Central Cuba Sugar Co. v. Commissioner of Internal Revenue. Commissioner of Internal Revenue v. Central Cuba Sugar Co, 198 F.2d 214, 2d Cir. (1952)
Uploaded by
Scribd Government DocsCentral Cuba Sugar Co. v. Commissioner of Internal Revenue. Commissioner of Internal Revenue v. Central Cuba Sugar Co, 198 F.2d 214, 2d Cir. (1952)
Uploaded by
Scribd Government Docs198 F.
2d 214
52-2 USTC P 9390
CENTRAL CUBA SUGAR CO.
v.
COMMISSIONER OF INTERNAL REVENUE.
COMMISSIONER OF INTERNAL REVENUE,
v.
CENTRAL CUBA SUGAR CO.
No. 225, Docket 22272.
United States Court of Appeals Second Circuit.
Argued June 4, 1952.
Decided July 7, 1952.
Writ of Certiorari Denied Nov. 10, 1952.
See 73 S.Ct. 167.
Robert A. Littleton, Washington, D.C. (Myles A. Walsh, New York City,
on the brief), for Central Cuba Sugar Co., petitioner.
Hilbert P. Zarky, Sp. Asst. to Atty. Gen. (Ellis N. Slack, Acting Asst.
Atty. Gen., and Lee A. Jackson, Sp. Asst. to Atty. Gen., on the brief), for
Commissioner, respondent.
Before AUGUSTUS N. HAND, CLARK and FRANK, Circuit Judges.
CLARK, Circuit Judge.
These are petitions by both the taxpayer Central Cuba Sugar Company and the
Commissioner of Internal Revenue for a review of a decision of the Tax Court
of the United States, 16 T.C. 882, sustaining in part only a determination by the
Commissioner of a deficiency in the taxpayer's income and excess profits taxes
for the fiscal years ending June 30, 1942 and 1943. The deficiency as assessed
by the Commissioner was $303,621.89 for 1942, and $17,980.49 for 1943; as
adjudged by the Tax Court it was $167,467.86 for 1942, and none for 1943.
Taxpayer is a New York corporation, formed in 1911. It has since then been
engaged in the cultivation, processing, and sale of sugar. Its properties,
including land and sugar mills, are entirely located in Cuba, save for a statutory
office maintained in New York City. The controlling interests are likewise
Cuban. Its accounting practices are based on a fiscal year ending June 30. On
November 14, 1942, taxpayer transferred all its assets to the Central Cuba
Sugar Company of Cuba under a plan of reorganization within I.R.C. Sec.
112(g), 26 U.S.C.A. 112(g), in exchange for the transferee's capital stock,
which was then distributed to taxpayer's stockholders.
2
The Commissioner's petition concerns the proper allocation of operation
expenses prior to this reorganization. The reorganization had been approved by
the Commissioner in July, 1942, under I.R.C. Sec. 112(i) as not motivated
solely as a tax-saving device. Following the transfer in November, taxpayer
claimed expenses of over $300,000 in its return filed for the fiscal year 1943,
and a gross income of only some $50,000, none of which was derived from
sales of sugar produced in 1942. It then sought to carry back the resulting
reported net loss of $250,000 to the fiscal year 1942 under I.R.C. Secs. 122(b)
(1), 23(s), 26 U.S.C.A. 122(b)(1), 23(s). The Commissioner ruled that this
could not be done, claiming that $300,000 of the claimed expense deductions
should be allocated to its successor concern. Taxpayer assigned this as error to
the Tax Court, which held that the Commissioner lacked the asserted power
'where a sound reason not primarily related to tax saving was the motivating
force of the transaction.'
The power to order such an adjustment in the tax accounting of related
corporations stems from I.R.C. Sec. 45, 26 U.S.C.A. 45, providing that where
two or more organizations are controlled by the same interests, the
Commissioner may apportion income and deductions where it is necessary to
prevent evasion of taxes or 'clearly to reflect the income of any of such
organizations.' The Commissioner does not contest the bona fides of the
transaction. He does not now controvert his previous finding that the
reorganization was not for the purpose of escaping taxes under I.R.C. Sec.
112(g), nor in fact does he even allege that its timing was more than fortuitous.
The claimed reason and justification for the order are rather that to divide the
fiscal year in November distorts the true income picture of what was generally
an extremely profitable operation. The reorganization occurred at a time when
substantial expenses had been incurred 'in getting ready for the next spring
grinding season,' but before the year's crop had been sold and income recorded,
which occurs from January to March. Hence the Commissioner contends that
irrespective of tax evasion, the reallocation of the deductions was necessary and
proper under I.R.C. Sec. 45 'clearly to reflect the income.'
