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Commissioner of Internal Revenue v. Sun Pipe Line Co.

March 23, 1942


On Petitions for Review of Decisions of the United States Board of Tax Appeals.

Author: Clark

Before CLARK and JONES, Circuit Judges, and GIBSON, District Judge.

CLARK, W., Circuit Judge.

The taxpayers are personal holding companies incorporated in Delaware. Prior to January 1, 1934 Piermont Corporation owed the First National Bank of New York $1,162,561.25. Foreseeing the consequences of a sudden calling of this demand loan, Piermont replaced the obligation with twenty-year debentures issued as of January 1, 1934. At the close of 1934 a sinking fund for the retirement of the debentures was established and a reserve of $50,000 set up for this purpose. Another $50,000 was added to the reserve in 1935. As of January 1, 1934 Sun Pipe Line Company had outstanding debentures aggregating $3,500,000. These bonds were refunded in 1934 at a saving of 1 1/2 per cent in the interest rate. In 1937 $3,400,000 of the refunded bonds was retired. In filing their income tax returns both taxpayers took credits, Piermont for the amount set aside in 1935 and Sun Pipe Line for $67,045.49 of the amount of the retirement. The applicable statute provides that such a credit shall be allowed in computing undistributed adjusted net income (upon which the personal holding company surtax is based) for*fn1 "Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness."*fn2

The Commissioner disallowed the deduction in both cases on the ground that the indebtedness was not incurred prior to January 1, 1934. The taxpayers thereupon prevailed upon the Board of Tax Appeals to reverse the Commissioner and this decision*fn3 is now on appeal. The single issue then is: Does a refusing operation undertaken subsequent to January 1, 1934 come within the meaning of the word "indebtedness" in the statute? The Treasury by regulation*fn4 says it does not. They insist that only in a renewal is the deduction permissible. The Board of Tax Appeals exhibit here, at least, less of the spirit of Zaccheus.*fn5 They emphasize the amount rather than the parties. If the amount has not changed, the personalities of the obligees are irrelevant in their view.

We think this must be so. Certainly as a matter of English, indebtedness has no reference to anything but amount. One is just as much obligated and it hurts just as much to pay one's bank as one's baker. It is the contract, not the parties who are bound by it, that matters. The term has been defined as an obligation to pay or perform*fn6 and is synonymous with owing.*fn7 Nowhere do the cases stress to whom.*fn8 It would require then some clearly expressed Congressional intent to justify us in finding a special meaning.

Far from finding any such legislative purpose the exact contrary seems to be true. As is known,*fn9 the primary purpose of Section 351 of the 1934 Act was to force the distribution of income of personal holding companies to their stockholders.*fn10 The latter would then become liable to surtax on such income at rates which are higher than that imposed upon corporate income.*fn11 But at the same time Congress wished to allow personal holding companies to make a reasonable accumulation for legitimate corporate purposes.*fn12 A reserve created to pay off existing obligations were recognized as such a purpose and therefore a deduction from net income for these reserves was permitted. The appropriate Committees said:

"Considerable hardship has been avoided by permitting the deduction from the adjusted net income of a reasonable amount used or set aside to retire indebtedness incurred prior to January 1, 1934. This will substantially and properly relieve personally owned corporations which have outstanding bonds or other indebtedness that must be met from current earnings before distributions can be made." Senate Finance Comm., S. Rep. No. 558, 73d Cong., 2nd Sess., p. 15.

"The denial of this deduction would cause hardship in numerous cases where, due to the particular circumstances of the corporation, a dividend distribution can not be made because of a necessity for legal reasons of using the earnings and profits to discharge the debts. Moreover, any loss of revenue caused by the continued allowance of this deduction can not increase, since indebtedness incurred after 1933 can not be used as a basis for the deduction. No corporation can be formed for the purpose of taking advantage of this deduction. Furthermore it is inevitable that the revenue loss must decrease as pre-1934 debts are retired." Ways and Means Comm., H. Rep. 1546, 75th Cong., 1st Sess., pp. 10-11.

From these reports it is plain that the date, January 1, 1934, was selected to prevent incorporated pocketbooks from being formed after the passage of the Act to take advantage of its provisions. "Indebtedness incurred" after that date were the words chosen rather than "personal holding companies incorporated" after the date in order to prevent those corporations already in existence from building up fictitious debt structures for which they might later set up reserves. So far as existing debt structures were concerned, Congress was resigned to the fact that it would be forced to permit tax free reserves to be accumulated for their liquidation. It was willing to let a deduction be taken by those corporations which fell within the Act to the extent of their existing debt structure. Congress was more interested in "indebtedness" as an amount rather than as a reference to specific contracts. In those cases where the deduction could have been taken but was not, there appears to have been no intent to prevent the deduction subsequent to a refund.

We are aware and have discussed*fn13 the somewhat complicated law that has grown up around Treasury Regulations. In a recent article Professor Shuck has well summarized the rather confusing conditions that surround it:

"The courts, awake to the need for stability in the law and flexibility in the administrative process, have, by exercising judicial restraint, given certain interpretative regulations a measure of protection. Thus, if the basis statute is ambiguous as to the portion interpreted;*fn14 if the administrative interpretation has been consistently adhered to by the administrative body;*fn15 if the interpretation is of long standing;*fn16 if it has been impliedly approved or ratified*fn17 by Congress through reenactment of the statutory provision without substantial change;*fn18 if the interpretation is not 'unreasoanble'*fn19 - if all these conditions are present in some degree - the court will generally recognize the validity of the interpretation." Schuk, Supreme Court of the United States, 28 Georgetown Law Journal 364, 366-368.

As we have found the Congressional intent so plain the law indicated does not seem to be applicable. Even if it were, only one of the conditions of the learned Professor is fulfilled in the present case. As is usually true, the administrative interpretation has been consistently adhered to by the administrative body. The interpretation however has not had a long continued application.*fn20 It is presumed that an interpretative regulation of long continued standing must have come to the attention of Congress. If Congress does not amend the Act, it is because it has accepted the administrative construction.*fn21 We do not believe that four years is a sufficiently long continued usage where the first two cases to raise the point before the Board of Tax Appeals are those we are now hearing on appeal.*fn22 In such circumstances the silent acquiescence of Congress may not be presumed, since legislative knowledge of the Regulations appears too doubtful.

The doctrine of statutory incorporation of a prior administrative ruling by reenactment without change is founded upon the belief, however fictitious,*fn23 that the members of Congress had some knowledge of the prior ruling. Where, as here, no positive proof of such knowledge exists, it might be presumed when the regulation has been in effect for some time. The presumption is here impossible, however, because the regulations had been in effect but three and five months respectively when Congress enacted the Revenue Act of 1938.*fn24 In the only case in point that we ahve been able to find, the presumption was denied although the regulation had been in existence for over eight months.*fn25 We ...

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