Court Opinion

ID: 4615923
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:33:26.447364+00
Date Added: 2024-06-11T07:55:01.743024
License: Public Domain

LYKES BROS. STEAMSHIP CO., INC. (FORMERLY LYKES BROS.-RIPLEY STEAMSHIP CO., INC.), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lykes Bros. S.S. Co. v. CommissionerDocket No. 96637.United States Board of Tax Appeals42 B.T.A. 1395; 1940 BTA LEXIS 865; November 29, 1940, Promulgated *865  Prior to the taxable years, petitioner entered into an agreement with the United States Shipping Board for the purchase of certain vessels which it agreed to operate over specified routes.  By further provision of this agreement petitioner was to deposit in a special bank account during the taxable years sums totaling $250,000 which might be expended only for capital purposes.  At approximately the same time petitioner executed a contract with the Postmaster General to carry mail over these same routes for compensation greatly in excess of the usual rates.  Held, petitioner may not exclude the sum of $250,000 from its taxable income since there is no showing that these amounts deposited pursuant to contract were required to be made up from the postal subsidy.  Robert N. Miller, Esq., and Ward Loveless, Esq., for the petitioner.  J. L. Backstrom, Esq., for the respondent.  ARUNDELL*1396  The respondent has determined deficiencies in income and excess profits tax for the calendar years 1934 and 1935 in the following amounts: YearIncome taxExcess profits tax1934$13,750.00$5,000.00193520,625.005,198.25*866  Only a portion of each deficiency is contested.  The single issue presented is whether amounts of $100,000 and $150,000 received by the petitioner as portions of its compensation under a mail contract in the years respectively of 1934 and 1935 should be excluded, as contended by petitioner, from its income in those years because such or like sums were required by contract with the United States Shipping Board Merchant Fleet Corporation to be set aside and were so set aside in those years to be used only for capital expenditures with the approval of the United States Shipping Board.  The facts have been largely stipulated and as so stipulated are adopted as our findings.  The material parts are set out hereinafter with our other findings.  FINDINGS OF FACT.  Petitioner is a Louisiana corporation, with its principal office in the Whitney Bank Building, New Orleans, Louisiana.  Prior to February 17, 1933, petitioner was engaged in the operation of certain vessels of the United States Shipping Board under an agreement by which petitioner received from the Shipping Board for each voyage a lump sum payment in addition to the general freight revenues collected on the trip.  The*867  general revenues thus collected did not on the average equal the cost of making the voyages.  At this time a Federal interdepartmental committee ewas appointed by the President, consisting of the Chairman of the United States Shipping Board, the Secretary of the Navy, the Secretary of Commerce, and the Postmaster General, the purpose of the establishment of which committee was, among others, to dispose of certain merchant steamships then owned by the Government and generally to take steps to encourage the growth of the United States Merchant Marine.  It functioned also to work out the details of postal contracts which were advertised and awarded in connection with the disposal of the Government-owned vessels.  The plan adopted was to finance in part the purchase and operation of the ships by awarding to the buyer, simultaneously with the contract of sale, a contract to carry United States mail on a mileage instead of a poundage basis.  Since the slow speed of the ships prohibited the carrying of any quantity of mail and the routes traveled had little postal value, it was anticipated that relatively great amounts would be paid for the carrying of a negligible quantity of *1397 *868  mail.  These payments were regarded as, and were intended to be, subsidies in aid of the building up of an American Merchant Marine. 1Negotiations with this committee or its representatives conducted by the petitioner resulted in the execution of three contracts, the substance of each of which is as follows: 1.  On February 17, 1933, the petitioner entered into a contract with the United States of America, which was represented therein by the United States Shipping Board.  Acting through the United States Shipping Board Merchant Fleet Corporation, the Shipping Board agreed to sell to the petitioner 52 steel steamships and their equipment, together with the trade names and good will of the four steamship lines under the names of which they were then operated from United States ports on the Gulf of Mexico to all parts of the world, all for a consideration of $2,461,790.  The purchase price was made payable, 2 1/2 percent in cash on the execution of the*869  agreement, an additional 22 1/2 percent in cash on the delivery of the vessels not later than July 1, 1933, and the remainder in 8 promissory notes with annual interest at 4 1/4 percent, such notes being due one at the end of each year following the agreement except the last which was made payable at the end of 7 1/2 years.  