Case Name: WILLIAMS INV. CO. v. UNITED STATES
Court: United States Court of Claims
Jurisdiction: United States
Decision Date: 1933-04-10
Citations: 3 F. Supp. 225
Docket Number: L-307
Parties: WILLIAMS INV. CO. v. UNITED STATES.
Judges: Before LITTLETON, WILLIAMS, WHALEY, and GREEN, Judges.
Reporter: Federal Supplement
Volume: 3
Pages: 225–240

Head Matter:
WILLIAMS INV. CO. v. UNITED STATES.
L-307.
Court of Claims.
April 10, 1933.
Edwin S. Mack and Frederic Sammond, both of Milwaukee, Wis., and Paul F. Myers, of Washington, D. C. (Miller, Mack & Fair-child, of Milwaukee, Wis., and Williams, Myers & Quiggle, of Washington, D. C., on the brief), for plaintiff.
Charles B. Rugg, Asst. Atty. Gen. (George H. Foster, of Washington, D. C., on the brief), for the United States..
Before LITTLETON, WILLIAMS, WHALEY, and GREEN, Judges.

Opinion:
LITTLETON, Judge.
Plaintiff was organized in October, 1922, a short time before the extra dividend of $500,000 was declared and paid by the Journal Company of which L. W. Neiman was the principal stockholder. Plaintiff received Nieman's share of the dividend of $142,000 in 1922, and it received further dividends declared and paid upon the stock of the Journal Company of $163,000 in 1923, $26,000 in 1924, $163,000 in 1925, $300,000 in 1926, and $400,000 in 1927. It also received dividends on stocks of other corporations of $1,900 in 1923, $1,920 in 1924, $26,550.25 in 1925, and $5,976 in 1926. The remainder of its income consisted of interest securities owned. Inasmuch as these dividends were received by plaintiff from domestic corporations they were not subject to tax under section 234 (a) (6) of the Revenue Acts of 1924 and 1926, 26 USCA § 986 (a) (6).
During the years 1922 to 1926, inclusive, involved in this case, L. W. Neiman, who through his ownership of all the plaintiff company's stock, which in turn owned the stock of the Journal Company, had, as reported in his income-tax returns, a net income of $26,000 for 1924, $36,000 for 1925, and $60,000 for 1926, upon which he paid a tax of $1,697.71, $2,643.38, and $5,664.30, respectively. The income of Nieman for these years, with the exception of 1926 when the plaintiff declared and paid him a dividend of $25,000, consisted almost wholly of his salary from the Journal Company.
Plaintiff had no paid employees. It paid no salaries to its officers, except in 1926, when it paid a total of $1,000 for officers' salaries. The company declared no dividends from 1922, the year of its incorporation, to 1926. In the last-mentioned year it declared a dividend of $25,000. At that time it had a surplus of $822,916.78. It declared no dividends in 1927, at the end of which year it had a surplus of $1,380,340.63. The sole business of the plaintiff was the holding of stocks and securities transferred to it by L. W. Nieman and the reinvestment of income therefrom. Nieman organized the plaintiff for this purpose and also for the purpose of accumulating funds sufficient for the purchase of the minority stockholdings of Hany J. Grant in the Journal Company. Grant became a member of the Journal Company in 1919 and in 1922 owned 29 per cent., or 409 shares, of the stock of that company. When he purchased this stock in 1919, he expected to pay for it largely from the dividends to be declared by the Journal Company. The Journal Company had been prosperous and had established the policy of declaring a fixed dividend of, first, $24,000 a year to and including 1918 and thereafter $48,000 a year. The annual net earnings of the Journal Company increased very materially from 1916 forward (finding 10). Since 1919 the company had contemplated an increase in its plant facilities and in 1922 the officers of the corporation contemplated that such changes would involve an expenditure of approximately $500,000. The increase in the plant facilities was completed in 1924 at a cost considerably in excess of the previous estimate. During this period the Journal Company continued to pay its regular annual dividend of $48,- , 000, and in 1922, at the request of Grant, it declared and paid an additional dividend of $500,000. The increased facilities were paid for from current receipts, without borrowing or additional capital.
In 1928 the Commissioner of Internal Revenue held and decided that plaintiff came within the provisions of section 220 of the Revenue Acts of 1924 and 1926 (26 USCA § 961 note), and assessed a tax of $283,387.42 upon its entire net income for the years 1924, 1925, and 1926, which, together with interest of $50,745.38, totaling $334,132.80, was paid September 30, 1929. Claims for refund for each year were filed and rejected, and this suit was timely instituted.
