Court Opinion

ID: 8593289
Source: CourtListenerOpinion
Date Created: 2022-11-23 15:56:11.379017+00
Date Added: 2024-06-11T16:54:42.059338
License: Public Domain

Laramoke, Judge,
dissenting:
The Commissioner of Internal Revenue has had his “pound of flesh.” What he seeks now by denying this refund is “unreasonably and excessively” punitive in nature.
The maj ority rests its holding on the grounds that taxpayer (in receiving) and Sterno, Inc. (in making) intended to treat the payments as compensation, albeit as later determined “excessive and unreasonable” and, in so doing, taxpayer is precluded from casting this transaction in another form. However, intent is not the touchstone in determining whether a corporate payment is a dividend or compensation for services actually rendered. The Supreme Court has indicated that the determinative factor is whether the corporate payment had the purpose of or was in effect a distribution of earnings and profits. Palmer v. Commissioner, 302 U.S. 63, 70 (1937). The fact that the payment was nominally made as compensation and the parties intended it to be so, does not prevent us from determining that it, in effect, constituted a distribution of earnings and profits. The majority seems to infer that we are precluded from reaching such a result because the Tax Court in Sterno, Inc., 18 T.C.M. 1149, determined the payments to be “unreasonable and excessive” compensation. The Tax Court did not have to and, in fact, did not determine the character of the excessive portion of the payments in the hands of the recipient. Having only Sterno, Inc. before it, there was no reason to characterize the excessive payment as a dividend; the fact of unreasonableness alone was sufficient to sustain the Commissioner’s *515determination. I believe that it is np to this court to decide whether such excessive payments were, in effect, a distribution of earnings and profits to the parent of Sterno, Inc.1 and a contribution of capital to the taxpayer herein. Such a determination depends upon the circumstances of each case. See Mertens, Law of Federal Income Taxation, 8 25.84 (1960 Ed.).
The majority as principal authority for its holding relies on Smith v. Manning, 189 F. 2d 345 (3d Cir. 1951) where compensation disallowed as a deduction to an individual payor was found not to be a gift to the payee. The determination of whether the excess amount received constituted a gift, turned on the factual issue of whether there was the requisite “donative intent.” The Eighth Circuit found that there was none. However, in determining whether a corporate payment is compensation or a dividend, the controlling factor is whether such a payment had the effect of a distribution of earnings and profits and not what the parties originally intended. Palmer v. Commissioner, supra; Waldheim v. Commissioner, 244 F. 2d 1, 5 (7th Cir. 1957); Robert Lee Merritt, 39 T.C. 257, 271 (1962); Fairmount Park Raceway, Inc., 21 T.C.M. 52 (1962), offid on other grounds, 327 F. 2d 780 (7th Cir. 1964). In the “compensation or gift” situations, the donative intent of the. payor is decisive, while in the “compensation or dividend” cases the effect of the payment is controlling. In holding the above cited cases inapplicable, the majority reasons that a taxpayer can take advantage of the re-characterization of the payments only when it is made by the government or a court. Such a distinction has no substance since a re-evaluation of the nature of the payments, either by the government or a court, is not necessary in determining whether the payments made as compensation are excessive. It is only when you have the recipient that such a determination becomes necessary.
We are not concerned here with a deduction for compensation disallowed as being excessive, where the recipient is merely an employee and does not have any proprietary in*516terest in the corporation. In such situations the characterization of the payment can never have the effect of a dividend, and it appears that the payments remain as compensation hi the hands of the recipient. In those situations, the donative intent would never be present, since the corporation originally intended them to be compensation for services. Here we are concerned with payments made to related entities. Although originally intended as compensation, the amounts paid were determined to be unreasonable. I believe that the excessive payments were, in effect, distributions of earnings and profits. I say this because, as established by the decision of the Tax Court, the commission payments to plaintiff, Sterno Sales, by Sterno, Inc., for many years prior to 1951, were such as to result in Sterno Sales operating on a break-even basis. It further appears that such arrangement was not changed until December 18,1951, when a written contract providing for the one and one-half percent additional amount was entered into. Further, although the contract recited that it was “to confirm our oral agreement as of January 1st, 1951,” the Tax Court found that there had, in fact, been no prior oral agreement and that the additional amount was fixed solely for the purpose of permitting Sterno Sales Corporation to make a profit (see footnote 1 of the Tax Court’s opinion in Sterno, Inc., supra). Still further, the court stated that it was unable to say that the services rendered “by or in the names of Sales Corporation” were worth anything more than the services of the salesmen themselves or were reasonably worth more than the salaries, commissions and expenses.
All of this points to a Tax Court determination that the only purpose of the amount of disallowed compensation here involved was a shifting (distribution) of the earnings and profits of Sterno, Inc. So viewed, the effect of the transaction was the payment of a dividend. Accordingly, the amount involved should be treated as the distribution of a dividend by Sterno, Inc. to the common parent, Sterno Corporation, and a contribution by the latter to the capital of plaintiff, Sterno Sales.
For the foregoing reasons I respectfully dissent.
ColliNS, Judge, joins in the foregoing dissenting opinion.

 The Commissioner will not be prevented from obtaining his added “pound of flesh” since he can invoke the mitigation sections (1311 et seq.) and tax the common parent on the dividends in effect paid to it by Sterno, Inc.