Corporation of America v. Commissioner , 4 T.C. 566 ( 1945 )

Corporation of America, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent

Corporation of America v. Commissioner

Docket No. 109579

United States Tax Court

4 T.C. 566; 1945 U.S. Tax Ct. LEXIS 253;

January 15, 1945, Promulgated

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Decision will be entered under Rule 50.

In its income tax return for the year 1930 petitioner deducted from gross income amounts paid for documentary stamp taxes. Its return then showed a large net income. Petitioner was a member of a group of affiliated corporations. A consolidated return was filed for the group showing a large net loss for 1930. Petitioner obtained a judgment that such taxes had been erroneously assessed and in 1939 the amount thereof was refunded to it. The total recoveries secured by all affiliated corporations in subsequent years did not equal their consolidated net loss for 1930. Held, that under section 116, Revenue Act of 1942, relating to the recovery of bad debts, prior taxes, and delinquency amounts, petitioner is entitled to the recovery exclusion contemplated by that statute.

George H. Koster, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

Van Fossan, Judge.

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VAN FOSSAN

The respondent determined a deficiency of $ 1,742.01 in the petitioner's income tax and $ 585.22 in its excess profits tax for the year 1939. The petitioner alleges an overpayment of $ 1,041.64 in its tax for that year.

The single issue is the taxability of amounts paid in 1930, under protest, for documentary stamp taxes and recovered by suit in 1939. The controversy arises from the fact that the petitioner filed a consolidated return, with affiliated corporations, which disclosed no tax liability of the group, whereas the petitioner's own net income was over $ 1,000,000. A similar issue relating to like amounts paid in the year 1931 was conceded by the respondent to have resulted in no tax liability, since the petitioner received no tax benefit therefrom.

FINDINGS OF FACT.

The facts were either admitted in the pleadings or stipulated. In so far as they are material to the issue, they are as follows:

The petitioner is a corporation, with principal offices in San Francisco, California. Its income tax return for the year 1939 was filed with the collector of internal revenue for the first district of California.

In the year 1930 the petitioner paid under protest certain documentary stamp taxes determined by the Commissioner of Internal Revenue to be due from it in the amount of $ 3,745.04. In the year 1931 the petitioner paid under protest certain documentary stamp taxes determined by the Commissioner of Internal Revenue to be due from it in the amount of $ 12,617.79. After the payment of these taxes, the petitioner filed refund claims contending that the assessment and collection of such stamp taxes was erroneous. After the refund claims were rejected by the Commissioner of Internal Revenue, the petitioner filed suit in the United States District Court, and as a result of this litigation, judgment was entered in favor of the petitioner. Thereafter, the sum of $ 15,566.88 representing stamp taxes paid in the years 1930 and 1931 and determined to have been erroneously assessed and collected was refunded to the petitioner in the year 1939.

In its income tax return for the year 1939, the petitioner did not include such refund of stamp taxes in its taxable income. The respondent determined that the refund of taxes constituted income taxable in the year 1939 and issued the deficiency notice accordingly.

In the year 1930 the petitioner was affiliated with Transamerica Corporation. In that year Transamerica Corporation and its affiliated corporations filed a consolidated income tax return which disclosed a net loss for income tax purposes of $ 1,938,812.43. No tax liability was disclosed on the return on the part of Transamerica Corporation or any of its affiliated companies or from the entire affiliated group. The income and deductions of the petitioner were included with the income and deductions of all of the affiliated companies in arriving at the net loss of $ 1,938,812.43. The deductions of the petitioner for the year 1930 included the stamp taxes paid by the petitioner in that year in the amount of $ 3,745.04.

In the year 1931 the petitioner was affiliated with Transamerica Corporation. In that year Transamerica Corporation and its affiliated corporations filed a consolidated income tax return which disclosed a net loss for income tax purposes of $ 33,931,911.99. The tax return for that year showed a situation similar to that existing in 1930, except that the stamp taxes paid in 1931 amounted to $ 12,617.79.

