
    ALPHA TANK & SHEET METAL MFG. COMPANY, A CORPORATION, v. THE UNITED STATES
    No. 50133.
    Decided December 1, 1953.
    
      
      Mr. Norman Begeman for plaintiff. Messrs. Lowenhaupt, Waite, Chasnof <& S tolar were on the briefs.
    
      Mr. J. W. Hussey, with whom was Mr. Assistant Attorney General H. Brian Holland, for defendant. Messrs. Andrew D. Sharpe and Ellis N. Slack were on the brief.
   Jones, Chief Judge,

delivered the opinion of the court:

Plaintiff seeks a refund of certain income and excess profits taxes assessed and paid for the calendar years 1943, to 1946, inclusive. The issue turns on whether the Collector of Internal Revenue was justified in reallocating the income as between two corporations.

The plaintiff, a Missouri corporation with headquarters in St. Louis, at all times material to the issues involved, was engaged in manufacturing metal products for specialized industries.

Since 1921 the plaintiff’s stock has been held entirely by Alfred . Allina and Herman F. Walz, except for small amounts held by members of their families.

The company was in financial difficulty in 1917, but its condition had improved by 1921, at which time Walz invested in it Since that date the ownership hás remained substantially the same. In 1928 the name of the company was changed to that of the plaintiff, after which date Allina and Walz remained the beneficial stockholders.

In 1928 plaintiff purchased land and erected a new and larger plant. In 1930 the company was again in financial difficulty. After an unsuccessful attempt to work out a solution of its difficulties, foreclosure proceedings on plaintiff’s plant were instituted, and in 1932 plaintiff signed a quitclaim deed to the property, During 1930 the plaintiff submitted to 17 (B) bankruptcy procetdings. A creditors’ committee headed by C. C. Johnson, who had acted in the same capacity in the previous difficulty, took over and operated plaintiff’s business. The committee rented the property for plaintiff’s operation, but in 1937 the plaintiff was compelled to vacate its plant as the property had been sold to another corporation.

Plaintiff acquired from the Liberty Foundry Company its present plant in 1937 at a cost of $50,000, represented by a first trust of $30,000 and a second trust of $20,000. By December 18, 1942 the second trust had been fully paid.

On October 12, 1942 Delmo Realty and Investment Company was incorporated with an authorized capital stock of 200 shares, only 50 of which were issued and placed in the name of Charles Wingate and others. Soon thereafter these 50 shares were cancelled and new certificates were issued, one for 48 shares to C. C. Johnson, and two for one share each to his son and his secretary. The shares were then indorsed in blank and placed in Johnson’s lock box to which Allina had access. Allina and Walz each contributed $500 to Delmo at the timé of its organization.

On January 18, 1943 plaintiff’s property was deeded to Delmo, and a 5-year lease of the property with renewal privileges was made to plaintiff at a .rental rate of $1,000 per month. The plaintiff was to pay all repairs, insurance, license fees and general taxes which would otherwise have been the obligations of Delmo. ■

. Delmo had acquired the property at the book valúe of $41,854.09, of which $1,854.09 was paid in cash, the balance being in the assumption of a $25,000 obligation secured by a deed of trust from plaintiff to Liberty Foundry Company, and the execution of a second deed of trust by Delmo to plaintiff in the sum of $15,000. The cash payment consisted of the $1,000 contributed by Allina and Walz, plus certain .amounts from the rentals plaintiff had paid to Delmo. Plaintiff guaranteed the payments on the first deed of trust.

No entry in Delmo’s books showed any financial interest of Allina and Walz in the Delmo Company. Delmo had no property except the plant occupied by plaintiff, and no in-oome or business except that of collecting the rents to which reference has been made.

Allina and Walz caused the organization of Delmo in •order that the rentals collected from plaintiff might be accumulated as a personal retirement fund for Allina and Walz .and for their widows in the event of the death of either. Another stated purpose-was to avoid the loss of the plant .and equipment in the event of possible financial difficulties •of plaintiff in the future.

