Court Opinion

ID: 4486043
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:34:08.895558+00
Date Added: 2024-06-11T15:03:47.525200
License: Public Domain

RUWE, J., dissenting: For the following reasons, I do not agree with the majority’s holding that petitioner, a former DISC, was the proper taxpayer with respect to income attributed to it for the year 1977. The majority opinion is based on a concern that were we to find petitioner totally lacking in substance, this “would, in effect, be calling a DISC a sham corporation” and thus undermine the purpose of the DISC legislation. Majority opinion at p. 1221. We need not be concerned with undermining the purpose of the DISC legislation in this case for the simple reason that petitioner was not a DISC during 1977. The majority opinion implies that even though petitioner was disqualified, it was still a DISC for some purposes. Sec. 992(a)(1) defines a DISC. Petitioner failed to meet the qualifications for DISC status which are contained in section 992(a)(1)(B) and section 993(b) and the regulations thereunder. This is undisputed. Section 992(a)(3) defines a “former DISC” as “with respect to any taxable year, a corporation which is not a DISC for such year but was a DISC in a preceding taxable year.” (Emphasis added.) Section 1.992-1(e), Income Tax Regs., states that “A corporation is a DISC for a taxable year only if such an election is in effect for that year and the corporation also satisfies the requirements of paragraphs (a) through (d) of this section.” (Emphasis added.) The majority opinion has already found that petitioner failed the test contained in section 1.992-l(c), Income Tax Regs., which is the same requirement set forth in section 992(a)(1)(B). It is true that once having made an election to be treated as a DISC, a corporation that fails to qualify as a DISC for a particular year will be considered as a DISC for subsequent years in which it meets DISC qualifications. There is no need to make another election. See sec. 1.992-2(d), Income Tax Regs. However, the benefits of tax deferral available through the DISC arrangement are simply unavailable for export transactions occurring during a year when the former DISC is disqualified. Arrangements related to foreign sales transactions during a year when a former DISC is not qualified should be judged using the same criteria that we would use in judging the substance of any other corporate transactions.1  The DISC legislative history quoted on page 1222 of the majority opinion is consistent with the above analysis. It is unquestioned that a corporate entity that is a DISC or former DISC can have “ ‘normal’ earnings and profits * * * which are the same as the earnings and profits of an ordinary corporation which never was a DISC.” S. Rept. 92-437, at 123 (1972), 1972-1 C.B. 559, 628. There is nothing, however, in this legislative history indicating that when a former DISC ostensibly earns “normal” profits, that the bona fides of its corporate activities should be judged on standards other than those applied to other corporations which are not Disc’s. The legislative history describes as “normal” those earnings and profits generated before the corporation became a DISC and those generated during a period when it was disqualified as a DISC. S. Rept. 92-437, supra, 1972-1 C.B. at 628. It seems beyond question that corporate activities preceding initial DISC election and qualification would be judged on the basis of business purpose and economic substance without any regard to the DISC provisions. Since the legislative history equates pre-DISC earnings with earnings during a disqualification period, why would we use DISC concepts in judging the latter and not the former? The DISC provisions simply don’t apply in making that judgment. Having eliminated the problem of potentially undermining the DISC statutory framework, this transaction should be judged on the basis of the facts presented. Petitioner contends that, in reality, it had no income because it did nothing to earn the income. Indeed, it could not have done anything based upon the findings of fact since it had no employees, performed no services, dealt with no customers, and did not even receive the payment of the amounts of income, which respondent argues it earned, until the following year.2  Normally, the choice of doing business in corporate form will be respected. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator’s personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. * * * [Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-439 (1943). Emphasis added.] However, tax avoidance, standing alone, is not sufficient to meet the business purpose test in Moline Properties and the fact finding in this case indicates clearly that there was no other business purpose and no business activity. See National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949); Noonan v. Commissioner, 52 T.C. 907 (1969), affd. 451 F.2d 992 (9th Cir. 1971); Aldon Homes, Inc. v. Commissioner, 33 T.C. 582 (1959). The only thing that petitioner did that might be construed as corporate activity was to maintain a bank account and separate records, and act as a conduit regarding funds of APC.3 These are minimum DISC requirements. See sec. 1.992-1(a)(1) through (8). Even respondent’s own regulations explicitly recognize that DISC qualification (which requires incorporation, books and records, a bank account, and payments) entitles a corporation to be recognized for tax purposes “even though such corporation would not be treated (if it were not a DISC) as a corporate entity for Federal income tax purposes.” Sec. 1.992-l(a), Income Tax Regs. One can hardly imagine a corporate entity more devoid of substance than petitioner during the year 1977. Having failed to qualify as a DISC, the only purpose for petitioner’s existence, i.e., tax deferral, became impossible. Petitioner had no other business purpose and no business activity during the year 1977. To the extent that it received funds, it served as a conduit of the income earned by APC. As a mere conduit, petitioner was essentially acting as an agent for APC. Under the principles set forth in Commissioner v. Bollinger, 485 U.S. _ (1988), APC, rather than petitioner, is the proper taxpayer with respect to the income earned during the taxable year 1977. 4  This is not a case where we need be concerned with the equities of allowing a taxpayer to unfairly avoid taxation under a form which it chose. It is clear that APC formed petitioner solely to take advantage of the DISC provisions, but for which there would have been no tax advantages under the facts of this case. When respondent determined that petitioner was not qualified as a DISC, the statute of limitations was still open with respect to APC and respondent had the knowledge and ability to totally disregard this purely tax-motivated transaction.5 Instead, respondent chose form over substance. This should not be allowed in a situation where a taxpayer fails to meet highly technical provisions of a statutory scheme that was intended to encourage and benefit taxpayers who engaged in exporting activities.6  Chabot, Whitaker, Kórner, Hamblen, Clapp, and Gerber, JJ., agree with this dissent.   Sec. 1.992-2(d) also indicates that a “former DISC” is subject to the DISC provisions of the Code. This is necessary only because prior accumulations of earnings and profits earned while qualified as a DISC must be accounted for. S. Rept. 92-437, at 93 (1972), 1972-1 C.B. 559, 611. It does not and cannot be meant to attribute all DISC corporate attributes to a former DISC. To do so would render the qualification requirements meaningless.    Even the amount which petitioner received in March 1978, ostensibly due to commissions earned in 1977, was immediately paid back to APC in the form of an advance payment on a producer’s loan and a distribution of previously taxed income on the assumption that petitioner qualified as a DISC. Since these characterizations of amounts petitioner paid back to APC depend on petitioner’s DISC qualification, they must be disregarded. It is then clear that petitioner was merely a conduit.    The majority suggests that because petitioner maintained a bank account, kept books and records, and held annual meetings, it must be recognized as a corporation for Federal income tax purposes under Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943). I disagree. This Court has held that, although an entity has engaged in similar activities, it would not be recognized as a corporation for tax purposes where it lacked a substantial business purpose for organization and had not engaged in any substantive business activities. See Aldon Homes, Inc. v. Commissioner, 33 T.C. 582 (1959). See also Visnapuu v. Commissioner, T.C. Memo. 1987-354; Horn v. Commissioner, T.C. Memo. 1982-741.    If we were to recognize petitioner as the bona fide recipient of sales commissions which are really a portion of APC’s profits, we would also be violating the principle that income must be taxed to the person or entity that earned it. Lucas v. Earl, 281 U.S. 111 (1930).    The majority does not, and could not, apply principles of equitable estoppel given the facts in this case. See Century Data Systems, Inc. v. Commissioner, 86 T.C. 157 (1986).    In similar cases respondent has disallowed the parent’s commission expense or reallocated the former DISC’S “income” back to the parent under sec. 482. It is possible that respondent will now feel free to choose whichever alternative produces the most tax.