The petitioner disclosed an income tax liability on its income and excess profits tax return for the year 1939 in the amount of $ 6,185.10. The tax was duly paid by the petitioner. On May 16, 1941, the respondent assessed a deficiency against the petitioner for income taxes for the year 1939 in the amount of $ 1,041.64. Such deficiency was duly paid by the petitioner on or about May 26, 1941.

The petitioner's net income for the year 1930 was $ 1,178,506.23 and was included in the consolidated return of Transamerica Corporation and its affiliates for the year 1930 in computing the consolidated net loss of $ 1,938,812.43 reported in that return.

The petitioner's operations for the year 1931 resulted in a net loss in the amount of $ 2,113,513.02. The net loss was included in the consolidated return of Transamerica Corporation and its affiliates for the year 1931 in computing the consolidated net loss of $ 33,931,911.99 reported in that return.

The net loss reported on the consolidated return of Transamerica Corporation and its affiliates for the year 1930 exceeded the total recoveries in subsequent years by all of the corporations, included in such consolidated return, of bad debts, taxes, delinquency amounts, and other sums taken as deductions in the consolidated return by an amount in excess of $ 3,745.04.

The net loss reported on the consolidated return of Transamerica Corporation and its affiliates for the year 1931 exceeded the total recoveries in subsequent years by all of the corporations, included in such consolidated return, of bad debts, taxes, delinquency amounts, and other sums taken as deductions in the consolidated return by an amount in excess of $ 12,617.79. The net loss of the petitioner for the year 1931 exceeded the total recoveries in subsequent years by the petitioner of bad debts, taxes, delinquency amounts, and other deductions of petitioner taken in the consolidated return of Transamerica Corporation and its affiliates for the year 1931 by an amount in excess of $ 12,617.79.

The net losses reported in the consolidated returns of Transamerica Corporation and its affiliates for the years 1930 and 1931 were not carried back or carried forward to any other year or years and were not used to reduce the tax liability of petitioner or any other coporation for any other year or years.

The $ 15,566.88 recovered by the petitioner in 1939 represented $ 3,500 of the sum of $ 3,745.04 paid as stamp taxes in 1930, $ 12,039.88 of the sum of $ 12,617.79 paid as stamp taxes in 1931, and $ 27 allowed by the court as costs.

The additional income tax for the year 1939 in the amount of $ 1,041.64 paid by the petitioner on May 26, 1941, resulted from the inclusion as taxable income to the petitioner for the year 1939 of $ 9,753.69 of the stamp taxes in the amount of $ 15,566.88 recovered by the petitioner in that year. On May 26, 1941, the petitioner paid interest in the amount of $ 72.67 on the deficiency of $ 1,041.64.

OPINION.

The issue presented is whether or not the petitioner is entitled to the statutory recovery exclusion under the provisions of section 116 of the Revenue Act of 1942. ^{*570 net income for that year although the group had a large net loss, obtained a tax benefit from the deduction of amounts paid by it as documentary stamp taxes during that year and recovered by it in 1939. If the petitioner obtained no such tax benefit, the amount of the recovery should be excluded from its income for 1939, under the provisions of section 116, which was made specifically applicable to taxable years beginning after December 31, 1938 (sec. 22 (b) 12 (E) (b), I. R. C.).}

The respondent's theory is that the petitioner's gross income for 1930 was reduced by the amount of $ 3,500 paid by it as documentary stamp taxes; that after such deduction it still had a net income; that the fact that because of affiliation it paid no tax and had no liability therefor is not material; and that its membership in the affiliated group which filed a consolidated return has no bearing on the issue.

The petitioner contends that, although its own return showed on its face a net income after deducting the amount in question, it was liable for no tax on its net income by virtue of its affiliation with a group of corporations filing a consolidated return; that a reduction of income and a reduction of tax are not synonymous; and that a recovery is taxable only if it relates to a reduction of tax liability in the year the deduction was taken.

