
    THE TOWN OF FAIRHAVEN, MASS., THE MILLICENT LIBRARY AND THE FAIRHAVEN WATER COMPANY v. THE UNITED STATES
    [No. 8-54.
    Decided July 12, 1956]
    
      
      Mr. Allen G. Gartner for the plaintiffs.
    
      Mr. Gilbert E. Andrews, with whom was Mr. Assistant Attorney General Charles K. Bice, for the defendant. Mr. Andrew^ D. Sharpe was on the brief.
   Littleton, Judge,

delivered the opinion of the court:

The plaintiffs brought this suit to recover Federal income taxes paid by the Fairhaven Water Company for the years 1945, 1946, 1947, 1948, and 1950, under the provisions of section 116 (d) of the Internal Revenue Code of 1939, as amended. 26 U. S. C. § 116 (d).

The facts as found by the commissioner of this court are not in dispute. The Town of Fairhaven, Massachusetts (hereinafter referred to as the Town), is a municipal corporation established by an act of the Massachusetts Legislature on February 22,1812. The government of the Town consists of a limited form of the New England Town Meeting. The Millicent Library (hereinafter referred to as the Library), was incorporated on December 1,1892, under a law of Massachusetts pertaining to the incorporation of religious and other nonprofit organizations. The charter of the Library stated that the purpose for which it was organized was the “establishment and maintenance of a Library.” Since it opened, the Library has been operated as a free, public library. The Fairhaven Water Company (hereinafter referred to as the Water Company), was organized in 1888 under the laws of Massachusetts pertaining to corporations organized for pecuniary profit. The purpose for which it was formed was to supply the inhabitants of the Town with water for domestic, manufacturing and other purposes, including the extinguishing of fires.

Henry H. Rogers, a native of the Town and a multimillionaire, was the principal benefactor of the Town. His gifts to the Town and its inhabitants included the Millicent Library, the Fairhaven High School, the Town Hall, the Rogers Grammar School, the Unitarian Memorial Church, and Cushman Park. Henry H. Rogers and his wife conveyed in trust a plot of land and the building situated thereon to their surviving children who, by deed of gift dated December 1, 1892, conveyed the property to the inhabitants of the Town. The deed read in pertinent part as follows:

* * * *whereas it is the purpose and intent of these grantors in making this conveyance to give to the Inhabitants of the Town of Fairhaven a Free Public Library as a memorial of our sister Millicent G. Rogers ; and whereas a building appropriate to the uses of such a Library has now been erected on said land, and our wish is that said building shall forever remain as at. present built without enlargement or alteration; and whereas it is also our purpose and design that the Inhabitants of Fairhaven, as a municipal corporation, shall be under no obligation whatever to support or maintain said library; * * *.

On May 22, 1893, Henry H. Rogers established a trust fund of $100,000 with the State of Massachusetts for the support of the Library. The State authorized the treasurer of the Commonwealth to receive and invest the $100,000 and to pay the annual income therefrom to the Library. During the years in suit, the Library annually received the sum of $2,500 from the trust.

In 1901, all the capital stock of the Water Company was given to the Library by Mr. Rogers. It was a matter of common knowledge in the Town that Mr. Rogers made the gift of the stock to the Library for its support.

The care, management, and control of the Library is vested in a board of 15 trustees, 12 of whom are required to be inhabitants of the Town. All the trustees serve without compensation for life, and vacancies on the board are filled by a vote of two-thirds of the remaining members. Prior to February 11,1949, no officer of the Town was, by virture of his office, an officer or trustee in the Library. In conducting its activities, the Library has endeavored to provide the entire community the best library services that were possible with, the available resources. In addition to the central library, it has maintained six branch libraries and provided collections of books for supplementary reading in the schools. Since 1929, the Library has carried on a special program consisting of story hours and moving pictures for children. In 1950, the book stock of the Library consisted of 46,611 volumes and the circulation of its book per capita was 4.95. The Library from 1892, until the latter part of 1948, was supported by the income from the trust fund established by Henry H. Eogers, by a small amount of miscellaneous gifts and donations and by dividends which the Library received as sole owner of the stock of the Water Company. These dividends provided the major portion of the funds used for the operation of the Library.