Plaintiff contends that it was not formed or, availed of for the purpose of preventing the imposition of the surtax upon its stockholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, and that it did not permit its gains or profits to accumulate beyond its reasonable needs. From a consideration of the statute and the evidence of record, we are of opinion that the plaintiff was formed and availed of for the purpose of preventing the imposition of the surtax upon its stockholders by permitting its gains and. profits to accumulate instead of being distributed, and have so found.
The sole business of plaintiff was the holding of stock of the Journal Company and other companies and the securities transferred to it by L. W. Fieman, who had theretofore been the majority stockholder of the Journal Company, and the reinvestment of the income received therefrom. We think the plaintiff was not only formed for the purpose of preventing the imposition of surtax upon its sole stockholder, but that it was availed of by him for that purpose. The fact that Fieman also had in mind the purpose of having plaintiff accumulate funds sufficient for the purchase of Grant's minority stock-holdings in the Journal Company, should the opportunity arise, cannot prevent the application of section 220 for the reason that it has not been shown that there was any necessity for that policy of the plaintiff and for the further reason that a purpose to accumulate a fund made up in large measure of the amount of surtaxes avoided through the accumulation of dividends paid to the holding company which would otherwise have been subject to the surtax, had that been paid to Fieman, comes within the spirit of section 220, especially when such purpose is so closely coupled with the main or principal purpose of preventing the imposition of surtax upon the stockholders of the holding company. All that Fieman accomplished by having the dividends of the Journal Company and certain other corporations paid to the plaintiff, a holding company, instead of to himself, was the saving in the amount of surtax which he would otherwise have had to pay. The argument that Fieman was failing in health and vigor and that, for this reason, the plaintiff was organized to accumulate a fund sufficient for the acquisition of additional stock in the Journal Company does not, in our opinion, prevent the application of section 220. Upon Fieman's death his stock in the plaintiff would pass to his widow, or such persons as he might designate by will, in the samé manner as any moneys, properties, or securities owned by him had the dividends and interest received by the plaintiff been paid to him instead of to it. Whoever should have received Fieman's stock in the plaintiff company, had he died during the period here involved, could have used it or disposed of it in the same way as they could have used or disposed of any other money or property left by him. A mere purpose on the part of the corporation in accumulating funds is not sufficient to place the ease beyond the reach of section 220 unless such purpose is supported by the needs of the business and we cannot see that the determination or establishment of such needs would be any more difficult than the determination of many other questions arising under the various revenue statutes.
It is next contended that section 220 violates the Tenth Amendment of the Constitution of the United States in that it constitutes an attempt by Congress under the guise of tax to exercise a power not delegated to the United States but one reserved to the states; that the regulation of the affairs of corporations which are chartered by states is reserved to state Legislatures; and that all discretion on declarations of dividends has been committed to boards of directors by the Wisconsin Legislature and responsibility and liability therefor have been fixed upon them.
The statute in question is strictly a revenue- act and its sole purpose is to raise revenue. The amount imposed and authorized to be collected, when the circumstances are such as to make the provisions of the section applicable, is imposed and designated as a tax. If viewed as a penalty, it is but the employment of one of the effective means to collect revenues. The section was enacted as a necessary aid to the effective enforcement of the powers clearly within the power of Congress, and we think the cases of Bailey v. Drexel Furniture Co., 259 U. S. 20, 42 S. Ct. 449, 66 L. Ed. 817, 21 A. L. R. 1432, known as the Child Labor Tax Case, and Hill v. Wallace, 259 U. S. 44, 42 S. Ct. 453, 66 L. Ed. 822, are not applicable here. See Alston v. United States, 274 U. S. 289, 47 S. Ct. 634, 71 L. Ed. 1052; Nigro v. United States, 276 U. S. 332, 48 S. Ct. 388, 72 L. Ed. 600.
It is also urged that by imposing such a high tax for failure to distribute earnings the corporations would be coerced into distribuí mg their earnings and thus all regulation of the conduct of business, essentially a state power, is effected. We think this result does not follow from the statute, but if the effect of the law be as urged the control of the business is no greater in this ease than to compel a corporation to disclose its invested capital, gross income, expense of doing business, indebtedness, and net earnings, and to make such reports public records.
