State v. Johnson

Ethridge, J.

The Mississippi Income Tax Act permits gains from certain types of installment sales to be returned on a deferred basis, authorizing the spreading of the income tax over the period of the installment payments. Miss. Code 1942, Sec. 9220-08(a). The taxpayer, Walter G. Johnson, Jr., appellee, received ten installment promissory notes representing part of the purchase price from him of certain shares of stock. He exercised his option under the statute to pay the Mississippi income tax on gains received in the years in which the deferred payments were received by him. Subsequently, he transferred these notes in a bona fide transaction to a merchandising corporation in which he owned the majority of stock, for the principal purpose of enabling the endorsee to use the notes as collateral in its business. In return, and as consideration for the transfer, he received substantially identical notes of the corporation payable to him in installments. The question is whether under Code Sec. 9220-08 (a) the .sale by taxpayer of these installment obligations, and the receipt by him as payment therefor of similar installment notes executed to him by the transferee, terminated the statutory privilege of paying his income tax on the installment payments when received; or whether taxpayer may continue to report his taxable gain under the new installment notes on the deferred payment basis. We conclude that the taxpayer retains that privilege.

The statute defines gross income as including gains and income from sales, and income derived from any source whatever. Sec. 9220-08(a) then states: “The amount of all such items shall be included in the gross income for the taxable year in which received by the taxpayer; provided, when property is sold upon what is known as the installment or deferred payment plan, and the initial payment is thirty per cent (30%) or less, (and the initial payment shall include the total sum paid, including assumption of mortgage or other indebtedness, during the taxable period in which such sale occurs) the net income realized may be included for taxation in that portion of any installment payment representing gain or profit in the year in which such payment is received.”

I.

The case involves an additional assessment for 1955 Mississippi income taxes.

On August 7, 1954 appellee Johnson sold to Mississippi Publishers Corporation 350 shares of stock in that corporation for a total consideration of $962,500. The purchaser paid him $250,000 in cash, and g’ave notes for the balance of $712,500, the notes being payable annually over a ten-year period, at $71,250 a year, at five per cent interest. The State Tax Commission, appellant, admits this was a valid installment payment sale under the above statute. There is no dispute between appellee and the Commission as to the amount of profits from the sale. Johnson paid the 1954 income tax due on the profit of $205,189.50 realized from the cash received by him in 1954 of $250,000.

On January 17, 1955 appellee organized a corporation known as Giles, Inc. Its principal purpose was to own, carry on and conduct a clothing, department or other type of store for the purpose of sale at retail of merchandise and articles of various types. It is undisputed, and the chancery court found, that this corporation was not organized with any tax purposes in mind, and without any thought by appellee at that time of selling the notes of Mississippi Publishers Corporation, owned by him, to Giles, Inc.; and that Giles, Inc. was organized for a bona fide purpose of establishing a high quality retail mercantile establishment in the City of Jackson.

On January 28, 1955, Johnson established an irrevocable trust for his children, with his wife as trustee, placing $48,000 in the trust. At the organizational meeting of Giles, Inc., Johnson purchased 52 per cent of the stock for a cash payment of $52,000, and Mrs. Johnson, as trustee, purchased 48 per cent of the stock by investing $48,000 of the trust funds.

Johnson made a detailed study of the need in Jackson of an additional department store. He discussed his plans with merchants in several cities of the nation, and with his attorneys, local merchants and bankers. In order to open the store in the early fall of 1955, work was begun, on renovating a building on Capitol Street. It was later found that the old structure was insufficient for the purposes, so it was demolished and work began on a new four story building. The anticipated cost of the building, the store’s equipment and operating expenses gradually began to increase considerably. The amount of cash which Giles, Inc. needed was not available. In order for Giles to secure the necessary financing, it had to have a better financial statement. Johnson concluded that this could be done only by a transfer to Giles, Inc. of the liquid and well-established notes of Mississippi Publisher Corporation. Giles could then use them as security for loans, and they would buttress its financial statement.

