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Mead Corp. v. Commissioner of Internal Revenue.

November 29, 1940


On Petition for Review of Decision of United States Board of Tax Appeals.

Author: Jones

Before BIGGS, CLARK, and JONES, Circuit Judges.

JONES, Circuit Judge.

The pending petition brings on for review a decision of the Board of Tax Appeals determining a deficiency in tax against the petitioner corporation for the year 1931 in the amount of the additional tax authorized by Sec. 104(a) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 26 U.S.C.A. Int. Rev. Acts, page 375. The tax there prescribed is 50% of the net income of "any corporation * * * formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed". This tax is in addition to the regular income tax to whcih corporations in general are subject and is levied upon the offending corporation's taxable net income as augmented in the manner provided by Sec. 104(c).

In the present case, the petitioning corporation's sole shareholder was another corporation whcih, as such, was not subject to surtax (Sec. 12, Revenue Act of 1928, 26 U.S.C.A. Int. Rev. Acts, page 352). However, the Board of Tax Appeals found that the petitioner was formed or availed of for the purpose of preventing the imposition of the surtax upon the individual owners of the stock of the parent corporation which owned the entire capital stock of the petitioner. Thereupon the Board concluded, as a matter of law, that the individual shareholders of the parent or holding corporation were the shareholders of the subsidiary (the petitioner) within the intent and meaning of Sec. 104(a) of the act and that, accordingly, the petitioner was liable for the additional tax. The Board of Tax Appeals rested its decision squarely upon its construction of the statute, holding that the term "its shareholders" as used in Sec 104(a) is sufficiently board to include, in the case of a subsidiary corporation, the stockholders of the parent or holding corporation. The opinion of the Board (a bare majority joining in the decision) was undoubtedly provoked by the elaborate scheme adopted and carried out by the parties interested in the petitioner in an obvious effort to minimize their own liability for income taxes as the facts disclose.

Prior to 1931, George W. Mead, his wife and their three childeren owned or controlled a majority of the issued and outstanding common stock of the Consolidated Water Power & Paper Company, a Wisconsin corporation. In that year, pursuant to a plan devised by Mead's lawyers and tax consultants, he caused three Delaware corporations to be formed, viz., the G. W. Mead Securities Corporation, the S.W.E. Corporation and the Mead Corporation (the petitioner). A variety of transfers ultimately found Mead, his wife and their children the owners of all of the common and prefereed stock of the Securities Corporation (Mead and his wife holding the common and their children the preferred), the Securities Corporation the owner of the entire capital stock of the Mead Corporation, and the Mead Corporation the owner of so much of the Consolidated Water Power & Paper Company stock as the Meads had actually owned outright. The S.W.E. Corporation, having served its purpose in the course of the transfers and being no longer useful, was dissolved.

In addition to the Power Company stock which Mead had owned outright, he had purchased, under a contract of January 3, 1927, from one Witter, his brother-in-law, a large block of Power Company stock. This stock, together with the MEads', constituted control of the Power Company. Under the contract of purchase, Mead, had given Witter his interest bearing notes payable serially over a period of ten years. The Witter stock, which was transferred to Mead at the time of his purchase, was delivered to Witter as collateral security for Mead's purchasemoney notes. At that time Mead had indicated his desire to form a corporation to hold all of the Mead's Power Company stock and Witter assented. However, nothing definite was done to that end until 1931, when the matters hereinabove referred to were undertaken.

The Mead Corporation on the day following its acquisition of the Power Company stock, which the Meads had owned outright, assumed Mead's obligation Witter under the contract of purchase and took totle to the unreleased Witter stock. New certificates for the stock were issued to the Mead Corporation and delivered by it to Witter as collateral security for the payment of the balance due on Mead's notes. Witter did not, however, release Mead from his personal liability on the notes.