We agree. This is an independent reason for reallocation and has been
traditionally cited as such. Asiatic Petroleum Co. v. C.I.R., 2 Cir., 79 F.2d 234,
certiorari denied 296 U.S. 645, 56 S.Ct. 248, 80 L.Ed. 459; Jud Plumbing &
Heating Co. v. C.I.R., 5 Cir., 153 F.2d 681; U.S. Treas. Reg. 111, Sec. 29.451(c).1 The Tax Court's assumption of the necessity of finding some ulterior
motivation- traditionally a thankless task in tax cases and one to be avoided if
possible- was error.
5
In addition, the invocation of I.R.C. Sec. 45 in these circumstances to deny
taxpayer claimed expense deductions was entirely proper. The section had its
genesis in provisions for consolidation of returns or accounts. Revenue Act of
1921, Sec. 240(d), 42 Stat. 227; Revenue Act of 1926, Sec. 240(f), 44 Stat. 9.2
Needless to say, consolidation would have shown the income which accrued
during the fiscal year for the enterprise as a whole. Allocation, likewise, should
be able to dissolve the fiction that it was unprofitable; Congress, in adopting
the original Sec. 45, Revenue Act of 1928, 45 Stat. 791, certainly intended it as
a device of comparable utility. The present statute was designed to deny the
power to shift income or deductions arbitrarily among controlled corporations,
and to place such corporations rather on a parity with uncontrolled concerns.
U.S. Treas. Reg. 111, Sec. 29.45-1(b). In the case at bar, had the taxpayer sold
its assets, including a crop of sugar about to be harvested, in an arm's-length
transaction, the temporarily invested expenses would have been recouped as
part of the purchase price. See U.S. Treas. Reg. 111, Sec. 29.45-1(a)(6). But in
a sale for stock between related corporations, no such income is recorded and
the accounts of the transferor cannot properly reflect the true income status of
the enterprise as a going concern. Hence, to achieve 'the rough matching of
expenses and income previously attained,' United States v. Lynch, 9 Cir., 192
F.2d 718, 721, allocation of the expenses to the concern which is to profit by
them is the only alternative. See Standard Paving Co. v. C.I.R., 10 Cir., 190
F.2d 330, certiorari denied 342 U.S. 860, 72 S.Ct. 87. The situation is closely
analogous to Jud Plumbing & Heating Co. v. C.I.R., supra, where the income
from long-term contracts was attributed to the corporation, despite the fact that
it had transferred its assets, including such contracts, to its principal stockholder
and gone out of business. See also Leedy-Glover Realty & Insurance Co. v.
C.I.R., 5 Cir., 184 F.2d 833; Miles-Conley Co. v. C.I.R., 4 Cir., 173 F.2d 958.
The Commissioner is therefore entitled to the review he seeks.
The taxpayer's petition raises two issues: one concerning the deductibility of a
certain interest claim for the fiscal years 1940, 1941, and 1942, the other as to
the year in which certain expense items properly accrued for tax purposes. As
to the items of interest, it appears that during the years in question, and for
some time prior thereto, taxpayer had been indebted to a certain Securities &
Real Estate Company, in the amount of about $8,700,000. Part of this debt bore
interest at 5%, the rest at 3%. Securities was owned by the same persons who
owned and controlled taxpayer. In 1934, Cuba declared a general moratorium
on debts, and provided that all those in excess of $800,000 were to bear interest
at the rate of 1% only. In 1941, by decree implementing the moratorium, it was
also provided that the debtor could relinquish the benefit of the law.
7
For the fiscal years ending June 30, 1940, and June 30, 1941, taxpayer paid and
deducted as interest on its tax return about $87,000, or one per cent of the total
indebtedness. During the fiscal year ending June 30, 1942, it paid a like amount
as interest and also paid some $500,000 of the principal. But on June 29, 1942,
it entered into an agreement with Securities, the creditor, purportedly waiving
the moratorium benefits, retroactively reinstating its original interest obligation
of 3% and 5% for the years 1940, 1941, and 1942, and reallocating the
principal payments as interest for those years. It now seeks to carry forward a
net operating loss for 1940 and 1941 based on the increased interest deduction
for those years, and to claim an interest deduction for 1942 of $340,000.
We think the Tax Court eminently correct in denying the claim. Accrued
interest can be deducted only when and to the extent that there exists a legally
binding obligation to pay it, fixed in all its terms within the taxable year.
Security Flour Mills Co. v. C.I.R., 321 U.S. 281, 64 S.Ct. 596, 88 L.Ed. 725;
Dixie Pine Products Co. v. C.I.R., 320 U.S. 516, 64 S.Ct. 364, 88 L.Ed. 420;
Spencer, White & Prentis v. C.I.R., 2 Cir.,144 F.2d 45, certiorari denied 323
U.S. 780, 65 S.Ct. 269, 89 L.Ed. 623. The purported agreement can have no
effect on the tax liability for the years prior to which it was adopted, the fiscal
years 1940 and 1941; because under the moratorium, taxpayer's obligation was
limited to $87,000, only interest in that amount could validly accrue. And as to
the fiscal year 1942, we think the agreement far too insubstantial and
unrealistic to constitute an economic factor on which to base federal tax
consequences. It was made between parties whose controlling interests were
identical. Only one would benefit federal taxwise from any paper adjustment in
the terms of the indebtedness. And it was entered frankly with the sole aim of
reducing these taxes. As has been often pointed out in the application of I.R.C.