Since its incorporation in 1888, the business of the Water Company has been conducted by a board of directors, including three officers, who are elected annually by the stockholders. The Water Company is regulated by the Massachusetts Department of Public Utilities, and may not increase its rates except on application to and approval by the Department of Public Utilities. A substantial portion of the profits of the Water Company were distributed to the Library for its support.

In 1948, it became apparent that either the services of the Library would have to be curtailed or the Town would have to furnish financial aid. The question was presented to the Town Meeting on December 8,1948, and it was unanimously voted to appropriate $4,000 to assist in paying the expenses of the Library for the year ending December 31, 1948. Similar appeals were made in subsequent years, and the Town made further appropriations for the Library in the amounts of $11,182 for 1949, and $11,716 for 1950. These annual appropriations were considered and acted upon in the same manner as appropriations for any department of the Town. An officer of the Town was made an ex officio member of the Board of Trustees of the Library in 1948 and continued as such thereafter as long as the Town appropriated money for the support of the Library.

The Town has never had any voice in the affairs of the Water Company. The Water Company charges the Town for all water used by it and the Water Company pays real estate, personal property and franchise taxes to the Town. The Water Company also pays taxes to the State and to the Town of Mattapoisett, Massachusetts.

The annual net income of the Water Company, as reported in its income and excess profits tax returns for the years involved here, the amount of Federal taxes paid, and the dates paid are shown in finding 19. The dividends paid by the Water Company to the Library during each of the years in suit were not deducted from the gross income of the Water Company before computing the amount of income tax due.

The Town filed with the Commissioner of Internal Revenue claims for refunds of the income taxes paid by the Water Company for 1945 on October 31, 1951, and for 1946, 1947, 1948, and 1950 on November 28,1951. Suit in this court was filed on January 8, 1954. The claims for refunds were formally rejected on January 9,1954.

Section 116 (d) provides:

In addition to the items specified in section 22 (b), the following items shall not be included in gross income and shall be exempt from taxation under this chapter: * * *
(d) Income of States, municipalities, etc.—
Income derived from any public utility or the exercise of any essential governmental function and accruing to any State, Territory, or the District of Columbia, or any political subdivision of a State or Territory, or income accruing to the government of any possession of the United States, or any political subdivision thereof.
Whenever any State, Territory, or the District of Columbia, or any political subdivision of a State or Territory, prior to September 8,1916, entered in good faith into a contract with any person, the object and purpose of which is to acquire, construct, operate, or maintain a public utility—
(1) If by the terms of such contract the tax imposed by this chapter is to be paid out of the proceeds from the operation of such public utility, prior to any division of such proceeds between the person and the State, Territory, political subdivision, or the District of Columbia, and if, but for the imposition of the tax imposed by this chapter, a part of such proceeds for the taxable year would accrue directly to or for the use of such State, Territory, political subdivision, or the District of Columbia, then a tax upon the net income from the operation of such public utility shall be levied, assessed, collected, and paid in the manner and at the rates prescribed in this chapter, but there shall be refunded to such State, Territory, political subdivision, or the District of Columbia (under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary) an amount which bears the same relation to the amount of the tax as the amount which (but for the imposition of the tax imposed by this chapter) would have accrued directly to or for the use of such State, Territory, political subdivision, or the District of Columbia, bears to the amount of the net income from the operation of such public utility for such taxable year.

The Town contends that it is entitled to recover all the income taxes paid by the Water Company for the years involved in this proceeding. It contends in the alternative that it is entitled to recover a proportionate part of the taxes determined pursuant to paragraph (1) of section 116 (d). The Town predicates both arguments on the assumption that it, as a political subdivision within the meaning of section 116 (d), was and is the owner, beneficially at least, of the Library, which in turn owns all the stock of the Water Company. However, the Town, as a municipal corporation and political subdivision, is not the legal or equitable owner of the Library. The Library was given in trust to the “Inhabitants of Fairhaven” and not to the Town as a municipal corporation. The deed of conveyance provided “the Inhabitants of Fairhaven, as a municipal corporation, shall be under no obligation whatever to support or maintain said library.” The Library was a separate non-profit corporation, directed and managed by a self-sustaining board of trustees. The Town, as a municipal corporation, had no control over the Library before it started contributing to its support. After it started contributing to the support of the Library it had only one ex officio member on the board of trustees. The inhabitants of the Town have no direct control over the library. The inhabitants of the Town, the Town, the Library and the Water Company are all separate legal entities.

