
    ROY B. SEWELL v. THE UNITED STATES
    [No. 47322.
    Decided October 6, 1947.
    Plaintiff's motion for new trial overruled March 1, 1948]
    
      
      Mr. W. A. Sutherland for the plaintiff. Mr. Randolph W. Thrower and Sutherland, Tuttle <& Brenna/n were on the brief.
    
      Mr. J. TV. Hussey, with whom was Mr. Acting Assistant Attorney General Sewall Key, for the defendant. Messrs. Robert N. Anderson and Andrew D. Sharpe were on the brief.
   Jones, Chief Justice,

delivered the opinion of the court:

After the plaintiff filed his income tax returns for the years 1938, 1939, 1940, and 1941 and paid the taxes shown thereon, the Commissioner of Internal Revenue levied an additional assessment by including therein the dividends paid on 558 shares of the stock of the Sewell Manufacturing Company and by including the dividends on an additional 102 shares for 1939,1940, and 1941. Plaintiff paid this additional assessment and seeks a refund on the ground that this particular stock had been given to his wife, Mary W. Sewell, in 1935,1936, and 1938.

In 1909 plaintiff and two brothers organized a partnership to engage in business as manufacturers of clothing. The business was incorporated in 1931 under the laws of the state of Georgia, as the Sewell Manufacturing Company, and plaintiff was elected a member of the board of directors. The three brothers and members of their families, with A. R. Lovvorn, a relative of plaintiff’s wife, have been the principal stockholders since the time of its incorporation.

Early in 1934 the three brothers discussed among themselves the idea of giving some of their stock to their wives. The other two brothers caused the transfers of a portion of their stock to be made to their wives at the time of the discussion. Plaintiff did not make the transfer at that time, but in December 1934 he endorsed in blank the certificates covering 500 shares of his stock and on June 1, 1935, after dividends had been declared between January 1, 1935 and June 1, 1935, and credited to his account, plaintiff directed the transfer on the records of the company of 500 shares of his stock to Ms wife as of January 1, 1935 and at the time directed a correction of the crediting of the dividends for that year so that they would be placed to her credit. The 500 shares in his name were cancelled and a similar number made out in the name of Mary W. Sewell. The certificate, however, remained in the stock certificate book until 1946, but in July or August 1935 plaintiff’s wife endorsed the certificate in blank. In the year 1936, 58 additional shares of stock were paid for out of the proceeds of the dividends previously declared on the 500 shares of stock and it is agreed that these 58 shares shall be treated the same as the original issue to Mrs. Sewell. Plaintiff caused an additional 102 shares to be transferred on the records to his wife before the end of the year 1938 and a certificate for these shares was issued in her name, dated December 28,1938 and in like manner remained in the stock certificate book until August 1946.

The internal affairs of the Sewell Manufacturing Company were handled informally and the wives never received notice of stockholders’ meetings, nor did they attend such meetings, nor did they issue proxies for their stock. Dividends were not paid by check but the amounts were credited to the various stockholders of record on the books of the company. Transfers by way of loans were made from time to time from the account of one stockholder to another, even in the absence of the particular stockholder from whose account the funds were being transferred. This was done under the direction of the secretary, and the practice was known to all the stockholders. Usually in such cases notes were prepared to be signed by the stockholder to whom the stock was transferred, but the practice was not always followed.

Plaintiff’s wife agreed that he might use any amount standing to her credit on the books of the corporation at any timé he needed it. Amounts standing to her account were occasionally transferred to his account and at times the entire amount of her account was so transferred.

Notes as evidence of the indebtedness were sometimes though not always executed by plaintiff. On April 1, 1935 plaintiff filed a credit statement with the First National Bank of Atlanta, Georgia, including among his assets the 500 shares heretofore referred to. He made similar statements in 1936 and 1937, in which the 500 shares were not included in his assets. The 1937 statement contained the following comment: “558 shares of Sewell Manufacturing Company-common stock owned by my wife and controlled by me are not included.”