The question may be stated otherwise: Whether "the recovery exclusion" statute is based on the petitioner's net income or its income tax liability. The language of section 22 (b) 12 (D), as amended by the 1942 Act, defines the term "recovery exclusion" as meaning the amount, determined in accordance with regulations prescribed by the Commissioner, of the deductions and credits allowed on account of the bad debt, prior tax, or delinquency amounts "which did not result in a reduction of the taxpayer's tax * * * reduced by the amount excludible in previous taxable years with respect to such debt, tax, or amount under this paragraph." Since there was no amount excludible in previous taxable years, the amount in controversy remains $ 3,500. It is noted that the statute mentions neither "net income" nor "income tax liability." It refers only to the "taxpayer's tax."

The pertinent provision of Regulations 111 (sec. 29.22 (b) (12)-1 (a)) defines the recovery exclusion as "an amount equal to the portion of such items which, when deducted or credited for a prior taxable year, did not result in a reduction of any tax of the taxpayer * * *." Section 29.22 (b) (12)-1 (b) (2) headed, "Determination of Recovery Exclusion for Original year for which Items were Deducted or Credited," states:

The recovery exclusion for the taxable year for which section 22 (b) (12) items were deducted or credited (that is, the "original taxable year") is the portion of the aggregate amount of such deductions and credits which could be disallowed without causing an increase in any tax of the taxpayer imposed under chapter 1 of the Internal Revenue Code (such as the normal tax, surtax, and victory tax) * * *

In the present proceeding the "taxpayer" is the petitioner.

We next turn to the legislative history of the statute. On page 45 of Report No. 2333 on H. R. 7378 (Revenue Bill of 1942) to the Seventy-seventh Congress, second session, we find the following:

There is at present considerable confusion as to the state of the law regarding the recovery of bad debts or taxes which have been taken as deductions in previous years. The confusion has arisen as to whether the taxation of the amount of the bad debt or tax recovered in the year of such recovery depends upon the tax benefit which the taxpayer derived from the deduction of these items in a prior year.

The bill settled this question by excluding from the gross income of the taxpayer in the year of the recovery the amounts recovered to the extent that the debt or tax did not in any prior taxable year reduce his income tax liability. Securities which become worthless and which result in a capital loss are allowed the same treatment as bad debts and taxes.

It will be noted that the report refers to the "income tax liability" of the taxpayer. On page 69 of that report, in the following comment on section 114 (later section 116), the same language is used:

SECTION 114. RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.

This section provides for the exclusion from gross income of amounts otherwise includible in gross income which are attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent that such debt, tax, or delinquency amount did not operate to reduce the income-tax liability of the taxpayer for any prior taxable year.

The amount of the exclusion from gross income is limited to the amount of the "recovery exclusion" with respect to the debt, tax, or delinquency amount which is recovered. The term "recovery exclusion" is defined as the amount of deductions or credits allowed on account of such bad debt, tax, or delinquency amount, which, in accordance with regulations to be prescribed by the Commissioner with the approval of the Secretary, did not result in a reduction of the taxpayer's income-tax liability for any prior taxable year, reduced by the amount excludible in previous taxable years under this section with respect to such debt or tax.

The report of the Senate Committee on Finance made in connection with H. R. 7378 contains almost identical comment.

In the above excerpts the phrase "income tax liability" is repeatedly used. In both the Senate and House Committee reports the "tax benefit" theory was recognized and approved. We need not discuss that theory as such. It has been recognized by the Bureau, by this Court, and by Congress. It is sufficient to say that it is now a part of the law.

In order to apply the tax benefit theory to the petitioner for the taxable year of 1939 we must revert to and examine its status as a taxpayer in 1930. The petitioner was affiliated with other corporations, and, pursuant to the privilege afforded it by section 141 of the Revenue Act of 1928, it joined in filing a consolidated return for the group.