For these reasons, on February 15, 1955, Johnson transferred to Giles, Inc. the ten installment notes of Mississippi Publishers Corporation, for their face amount of $712,500. The consideration for the transfer was ten notes of Giles, Inc., executed by Johnson as President thereof, payable to Johnson individually, in identical amounts of those of the Mississippi Publishers Corporation and payable on the same dates. Hence there was no profit or taxable gain from this transaction, nor was there any loss from it. This was an outright sale and transfer of Mississippi Publishers notes by Johnson to Giles, Inc. Johnson retained no individual rights in them. The consideration paid him was the ten installment notes of Giles, Inc. payable to him. A certified public accountant testified for appellee that it is usual and customary in business for stockholders in a corporation to sell valuable property to it for a long-term consideration. This gives the corporation the necessary credit with which to operate its business and meet its obligations. He said that in his opinion ths transfer of the Mississippi Publishers notes to Giles, Inc. greatly increased its financial responsibility and enabled it to operate in the money market as an established business.

However, between February 15 and April 7, 1955, there was a change in the financial condition of Giles, Inc. During this period it was discovered that the old building was not suitable for renovation, and it was going to cost approximately $600,000 to build and equip a new building; that Giles, Inc. needed about $1,000,000 for construction of the building and operating' capital. Upon advice of counsel, bankers and accountants, inquiry was made of Mississippi Publishers Corporation as to whether it would be interested in prepaying the notes. Mississippi Publishers accepted this offer, and paid the full face amount of the notes to Giles, Inc. Johnson individually received none of this money. It was used by Giles, Inc. in financing construction of the building, securing inventory, and preparing for opening of the store. When Giles, Inc. opened, it had actual physical assets of approximately $1,000,000, not including the value of its eighteen-year lease.

The tax year involved is 1955. In that year Giles, Inc. paid appellee $85,000 on its indebtedness to him under the installment notes. Appellee considered this a receipt attributable to and including profits from his sale of stock, so in his 1955 income tax return he reported this $85,000 from Giles, Inc. as a portion of the profits of his sale of stock to Mississippi Publishers Corporation. He paid income tax on the part constituting realized net income from the sale. However, the commissioner of the income tax division, State Tax Commission, made an additional assessment against Johnson for 1955 taxes. He decided that the disposition by Johnson of the Mississippi Publishers notes to Giles, Inc. terminated the deferred payment privilege under the statute; that the statute refers to the sale of tangible personal property rather than intangible; and that the transaction with Giles, Inc. was not an arms-length deal.

The full Commission affirmed this additional assessment for 1955 of the full amount of the profits on the sale of the stock to Mississippi Publishers Corporation, the assessed remainder being $584,790.50. In other words, the Commission took the position that upon the disposition by sale of these installment obligations, there was a termination of the installment contract privilege, and the remaining taxable gain, resulting from the initial sale, must be reported in the year in which the installment obligations are sold. This resulted in an additional 1955 tax of $34,152.85, plus interest. Johnson appealed to the chancery court. Code Sec. 9220-31. After a hearing at which Johnson and a certified public accountant testified, the chancery court reversed the order of the State Tax Commission and vacated the additional assessment for the year 1955. It found that the transfer of the Mississippi Publishers notes to Giles, Inc. was for the purpose of giving financial stature to the transferee and to assist it in financing its obligations. Giles, Inc. was organized as a legitimate business venture. There is no prohibition in the tax statute of a subsequent sale of installment notes. The second sale, from Johnson to Giles, Inc., was a bona fide transaction, and payment of income tax can continue to be made on an installment sale basis when the profits are actually received.

II.

The quoted part of Code See. 9220-08 (a) was incorporated in the Mississippi Income Tax Act in 1948. Miss. Laws 1948, Ch. 464, Sec. 1. It is modeled substantially upon Sec. 453, subsections (a) and (b) of 26 U. S. C. A., the Federal Income Tax Act. However, the federal act contains a provision that, if an installment obligation is sold, the gain results at the time of the sale. 26 U. S. C. A. Sec. 453(d); 47 C. J. S., Internal Revenue, Sec. 187; 27 Am. Jur., Income Taxes, Sec. 200; 2 Mertens, Law of Federal Income Taxation (Rev. Ed. 1955), Secs. 15.26-15.29; Anno., 156 A. L. R. 1242 (1945). The Mississippi Income Tax Act contains no provision similar to Sec. 453(d), 26 U. S. C. A., pertaining to a gain or loss on disposition of installment obligations.