These notes were to be secured by mortgages on the vessels in a specified form.  In further consideration of the agreement the petitioner agreed to maintain for five years lines as common carriers of cargo from United States ports on the Gulf of Mexico to ports in the Orient, Mediterranean, the United Kingdom and Ireland, and Continental Europe.  It was agreed, in addition, that petitioner would maintain adequate service on these lines, making on each a specified minimum of voyages each year and calling at certain named ports for mail, passengers, and cargo.  Petitioner agreed not to use the vessels purchased to compete with certain named steamship lines which were under agreement with the seller to maintain service comparable to that provided above, or with any steamships operated by the United States Shipping Board, and in return the seller agreed not to*870  operate directly or indirectly any vessels in competition with petitioner on its agreed routes.  In addition it was provided that whereas the petitioner was about to enter into a ten-year contract with the Postmaster General for the carrying of mails on the lines purchased and for the expenditure of $20,000,000 within nine years on the construction or reconstruction of vessels, it was agreed between petitioner and seller in substantially the same terms that $20,000,000 would be thus expended, $6,000,000 within the first five years and not less than $3,000,000 within each of the next four years.  Petitioner agreed to deposit $2,700,000 with *1398  a designated bank to the account of the "Lykes Bros.-Ripley Steamship Co., Inc., Special Deposit" within nine years, $100,000 for the first year, $150,000 for the second, thereafter the amount for each year increasing by $50,000 to a total for the ninth year of $500,000, all under a form of agreement approved by the United States Shipping Board.  These amounts, which might be changed by order of the Shipping Board, were to be disbursed only upon the order of the Shipping Board for these purposes: (a) For constructing or outfitting*871  new vessels built under the agreement, (b) for remodeling or reconditioning any vessels under the agreement, (c) for the purchase of substituted vessels, (d) for "emergency requirements for regular operation of said lines or any of them upon prior written approval of the seller." Petitioner was authorized to expend directly such amounts as it saw fit for new construction or reconditioning, remodeling, improvement, or substitution of vessels pursuant to the contract, the amounts so expended to reduce pro tanto the amount required to be deposited in that year and, if in excess of that amount, the sums required to be deposited in following years.  The United States Shipping Board might, with the prior approval of the Postmaster General, allow discontinuance in part or whole of the requirement of these deposits and allow withdrawal of previous deposits "for purposes other than as herein specified, as in its judgment may be warranted in the circumstances." The petitioner agreed further to maintain certain specified amounts of outstanding common stock and of quick assets.  Finally, it was provided that the agreement was to become effective only if any when the mail contract between*872  petitioner and the Postmaster General covering these four lines was executed, and in case this was not done by June 1, 1933, the agreement was to become null and void.  2.  On February 21, 1933, petitioner executed an agreement with the United States of America, represented by the Postmaster General, which recited first that the Postmaster General had accepted petitioner's proposal to render the service specified in a certain advertisement issued on January 19, 1933.  The agreement then provided that the petitioner should carry over specified routes from United States Gulf ports to all parts of the world, being the same lines over which petitioner had agreed with the United States Shipping Board to maintain service, all United States mails offered, such mail passengers as the Postmaster General should direct free of charge, postal officials, and mail supplies, and to carry one or two American-born apprentices per ship who should be educated thereon and paid at the rate of not less than $30 per month.  The petitioner agreed in addition to begin service under the contract with ships of specified speed and to construct new vessels or reconstruct *1399  old vessels during the*873  term of the contract at a total cost of $20,000,000, during the first five years $6,000,000 of this amount to be spent and not less than $3,000,000 each year to be expended during the next four years.  The obligation to spend $20,000,000 might be modified, however, by the Postmaster General.  The consideration for this service was placed on a mileage basis.  The Postmaster General agreed to pay amounts ranging upward from $2.50 per mile for vessels of class 6 to $12 per mile for vessels of class 1.  The classification of the vessels was based on speed, without regard to tonnage.  The petitioner was authorized, with the approval of the Postmaster General, to operate in performance of the contract vessels of any class.  The Postmaster General was given authority also to reduce or postpone the $20,000,000 required to be expended should traffic conditions warrant.  