Source: https://caselaw.findlaw.com/us-supreme-court/336/422.html
Timestamp: 2019-04-25 19:02:55+00:00

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NATIONAL CARBIDE CORP. v. COMMISSIONER OF INT. REV.
Mr. Erwin N. Griswold, of Cambridge, Mass., for petitioners.
Mr. Hilbert P. Zarky, of Washington, D.C., for respondent.
The contracts between Airco and its subsidiaries provided, in substance, that the latter were employed as agents to manage and operate plants designed for the production of the products assigned to each, and as agents to sell the output of the plants. Airco was to furnish working capital, executive management and office facilities for its subsidiaries. They in turn agreed to pay Airco all profits in excess of six percent on their outstanding capital stock, which in each case was nominal in amount. 3 Title to the assets utilized by the subsidiaries was held by them, and amounts advanced by Airco for the purchase of assets and working capital were shown on the books of the subsidiaries as accounts payable to Airco. The value of the assets of each company thus approximated the amount owed to Airco. No interest ran on these accounts. [336 U.S. 422 , 426] Airco and its subsidiaries were organized horizontally into six overriding divisions: corporate, operations, sales, financial, distribution, and research. Officers heading each division were, in turn, officers of the subsidiaries. Top officials of Airco held similar positions in the subsidiary companies. Directors of the subsidiaries met only to ratify the actions of the directors and officers of Airco.
Airco considered the profits turned over to it by the subsidiaries pursuant to the contracts as its own income and reported it as such. Petitioners reported as income only the six per cent return on capital that each was entitled to retain. Similarly, in declaring the value of their capital stock for declared value excess profits tax purposes, the subsidiaries reported only the nominal amounts at which the stock was carried on the books of each. The Commissioner notified petitioners of substantial income and excess profits tax deficiencies in their 1938 returns, having taken the position that they are taxable on the income turned over to Airco as well as the nominal amounts retained. The Tax Court held, however, that the income from petitioners' operations in excess of six per cent of their capital stock was income and property of Airco. 8 T.C. 594. Three judges dissented. The Court of Appeals for the Second Circuit reversed. 167 F.2d 304. We granted the petition for a writ of certiorari, 335 U.S. 810 , because of this conflict of opinion and the disagreement between courts as to the continuing vitality of Southern Pacific Co. v. Lowe, 1918, 247 U.S. 330 .
Petitioners' contention is, in substance, that our decision in Moline Properties, Inc., v. Commissioner of Internal Revenue, 1943, 319 U.S. 436 , 1135, which held that the tax laws require taxation of the corporate entity if it engages in 'business activity,' expressly excepted the situation in which the corporation is the agent of its owner; that Southern Pacific Co. v. [336 U.S. 422 , 427] Lowe, supra, defines the content of 'agency' for tax purposes; and that, as the Tax Court found, this Court's characterization of the relationship between the corporations in the Southern Pacific case is 'aptly descriptive' of the relationship between Airco and petitioners. It must follow, according to petitioners, that income received by them and transmitted to Airco is taxable only to Airco.
Respondent does not quarrel with the first and third propositions. The collision occurs at the second. The issue as presented by petitioners is, therefore, whether the principal-agent relationship described in the Southern Pacific case-and the similar arrangement between Airco and petitioners-contains the 'usual incidents of an agency relationship,' as that phrase was used in Moline roperties, Inc., v. Commissioner, supra.
'* * * the Central Pacific and the Southern Pacific were in substance identical because of the complete ownership and control which the latter possessed over the former, as stockholder and in other capacities. While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control.' 247 U.S. at page 337, 38 S.Ct. at page 542. It is thus clear beyond doubt that the subsidiary was not referred to as an agent of the parent in the usual or technical sense. 'Agency' and 'practical identity,' as those words are used in the Southern Pacific case, are unquestionably opposite sides of the same coin. 6 The close relationship between corporations because of com- [336 U.S. 422 , 429] plete ownership and control of one by the other was the basis for the result reached, whatever its articulation.
We think, therefore, that petitioners' argument is without merit because based on an erroneous interpretation of Southern Pacific Co. v. Lowe, supra. The agency argument, to quote the opinion in Moline Properties, 'is basically the same argument of identity in a different form * * * the question of agency or not depends upon the same legal issues as does the question of identity previously discussed.'9 Ownership of a corporation and the control incident thereto can have no different tax consequences when clothed in the garb of agency than when worn as a removable corporate veil.
