Appeal from the United States District Court for the District of New Jersey (D.C. Civil Action No. 445-73).
Adams and Hunter, Circuit Judges, and Murray M. Schwartz, District Judge.
Plaintiffs initiated this action in April, 1973 under 28 U.S.C. § 1346(a)(1)*fn1 to recover approximately $8,000 in income taxes which they alleged were erroneously collected for the taxable year 1966. The government, before answer, moved to dismiss for want of jurisdiction, on the ground that the suit had not been preceded by a claim for refund filed within the time period required by statute. The district court, after hearing, denied the motion to dismiss.*fn2 The government subsequently filed an answer and an amended answer denying the appropriate paragraphs of the complaint, but did not press any defense other than the one rejected on the motion to dismiss. After a hiatus of nearly two years, judgment was entered for plaintiffs in the amount claimed, plus interest.*fn3
On appeal, the government does not attempt to contest either the fact or the amount of the overpayment. We agree, however, with appellant's claim that the district court erred in denying the motion to dismiss, and therefore reverse.
The taxable year in question ended August 31, 1966, and plaintiffs filed their return and paid their taxes on or about September 20, 1966. For nearly fifteen years prior to these dates plaintiffs had invested sums of money in Manufacturers Credit Corporation ("MCC"), taking in return demand notes of the corporation providing for monthly interest payments at 15 percent per annum. During fiscal 1966, plaintiffs received payments from MCC totaling nearly $18,000. These payments were designated as earned interest by MCC, and there is no reason to believe that plaintiffs suspected otherwise. Accordingly, this sum was shown as earned interest income on plaintiffs' 1966 tax return, and resulted in an additional tax payment of nearly $8,000, the amount in controversy here.
MCC filed a petition for reorganization under Chapter XI of the Bankruptcy Act in August, 1967. One controversy spawned by that petition reached this court in Manufacturers Credit Corp. v. SEC, 395 F.2d 833 (3d Cir. 1968). The opinion in that case, filed in May 1968, describes the history, structure and operations of MCC and its subsidiaries and affiliates in some detail, and contains the following passage:
In reality, [the founder of MCC] employed these financing corporations as instrumentalities whereby he borrowed ever increasing huge amounts of money from the public. His scheme was to have the corporations turn over to him the proceeds from the sale of the unsecured promissory notes whereupon he paid the interest charges and other expenses. The corporations were represented as the borrowers to preclude the defense of usury. As interest accrued and principal amounts matured new notes were sold and their proceeds used to meet the earlier obligations. The result of this method of financing was an increasingly complicated debt structure with thousands of notes outstanding issued by various debtors, bearing different interest rates and maturing at different dates. The payments required by the terms of these notes in 1966 amounted to approximately $6,000,000 for interest and an equal amount for principal. As against this debt servicing charge of $12,000,000, the 1966 combined profits of all of the companies was approximately $300,000.
Id. at 837 (footnote omitted). That MCC, its affiliates and principals had in fact been involved in a vast "Ponzi scheme" was confirmed by an accountants' report filed in connection with the bankruptcy proceedings in June, 1968. This report concluded that MCC had never had earnings sufficient to pay interest and that the facts had been fraudulently concealed from note holders.
Plaintiffs filed a claim for tax refund in November, 1970, contending that in view of the disclosures of MCC's operations the payments received in 1966 should be treated as a tax-free return of principal rather than as interest income. The District Director of IRS denied the claim for untimeliness.
Section 6511(a) of the Internal Revenue Code of 1954, as amended, 26 U.S.C. § 6511(a), provides
Period of limitation on filing claim - Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later . . . .
There can be no question but that plaintiffs' claim failed to comply with the literal requirement of the statute.
Section 7422(a) of the Code, 26 U.S.C. § 7422(a) provides
No suit prior to filing claim for refund - No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary or his delegate, according to the ...