After the completion of the incorporations and the transfers and assignment to which we have referred, Mead became president, treasurer and a director of both the Mead Corporation and the Securitites Corporation, his two sons becoming the other officers and directors of both corporations.Neither corporation conducted any business. The activities of the Mead Corporation (except for a bank stock investment in relief of a personal undertaking of Mead) consisted of its receipt of dividends on the Power Company stock, payment of interest and principal on account of the obligations for the witter stock, payment of dividends to its sole stockholder, the Securities Corporation, and the payment of the expenses incident to the creation and organization of the three Delaware corporations and the effection of the plan of transfers. The Securities Corporation's sole activity was its receipt of dividends from the Mead Corporation and its payment of dividends on its own stock to the holders thereof, the members of the Mead family. Mead's ascribed purpose for the roundabout transfer of the Power Company stock was that the Mead's entire holdings of Power Company stock might be placed in one control and that the transfers might be consummated under the reorganization provisions of the Revenue Act of 1928, Sec. 112, 26 U.S.C.A. Int. Rev. Acts, page 377, so as not to determine a taxable gain to the Meads by reason thereof.However, the further use of both the Securities Corporation and the petitioner for the continued holding and control of the Power Company stock did serve to reduce very considerably the liability of Mead and his wife for taxes on ordinary income. The effect on the income tax liability of the Mead children was negligible.

The Board of Tax Appeals found that "The petitioner was formed and availed of for the purpose of avoiding the imposition of surtax upon members of the Mead family, particularly George W. Mead and his wife, Ruth W. Mead". As that finding is supported by supported by substantial evidence, it may not now be distrubed.Helvering v. National Grocery Co., 304 U.S. 282, 58 S. Ct. 932, 82 L. Ed. 1346. Nor would we be be disposed to find otherwise were it within our power to do so. Whatever other motives Mead may have had in forming the holding companies to retain and exercise the Mead family's former ownership and control of the Power Company stock, his desire to reduce his own and his wife's liability for income tax was uppermost. Nevertheless, the question presented by the record in this case is not whether the Meads should be subject to additional taxes as being the substantial owners of the Power Company stock and, as such, asscountable for the income therefrom from whether distributed to them or not. The respondent made no claim that the ostensible reorganization was a mere device to relieve the Meads of tax liability or that they are still the substantical owners of the Power Company stock, wherefore the entities of both the petitioner and the Securities Corporation should be disregarded. The question here is simply whether the petitioner is subject to the additional tax prescribed by Sec. 104(a).

The statute, by its terms, lays the tax upon a corporation which prevents, in the manner of denounced by the act, the imposition of the surtax upon "its shareholders". The words are plain and it is from them that the intent of Congress is to be derived. United States v. Standard Brewery, 251 U.S. 210, 217, 40 S. Ct. 139, 64 L. Ed. 229; Adams Express Co. v. Commonwealth of Kentucky, 238 U.S. 190, 199, 35 S. Ct. 824, 59 L. Ed. 1267, Ann. Cas. 1915D, 1167; Bate Refrigerating Co. v. Sulzberger, 157 U.S. 1, 87, 15 S. Ct. 508, 39 L. Ed. 601. Shareholders of a corporation, in the usual and ordinary acceptation of the term, are the holders of its stock as the record owners thereof. Treasury Regulation 74, Art. 543, interpreting Sec. 104 of the Revenue Act of 1928, so recognizes.*fn1 The possessive pronoun "its" which, in Sec. 104(a), limits and thus identifies the "shareholders" whose freedom from surtax the corporation stall not serve except it be penalized, refers to the corporation made subject to the tax. It is the taxpayer corporation which is forbidden to accumulate its "gains and profits" for the purpose of preventing the imposition of the surtax upon its shareholders. However, in the present case, no amount of accumulation of gains and profits or failure to distribute surplus would relieve the petitioner's sole stockholder of liability for surtax. That shareholder, being a corporation, was not subject to surtax. Revenue Act of 1928, Sec. 12. Hence the statute, by its terms, does not apply to the facts of the instant case. To say that the term "its shareholders" means not only the corporation's actual shareholders but also the shareholders of its shareholders would be to add to the statute something that is not there and to give it an effect which its plain words do not compel. This we may not do. "To supply omissions transcends the judicial function." Iselin v. United States, 270 U.S. 245, 251, 46 S. Ct. 248, 250, 70 L. Ed. 566; Smietanka v. First Trust & Savings Bank, 257 U.S. 602, 607, 42 S. Ct. 223, 66 L. Ed. 391. Any extension or retraction of the policy expressed by a statute is for the Legislature and not for the courts. La Belle Iron Works v. United States, 256 U.S. 377, 393, 41 S. Ct. 528, 65 L. Ed. 998; Brushaber v. Union PAcific R. Co. 240 U.S. 1, 25, 36 S. Ct. 236, 60 L. Ed. 493, L.R.A. 1917D, 414, Ann.Cas. 1917B, 713; Billings v. United States, 232 U.S. 261, 282, 34 S. Ct. 421, 58 L. Ed. 596; Cook v. Tait, D.C., 286 F. 409, 414, affirmed 265 U.S. 47, 44 S. Ct. 444, 68 L. Ed. 895.