In construing the Mississippi statute, we must interpret the terms of Sec. 9220-08(a). It applies where property is sold upon the deferred payment plan, and the initial payment is 30 per cent or less. Both of those conditions exist here. Moreover, the negotiable notes of Mississippi Publishers Corporation were choses in action or property which could be “sold.” Miss. Code Secs. 692, 690. The word “property” in the statute is not limited to tangible property.

Following the terms of Sec. 9220-08(a), and with these conditions of the deferred payment option existing, the statute provides that ‘ ‘ the net income realized may be included for taxation in that portion of any installment payment representing gain or profit in the year in which such payment is received.” Giles, Inc. paid Johnson for the Mississippi Publishers notes with its own installment notes. He received no realized profit for 1955 except the gain resulting from the payment of $85,000 made to him that year by Giles, Inc. on its installment notes. He reported and paid the income tax on that profit for that year. The statute authorizes him to include any gain he received “in the year in which such payment is received.” He did not receive any other gain in 1955 on the installment notes. The literal terms of the statute manifestly apply to this situation. Under the installment option, the tax is not imposed upon anticipated profits, but upon payments actually received, upon realized profits.

Appellee had the right to sell the Mississippi Publishers notes on the installment plan, and under the statute there were no payments received by him on the stock sale until and as payments were made for the Giles notes by Giles, Inc.

Appellants contend that upon the disposition by sale of the Mississippi Publishers notes to Giles, Inc., there was a termination of the installment contract and the remaining taxable gain from the initial sale of stock must be reported in that year. It is argned that the installment sale section presupposes a continuation of the initial installment contract. There is no statement in the statute to that effect, and no terminology warranting that inference. The deferred payment option continues, where there is a bona fide sale of installment obligations, until the taxpayer realizes a gain. Although the initial installment notes of Mississippi Publishers Corporation were sold by Johnson to Giles, Inc., he received in return installment notes in the same amount.

Appellants assert it is not necessary for the Mississippi act to contain a specific provision dealing with disposition of installment obligations, in order to find a taxable gain in the year of disposition. We cannot agree.

It is a well-established rule that a taxing statute must be strictly construed against the taxing power and in favor of the taxpayer, and all doubts as to whether or not a tax has been imposed must be resolved in favor of the taxpayer. Town of Utica v. State of Miss., 166 Miss. 565, 148 So. 635 (1933); Gulley v. Jackson International Co., 165 Miss. 103, 145 So. 905 (1933) ; Conrad Furniture Co. v. Miss. State Tax Commission, 160 Miss. 185, 133 So. 652 (1931); Pan Am Petroleum Corp. v. Miller, 154 Miss. 565, 122 So. 393 (1929); State v. Union Tank Car, 151 Miss. 797, 119 So. 310 (1928); Texas Co. v. Wheeless, 185 Miss. 799, 187 So. 880 (1939); Gulf and Ship Island Railroad Co. v. Harrison County, 192 Miss. 114, 4 So. 2d 717 (1941); Independent Linen Service v. Stone, 192 Miss. 832, 6 So. 2d 110 (1942); Chickasaw County v. G. M. & O. Railroad Co., 195 Miss. 754, 15 So. 2d 348 (1943); Virden Lumber Co. v. Stone, 203 Miss. 251, 33 So. 2d 841 (1948); Stone v. Virden Lumber Co., 205 Miss. 841, 39 So. 2d 498 (1949); Stone v. Nelson Exploration Co., 211 Miss. 199, 51 So. 2d 279 (1951); Stone v. General Box Co., 212 Miss. 60, 53 So. 2d 85 (1951).