The Town contends that these separate legal entities should be ignored and that wbat it calls substance should prevail over form. The general rule in Federal taxation is, of course, that the corporation must be considered an entity separate and distinct from its stockholders. Moline Properties, Inc. v. Commissioner, 319 U. S. 436, and the cases cited therein. The exception to that general rule is limited to sham transactions and situations involving transactions or matters that lack a business purpose and are a mere formality. See Ingle Coal Corporation v. United States, 131 C. Cls. 121, cert. denied 350 U. S. 842, and the cases cited therein. There is, of course, no sham transaction involved in the instant case. Also, each of the legal entities had obvious legitimate reasons for a separate legal existence and many legal consequences flow therefrom, thus making the separate existence more than a mere formality.

The majority of the courts that have interpreted section 116 (d) have held that the political subdivision must be considered a separate legal entity from the business corporation that it owned and had an interest in, and have refused to exempt the income of the corporation from taxation. Omaha Public Power District, a public corporation and political subdivision of the State of Nebraska, et al. v. O'Malley, Docket No. 15,425, (decided May 3,1956), Eighth Circuit United States Court of Appeals; City of Burlington v. United States, 148 F. 2d 887; Bear Gulch Water Co. v. Commissioner, 116 F. 2d 975, cert. denied 314 U. S. 652; Citizens Water Co. v. Commissioner, 87 F. 2d 874, cert. denied 302 U. S. 694. Contra, Keokuk & Hamilton Bridge, Inc. v. Commissioner, 180 F. 2d 58. It is clear from the above cases that the Inhabitants of the Town, the Town, the Library and the Water Company are separate legal entities, and as such, the first sentence of section 116 (d) has no application because no income of the Water Company accrued to the Town as a political subdivision. The income of the Water Company, to the extent of the dividends, may have “accrued” to the Library; however, it cannot be said that it “accrued” to the Town. The benefit received by the Town was the indirect relief of a general obligation to furnish its inhabitants with an adequate library. The Town, therefore, is not entitled to recover the taxes paid by the Water Company.

Nor is the Town entitled to recover any of the taxes paid by the Water Company on its alternative ground for the same reason. The Town does not own or control the Library and, of course, does not have a contract with the Water Company and therefore does not come within the terms of paragraph (1) of section 116 (d). The right to recover, if any, of the remaining parties in this case has not been considered since it is apparent that they have abandoned their claims. The Town of Fairhaven is not entitled to recover and therefore the plaintiffs’ petition is dismissed.

It is so ordered.

Laeamoee, Judge; Madden, Judge; Whitaker, Judge; and Jones, Chief Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the briefs and argument of counsel, and the report of Commissioner Wilson Cowen, makes the following findings of fact:

1. Plaintiffs brought this suit to recover Federal income' taxes paid by the Fairhaven Water Company for the years 1946, 1946, 1947, 1948 and 1950. Following the filing of plaintiffs’ reply to defendant’s answer, the parties agreed that the only claim presented in this action is the claim of the Town of Fairhaven under Section 116 (d) of the Internal Kevenue Code of 1939.

2. The Town of Fairhaven, Massachusetts (hereinafter referred to as the Town), is a municipal corporation established by an act of the Massachusetts Legislature on February 22,1812. The government of the Town consists of a limited form of the New England Town Meeting. The Town Meeting is composed of five members elected by popular vote from five precincts of the Town and some members at large, who by virtue of their offices, are automatically Town Meeting members. An elected officer, known as a Moderator, presides at all Town Meetings. The executive officers are three Selectmen who supervise the expenditure of money, which has been authorized by vote of the Town Meeting, and who function generally in an executive capacity for the Town.

A finance committee, consisting of three members at large and three from each of the five precincts, holds hearings on budgets for the various departments of the Town and submits recommendations for appropriations to the Town Meeting for its consideration and approval.

3. The Millicent Library (hereinafter referred to as the Library), was incorporated on December 1, 1892, under a law of Massachusetts pertaining to the incorporation of religious and other non-profit organizations. The charter of the Library stated that the purpose for which it was organized was the “establishment and maintenance of a Library.” It was incorporated originally under the name of Millicent Library Corporation, but on June 2, 1896, the name was changed to the Millicent Library. Since it opened, the Library has been operated as a free, public library.