Plaintiff’s wife, Mary W. Sewell, reported as her own income the amounts credited to her own account as dividends during the years 1935 to 1941, inclusive. The Commissioner of Internal Revenue excluded these amounts from the wife’s income and her taxes were adjusted accordingly. Plaintiff’s counsel has stipulated that proper adjustment of the wife’s liability for taxes on the income involved will .be made if it be held that the dividends are not taxable as plaintiff’s income.

In 1939 Mrs. Sewell’s account with the Sewell Manufacturing Company was charged amounts totaling $7,135" which was paid in connection with a home being built on a lot belonging to her. In 1940 and 1941 there were transfers of $9,850 and $7,850, respectively, to Mrs. Sewell’s bank from her account with the Sewell Manufacturing Company, which she used for household and personal expenses, contributions, house and grounds, insurance policies, care of mother, and property taxes.

Prior to 1939 expenditures of the character listed were generally paid by Roy B. Sewell, the plaintiff. Most of the insurance policies referred to were on plaintiff’s life, with about one out of four or five being on the life of Mrs. Sewell.

For the years 1935,1936 and 1937 plaintiff had filed returns and paid income taxes and had not included in his returns the dividends on the 500 shares of stock. The Commissioner of Internal Revenue included the dividends in plaintiff’s income and made a deficiency assessment. The resulting deficiencies were appealed by plaintiff to the Tax Court. These appeals were consolidated with similar appeals by the brothers when they reached the Tax Court for trial. On February 7, 1944, the Tax Court decided this appeal adversely, including in its findings of ultimate facts the following:

None of the stock transfers in question were intended by the Sewell brothers to vest dominion and control over the shares of stock transferred in their respective wives. It was their intention to retain, and they did retain, that control and dominion in themselves. Each of the wives knew such intention existed, and each impliedly agreed that her husband retain control over the stock in her name. Completed gifts of the stock certificates so transferred were not made.

On January 9, 1945 plaintiff filed his petition with the Circuit Court of Appeals for the Fifth Circuit, seeking a review of the Tax Court’s decision. On account of subsequent orders, however, the record did not reach the Circuit Court of Appeals until June 1, 1945.

On June 9, 1945, plaintiff executed a trust instrument by the terms of which he conveyed to the First National Bank of Atlanta, Georgia, for the benefit of plaintiff’s mother and others, all his right, title and interest, if any, in 25 shares of the 500 shares for which certificate was made out to plaintiff’s wife in 1935, and 25 shares covered by the certificate which was made out to plaintiff’s wife in 1938. The deed of trust recited as plaintiff’s view that he did not own the stock covered by the trust, as it had been his intention to make the gift of the stock to his wife in 1935 and 1938 but that the Bureau of Internal Revenue for income tax purposes had taken the position that title to the stock remained in him. On June 13, 1945 the First National Bank of Atlanta accepted the appointment as trustee, after having been advised by its counsel of the decision of the Tax Court as to ownership, and the fact that neither plaintiff’s wife nor the corporation would relinquish the stock without a contest. The chief purpose of plaintiff in conveying the stock in trust was to obtain an adjudication in the state court of the ownership of the stock.

On June 23, 1945, the First National Bank of Atlanta as trustee filed suit in the state court against the Sewell Manufacturing Company and plaintiff’s wife, Mrs. Mary W. Sew-ell, asserting that the company wrongfully declined on demand to issue any stock certificates to the bank covering these two lots of 25 shares each. The defendants asserted that the shares involved were the sole property of Mrs. Mary W. Sewell by reason of valid and completed gifts theretofore made by the plaintiff.

On June 26,1945, plaintiff’s wife brought suit in the circuit court of the same county in Georgia against the Sewell Manufacturing Company and plaintiff under the Declaratory Judgment Act of Georgia which had been enacted February 12,1945, to determine the ownership of the remaining shares standing in her name which had not been covered by the deed of trust.