The plaintiff and Delmo filed their income and excess profits tax returns for the years 1943 to 1946, inclusive.

The plaintiff in filing its tax returns for the years involved •deducted as ordinary and necessary expenses the amount of the rental payments for the plant property.

The Collector of Internal Revenue disallowed plaintiff’s •deductions of rental payments from plaintiff to Delmo, added these to plaintiff’s income, thus combining the income of both, then made adjustments for the tax paid by Delmo, and levied and collected an additional net assessment against plaintiff in the sum, including interest, of $9,731.89. Some additional levies for the year 1946 were collected.

The details of these transactions are set out in findings 15 to 18, inclusive.

The plaintiff claims the Commissioner of Internal Revenue under the facts of record had no right to reallocate the income and that the additional taxes should not have been assessed and collected..

The defendant pleads that the deductions were properly •disallowed under section 45 (26 U. S. C. 1946 ed., sec. 45) of the Internal Revenue Code, and that the disallowance was further justified by section 129 (a) of the same code.

The two sections are set out in the footnote.

We agree that the Collector of Internal Revenue had full authority for the action taken. Delmo was organized, owned, and controlled by the same two stockholders, Allina and Walz, who owned and controlled the plaintiff. The trial commissioner has found and we agree that the facts justify a finding that Delmo was used by them simply to hold legal title to the operating plant used by plaintiff, to accumulate the rentals collected from plaintiff for the personal benefit of the stockholders and to reduce the income of plaintiff.

The plaintiff insists and cites a number of authorities to the effect that a taxpayer is privileged to minimize his tax and is free to adopt such organization of his affairs as he may choose. That general principle is correct. But the application of that well-recognized rule depends on the facts of the case, the substance of the organization, and the use that is made of it.

The application of this principle does not mean that a person may reduce his income tax by transferring his money from one pocket to another even though he uses a different pair of trousers. A man with a half-dozen pockets might almost escape liability altogether.

We quote from Higgins v. Smith, 308 U. S. 473, 477-78, in which the Court used the following language:

* * * A taxpayer is free to adopt such organization for his affairs as he may choose * * *.
On the other hand, the Government may not be required to acquiesce in the taxpayer’s election of that form for doing business which is most advantageous to him. The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.

We find no legitimate corporate business motive was involved in the organization of Delmo. The transfer of the plant to it and the lease back to plaintiff were integral parts of the same transaction. The attempted creation of deductions for rentals of a plant when there was no real change in ownership in the circumstances of this case is not a sufficient business motive.

When the revenue agent examined the 1943 returns of the plaintiff he discovered from plaintiff’s books that the plant property had been disposed of although nothing in the returns disclosed that fact. By diligent inquiry he learned of the existence and location of Delmo to which the plant had been deeded. O. C. Johnson, president of Delmo, insisted that the stock standing in his name represented his own investment and that neither plaintiff, Allina nor Walz had any financial interest in -the company. . Further investigation by the revenue agent disclosed the beneficial ownership of Del-mo’s stock. The Commissioner, therefore, combined the. accounts of plaintiff and Delmo, resulting in additional assessment against plaintiff and allowing credit for overassessment against Delmo. The tax liabilities were adjusted accordingly.

It further appears that there was no material substance to the claim that the deed of transfer was made to Delmo so that in the event plaintiff again got into financial difficulties it would not lose the plant since plaintiff remained liable on the first trust for $25,000, in fact, guaranteed its payment, which was the balance due at that time on the first trust between Alpha and Liberty. The plaintiff thus escaped no liability. There was no substantial business purpose in organizing Delmo and no substantial business was conducted by it.

In order to reflect clearly the income of the plaintiff the Commissioner of Internal Kevenue correctly allocated all income, deductions, credits and allowances claimed by Delmo, arising from its holding of title to plaintiff’s manufacturing plant, to the plaintiff in each of the years involved.