The manifest purpose of the legislature was to tax anticipated profits from an installment sale only when “received.” The statute authorizes installment sales without limiting- the time within which the installments can be made. Appellants advance the theoretical argument that a ‘ ‘ taxable gain ’ ’ is realized on an installment sale at the time of the transaction, not when and if the installment obligations are satisfied. The undisputed evidence of Morgan, the certified public accountant who testified for appellee, is that the “gain” with reference to the sale of Mississippi Publishers stock to that corporation is not realized until and as the Giles notes are collected. Any number of events could occur after an installment sale to prevent the State from collecting the tax on theoretical paper profits. This is a risk which the State must take under the present act, when it does not impose a tax on profits from installment sales until payment is received, or does not terminate the privilege upon disposition.

Appellants in effect argue that this case should be decided as if the State had a statute similar to subsection (d) of Sec. 453, 26 U. S. O. A. The Federal Government had an installment statute similar to Sec. 9220-08 (a) prior to 1928. Because of interpretations of the Board of Tax Appeals and Federal Courts that no gain resulted at the time of the sale of an installment obligation, the Congress enacted in 1928 what is now 26 U. S. C. A., Sec. 453(d), which provides that, if an installment obligation is sold, the gain results at the time of the sale. The Federal amendment was found to be necessary to reach that result. Federal decisions prior thereto make that conclusion manifest. 2 Mertens, Law of Federal Income Taxation, Sec. 15.27. Nevertheless, we cannot, in effect, amend the Mississippi statute by inferring that provision.

In brief, the interpretation of the pre-1928 Federal Act, which was similar to the present Mississippi statute, shows that Federal administrative agencies and courts were reaching an opposite conclusion to that now urged by appellants. The purpose of Sec. 9220-08 (a) was to postpone the tax on deferred installments until the taxpayer realized a gain. The additional assessment would frustrate that clear legislative purpose. It would be contrary to the specific terms of the act.

III.

The only remaining method by which the additional assessment could be sustained would be to hold that the taxpayer’s dealings with Giles, Inc. were fraudulent and were based upon a sham or subterfuge. The recited facts demonstrate that this was not the case; that in fact the taxpayer organized the corporation and transferred the Mississippi Publishers notes to it for legitimate business purposes in good faith. The Commission offered no evidence whatever to the contrary. An inference of bad faith would therefore have to be made upon conjecture and speculation, and in the face of clear findings of fact by the chancery court that these transactions were bona fide. Transactions with a closely held corporation should be carefully examined, but, where such transactions are shown to be in good faith and for legitimate business purposes, they are upheld as proper and valid. These circumstances are shown, by the undisputed evidence and by the chancellor’s findings of fact, to exist here. "We would not be warranted in overturning the facts and the findings of the trial court upon mere conjecture and speculation that the taxpayer was trying to evade the tax.

The taxpayer’s sale of the notes and related actions were not a subterfuge or a sham, but legitimate business transactions. There was ample evidence to support the findings of the chancery court to this effect. Chisholm v. Commissioner, 79 F. 2d 14 (C. A. 2nd, 1935), cert. den., 296 U. S. 641, 56 S. Ct. 174, 80 L. Ed. 456; U. S. v. Bondurant, 245 F. 2d 265, (C. A. 6th, 1957); Sun Properties U. S., 220 F. 2d 171, (C. A. 5th, 1955); Tupelo Garment Co. v. State Tax Commission, 178 Miss. 730, 173 So. 656 (1937); Jones v. Helvering, 71 F. 2d 214 (C. A. D. C., 1934).

In summary, appellee did not receive any of the proceeds of the sale of Mississippi Publishers notes by Giles, Inc. to Mississippi Publishers Corporation. This money went into the accounts of Giles, Inc. Appellee has reported and paid tax on the 1955 installment payment made by Giles, Inc. to him. Under Sec. 9220-08(a) he is liable for income taxes on the gain from this installment sale when and as installment payments are received by him. The record reflects a legitimate business transaction falling clearly within the terms of the statute. The effect of a sale or disposition of installment notes under circumstances constituting a subterfuge, sham or fraud is not an issue in this case. That situation would cast the issues in a different light, and would necessitate the application of different legal principles.

Affirmed.

McGehee, C. J., and Hall, Holmes, and Gillespie, JJ., concur. Roberds and Arrington, JJ., took no part.