It was urged in Flint v. Stone Tracy Company, 220 U. S. 107, 31 S. Ct. 342, 359, 55 L. Ed. 389, Ann. Cas. 1912B, 1312, that such enforced disclosures, together with the making of such disclosures public records, invalidated the' Corporation Tax Law of 1909 as being the exercise of control over corporations and as having no direct connection with the raising of revenue. In answering this contention, as well as one that the act taxing the corporations created by the state might destroy the right of the states to so create such corporations, the court said:
"The taxation being, as we have held, within the legitimate powers of Congress, it is for that body to determine what means are appropriate and adapted to the purposes of making the law effectual. In this connection the often-quoted declaration of Chief Justice Marshall in McCulloch v. Maryland, 4 Wheat. 316, 421, 4 L. Ed. 579, 605, is appropriate: 'Let the end be legitimate, let it be within the scope of the Constitution, and all means which are appropriate, which are plainly adapted to- that end, and which are not prohibited, but consist with the letter and spirit of the Constitution, are constitutional.'
"Congress may have deemed the public inspection of such returns a means of more properly securing the fullness and accuracy thereof."
In the present case section 220 was clearly adopted by Congress to make more effectual the collection of the revenue and was in itself a revenue-producing measure.
The section does not make the accumulation of surplus an absolute test for classification, but merely a prima facie classification. It does not tax all corporations which accumulate their surplus, but classifies those as subject to the tax who make,such accumulation for the purpose of preventing the imposition of the surtax on their stockholders, leaving each corporation free to establish as a fact, if such be the fact, that the accumulation was for the needs of the business. The presumption is not conclusive.
Substantially the same questions presented in this case were before the Circuit Court of Appeals for the Second Circuit in United Business Corporation of America v. Commissioner of Internal Revenue, 62 F.(2d) 754, 755, in which the court said:
"The objections to the order in this court are substantially as follows: That section 220 applies only when the accumulation is Unreasonable for the corporate purposes; that it was applied retroactively, and, sinee it imposed a penalty, could not be constitutionally enforced before it was passed; that it is too uncertain in its terms to be valid; that it offends the Tenth Amendment.
"Ordinarily it will indeed be difficult to prove the forbidden purpose, unless the accumulations are too large for the fair needs of the business. But it may not be impossible to do so, even though the profits arise out of normal business, as they did not here. The management may for example be shown to have always been sanguine, and to have withheld only small reserves, though prudence justified more. A sudden change of policy, coincident with large increases in tha surtax rates, might in that situation betray a purpose to accumulate against a season more propitious for distribution. Or the officers might unguardedly disclose a scheme to avoid surtaxes, though the other evidence was not enough. A statute which stands on the footing of the participants' state of mind may need the support of presumption, indeed be practically unenforceable without it, but the test remains the state of mind itself, and the presumption does no more than make the taxpayer show his hand. Pariso v. Towse, 45 F.(2d) 962 (C. C. A. 2); Alpine Forwarding Co. v. Pennsylvania R. R. Co., 60 F.(2d) 734 (C. C. A. 2).
"Here the purpose appears to us, if not transparent, at least plain enough to leave no doubt. The company was in its origin no more than a convenience for Smith's real property holdings. While its charter allowed other activity, unless it were to buttress its financial position,, it was discordant with the main design to fill it with nearly nine hundred thousand dollars of shares of stock. Smith was patently in control; when he turned over his personal holdings to exempt himself from taxation, he was using the company for that purpose, and the company, his creature, by its complaisance incurred the added tax. * • *
"The intent being plain, the .only question is whether Congress expressed • its will. certainly enough to be enforced, and whether any other constitutional obstacle is in the way. The argument is that the standard set is too vague for execution; that it is impossible definitely to say when the purpose of those who use the corporation to accumulate its profits is to exonerate its shareholders. Purpose is indeed not often a factor in legal transactions, though at times it is; but intent is often material, and whatever the difficulties of proof, the issue is concrete enough. Nothing is more frequent in human relations than the effort to learn what goes on in others' minds. The presumption is indeed less definite, and it is this especially that the petitioner attacks, relying upon the decisions which upset the efforts of Congress to control prices during the Great War. U. S. v. L. Cohen Grocery Co., 255 U. S. 81, 41 S. Ct. 298, 65 L. Ed. 516, 14 A. L. R. 1045. The argument misconceives the scope of those decisions. Standards of conduct, fixed no more definitely, are common in the law; the whole of torts is pervaded by them; much of its commands are that a man must act as the occasion demands, the standard being available to all. The vice of fixing maximum prices is that it requires recourse to standards beyond ascertainment by sellers, by which therefore they' cannot in practice regulate their dealings. That is not true of the reasonable needs of a business, which is immediately within the ken of the managers, the supposititious standard, though indeed objective, being as accessible as those for example of the prudent driving of a motor ear, or of the diligence required in making a ship seaworthy, or of the extent of proper inquiry into the solvency of a debtor. Moreover, since the result of the presumption is at most no more than to compel the taxpayer to disclose the facts, and since the tax itself is definitely enough determined, the whole issue, is irrelevant.