The result reached by the Court of Appeals is clearly required by our later decisions. Our reluctance to erase Southern Pacific from the books has been due not to any belief that it lays down a correct rule for tax purposes generally, but to the fact that it concerns 'very peculiar facts' which make it clearly distinguishable from later cases involving the tax status of a subsidiary or other wholly owned corporation. 12 For that reason, we have, instead, held that it lays down no rule for tax purposes. [336 U.S. 422 , 433] Burnet v. Commonwealth Improvement Co., supra, 287 U.S. at page 419, 53 S. Ct. at page 199; Moline Properties, Inc., v. Commissioner of Internal Revenue, supra, 319 U.S. at page 439, 63 S.Ct. at page 1134. That the concept of identity of the corporation with its owner set out in the Southern Pacific case is incompatible with later decisions of this Court may be demonstrated by a consideration of the facts enumerated and relied upon by the Tax Court, which based such reliance on the emphasis placed upon similar facts in the Southern Pacific case. These facts relate to the ownership, control, and right to income reserved by the parent.
Not do the contracts between Airco and petitioners by which the latter agreed to pay all profits above a [336 U.S. 422 , 436] nominal return to the former, on that account, become 'agency' contracts within the meaning of our decisions. The Tax Court felt that the fact that Airco was entitled to the profits by contract shows that the income 'belonged to Airco' and should not, for that reason, be taxed to petitioners. Our decisions requiring that income be taxed to those who earn it, despite anticipatory agreements designed to prevent vesting of the income in the earners, foreclose this result. Lucas v. Earl, 1930, 281 U.S. 111 ; Helvering v. Clifford, 1940, 309 U.S. 331 ; United States v. Joliet & Chicago R. Co., 1942, 315 U.S. 44 ; Commissioner v. Sunnen, 1948, 333 U.S. 591 . Of course one of the duties of a collection agent is to transmit the money he receives to his principal according to their agreement. 17 But the fact that petitioners were required by contract to turn over the money received by them to Airco, after deducting expenses and nominal profits, is no sure indication that they were mere collection agents. Such an agreement is entirely consistent with the corporation-sole stockholder relationship whether or not any agency exists, and with other relationships as well. 18 [336 U.S. 422 , 437] What we have said does not foreclose a true corporate agent or trustee from handling the property and income of its owner-principal without being taxable therefor. Whether the corporation operates in the name and for the account of the principal, binds the principal, by its actions, transmits money received to the principal, and whether receipt of income is attributable to the services of employees of the principal and to assets belonging to the principal19 are some of the relevant considerations in determining whether a true agency exists. If the corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned by the principal, if such is the case. Its business purpose must be the carrying on of the normal duties of an agent. 20 Absence of the factors mentioned above, and the essentiality of ownership of the corporation to the existence [336 U.S. 422 , 438] of any 'agency' relationship in the Moline Properties, Commonwealth Improvement Co., and Southern Pacific cases indicates the fallacy of the agency argument made in those case.
The same fallacy is apparent in the contention that petitioners are agents of Airco. They claim that they should be taxable on net income aggregating only $1,350, despite the fact that during the tax year (1938) they owned assets worth nearly 20 million dollars, had net sales of approximately 22 million dollars, and earned nearly four and one-half million dollars net. Their employees number in the thousands. We have passed the question whether Airco's interest in these assets is that of owner of the subsidiaries or lender, but whatever the answer, they do not belong to Airco as principal. The entire earnings of petitioners, except for trifling amounts, are turned over to Airco not because the latter could command this income if petitioners were owned by third persons, but because it owns, and thus completely dominates the subsidiaries. Airco, for sufficient reasons of its own, wished to avoid the burdens of principalship. 21 See Moline Properties, Inc., v. Commissioner of Internal Revenue, supra; Sheldon [336 U.S. 422 , 439] Building Corporation v. Commissioner of Internal Revenue, 7 Cir., 1941, 118 F.2d 855. Compare Forshay v. Commissioner of Internal Revenue, 1930, 20 B.T.A. 537. It cannot now escape the tax consequences of that choice, no matter how bona fide its motives or longstanding its arrangements. When we referred to the 'usual incidents of an agency relationship' in the Moline Properties case, we meant just that-not the identity of ownership and control disclo ed by the facts of this case.