The first of these suits, by the trustee against the Sewell Manufacturing Company and plaintiff’s wife, was tried before a jury on July 18 and concluded on July 19, 1945, all parties being represented by counsel. Substantially the same evidence was introduced on behalf of the plaintiff and the defendant that had been introduced in the trial of the case before the Tax Court. The presentation of the evidence in the state court by the bank’s counsel was not less able or less vigorous than the presentation by the Commissioner of Internal Revenue in the Tax Court. In charging the jury the presiding judge instructed it to determine whether or not the gifts relied upon by the defendant were valid and that if it determined that such gifts were valid it should return a verdict for the defendant, but that if it determined that Roy B. Sewell did not make valid gifts of his stock in 1935 and 1938 a verdict should be rendered for the plaintiff. The jury was instructed that the issues were separate and that it could find one gift valid and the other invalid. The verdict of the jury was returned on July 19, 1945 in favor of the' Sewell Manufacturing Company and Mrs. Mary W. Sewell, defendants, on both issues, and judgment was entered accordingly. No appeal was taken.

The second action, being by plaintiff’s wife against the Sewell Manufacturing Company and the plaintiff, was submitted on July 19,1945, to the judge who had presided in the suit referred to above. It was submitted on the complete printed record in the appeal pending before the United States Circuit Court of Appeals for the Fifth Circuit from the decision of the Tax Court and included a transcript of all the oral testimony given in the Tax Court cases, as well as the documentary evidence introduced in those cases and the briefs that had been filed by the respective parties in the Tax Court, as well as the oral and documentary evidence that had been introduced in the case which the presiding judge had just conducted.

The court took the case under advisement and on August 2 rendered a declaratory judgment that in the year 1935 a legally valid and completed gift without any restriction, condition or reservation had been made by the plaintiff, Roy B. Sewell, to his wife, Mrs. Mary W. Sewell, of 500 shares of stock of the Sewell Manufacturing Company, and that since 1935 Roy B. Sewell had had no right, title or interest in any part of said stock. A similar order was entered as to the remaining shares involved in the second gift. No appeal was taken from this judgment.

Un August 17, 1945, and before argument on the appeal from the decision of the Tax Court, the plaintiff filed a motion in the United States Circuit Court of Appeals for the Fifth Circuit asking that the case pending in that court be remanded to the Tax Court for the purpose of permitting introduction in the Tax Court of the two judgments above referred to. The motion was denied and the judgment of the Tax Court was affirmed November 9, 1945, 151 F. (2d) 765. In passing on the motion to remand the Circuit Court of Appeals used the following language:

The question involved here is one of intent, that is, whether or not the petitioners intended to make a completed gift inter vivos of the corporate stock to their respective wives, or whether the stock was placed in their wives’ names only for tax purposes with the alleged donors retaining the same dominion and control as if there had been no transfer. There are ample facts in the record to justify the factual finding by the Tax Court that the donors merely intended to accomplish the latter purpose.
A decision of the state court is binding between the parties in the settlement of their legal rights inter sese, but the income tax consequences of such transactions are for the Tax Court. Estoppel, laches, acceptance of benefits, rights of third parties, are incidents that might affect the decisions of the state courts in a contest between the parties, which would have no bearing in a controversy between the parties and the United States over income taxes imposed by virtue of a Federal Statute.

While there are some difficulties due to the state court’s decision, we cannot escape the conclusion that for the years in which these taxes were levied the Commissioner had every reason for assessing the additional taxes against the plaintiff. Section 22 of the Bevenue Act of 1938, c. 289, 52 Stat. 447, is very broad in its general definition of what constitutes income.

At the time the Commissioner of Internal Bevenue made the additional levies, the stock in question had remained in the corporation’s stock records book in the vault in the corporation’s office. At no time after the first stock was placed in Mrs. Sewell’s name did she receive any notice of or attend any stockholders’ meeting, nor send in any proxies or take any part whatever in the business of the corporation. The husband continued to manage all affairs as previously, and he manifestly had control of the dividends and the right to use them any time he saw fit. Prior to 1939 from time to time the full balances shown in Mrs. Sewell’s account on the corporation’s books were set over to plaintiff for his use. Beginning-in 1939 these amounts were not thus transferred, but the sums were used for the paying of expenses that had theretofore usually been paid by the plaintiff. It is difficult to escape the conclusion that he had full charge and control of the stock and might have disposed of it during that period in any way he saw fit.