4. The Fairhaven Water Company (hereinafter referred to as the Water Company), was organized in 1888 under the laws of Massachusetts pertaining to corporations organized for pecuniary profit. The purpose for which it was formed was to supply the inhabitants of the Town with water for domestic, manufacturing and other purposes, including the extinguishing of fires. It started business with a capital stock issue of 1,000 shares of a par value of $100 each, and in 1922 its capital stock increased to 1,600 shares having the same par value per share.

5. Henry H. Rogers, a native of the Town who became a multimillionaire through his business association with John D. Rockefeller, Sr., in the Standard Oil Company, was the principal benefactor of the Town. His gifts to the Town included the Millicent Library, the Fairhaven High School, the Town Hall, the Rogers Grammar School, the Unitarian Memorial Church, and Cushman Park.

6. Millicent Rogers, a daughter of Henry H. Rogers, died at the age of 17. Mr. Rogers decided that a free, public library should be established in the Town as a memorial to his daughter. Henry H. Rogers and his wife conveyed in trust a plot of land and the building situated thereon to their surviving children, who, by deed of gift dated December 1, 1892, conveyed the property to the inhabitants of the Town. The deed read in pertinent part as follows:

* * * whereas it is the purpose and intent of these grantors in making this conveyance to give to the Inhabitants of the Town of Fairhaven a Free Public Library as a memorial of our sister Millicent G. Rogers; and whereas a building appropriate to the uses of such a Library has now been erected on said land, and our wish is that said building shall forever remain as at present built without enlargement or alteration; and whereas it is also our purpose and design that the In habitants of Fairhaven, as a municipal corporation, shall be under no obligation whatever to support or maintain said library; Now Therefore this conveyance to said Inhabitants of Fairhaven is made in Trust for the following uses and purposes, viz:
First: Said land and the building thereon shall never be used for any other purpose than for a Free Public Library.
Second: Said Free Public Library shall be named the Millicent Library. Third: The building now standing on said land shall not be changed, altered or enlarged externally, unless the same is substantially destroyed by fire or other casualty, in which case a new building suitable for the purposes of a library may be erected m its place. Fourth: The land above described which is not occupied by the building used for a library shall not be occupied by any other building whatever. Fifth: The Inhabitants of Fairhaven as a municipal corporation shall in no event be under any obligation whatever to maintain said land and building for the purposes of a Free Public Library, or to repair or preserve said building; or to be at any cost or expense in relation thereto. Sixth: In the execution of this Trust the exclusive control, management and care of said land and building shall be exercised by the Millicent Library Corporation, a corporation duly organized under the laws of the Commonwealth of Massachusetts.

7. On May 22, 1893, Henry H. Rogers established a trust fund of $100,000 with the State of Massachusetts for the support of the Library. By act of the State Legislature the treasurer of the Commonwealth was authorized to receive and. invest the $100,000 and to pay the annual income therefrom to the Library. During the taxable years in suit, the Library annually received the sum of $2,500 from the trust.

8. Sometime prior to 1901, Henry H. Rogers had acquired all of the capital stock of the Water Company. About March 2, 1901, the trustees of the Library were informed tbat all of the capital stock of the Water Company had been given to the Library by Mr. Rogers. By appropriate action, the trustees voted to accept the gift of the stock, and since that time, the Library has continued to hold all outstanding shares with the exception of three qualifying shares held by directors of the Water Company. The three shares have been assigned in blank to the Library. It is a matter of common knowledge in the Town that Mr. Rogers made the gift of the capital stock of the Water Company to the Library for its support.

No evidence was presented in respect to any restriction placed upon the disposition of the capital stock by the Library.

9. The care, management, and control of the Library is vested in a board of 15 trustees, 12 of whom are required to be inhabitants of the Town. All of the trustees serve without compensation for life, and vacancies on the board are filled by a vote of two-thirds of the remaining members. Prior to February 11, 1949, no officer of the Town was, by virtue of his office, an officer or trustee in the Library. Henry H. Rogers was the first president of the Board of Trustees.