The contract term was limited to a period of ten years.  It was agreed that should the United States Shipping Board refuse to make a construction loan to the petitioner for construction or reconstruction of vessels required by this contract, the petitioner was to be relieved from any obligations and the contract would become*874  null and void.  3.  A third agreement was executed on April 6, 1933, between petitioner, the United States Shipping Board Merchant Fleet Corporation and the Whitney National Bank of New Orleans, Louisiana, designating the last named as the depository for the $2,700,000 agreed to be made by petitioner over a period of nine years.  The bank agreed to pay out the deposit on checks of the petitioner upon written approval of the Shipping Board.  Annual interest on the funds was to be paid to petitioner and at the expiration of nine years or on the sooner termination of the contract any funds remaining in the deposit were to be subject to petitioner's unqualified disposal.  No mail was carried on the lines acquired by petitioner at the time of purchase.  Thereafter a negligible quantity of mail which petitioner itself placed in the mails and marked for transport on these lines was carried by the petitioner's vessels.  On February 27, 1933, the following letter was written by the Postmaster General to the Chairman of the United States Shipping Board: OFFICE OF THE POSTMASTER GENERAL WASHINGTON, D.C.FEBRUARY 27, 1933.  Hon. T. V. O'CONNOR, Chairman, United States Shipping*875  Board.MY DEAR MR. O'CONNOR: On February 21 you sent this Department three certified copies of the Board's sales contract executed on February 17, 1933 with Lykes Bros.-Ripley Steamship Co., Inc., in order that we might consider the suggestion that this contract be accepted in lieu of bond on the mail contract awarded February 21, 1933 to Lykes Bros.-Ripley Steamship Co., Inc., for Route No. 57.  *1400  I am advised that Article 12 in your sales contract, providing for the placing of a certain amount of mail pay in escrow and requiring the consent of the Postmaster General to any modification of the deposits to be made by the buyer, was inserted with the view this would enable the Lykes Bros.-Ripley Steamship Co., Inc., to have this sales contract accepted in lieu of bond on the mail contract.  The contractor has furnished me with an acceptable bond for his mail contract and the contract has been executed.  In view of the fact that the contractor's obligations under his mail contract have been satisfactorily covered by the bond given this Department, I see no necessity for Article 12 in the Board's contract and if my consent is required to permit the elimination of*876  Article 12 it is hereby given.  Very truly yours, [Signed] WALTER F. BROWN On March 20, 1933, the Shipping Board made an amendatory agreement with the petitioner by which the requirement of a $300,000 bond in the original agreement was eliminated and the requirement that the Postmaster General consent to any changes made in the terms of the $2,700,000 deposit was eliminated.  During the calendar years 1934 and 1935 petitioner received respectively $2,280,122.50 and $2,177,025.00 pursuant to its contract with the Postmaster General as set out in (2) above.  The postal service rendered in these two years, compensated on the United States poundage rate, would have cost $133.76 for 1934 and $96 for 1935.  The amounts received by petitioner pursuant to its contract with the Postmaster General were kept in the Whitney National Bank of New Orleans in an account separate from the account in which it deposited its ordinary revenues and such amounts were reflected in a separate account on petitioner's books.  The only moneys kept in this bank account outside those received under the postal contracts were sums received as interest on the amounts deposited in the escrow account.  Funds*877  from this account were used in part to offset ordinary operating losses, and transfers for this purpose and for operating expenses were made from time to time from this account to the general operating revenues of the company as needed.  On April 11, 1934, petitioner drew a check for $100,000 on the account in which its postal funds were kept, separately, payable to the order of "Lykes Bros.-Ripley Steamship Co., Inc. - Special Deposit" in performance of its agreement set out under (1) above.  From the same source and by the same method on April 13, 1935, it paid to "Lykes Bros.-Ripley Steamship Co., Inc., - Special Deposit" the $150,000 it was obligated to pay in 1935.  During the taxable years no part of the amounts deposited in escrow with the Whitney National Bank were used by petitioner for any purpose.  Petitioner had gross revenues from freight and the operation of its vessels, exclusive of amounts received from the Postmaster General, *1401  of $6,504,029.14 for the calendar year 1934 and of $6,653,345.81 for the calendar year 1935.  It received during 1934 from the Whitney National Bank interest on the funds in the "Special Deposit" in the amount of $497.89, and*878  in the year 1935 in the amount of $1,545.07.  