Opinion ID: 3012672
Heading Depth: 2
Heading Rank: 1

Heading: Furnace A

Text: Inductotherm argues that it was not required to treat the sale proceeds for Furnace A as income in 1991 under the Claim of Right Doctrine. That Doctrine, set out in North American Oil Consolidated v. Burnet, 286 U.S. 417 (1932), holds that funds received by a taxpayer will be considered income if (1) “a taxpayer receives earnings under a claim of right” and (2) “without restriction as to its disposition,” “even though it may still be claimed that [the taxpayer] is not entitled to retain the money, and even though [the taxpayer] may still be adjudged liable to restore its equivalent.” Id. at 424. Here, Inductotherm has conceded that it received the Furnace A proceeds under a “claim of right,” i.e., it acknowledged its entitlement to the proceeds. However, it disputes that it held the Furnace A proceeds without restriction as to disposition in 1991. Inductotherm reasons that the Executive Order, issued during its 1991 tax year, required it to place the funds in a blocked account (which, however, it did not do) and thus restricted its discretion as to those funds in 1991. Inductotherm relies principally on a line of cases holding that public utilities were not required to recognize as income customers’ deposits, prepayments, or “overrecoveries,” which those utilities clearly were obligated to return, despite the fact that the utilities commingled the funds (as Inductotherm did). See, e.g., Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203 (1990) (customer deposits made to assure prompt payment of future bills not income; even though funds commingled with general funds, deposits represent merely loans because customers are entitled to demand return of funds under specified circumstances); Mutual Tel. Co. v. 3. The District Court had jurisdiction under 28 U.S.C. § 1331. We exercise jurisdiction pursuant to 28 U.S.C. § 1291. Because the issues in this appeal are questions of law, our review is plenary. Epstein Family P’ship v. Kmart Corp., 13 F.3d 762, 765-66 (3d Cir. 1994). 6 United States, 204 F.2d 160, 161 (9th Cir. 1953) (monies utility held in reserve at the direction of the Public Utilities Commission were not income because “it cannot be said that the receipts came into the possession of [the utility] subject to its ‘unfettered command’ and that it was free to enjoy the receipts at its option”); Florida Progress Corp. v. Commissioner, 114 T.C. 587, 599 (T.C. 2000) (“Because the time and method of refunding overrecoveries is controlled by [agencies] rather than by Florida Power, [it] does not have complete dominion over the overrecoveries and is not required to recognize them as income when received.”); Houston Indus. Inc. & Subs. v. United States, 32 Fed. Cl. 202, 210 (Fed. Cl. 1994) (“overrecoveries” for fuel costs are not income because “[e]very dollar of overrecovery must eventually be repaid.”). The Government argues that these utility cases are not analogous because the first prong of the Claim of Right Doctrine was not satisfied: the utilities did not claim that they were entitled to the funds for their own benefit. Rather, they conceded at all times that they held the funds in a fiduciary capacity or, at least, with a clear obligation to return the funds. Moreover, as to the second prong, the utilities’ discretion with respect to the funds was at all times limited by extensive regulatory oversight by state administrative agencies. The Government directs our attention instead to James v. United States, 366 U.S. 213 (1961), which held that money embezzled must be included in income, even though it likely would have to be disgorged in the future. Just as Inductotherm argues that its commingling of the Furnace A proceeds is not dispositive under the utility cases, the Government cites James for the proposition that Inducotherm’s legal duty to block the proceeds under the Executive Order is likewise not dispositive. In James, it was clear that the embezzler had no right to the funds at issue. Nonetheless, because the embezzler treated the funds as his own during the relevant tax year, he was required to recognize those funds as income. We agree with the Government. As already noted, Inductotherm’s concession (no doubt correct) that it asserted title to the proceeds of Furnace A’s sale in 1991 answers the first prong of the Claim of Right Doctrine. 7 As to the Doctrine’s second prong (no disposition restriction on the sale proceeds), Inductotherm, having commingled the funds instead of blocking them, placed itself in a position of complete dominion over those funds (at least during the 1991 tax year). In this context, the Executive Order was “a potential or dormant restriction . . . which depends on the future application of rules of law to present facts [and therefore was] not a ‘restriction on use’ within the meaning of North American Oil v. Burnet.” Healy v. Commissioner, 345 U.S. 278, 284 (1953). The Government was entitled to prosecute Inductotherm for failure to comply with the Executive Order. However, as with any regulation or criminal law, the Government had the discretion not to pursue Inductotherm’s Executive Order violation. Thus, Inductotherm’s control over the Furnace A proceeds was analogous to that of the embezzler in James.4 See also Continental Illinois Corp. v. Commissioner, 998 F.2d 513 (7th Cir. 1993) (because bank’s obligation to refund interest paid over a known percentage is contingent on the fulfillment of conditions by the debtor, and thus the obligation is uncertain, bank must treat interest as income in year received). That Inductotherm was required after the conclusion of the 1991 tax year to block the Furnace A proceeds is in no way relevant to the analysis. There are numerous cases in which a taxpayer treated funds as its own in one year, only to find that it was required to disgorge them in a later year. In all these cases, courts required the taxpayer to recognize the funds as income in the year received, notwithstanding the later disgorgement. See, e.g., Healy, 345 U.S. 278 (salary a taxpayer earned in one year from a closed corporation in which he was an officer and stockholder, which had to be returned to the company in a subsequent year because it was excessive compensation, was income in the year the salary was earned); Wentworth v. Commissioner, 510 F.2d 883 (6th Cir. 1975) (taxpayer whose stock was illegally redeemed was required to recognize proceeds from redemption in year he received 4. While we do not suggest that Inductotherm’s behavior was criminally culpable (as was that of the taxpayer in James), its position for tax purposes is legally indistinguishable. 8 them, despite later duty to return proceeds); United States v. Lesoine, 203 F.2d 123 (9th Cir. 1953) (taxpayer properly included dividend as income in the year it was received, even though it was later determined that dividend had to be repaid to corporation because there was insufficient surplus for payment); Saunders v. Commissioner, 101 F.2d 407 (10th Cir. 1939) (sums taxpayers received from the sale of corporation’s capital stock were income, although taxpayers returned money to corporation on advice of counsel, who said that taxpayers were not entitled to receive funds). In this context, the Claim of Right Doctrine does not shield the Furnace A proceeds from being income in 1991.