Sec. 23(b), it is the actualities of the relationship between the parties that
control; the label 'interest' is not alone sufficient. C.I.R. v. Schmoll Fils
Associated, 2 Cir., 110 F.2d 611, 613.
The taxpayer also takes issue with the Tax Court's determination that certain
claimed items of expense were not deductible during the fiscal year 1942.
These expenses were incurred as to sugar produced, ground, bagged, stored,
and sold prior to June 30 of that year, but not shipped and paid for by the
purchaser until later. The largest is $126,828.42 for storage of sugar on hand as
of that date. The Commissioner concedes that there should be a remand to the
Tax Court for determination of the portion of this figure incurred for actual
housing of the sugar in bags during the fiscal year 1942. Lighterage, however,
cannot be deducted as part of this item. This is an expense which does not
accrue properly until the service is actually performed.
10
The Tax Court was correct in disallowing the claimed item for 'weighing,
mending bags, and polarizing sugar for shipment.' This operation occurs at the
time of shipment, and not when the sugar is placed in storage, and hence the
expense is properly allocable to the fiscal year in which the service if
performed.
11
The final item of brokerage commissions perhaps requires fuller discussion.
The commissions claimed as an expense for the fiscal year 1942 were those
payable on contracts of sale entered into between taxpayer and purchasers of
sugar during that year, but pursuant to which the sugar was not delivered and
payment received until later. Taxpayer generally kept its accounts on an accrual
basis. Income from sales of sugar was accrued as of the date of sale, though
perhaps not received until after the end of the fiscal year of production.3 We
think the expenses of the sales, including commissions, should likewise be
accrued during that year, despite the fact that they, too, were not payable until
delivery. The Commissioner contends that the deduction should not be allowed
because the obligation to pay was too indefinite. It appears that the commission
expenses, like the final settlement price, were subject to some adjustment in
accordance with final weighing just prior to shipment, and, moreover, that if the
contract were not carried out the broker forfeited his commission. The
Commissioner contends that Spencer, White & Prentis v. C.I.R., supra, and
Capital Warehouse Co. v. C.I.R., 2 Cir., 171 F.2d 395, apply. We interpret
these cases as requiring only an established liability, however, in accord with
United States v. Anderson,269 U.S. 422, 46 S.Ct. 131, 70 L.Ed. 347, and Lucas
v. American Code Co.,280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538, 67 A.L.R.
1010. Here the services had been performed, and the possibility that some of
the contracts might not finally be executed was, if anything, a condition
subsequent to payment by taxpayer. And the adjustments of the commissions in
accordance with the final weight of the sugar shipped were insubstantial.4
Where the amount of the obligation and its final payment is so certain as here,
it would seem the height of business judgment and tax wisdom to establish a
reserve and deduct the expense thus set aside in the year in which the related
income accrues.5 The case falls squarely within the principles laid down in
Harrold v. C.I.R., 4 Cir., 192 F.2d 1002, and Ohmer Register Co. v. C.I.R., 6
Cir., 131 F.2d 682, 143 A.L.R. 1164.
12
On the Commissioner's petition the decision is reversed and the proceedings
are remanded for computation of the taxes on the basis of allocation of
expenses as made by the Commissioner. On the taxpayer's petition the decision
is affirmed except as to storage expenses and brokerage fees properly accruing
to the taxpayer during the fiscal year 1942; as to those, the decision is reversed
and the proceedings remanded for their determination and deduction.
But cf. Cooper, Section 45, 4 Tax L.Rev. 131, 157-158
The history of Section 45 is set out in National Securities Corp. v. C.I.R., 3 Cir.,
137 F.2d 600, certiorari denied 320 U.S. 794, 64 S.Ct. 262, 88 L.Ed. 479;
Asiatic Petroleum Co. v. C.I.R., 2 Cir., 79 F.2d 234, certiorari denied 296 U.S.
645, 56 S.Ct. 248, 80 L.Ed. 459
It was even taxpayer's practice to accrue income from sugar produced but not
sold during the fiscal year of production in accordance with market prices.
However, in 1942 the entire crop was disposed of prior to June 30
A member of petitioner's accounting department testified as follows:
'Q. Now, wasn't the amount that you received dependent somewhat on the
polarization of sugar? A. Well, the polarization doesn't make- doesn't amount to
much.
'Q. It was dependent upon that was it not? A. Yes. You may not be sure.
'Q. In other words, your sugar hadn't polarized 96 degrees? A. That is right.
'Q. If it varied from that, adjustment had to be made in the price? A. That is
correct.
'Q. Was the broker's commission fixed on the final price as adjusted? A. That is
right.'