The petition is dismissed. It is so ordered.

Madden-, Judge; Whitaker, Judge; and Littleton, Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the report of Commissioner William E. Day, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff was, at all times material herein, a Missouri corporation with its plant and principal place of business at 5001 South 38th Street (also known as 3800 Delor Street) in St. Louis, Missouri. The plaintiff’s business is the fabrication of metal products for specialized industries.

2. Since 1921 the plaintiff’s stock has been entirely held by Alfred Allina and Herman F. Walz, except for small amounts held by members of their families.

During the period from 1943 to 1946, the stock of the plaintiff company was held as follows:

COMMON

1943-44 1943 1943

Alfred Allina_ _192 186 186

Herman Walz_ _232 232 222

Clarence Garvey_ _ 1 *1 *1

Mrs. Walz_ _ 7 7 7

Alfred Epstein_ 8 8

Fred Walz_ 1 11

Stanley Allina-6 6

PBEFEBEED

Alfred Allina_ 100 shares

Herman Walz_ 45 shares

Stanley Allina_ 5 shares

3. In 1917 Alfred Allina was employed by a creditors’ committee as manager of Alois Anfrichtig Copper and Sheet Iron Manufacturing Company in St. Louis, a company owned by the estate of the deceased father of Allina’s wife. Charles Aufrichtig, a brother of Allina’s wife, had managed the company until his death in 1917, just prior to Alfred Allina’s employment as manager. The chairman of the creditors’ committee was one C. C. Johnson. By 1920 or 1921, the financial affairs of the Aufrichtig Company had improved, and Mr. H. F. Walz invested in it. In 1928 the name of the Aufrichtig Company was changed to Alpha Tank & Sheet Metal Mfg. Company, the plaintiff herein. Allina and Walz were thereafter the principal beneficial stockholders. Also in 1928 plaintiff purchased land at 3883 Delor Street and built a new and larger plant thereon. By 1930, the company was again in financial difficulties and was unable to satisfy its creditors or to meet the payments on the mortgage bonds which had been issued at the time the plant was built. Mr. C. C. Johnson again headed a committee of creditors and with Allina and Walz tried unsuccessfully to work out a solution of plaintiff’s difficulties. Foreclosure proceedings on plaintiff’s plant property were instituted but finally in 1935 plaintiff signed a quitclaim deed to the property. During 1936 the plaintiff went through 77 (B) bankruptcy proceedings. The creditors’ committee, which took over and operated plaintiff’s business, thereafter rented the property for plaintiff’s operations. In 1937 plaintiff was compelled to vacate its plant because the plant had been sold to another corporation.

4. The plaintiff acquired its present plant at 5001 South 38th Street in St. Louis in 1937 from the Liberty Foundry Company. The cost was $50,000 represented by a $30,000 first trust and a $20,000 second trust, both payable in five years. C. C. Johnson and an attorney, Clarence Garvey, thereafter acted with Allina and Walz as the executive committee of plaintiff, although neither Johnson nor Garvey ever owned any stock in the corporation.

5. The minutes of a special meeting of the directors of the plaintiff held August 22,1942, provide in part as follows:

The Chairman stated that the meeting had been called for the purpose of discussing a proposal which had been made by one C. C. Johnson to purchase the equity which Alpha has in its land and buildings and assume the outstanding indebtedness. Mr. Allina stated that the negotiations had not reached the stage where a definite offer had been made but had been informed by Mr. Johnson that if Alpha decided to sell he would form a Company and take title in the name of such Company after incorporation. The meeting was then thrown open to a general discussion of the advisability of disposing of the plant property to some one — if not Mr. Johnson and his associates and all of the Directors were in agreement that they did not wish to experience a repetition of the disaster which overtook the Company at the time of its Reorganization under Chapter 77 of the Bankruptcy Act and m connection with which it lost title to its plant property then occupied and located just west of the present plant but on the North side of Delor Street. Mr. Allina expressed the opinion that the Company would be better off were it to divest itself of its real estate provided it could rent or lease suitable premises at a reasonable figure and thereby free assets which would otherwise be frozen in plant property for usage as liquid working capital. The other Directors expressed their concurrence m the views expressed by Mr. Allina and upon motion duly made, seconded and unanimously carried, Mr. Allina was authorized to negotiate further with Mr. Johnson or others in the matter of disposing of the Plant property, provided a suitable leasing arrangement could be made part of any sale which might be effected.

