all of the shares of capital stock of petitioner would be held by the record holders irrevocably and in perpetuity for the benefit of Amherst College.
On June 23, 1950, Weed and his two daughters executed an instrument of trust which provided that they were trustees of their stock in the petitioner corporation for the benefit exclusively of Amherst College.
Weed, in accordance with the decisions reached at Amherst, concluded the negotiations with L. L. Lally, for the purchase of the various Lally enterprises.
It was agreed by Weed and Lally that the various Lally enterprises should first be consolidated into one company, Lally's Incorporated, and that then such consolidated business should be acquired by petitioner through a merger of Lally's Incorporated into petitioner, at a purchase price based upon the assets and liabilities of Lally's Incorporated as of June 30, 1947, with adjustments to the date when the merger became effective.
The first phase of this plan was completed through acquisition by Lally's Incorporated of all the outstanding stock of Lally's Nebraska Company in July 1947, followed by the dissolution of both the subsidiary Nebraska Company and Lally's Service, Incorporated.
The outstanding capital stock of Lally's Incorporated on July 31, 1947, consisted of 7,592 shares, owned in varying amounts by 19 individuals.
On July 26, 1947, petitioner entered into a written Agreement and Plan of Merger with Lally's Incorporated. The merger of Lally's Incorporated into petitioner became effective at the close of business on July 31, 1947, and it thereby acquired all of the assets and liabilities of Lally's Incorporated, and the entire capital stock of Lally's Incorporated was cancelled.
In consideration of the foregoing petitioner paid to Lally as trustee for the shareholders of Lally's Incorporated $100,000 in cash and executed a note maturing March 15, 1967, bearing interest at 4 per cent, in the amount of $277,856.83 payable to said Lally as trustee.
In accordance with the aforesaid merger agreement, on April 1, 1948, upon completion of an audit of Lally's Incorporated as of July 31, 1947, petitioner executed and delivered to L. L. Lally as trustee for shareholders of Lally's Incorporated an additional note maturing on March 15, 1967, in the sum of $5,314.11.
The purchase price in the total amount of $383,170.94 for the Lally enterprises was arrived at as the result of arm's length negotiations and Weed considered it a low price.
With the exception of the attorney's fee in connection with the organization of petitioner, no fee, commission, or compensation in any form was paid to anyone in connection with the acquisition by petitioner of the Lally enterprises.
Petitioner financed the cash payment of $100,000 by borrowing that amount from Mississippi Valley Trust Company, pursuant to a loan agreement dated July 31, 1947, on its note maturing December 31, 1950, and bearing 2 per cent interest per annum. The above-mentioned notes to Lally were subordinated to the note payable to the Mississippi Valley Trust Company.
The Trust Company note provided for amortization thereof through payment of 33 1/3 per cent of petitioner's net earnings each year or $50,000 yearly, whichever was less. If the earnings should be less than $50,000 in any year, then petitioner was to apply 40 per cent of its net earnings to amortization of said note. On April 1, 1948, petitioner paid $13,000 to the Mississippi Valley Trust Company in respect of principal of said note.
The Lally notes provided for amortization by annual payments on March 15 of each year, beginning March 15, 1949, of the lesser of the following amounts: (a) 25 per cent of the net profits from operations attributable to business acquired from Lally's Incorporated, or (b) the sum of $100,000.
Since August 1, 1947, petitioner has actively engaged in the business of distributing within certain parts of Iowa and Nebraska various automobile accessories, such as carburetors, windshield wipers, piston rings, bumpers, ignition systems, and starting and lighting systems, and operated the automobile service garage at 12th and Mulberry Streets in Des Moines, Iowa, which businesses had formerly been carried on by Lally enterprises. In order not to break the continuity and to preserve the good will attached to the name ‘Lally's,‘ the businesses were carried on under the name ‘Lally's, a division of Joseph B. Eastman Corporation.‘
Most of the operating and sales personnel of the former Lally enterprises were employed by petitioner after its acquisition of the Lally businesses, including key managerial personnel.
In addition to his original contribution of $1,000 for petitioner's capital, Weed, in December 1947 made a further contribution of $4,000 to petitioner's working capital.
Weed also devoted his time and efforts to petitioner without compensation therefor, nor did he ever request reimbursement for traveling expenses incurred by him on petitioner's behalf.