It was a close family corporation. The issuance of stock and the endorsement of it and permitting it to remain on the books of the corporation gave him a free hand in handling it. It is necessary to look behind the mechanics of these transactions to determine the real ownership. The decisions of the state court in 1945 undertook by decree to make fixed over a ten-year previous period a status that had been fluid during the entire time. During the years in controversy the apparent ownership of these shares could be moved around like the sun and moon in a theater and made to shine from any angle to suit the whims of the stage director or the pleasure of the audience.

This seems to have been the status of affairs during the tax years involved and up to the time of the decision by the state court. After the decision by the state court, the shares of stock were taken from the stock certificate book and physically delivered to Mrs. Sewell in the summer of 1945. When this decision was rendered and the stock certificates were actually delivered it could be argued much more persuasively that she then had control and plaintiff no longer had control of the shares of stock, but in all the circumstances of this case we are unwilling to give the decision of the state court a retroactive application to the extent of determining the validity of Federal income taxes collected during the years involved. Up to that time the Commissioner of Internal Eevenue had every right to treat the dividends as within the control and dominion of the plaintiff. This conclusion is further bul-warked by the fact that exactly the same question was presented before the Tax Court, with the exception of the judgment of the state court, which had not then been rendered, and was presented to the Circuit Court of Appeals, which decided that the judgment of the state court was not binding for the years 1935, 1936 and 1937. On further appeal the Supreme Court denied an application for certiorari. In the light of this decision it would make a manifest conflict to hold that in an exactly similar situation the dividends for 1938,1939,1940 and 1941 should not be included in the income of plaintiff as they had been included in his income for 1935, 1936 and 1937.

The plaintiff cites a number of cases, including Blair v. Commissioner, 300 U. S. 5; Freuler v. Helvering, 291 U. S. 35; Sharp v. Commissioner, 303 U. S. 624; Masterson v. Commissioner, 141 F. (2d) 391.

The Blair case, supra, is somewhat similar and tends to support the position taken by the plaintiff in the case at bar. However, that case turned largely upon whether a testamentary trust was a spendthrift trust that barred the voluntary alienation of the interest of the beneficiary under the laws of the state in which the donor resided. The decision by an Illinois court upholding the right of the life beneficiary ■ of the trust to assign parts of his interest was held conclusive as to the validity of the assignment. In the opinion the court, at page 12, stated:

There is here no question of evasion or of giving effect to statutory provisions designed to forestall evasion; or of the taxpayer’s retention of control. [Italics supplied.]

In the Freuler case a fiduciary of a trust estate omitted to make proper deductions for depreciation and thus overstated the net income of the estate and overpaid the beneficiary. The excess thus received by the latter was held no part of the income and should not have been included in his return. A state court decision construing the statute respecting distribution of trust estates in California was held binding. Apparently this state decision was in effect at the time of the assessment.

The Sharp case was also an estate case and merely followed the decisions in the Blair and Freuler cases.

The Masterson case presented a somewhat similar though not identical question. At any rate, it was decided by the same Circuit Court of Appeals which later decided the case of the plaintiff for the 1935, 1936 and 1937 taxes.

Most of the cases cited by the plaintiff involve either the legal rights of beneficiaries of trusts where state courts had previously determined those rights under the trust instrument, or an estate tax controversy in which a state court had previously determined ownership of the property involved.

In some circumstances a state decision’determining ownership and control would have the effect also of determining whether income taxes on a particular transaction should be collected from one person or from another.

There are other factual situations in which the decision of a state court settling the question of ownership and control as between the parties themselves might still not settle the-basis of Federal income taxes.

In Commissioner v. Tower, 327 U. S. 280, there was a gift of stock by Tower to his wife and a subsequent dissolution of the corporation. A partnership was created in which the wife became a limited partner, contributing the value of the-donated stock. The question was the taxability to the husband of that portion of the income which derived from the: wife’s contribution to the partnership assets. It was contended on behalf of the husband that the arrangement constituted a partnership under state law and hence it should be held that there was a valid partnership for tax purposes. In sustaining the Commissioner’s action in taxing the husband on the income, the Supreme Court said:

But the Tax Court in making a final authoritative finding on the question whether this was a real partnership is not governed by how Michigan law might treat the same circumstances for purposes of state law. Thus, Michigan could and might decide that the stock-transfer here was sufficient under state law to pass title to the wife, so that in the event of her death it would pass to whatever members of her family would be entitled to receive it under Michigan’s law of descent and distribution. But Michigan cannot, by its decisions and laws governing questions over which it has final say, also decide issues of federal tax law and thus hamper the effective enforcement of a valid federal tax levied against earned income.