6. By December 18,1942, the notes payable by the plaintiff to Liberty Foundry Company totaling $20,000, which had been secured by the second deed of trust (referred to in finding 4), were fully paid by the plaintiff.

7. On October 12,1942, Delmo Realty & Investment Company (hereinafter referred to as Delmo) was incorporated under the laws of the State of Missouri with authorized capital stock of 200 shares without par value. The only stock issued, however, was 50 shares of which 48 were placed in the name of Charles Wingate, an attorney associated with Clarence Garvey, one share was issued to J. F. Lister, one of Garvey’s employees, and one share was issued to M. J. Theobold, a stenographer in Garvey’s office. On January 18, 1943, the original stock certificates were cancelled and new certificates were issued as follows: a certificate for 48 shares to C. C. Johnson, one for one share to his son, E. C. Johnson, and one for one share to Mr. Johnson’s secretary. The shares were then endorsed in blank and placed in C. C. Johnson’s lock box to which Mr. Allina had access. The certificates were held in that manner until January 15,1946, when Johnson, then holding the office of president of Delmo, severed his connections with plaintiff and with Delmo. Allina and Walz financed and caused to be organized the Delmo Eealty & Investment Company and at no time did anyone other than they beneficially own any stock in the corporation, although no stock stood in their names throughout the taxable periods here involved.

8. Delmo was organized for the sole purpose of holding the title to the land and buildings comprising plaintiff’s operating plant at 5001 South 38th Street in St. Louis, Missouri. Part of the transaction was that plaintiff was then to rent the plant from Delmo for plaintiff’s continuing operations therein. On January 18, 1943, plaintiff’s plant property was deeded to Delmo, and a five-year lease from Delmo to the plaintiff at $1,000 per month, with renewal provisions, was executed at the same time. The lease also required that the plaintiff pay for the cost of all repairs, insurance premiums, license fees, and general taxes which would otherwise have become obligations of Delmo. At no time did plaintiff or Messrs. Allina and Walz intend to relinquish possession and control of plaintiff’s manufacturing plant. The plan was to continue the use of the plant by plaintiff exactly as before the transfer of title to Delmo.

9. Delmo was organized upon the contribution in currency of $500 each by Messrs. Allina and Walz individually. It acquired plaintiff’s plant property by warranty deed from plaintiff at plaintiff’s book value for the property, $41,854.09. Delmo paid the consideration by assumption of a first deed of trust from plaintiff to Liberty Foundry Company of $25,000, a second deed of trust issued by Delmo to the plaintiff of $15,000, and cash of $1,854.09, with plaintiff guaranteeing the payments on the first deed of trust. The $1,854.09 cash used in the transaction consisted of the $1,000 paid in by Allina and Walz to finance the organization of Delmo, plus certain amounts paid by plaintiff to Delmo as rentals before the deed and the lease were executed. No entry in Delmo’s boobs or records showed any financial interest of Allina and Walz in the Delmo Company, except the book entry showing the contribution of $500 each by Allina and Walz. Delmo maintained no office and kept no books on the premises at 5001 South 38th Street. Delmo had no property except the plant occupied by plaintiff nor any income or business of any character except collecting the rents from plaintiff. Delmo’s books were kept by C. C. Johnson at the office of Johnson Industries, 7th and Kussell Streets in St. Louis. The notes secured by the first and second deeds of trust were ultimately paid in full.