On June 15, 1937, after the passage of the Merchant Marine Act of 1936, discontinuing after June 30, 1937, mail contracts such as that one here involved, a settlement agreement was entered into between the United States Maritime Commission and the petitioner, by the terms of which the reciprocal claims of the parties were adjusted.  So far as is material here the contract provided that the sum of $450,000 deposited in the "Special Deposit" account by the petitioner in the Whitney National Bank of New Orleans, Louisiana, should remain in that bank to be disbused only on order of the Maritime Commission for cost of constructing and equipping new vessels built by or for petitioner under the Merchant Marine Act, 1936.  OPINION.  ARUNDELL: The question for decision is whether the respondent erred in including in petitioner's income for 1934 and 1935 the amounts of $100,000 and $150,000, respectively, that were deposited by the petitioner in a special account as described in the findings of fact.  The petitioner's views are that the amounts deposited were either parts of a government subsidy useable only for capital purposes, hence not*879  income under , or that they were not received for the petitioner's separate use, benefit, and disposal and so are not income within the definition in . The respondent takes the position that the full amounts paid to the petitioner by the Post Office Department were taxable income, it that they were received by it without restriction and solely as compensation for carrying mail and other services; that no part of the sums received was required to be placed in escrow; and that the amounts placed in escrow were not solely for capital purposes.  At the outset it is to be noted that the petitioner, while contending that the full sums received from the Post Office Department were subsidies, does not contend that such classification of them removes the full sums from the category of taxable income.  It does not claim that the doctrine of the Cuba Railroad Co. case goes so far as to exempt all of the mail payments, but limits the application of that case to the sums set aside in the special bank account.  There is little room for doubt that the entire sums paid to the*880  petitioner in the taxable years were subsidies in the sense that they were governmental aids or grants designed to encourage the expansion of the American Merchant Marine.  The huge sums paid in *1402  excess of normal postal rates were clearly for that purpose.  But, applying the broad term of subsidy to the amounts paid to the petitioner does not solve the question in issue here, because of the different purposes for which such governmental grants are made.  From the Supreme Court cases a few general rules may be drawn.  Governmental grants made in order to induce construction and operation of railroads are not mere gifts. . Such a grant made to a railroad company proportionate to mileage of railway completed is treated as a reimbursement for capital expenditures and is not income. A grant to a railroad to make up a deficiency in operating income is income for Federal tax purposes.  . The real point at issue in this case is whether the payments by the Government, *881  to the extent of the sums set aside by the petitioner, were made for capital purposes within the principle of the Cuba Railroad Co. case.  This must be determined on the basis of the agreement between the United States and the petitioner.  The agreement relating specifically to the payments to be made to the petitioner is that of February 21, 1933, executed by the petitioner and the Postmaster General.  The only requirement in that contract calling for any expenditure by the petitioner was that the petitioner should construct or reconstruct vessels at a cost of $20,000,000 within the 10-year period of the contract, subject to reduction in amount by the Postmaster General.  The provisions relating to that requirement do not in any way require that any part of the revenues from carrying the mails be set aside or that the cost of construction be paid from such revenues.  There is no tie-up in the contract between the mail revenues and the construction to be performed by the petitioner.  The revenues were purely on a mileage basis, without any reference to the amount or cost of construction of vessels by the petitioner.  Therefore, under this contract it can not be said, as in the*882 Cuba Railroad Co. case, that there is any indication of a purpose that the mail revenues were to be in reimbursement to the petitioner for capital expenditures.  The petitioner says that the contracts for the purchase of vessels and for the transportation of ocean mail pay were interdependent, and that it was understood by all parties to both contracts that deposits required under the purchase contract would be made from the ocean mail pay.  There is partial interdependence of contracts in that the purchase contract of February 17, 1933, was to become effective only if and when a mail contract with the Postmaster General was executed, and further in that the purchase contract provided *1403  that the deposits were not to be required if the mail contract was terminated or modified without fault of the petitioner, or if Congress did not make a timely appropriation to pay for the mail services to be rendered by the petitioner.  These provisions are all in the negative, providing what shall not be done under the named circumstances.  