No trustee, or officer, or member of the board of directors of petitioner has ever received any compensation for his services.
Except for payments pursuant to petitioner's loan agreement with Mississippi Valley Trust Company and except for payments pursuant to petitioner's notes held by the trustee for former shareholders of Lally's Incorporated no distributions have been made by petitioner other than to Amherst College.
On April 1, 1948, petitioner distributed to Amherst College the sum of $15,000.
The formation of petitioner, the purchase of the Lally enterprises, and the merger of Lally's Incorporated into petitioner were part of an integral plan for acquiring the assets and business of Lally's Incorporated and making the income therefrom available for the uses and purposes of Amherst College. The group which organized petitioner chose the particular form of organization adopted by petitioner as being the most suitable for administration of the acquired properties, for the purpose of insulating the stockholders and Amherst College against risks, and in an endeavor to achieve tax exemption for petitioner under section 101(6) of the Internal Revenue Code. The attorney who assisted and counseled Weed in the organization of petitioner told Weed that there was no question in his mind that petitioner was exempt, and that he had a ruling from McLarney (of the Commissioner's office) in the case of Ramsey or the Medlaw Corporation that it was tax exempt.
Petitioner filed returns for the taxable periods in question with the collector of internal revenue, at St. Louis, Missouri, on Form 990, Annual Return of Organization Exempt from Income Tax under section 101 of the Internal Revenue Code and on Form 1120, U.S. Corporation Income Tax Return. In the Forms 1120, petitioner claimed exemption under section 101(6), Internal Revenue Code.
On June 4, 1947, petitioner filed a written request with respondent for a ruling declaring its exemption from taxation by virtue of the provisions of section 101 of the Internal Revenue Code.
On July 19, 1948, respondent notified petitioner that he did not consider petitioner exempt from Federal income taxes under that section, and thereinafter issued the deficiency notices here in question asserting income tax liabilities for the fiscal period August 1 to December 31, 1947, and for the calendar year 1948.
OPINION.
DISNEY, Judge:
We have here another question as to application of section 101(6) of the Internal Revenue Code,
i.e., whether the petitioner is a corporation exempt from taxation. The petitioner correctly states that the question is whether the language ‘organized and operated exclusively for charitable * * *purposes‘””” applies to the facts here involved. It goes on to state that the question was considered by this Court ‘in respect of a similar situation‘ in C. F. Mueller Co., 14 T.C. 922. The respondent says, correctly in our opinion, that the two cases are more than similar, are in fact on ‘all fours,‘ and points out that the petitioner here does not seek to distinguish the Mueller case but asks us to reexamine its decision and reach the opposite conclusion here. Petitioner on brief specifically asks us to reexamine the implications of Willingham v. Home Oil Mill, 181 F.2d 9, and in effect if not in words presses for reexamination of our conclusions in the Mueller case.
SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.The following organizations shall be exempt from taxation under this chapter—(6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation:
On May 5, 1951, the United States Court of Appeals, Fourth Circuit, decided United States v. Community Services, Inc., 189 F.2d 421, holding, as did this Court in the Mueller case, that a corporation organized and operated to turn over its profits to a charitable organization is not exempt. The case involved section 1426(b)(8), Internal Revenue Code (now section 1426(b)(9)(B)) and not section 101(6) but the statute involved is the same in both statutes in that section 1426(b)(9)(B) makes section 101(6) a part thereof. The cases cited by petitioner here were examined. Petitioner agrees that the case is a direct conflict with the Home Oil Mill case, supra.
It is clear that this precise question has been decided by us in the Mueller case; and we see no reason to discuss it at length here. Though the petitioner suggests that the policy to tax commercially derived income to all charities was not made a part of the Federal tax structure under section 301, 302 and 303 of the Revenue Act of 1950, approved after the Mueller decision, we do not find in that Act ground for the inference seen by petitioner. Since the filing of briefs in this case, the United States Court of Appeals, for the Third Circuit, reversed the Mueller case 190 F.2d 120. With all due respect to that court, we adhere to the conclusions expressed by us in that case, and cited in Community Services, Inc., supra. We, therefore, conclude and hold that the petitioner is not, under section 101(6), Internal Revenue Code, a corporation exempt from tax. Because of the concession by the respondent as to penalty,
Decision will be entered for the respondent as to the deficiency determined, without penalty.