10. In conducting its activities, the Library has endeavored to provide the entire community the best library services that were possible with the available resources. The Library staff consists of a college-trained librarian and a number of assistants. In addition to the central library, it has maintained six branch libraries and provided collections of books for supplementary reading in the schools. Since 1929, the Library has carried on a special program consisting of story hours and moving pictures for children. In 1950 the book stock of the Library consisted of 46,611 volumes and the circulation of its books per capita was 4.95.

11. In accordance with the wishes of the donor, the Library was kept open 12 hours a day for 7 days a week, including holidays, until ’ 1947, except for two occasions when the Board of Health required it to close for epidemics. After World War II, costs and salaries increased to the extent that in 1947 the Library was forced to close on Sundays and holidays and during the evenings of three days a week.

From 1892 until tbe latter part of 1948, the Library was supported by income from the trust fund established by Henry H. Rogers, by a small amount of miscellaneous gifts' and donations and by the dividends which the Library received as sole owner of the stock of the Water Company. These dividends provided the major, portion of the funds used for the operation of the Library.

12. Since its incorporation in 1888, the business of the Water Company has been conducted by a board of directors, including three officers, who are elected annually by the stockholders. No officer of the Town has ever been an officer or director of the Water Company by virtue of his office.

The Water Company is regulated by the Massachusetts Department of Public Utilities and may not increase its rates except on application to and approval by the Department of Public Utilities. During the years 1922 to 1953 the Water Company was not permitted to increase its rates, although its net income declined after 1945. The decline in its income was due to the rising costs of materials and labor and to the fact that its earnings remained relatively constant.

At one time the Water Company surrendered a part of its franchise covering one section of the Town because of a lack of funds needed to install water mains. The Town then assumed the responsibility of making the installation and also supplied water which it obtained from the Water Company.

One of the original members of the Board of Trustees of the Library was Thomas A. Tripp who, for many years until his death in 1953, also was president of the Water Company. His paramount interest was the welfare of the Library and, as a result, the financial condition of the Water Company was considerably affected by the amount of dividends paid to the Library.

13. The following table shows the amount of dividends paid by the Water Company to the Library as compared with the net income of the Water Company after payment of Federal income taxes for the years 1945 through 1950:

Year Dividends Net income after taxes
1945_ $11, 200. 00 $7, 945. 31
1946_ 11, 200. 00 12, 323. 61
1947_ 11, 700. 00 10, 294. 72
1948_ 12, 400. 00 14, 686. 26
1949_ 5,500.00 None
1950_ 8, 000. 00 7, 751. 17

The year 1949 is not involved in this action. During that year the Water Company suffered a loss of $2,807.76 and paid no Federal income taxes.

14. By June 5, 1948, it became apparent to the Board of Trustees that the Library would be compelled to greatly curtail the services it provided unless it could get financial aid from the Town. The expenses of the Library had increased, primarily because of higher salaries paid to its staff after the war. Dividends received from the trust established by Mr. Bogers had declined from $3,500 to $2,500 per annum. It was known that the amount of dividends from the Water Company would decrease. The Water Company had been denied a rate increase by the Massachusetts Department of Public Utilities and was also required to expand its facilities. During 1948, the Water Company issued 10-year notes in the principal amount of $100,000 and used the proceeds to pay off bank loans and to finance necessary extensions and additions to its plant. Having no other sources of income available, the Library appealed to the Town for assistance and the matter was referred to the finance committee. After due consideration, the question was presented to the Town Meeting on December 8,1948, and it was unanimously voted to appropriate $4,000 to assist in paying the Library’s expenses for the year ending December 31, 1948. Similar appeals were made in subsequent years, and the Town paid further appropriations to the Library in the amounts of $11,182 for 1949 and $11,716 for 1950. These annual appropriations were considered and acted upon in the same manner as appropriations for any department of the Town. The appropriations were paid pursuant to Chapter 40, Section 5, of the General Laws of the Commonwealth of Massachusetts.

15. Prior to December 8,1948, the Town never contributed any amount for the support of the Library. Likewise, prior to February 11,1949, the bylaws of the Library did not contain a provision for making an officer of the Town an ex officio member of the Board of Trustees of the Library.