There is nothing in them requiring the affirmative act of setting aside any of the ocean mail pay.  And so, even finding a partial interdependence*883  of contracts, we are unable to find therein what is essential to the petitioner's case, namely, that the deposits were required by the contract to be made out of the income received under the ocean mail contract.  See , and cases there cited.  It must be remembered that in each of the taxable years the petitioner had revenues from other sources of over $6,000,000, and on the record in the case there is no reason to suppose that the deposits required were intended to be made from postal revenues rather than from the other revenues.  Moreover, there is no relation by amounts or percentages between the sums to be deposited and those to be received under the ocean mail contracts; the deposits were to be made without regard to how much or little was realized under the mail contracts.  The chief reliance of the petitioner to show intended appropriation of mail pay to the deposit requirements is the letter of the Postmaster General which is set out in the findings of fact.  In that letter article 12 of the sales contract is spoken of as "providing for the placing of a certain amount of mail pay in escrow." If this statement in the*884  letter can be taken to mean that the parties understood that a part of the mail pay was to be set aside, it still does not establish the petitioner's case.  A reading of the whole letter shows that it was thought that the setting aside was to be for the purpose of providing security "in lieu of bond on the mail contract." Quite obviously the Postmaster General had no thought that the escrow provision was intended to require an appropriation to capital purposes, and in this view the principle of Cuba Railroad Co. does not apply.  When, following the Postmaster General's letter, an amendatory agreement was executed by the Shipping Board and the petitioner eliminating that part of the ship purchase contract which required the approval of the Postmaster General for the modification or postponement of deposits, the principal connecting link between the two contracts was broken.  Accepting the Postmaster General's construction of the contracts that the deposit arrangement was to secure performance, it would seem that after the amendment of March 20 the deposits were required by the Shipping Board as security for performance of the purchase contract rather than to *1404  assure*885  the making of any capital expenditures.  That securing performance was the principal purpose is indicated by the fact that none of the deposits were disbursed for any purpose during the life of the contract.  One of the provisions of the Shipping Board contract is that the petitioner might spend directly for new construction, reconditioning, remodeling, or improvement of vessels any amounts it saw fit, and any sums so spent should reduce the amounts required to be deposited.  This seems to us to indicate that the parties did not intend to require a part of the mail payments to be set aside.  Under this provision, if the petitioner had expended for any of the several purposes listed, the amount of $100,000 in the first year and $150,000 in the second year, regardless of the source of the funds expended, it would not have been required to deposit any sums with the Whitney bank.  This demonstrates that the parties to the contracts did not intend that the deposits were to be required to be made out of the mail payments.  Either a deposit from any source, or construction, remodeling, etc., to the extent provided, would leave the entire mail payments free to be used by the petitioner for*886  any purpose, hence income within the rule of An important fact in this case is that the mail payment income was directly dependent upon operations.  If petitioner operated its vessels and carried ocean mails it was to be compensated therefor, based upon mileage and the class of vessel operated.  The income was not, as in Cuba Railroad Co., dependent on construction, and, after the Postmaster General's waiver of the deposit provisions in February 1933, it was in no way contingent on the making of deposits.  On the facts, then, the case becomes very like that of , which involved the taxability of sums paid to railroads to make up deficiencies in operating income.  The Supreme Court pointed out in that case that the railroads "were bound to operate their properties in order to avail themselves of the government's proffer.  Under the terms of the statute, no sum could be received save as a result of operation." Concluding on that point, the Court said: Clearly, then, the amount paid to bring the yield from operation up to the required minimum was as much income*887  from operation as were the railroad's receipts from fares and charges.  In this case, as in the one quoted, the entire receipts were from the operation of the petitioner's property and equally are income.  Decision will be entered for the respondent.Footnotes1. See Message from the President of March 4, 1935, Transmitting Views and Two Reports on Subject of Adequate Merchant Marine, p. 2; see also General Report of Postmaster General to the President, January 11, 1935, pp. 7-9. ↩