The report of the Senate Committee on Finance to the Seventieth Congress, first session, page 15, reveals the congressional background of section 141.

Running through all of the reports is the concept that the petitioner and the other corporations filing a consolidated return in 1930 constituted a single business entity and are considered as a taxable unit, and that the tax liability (and hence the tax) in that year, as contemplated by the recovery exclusion statute, was the tax of the group of which the petitioner was an integral part. By reason of that relationship and of the consequent consolidated net loss, it is our opinion that the petitioner derived no tax benefit from the deductions for "prior taxes" in 1930.

The intervention of the consolidated return, itself only one of the many factors making up the complete tax picture, served to make it impossible for the petitioner to derive the tax benefit prerequisite to the tax sought by the respondent for the year 1939. The ultimate question is: Did the taxpayer receive any tax benefit from the deduction of the prior year taxes? The question is not: Would it have enjoyed that benefit if the consolidated return statute had not been in force or if it had chosen not to adopt the consolidated return method of reporting its income? We must take the facts as we find them, not as they might have been.

It is explicit in the statute that, in order to be entitled to a recovery exclusion from income, the amount so recovered by the taxpayer must not represent deductions which resulted in a tax benefit or saving to it. Since the taxpayer, this petitioner, in 1930 was subject to no tax liability -- and hence no tax -- the deductions for documentary stamp tax payments afforded it no tax benefit.

In the light of the legislative history relating to both the 1942 and 1928 Acts, and of the regulations promulgated thereunder, we have no doubt that in construing section 116 of the 1942 Act the true criterion is the effect which a deduction taken in a prior year had on the petitioner's income tax liability. Since petitioner had no tax liability and consequently derived no benefit from the deduction, no amount arising from the recovery of the taxes so paid is includible in the petitioner's income for the year 1939.

The respondent cites and relies upon Central Loan & Investment Co., 39 B. T. A. 981, and Robert A. Haughey, 47 B. T. A. 1. Both of these cases, however, were decided before the enactment of the 1942 Act and, by reason of the change in the law, are not in point. By the provisions of section 116, defining a recovery exclusion, the benefit of the act is made to depend on the fact whether the deduction resulted "in a reduction of taxpayer's tax." This specific definition takes precedence over all prior rulings and holdings as to the character and effect of a deduction urged as a basis for recovery exclusions. The statute is to be applied according to its terms. In the instant case, by reason of its affiliation with other corporations, the taxpayer in 1930 had no tax liability and no tax. Therefore, the deduction "did not result in a reduction of taxpayer's tax" and petitioner is entitled to a recovery exclusion in respect of the stamp taxes refunded in 1939.

The amount of stamp taxes recovered in 1939 was $ 15,566.88, of which $ 3,500 represented stamp taxes paid in 1930; $ 12,039.88 similar taxes paid in 1931; and $ 27 allowed as court costs. The $ 12,039.88 is conceded to be excluded from the petitioner's income for the taxable year and obviously the court costs are not an item of income. We hold that the petitioner is also entitled to a recovery exclusion of $ 3,500 received in 1939.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 116. RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.

  (a) Exclusion From Income. -- Section 22 (b) (relating to exclusions from gross income) is amended by adding at the end thereof the following new paragraph:

  "(12) Recovery of bad debts, prior taxes, and delinquency amounts. -- Income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount. For the purposes of this paragraph:

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  "(B) Definition of Prior Tax. -- The term 'prior tax' means a tax on account of which a deduction or credit was allowed for a prior taxable year.

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  "(D) Definition of Recovery Exclusion. -- The term 'recovery exclusion', with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, of the deductions or credits allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a reduction of the taxpayer's tax under this chapter (not including the tax under section 102) or corresponding provisions of prior revenue laws, reduced by the amount excludible in previous taxable years with respect to such debt, tax, or amount under this paragraph.

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