The minutes of the Town Meeting of December 8, 1948, stated that since the Town was appropriating money for the Library, the Town should be represented on the Board of Trustees and that the board was agreeable to such representation.

On December 11, 1948, the Board pf Trustees wrote the Town, requesting financial aid for the Library for the year 1949 and suggesting that, in the event the Town decided to help the Library, some officer of the Town such as the Chairman of the Selectmen should be made a trustee in order that he could become familiar with the problems and the management of the Library. Thereafter, on February 11, 1949, the bylaws of the Library were amended to read in pertinent part as follows:

Whenever and so long as the Town of Fairhaven appro-Eriates money toward the support of the Millicent library Corporation the Chairman of the Board of Selectmen shall be ex-officio a member of the Board of Trustees.

16. By a law of Massachusetts, the Selectmen of the Town are required to publish an annual Town report for the use of the inhabitants. The report for the year 1950, in evidence as plaintiffs’ exhibit 28, contained a financial report made by the treasurer of the Water Company, as well as a rather extensive report of the activities and financial condition of the Library.

17. The Town has never had any voice in the affairs of the Water Company. The Water Company charges the Town for all wafer used by it and the Water Company pays real estate, personal property and franchise taxes to the Town. The Water Company also pays taxes to the State of Massachusetts and to the Town of Mattapoisett, Massachusetts. The amounts collected by the Town from the Water Company in real estate and personal property taxes compared to the amounts contributed by the Town toward the support of the Library during the years 1945-1950 are shown in the following table:

Taxes paid, by water company Contributions by town to library
1945_ $7, 813. 80 None
1946__- 8, 573. 48 None
1947_ 9,333. 15 None
1948. _ 9,767. 25 $4, 000. 00
1949___ 9, 767. 25 11, 182. 00
1950_ 10, 309. 88 11, 716. 00
Total__— $55, 564. 81 $26, 898. 00

18. Since 1888, the Town has been vested with the right, to take, by purchase or otherwise, the franchise and all other property of the Water Company upon payment to the Water Company of the total cost of the property with interest on each expenditure from its date to the date of taking. The interest rate was originally set at seven percent per annum, but the Legislature of Massachusetts reduced this rate to five percent per annum on April 24,1893.

Over a period of 20 years, the Town and Water Company have negotiated from time to time with respect to the purchase of the Water Company by the Town. While these negotiations have not ended, the evidence shows that the Town has not made any decision on the matter. One of the principal difficulties involved in the negotiations has been the feeling on the part of the officials of the Water Company that a large percentage of the purchase price would have to be used for the payment of taxes, including Federal income taxes on long-term capital gains.

19. The annual net income of the Water Company, as reported in its income and excess profits tax returns for the years involved here and the amount of Federal taxes paid, are shown in the table below. The stated amounts of income taxes were paid in four equal installments on or before the fifteenth day of the months of March, June, September, and December of each year following that for which the return was made. The dates on which the returns were filed and the date of the last payment of such taxes for each of the years are also shown in the table.

The dividends paid by the Water Company to the Library during each of the years in suit were not deducted from the gross income of the Water Company before computing the amount of income tax due.

20. The Town filed with the Commissioner of Internal Revenue claims for refund of the income taxes paid by the Water Company for 1945 on October 31,1951, and for 1946, 1947, 1948, and 1950 on November 28, 1951. The Boston office of the Internal Revenue Service investigated the facts pertaining to the claims for refund, and in August 1952, that office reached the decision that the claims were allowable in full. Thereupon, an official of the Town signed a form accepting the over-assessments as correct. The regulations then in effect required that the claims for refund be reviewed in the central office at Washington, D. C. Upon review in the central office, the claims were referred back to the Boston office for rejection, and a revenue agent’s report, which recommended rejection, was issued on August 10, 1953. This suit was filed January 8,1954. The required statutory notice of rejection was issued January 9,1954.

21. By agreement of the parties, the trial of this suit was limited to the issues of law and fact relating to the right of the Town to recover.

conclusion op law

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiffs are not entitled to recover, and the petition is therefore dismissed. 
      
       The plaintiffs are the Town of Fairhaven, Mass., the- Millicent Library and the Fairhaven Water Company. By agreement of the parties, the claim presented in this action is limited to the issues of law and fact relating to the right of the Town of Fairhaven to recover.
     