It is true that in that case there was a holding by the Tax Court that the arrangement was for the express purpose of reducing taxes. However, on this point the Supreme Court said that such a showing “simply lends further support to the inference that the husband still controls the income from his partnership interest, that no partnership really exists and that the earnings were really his, and are therefore taxable to him and not to the wife. * * * To rule otherwise would mean ordering the Tax Court to shut its eyes to the realities of tax avoidance schemes.”

The cases cited by both plaintiff and defendant frequently turn on the facts and circumstances that were presented in the particular case.

The case of Doll v. Commissioner, 149 F. (2d) 239, certiorari denied, 326 U. S. 735, involved a situation where the plaintiff had given his wife a half interest in his business and thereafter drew up written articles of partnership with her. Later, on petition by the wife, the Circuit Court of St. Louis County, Missouri, entered a declaratory judgment construing her rights under the partnership agreement and her interests in the partnership assets and business, holding the agreement valid. In rej ecting the controlling effect of the state decision the United States Circuit Court of Appeals used the following language in respect to federal income tax laws:

Congress may choose its own criteria and make or not make State law control the application of its acts.

The court upheld the Commissioner’s assessment of the entire partnership income against the husband.

In Burnet v. Wells, 289 U. S. 670, 678, the court said:

Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis.

In Commissioner v. Court Holding Co., 324 U. S. 331, 334, the court used the following language:

To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.

To the same effect is the recent case of Guinness v. The United States, decided by this court on July 7, 1947. [Ante, p. 84.]

We think that a state court decision that title is in the wife is not necessarily determinative of the federal tax question involved in taxing the income. It is rather well settled by many decisions that under section 22 (a), 26 U. S. C., a person may be taxed on profits earned from property which he neither owns nor controls and under some circumstances on income which he neither owns nor controls. Lucas v. Earl, 281 U. S. 111; United States v. Joliet & Chicago R. R. Co. 315 U. S. 44.

There is a class of cases involving transactions between or among members of one family in which the transactions are viewed for income tax purposes not in light of the technical considerations of legal ownership, but rather with a special scrutiny of the arrangements and devices which, though valid under state law, might be utilized to the detriment of the revenue. Helvering v. Clifford, 309 U. S. 331; Helvering v. Horst, 311 U. S. 112; Harrison v. Schaffner, 312 U. S. 579, and Commissioner v. Tower, supra.

The circumstances surrounding the transactions in the instant case are such as to lead us to conclude, as they did the Commissioner, that for federal tax purposes the dividends should be treated as income of the husband. The fact that the donee was the wife of the donor, that the wife in no way contributed to the business success, that the stock was readily available for credit purposes, that the dividends were available for the use of the husband, and the wife used part of the dividends to pay expenses of the family previously paid by the husband, and that about the only act of consequence which was consistent with title in the wife was the inclusion of the amount of the dividends in the wife’s income tax return, bring this case within the class of “family group” cases of which Commissioner v. Tower, supra, is typical. In the Tower case the stock given to the wife was converted into an interest in a partnership which produced the income subjected to the tax. In this case the stock given to the wife produced the income.

In this free atmosphere of exchange and transfers it is difficult for this court to determine the motives that actuated those who were involved in the various transactions, but it seems to us that it would have been just as difficult for the state court to isolate and identify such motives. However effective the decision of the state court may have been, after that decision was rendered, in determining the title to and control of the property as between the parties involved in that litigation, we do not feel that it should govern for Federal income tax purposes the peculiar set of circumstances that prevailed during the intervening years prior to that decision when these taxes were involved. The law is concerned with the substance of things rather than mere forms. The tagging and naming of a thing does not alter its character.

We find that plaintiff, in the peculiar circumstances of this case, should not recover the additional taxes that were collected for the years 1938,1939,1940, and 1941, and the petition will be dismissed.

It is so ordered.

Madden, Judge; Whitakek, Judge; and Littleton, Judge, concur.  