We have considered the other arguments made by petitioners and find them to be without merit. The judgment of the Court of Appeals is affirmed.
[ Footnote 2 ] Wilson Welder had a net deficit during the year here involved and is not a petitioner in this action.
[ Footnote 3 ] Sales had outstanding 125 shares of stock of $100 par value; Carbide's outstanding capital stock was 50 shares of $100 par value; Carbonic also had 50 shares of $100 par value.
[ Footnote 4 ] Mertens, Law of Federal Income Taxation (1948 ed.), Vol. 10A, p. 237.
[ Footnote 5 ] Finkelstein, The Corporate Entity and the Income Tax, 44 Yale L.J. 436, 448.
[ Footnote 7 ] The case other than Southern Pacific relied upon by the Tax Court was Munson Steamship Line v. Commissioner of Internal Revenue, 2 Cir., 77 F.2d 849. That case w explained in Moline Properties, Inc., v. Commissioner of Internal Revenue, supra, as depending upon a particular legislative purpose which justified disregarding the separate entity.
[ Footnote 8 ] Plaintiff's Exhibit P, No. 452, October Term 1917, is an income tax statement of the subsidiary, central pacific Co., showing payment of income taxes on $3,333,846.18, its total net income for 1913 less one- sixth (i.e., making an allowance for the two months before the income tax law went into effect March 1).
[ Footnote 9 ] 319 U.S. at pages 440-441, 63 S.Ct. at page 1135.
[ Footnote 10 ] 8 T.C. 594, 611. After enumerating the facts considered pertinent, the court concluded: 'It is true, of course, that taken separately some of the foregoing facts would not be sufficient in themselves to make inoperative the general rule that corporations are separate juristic persons and are to be so treated for tax purposes. We think, however, that when all these facts are viewed together they bring petitioners within the rule announced by the Supreme Court in Southern Pacific Co. v. Lowe, supra.' 8 T.C. at page 614.
It should be added that the Court of Appeals, whose opinion was written by its Chief Judge, did not so much as mention the agency argument now made by petitioners. Its only references to agency were isolated quotations from the Tax Court's opinion and the contracts quoted in footnote 1. The court's opinion phrases the question as 'when a wholly owned subsidiary of a parent corporation shall be treated for purposes of income taxation as a separate taxable person, and when as merely a part of the corporate activities of the parent'. 167 F.2d 304, 305.
[ Footnote 11 ] 167 F.2d at page 307.
[ Footnote 12 ] Two basic distinctions between the Southern Pacific case and subsequent cases, except Gulf Oil Corporation v. Lewellyn, 1918, 248 U.S. 71 , which followed Southern Pacific, are immediately apparent. First, the Southern Pacific case involved taxation of the parent-owner rather than the subsidiary corporation; second, the question was when the income had been earned, rather than who had earned it. The importance of these distinctions is indicated by the fact that the subsidiary paid income taxes upon income received subsequent to March 1, 1913, see footnote 8, supra, and that the parent did not dispute its tax liability for dividends from post-1913 earnings of the subsidiary. The decision is based on an interpretation of the Income Tax Act of 1913. The Court felt that it was not the intent of the Act to tax earnings prior to the effective date of the Act, and that the Central Pacific's pre-1913 income had actually accrued to the parent before the effective date of the Act. The opinion states that 'The case turns upon its very peculiar facts, and is distinguishable from others in which the question of the identity of a controlling stockholder with his corporation has been raised.' 247 U. S. at pages 338-339, 38 S.Ct. at page 543. By its very terms, the decision is limited to its precise facts.
[ Footnote 13 ] Much of the testimony introduced by petitioners had to do with the intercorporate relationship between Airco and its subsidiaries, the use of certain facilities by two or more of the subsidiaries, the duties of various officers who held positions with Airco and its subsidiaries, and the services performed for all of the subsidiaries by certain departments of Airco. So far as this testimony shows the integration of the corporate system and its direction by Airco, it is, as we have indicated, immaterial. So far as it indicates that the subsidiaries received the use of equipment and services for which they were not charged, it is relevant as showing that their income was distorted to that extent, but it does not indicate that the income received 'belonged' to Airco at the time of its receipt. The Commissioner made allowance for this distortion by allocating over $ 400,000 of the expenses reported by Airco to petitioners under the authority given him by 45 of the Revenue Act of 1938, 26 U.S.C. 45, 26 U.S.C.A. 45.