Even though the Meads should have been required to pay a surtax on the basis that the income from the Power Company stock was really theirs, we would not be warranted in extending the terms of a simple statute in order that they might now be reached indirectly. No matter how desirable an extension of the congressional intent may appear to be, it is our duty to observe the limits fixed by Congress and to act accordingly. Commissioner of Immigration v. Gottieb, 265 U.S. 310, 313, 44 S. Ct. 528, 68 L. Ed. 1031. When the legislative intent has been expressed in plain and unambiguous words, it is the duty of the courts to apply and enforce a statute as written. There is then no room for cosntruction. Yerke v. United States, 173 U.S. 439, 442, 19 S. Ct. 441, 43 L. Ed. 760; Lake County v. Rollins, 130 U.S. 662, 670, 9 S. Ct. 651, 32 L. Ed. 1060. Resort to rules of construction is permissible only where there is doubt or ambiguity in the statutory expression. Russell Motor Co. v. United States, 261 U.S. 514, 519, 43 S. Ct. 428, 67 L. Ed. 778; Caminetti v. United States, 242 U.S. 470, 485, 37 S. Ct. 192, 61 L. Ed. 442, L.R.A. 1917F, 502, Ann. Cas. 1917B, 1168. Here, there was neither.

Yet, the majority of the Board of Tax Appeals imputed ambiguity to the words "its shareholders" and then construed the term as embracing the shareholders of the parent corporation. But even if the doubt, which the Board thus raised, actually existed, a tax statute is not to be extended by implication or enlarged by construction so as to embrace matters not specifically pointed out therein. Crooks v. Harrelson, 282 U.S. 55, 61, 51 S. Ct. 49, 75 L. Ed. 156; Burnet v. Sanford & Brooks Co., 282 U.S. 359, 367, 51 S. Ct. 150, 75 L. Ed. 383; United States v. Merriam, 263 U.S. 179, 188, 44 S. Ct. 69, 68 L. Ed. 240, 29 A.L.R. 1547; Van Camp & Sons Co. v. American Can Co., 278 U.S. 245, 353, 49 S. Ct. 112, 73 L. Ed. 311, 60 A.L.R. 1060; United States v. Field, 255 U.S. 257, 262, 41 S. Ct. 256, 65 L. Ed. 617, 18 A.L.R. 1461; Gould v. Gould, 245 U.S. 151, 153, 38 S. Ct. 53, 62 L. Ed. 211.

Moreover, Sec. 104(a) is penal. Although the provision is a remedial sanction to be applied civilly (Helvering v. Mitchell, 303 U.S. 391, 402, 58 S. Ct. 630, 82 L. Ed. 917), its penal nature was, none the less, noted in Helvering v. National Grocery Co., supra, 304 U.S. at page 288, 58 S. Ct. 932, 82 L. Ed. 1346. In United Business Corp. of America v. Commissioner, 19 B.T.A. 809, 826, affirmed 2 Cir., 62 F.2d 754, certiorari denied 290 U.S. 635, 54 S. Ct. 53, 78 L. Ed. 552, the Board of Tax Appeals said with respect to a similar provision in the Revenue Act of 1921, Sec. 220, 42 Stat. 247, where the tax was half that of Sec. 104(a) in the 1928 Act, that the section was 'highly penal". And in Charleston Lumber Co. v. United States, D.C., 20 F.Supp. 83, 87, the court, in passsing upon a similar provision in the Revenue Act of 1924, Sec. 220, 26 U.S.C.A. Int. Rev. Acts, page 31, said that the statute imposed a tax "which is in effect a penalty" and, therefore, "should be strictly construed and should not be extended to cover cases which do not fall within its letter". The respondent answers that a strict construction does not require that the legislative intent be violated. As much may readily be conceded. But, that does not authorize any and all constructions that might possibly be made. To so permit would be to use the rule, as the respondent seeks to do, not ...

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