"A more plausible objection is that the tax imposed on the company bears no relation to the surtaxes on the shareholders. This was not true before 1921, until when the shareholders were themselves taxed as though members of a personal service company. Doubts apparently arose as to the validity of taxing income which the taxpayers had never received, and in 1921 it was thought safer to tax the company itself in an amount not based upon that lost. We can see no objection. While the forbidden purpose is of those who use the company, that purpose may be imputed to the company itself, since they cannot use it unless they are in control, and it can have no other than an imputed purpose anyway. Nor does this trench upon the reserved powers of the states; companies may accumulate what profits they please so long as they do not do so to defeat the fiscal policies of the United States. Their business, whose regulation is wholly for the states, does not include the manipulation of dividends to avoid taxes; by definition that has nothing to do with the normal management of their affairs. Congress in raising revenue has incidental power to defeat obstructions to that incidence of taxes which it chooses to impose."
It is next contended that the section deprives plaintiff of property without due process of law in violation of the Fifth Amendment to the Constitution, in that it prescribes a confiscatory penalty for refraining from doing that which there is no obligation to do and which the Congress is not empowered to compel; and also violates the said amendment in that it imposes a penal burden dependent upon a standard which is vague, indefinite, and uncertain; and that it imposes a tax or penalty resting upon no reasonable classification, having no relation in amounts or burden to the alleged purpose,' and which is arbitrary and capricious.
Most of what has been stated above, particularly the decision in the case of United Business Corporation of America v. Commissioner, supra, applies to this phase of. the ease. The due process clause of the Fifth Amendment is a regulatory provision as to the manner or mode of the exercise of the other powers conferred by the Constitution. It cannot be invoked to prohibit the exercise of those powers. In Brushaber v. Union Pacific Railroad Company, 240 U. S. 1, 24, 36 S. Ct. 236, 244, 60 L. Ed. 493, L. R. A. 1917D, 414, Ann. Cas. 1917B, 713, the court said:
"So far as the due process clause of the 5th Amendment is relied upon, it suffices to say that there is no basis for such reliance since it is equally well settled that such clause is not a limitation upon the taxing power conferred upon Congress by the Constitution; in other words, that the Constitution does not conflict with itself by conferring upon the one hand, a taxing power, and taking the same power away, on the other, by the limitations of the due process clause. Treat v. White, 181 U. S. 264, 21 S. Ct. 611, 45 L. Ed. 853; Patton v. Brady, 184 U. S. 608, 22 S. Ct. 493, 46 L. Ed. 713; McCray v. United States, 195 U. S. 27, 61, 24 S. Ct. 769, 49 L. Ed. 78, 97, 1 Ann. Cas. 561; Flint v. Stone Tracy Co., 220 U. S. 107, 158, 31 S. Ct. 342, 55 L. Ed. 389, 416, Ann. Cas. 1912B, 1312; Billings v. United States, 232 U. S. 261, 282, 34 S. Ct. 421, 58 L. Ed. 596, 605. And no change in the situation here would arise even if it be conceded, as we think it must be, that this doctrine would have no application in a ease where, al though there was a seeming exercise of the taxing power, the act complained of was so arbitrary as to constrain to the conclusion that it was not the exertion of taxation but a confiscation of property; that is, a taking of the same in violation of the 5th Amendment; or, what is equivalent thereto, was so wanting in basis for classification as to produce such a gross and patent inequality as to inevitably lead to the same conclusion."
It is true that it has been held that a taxing act may be so unreasonable and arbitrary as to violate the due process clause of the Fifth Amendment, Nichols v. Coolidge, 274 U. S. 531, 47 S. Ct. 710, 71 L. Ed. 1184, 52 A. L. R. 1081, Untermyer v. Anderson, 276 U. S. 440, 48 S. Ct. 353, 72 L. Ed. 645, but in both of these cases the unreasonableness did not lie in the lack of equality in the treatment of those clearly within the classification. The invalidity in those cases arose because of the inclusion of the eases based on events which had transpired before the enactments when there could have been no thought of taxation to evade.