[ Footnote 14 ] 45 B.T.A. 647, 650.
[ Footnote 15 ] As a practical matter, a considerable part of the assets of petitioners was supplied out of profits from their operations. Even though assets were purchased directly out of the earnings of a subsidiary, however, the amount withdrawn was entered in the accounts payable by the subsidiary and in the accounts receivable of Airco, since substantially all profits of the subsidiaries were, by contract, payable only to the parent.
[ Footnote 16 ] Since petitioners were required to pay all profits except very small amounts to Airco each year, it was obviously impossible for them to pay the accounts payable to Airco. See note 15. Mr. C. E. Adams, Chairman of Air Reduction Corporation, testified that the assets of the subsidiaries represented by the accounts payable could be realized by Airco only upon dissolution of the subsidiaries. In other words, there was never any expectation that the accounts would be paid prior to dissolution. Since no interest ran on these accounts, the 'loans' were identical, except in name, with contributions of capital. See American Cigar Co. v. Commissioner of Internal Revenue, 2 Cir., 33 F.2d 425; Hoyt v. Commissioner of Internal Revenue, 2 Cir., 145 F.2d 634; Van Clief v. Helvering, 77 U.S.App.D.C. 337, 135 F.2d 254; Reading Co. v. Commissioner of Internal Revenue, 3 Cir., 132 F.2d 306. Levy and Simonds, Stockholder Advances to Corporations . . . Are They Loans or Capital Contributions? 25 Taxes 127, 128, state that 'intention to lend and expectation of repayment are necessary to the existence of a valid debt.' The fact that no interest ran on these 'loans' is, of course, further indication that they are capital contributions. Berry Motor Car Co., 43 B.T.A. Memo. Op. 1209, Jan. 25, 1941.
[ Footnote 17 ] Restatement o Agency, 427.
[ Footnote 18 ] In United States v. Joliet & Chicago R. Co., 1942, 315 U.S. 44 , a lessee railroad agreed to pay rental payments to the lessor's stockholders directly. The lessor thereafter carried on no active business. It was nevertheless held taxable on the income received by its stockholders, since they received the payments only because they held its stock.
'Art. 22(a)-1. What included in gross income.ÄGross income includes in general compensation for personal and professional services, business income, profits from sales of and dealings in property, interest, rent, dividends, and gains, profits, and income derived from any source whatever, unless exempt from tax by law. (See sections 22(b) and 116.) In general, income is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. * * *' See Eisner v. Macomber, 1920, 252 U.S. 189, 207 , 9 A.L.R. 1570; Merchants Loan & Trust Co. v. Smietanka, 1921, 255 U.S. 509, 519 , 15 A.L.R. 1305.
[ Footnote 20 ] Of course even a corporation which satisfies the usual tests of agency may be disregarded by the Commissioner if it is a sham or unreal. Higgins v. Smith, 1940, 308 U.S. 473 ; Gregory v. Helvering, 1935, 293 U.S. 465, 97 A.L.R. 1355. Escaping taxation is not a 'business' activity. See National Investors Corporation v. Hoey, 2 Cir., 144 F.2d 466.
'Frankly, in 1918 and still, Air Reduction, Inc., was and is a New York corporation. Even at that early date it became evident, as I already said, we were going to have plants scattered all over the United States. We didn't want to domicile the parent company in 48 states of the Union and have us subject to service in all those states, that is, have the parent company subject to service in all those states, and that was distinctly a reason for using this corporate setup in connection with operations to be run as divisions, just as the contract sets forth.
It is thus apparent that Airco was attempting to avoid the status of principal vis-a-vis its subsidiaries. As principal it would have been subject to service of process through its agents; as owner of the subsidiary it was not. See Peterson v. Chicago, R.I. & P.R. Co., 1907, 205 U.S. 364, 391 ; Cannon Mfg. Co. v. Cudahy Packing Co., 1925, 267 U.S. 333 . The purpose of having officers of subsidiaries who could deal directly with customers does not indicate an agency relationship. On the contrary, the very purpose of the organization adopted was to lead customers to believe that they were dealing with top men in the company actually manufacturing and selling the products they purchased.

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