The retroactive feature of the act which undertook to reach property which had completely passed beyond the power and control of the donor before the act was passed was regarded as so palpably arbitrary and unreasonable as to offend against the due process clause of the Fifth Amendment. The ground upon which the act before the court in those cases was held invalid does not apply here.
In the enactment of section 220 Congress has not, as contended by the plaintiff, commanded that corporations distribute to their stockholders all gains in excess of their reasonable needs. There is no command, and hence no penalty for failure to comply. The section classifies such corporations as accumulate unreasonably their earnings for the purpose of preventing the imposition of the surtax on their stockholdings, and, having so classified, a tax is levied. The fact that the tax may bear more heavily upon the corporation than it would upon the stockholders is a matter with which the court has no concern. The fact that it is possible for corporations to conduct their business so as to fall without the classification and avoid the 50 per centum tax imposition does not convert the tax into a penalty for failure so to do. This seems to be the logic of the decisions of the Supreme Court in the oleomargarine cases. Section 220 deals with income as such, and, since the purpose of its enactment was to aid in the collection of revenue, it need not be tested by the rules of exactness usually required in the imposition of penalties, nor does the fact that the tax of 50 per centum is greatly in excess of the tax which would be payable by the stockholders make the classification unreasonable.
To hold section 220 to be beyond the power of Congress would be almost the equivalent of holding that Congress is impotent to prevent evasions of its tax laws. Without section 220, or its equivalent, potential taxpayers could by the mere forming of a corporation evade all surtaxes.
It is finally contended that section 220 deprives plaintiff of property -without due process of law in violation of the Fifth Amendment, in that it imposes a purported tax upon the income of obligations of the United States in derogation and in violation of contracts between plaintiff and the government, and in contravention of the freedom of such income from taxation which is pledged by the government's good faith and credit.
During each of the taxable years in question plaintiff received $13,090 as interest upon certain first, second, third, and fourth Liberty loan bonds, and these amounts were included by the defendant in the income of plaintiff upon which the tax imposed by section 220 was assessed and collected. Section 220 requires that such interest shall be included in the net income subject to tax if such income "would be subject to tax in whole or in part in the hands of an individual owner." The income from the government obligations involved in this ease was subject to estate and inheritance tax, surtaxes, and excess and war-profits taxes. Congress has not attempted to define the nature of the tax imposed by section 220 and the statute does not require that the tax be defined to be other than a surtax. The tax imposed by the section partakes of the attributes of a surtax or excess-profits tax more than any other, and section 220 was intended as an auxiliary to that portion of the income-tax provisions relating to surtax. It was designed to prevent the evasion of surtaxes by stockholders and we think it avails nothing to show that the tax is 50 per cent, of the net income without regard to the amount of unreasonable accumulation. The interest received by plaintiff from the government bonds was not subject to the normal income tax imposed by sections 230 of the Revenue Acts of 1924 and 1926 (26 USCA § 981 note), and it has not been so taxed. As shown in the findings, the interest of $13,090 received by plaintiff each year from the government bonds was reported in its returns of income; but no tax was paid thereon, inasmuch as such interest was exempt from the tax imposed by section 230. "It will be understood that Congress has very ample authority to adjust its income taxes according to its discretion, within the bounds of geographical uniformity. Courts have no authority to pass upon the propriety of its measures; and we deal with the present criticism only for the purpose of refuting the contention, strongly urged, that the tax is so wholly arbitrary as to amount to confiscation." La Belle Iron Works v. United States, 256 U. S. 377, 41 S. Ct. 528, 532, 65 L. Ed. 998.
The courts cannot limit the discretion of Congress in the exercise of its constitutional power to levy taxes because the court might deem the tax oppressive. Veazie Bank v. Fenno, 8 Wall. 533, 19 L. Ed. 482; McCray v. United States, 195 U. S. 27, 24 S. Ct. 769, 49 L. Ed. 78, 1 Ann. Cas. 561.
The petition must be dismissed. It is so ordered.
WILLIAMS, J., concurs.
WHALEY, J., concurs in the result.
BOOTH, C. J., took no part in the decision of this ease on account of illness.