10. Allina and Walz caused the organization of Delmo, the transfer of plaintiff’s plant property to it, and the lease of the property to plaintiff'in order that the rentals collected from plaintiff by Delmo could be accumulated as a personal retirement fund for Allina and Walz and for their widows upon the death of either. Another consideration was to avoid loss of the entire plant and equipment in case of future financial difficulty of plaintiff.

11. During the years 1943 through 1946, plaintiff paid as rentals to Delmo, under the lease of its plant from Delmo, the following amounts: 1943 — $12,000; 1944 — $12,000; 1945— $11,433; and 1946 — $8,000. In addition, plaintiff paid all repairs, insurance premiums, license fees and general taxes of Delmo. The aggregate rentals represented the reasonable rental value of the premises at 5001 South 38th Street, St. Louis, taking into consideration the payment by the plaintiff for repairs, insurance, license fees and general taxes.

12. The plaintiff and Delmo duly filed their income and excess profits tax returns for the calendar years here involved and paid the taxes thereon shown due. In each of the years, plaintiff deducted as ordinary and necessary expenses the amounts of rental payments made to Delmo, and Delmo reported such payments as its only income. Nothing in the returns disclosed the sale or transfer of plaintiff’s plant property to Delmo in 1943.

13. Internal Revenue agents, among other adjustments, disallowed as deductions to plaintiff the rental payments for each of the years 1945 and 1946, inclusive, on the ground that:

The taxpayer claims a deduction for rent paid to a controlled company which company was apparently organized for the purpose of shifting income and reducing taxes. In accordance with Section 45 of the Internal Revenue Code [it] is so held that the deduction claimed is not allowable.

Although the Internal Revenue Agent’s reports for the years 1943 and 1944 are not in evidence, it appears from the testimony of the agent that the disallowance as deductions to the plaintiff of the rental payments for the years 1943 and 1944 was made on the same grounds as set forth above.

14. When the revenue agent was assigned to examine the 1943 tax returns of the plaintiff, he discovered from plaintiff’s books that the plant property had been disposed of within the year, although nothing in the returns disclosed the fact. By diligent inquiry he learned of the existence and location of Delmo Realty & Investment Company to which the plant had been deeded at plaintiff’s depreciated book value. C. C. Johnson, president of Delmo, insisted that the stock standing in his name represented his own investment, and that the plaintiff, Mr. Allina and Mr. Walz had no financial interest whatever in Delmo. Further investigation by the revenue agent disclosed the facts as to the beneficial ownership of Delmo’s stock, and the agent, therefore, combined the accounts of plaintiff and Delmo and recomputed tax liabilities accordingly. He recommended assessment of tax deficiencies against plaintiff and resultant overassessments in favor of Delmo. On May 26,1947, Delmo, by its then President Walz, executed a form accepting as correct the overassessments determined in its favor and consenting that the overassessments might be credited to the extent necessary against the total deficiencies determined against the plaintiff.

15. As a result of revenue agents’ recommendations adopted by the Commissioner of Internal Revenue, an excess profits tax deficiency plus interest thereon was assessed against plaintiff for the calendar year 1943, by reason of various adjustments. The deficiency assessed for 1943 was $12,165.75. and the interest thereon was $2,288.68, a total of $14,454.43. Of that amount the part attributable to the denial of rental deductions in 1943 was $10,800 and the apportioned interest was $2,031.74. The additional assessment against plaintiff for 1943 was satisfied as follows:

10% postwar credit-$1,216.57
November 6,1947, payment- 6,839.85-
November 3, 1947, credit from Delmo’s excess profits tax overassessment for 1943- 2,158.42:
November 3, 1947, credit from plaintiff’s 1943 income tax overpayment_ 122.07
November 3, 1947, credit from plaintiff’s income tax overpayment 1944- 272.00-
June 15,1949, payment_ 3, 845. 52
Total_ 14,454.43:

Additional interest for late payment of the balance was also collected on June 15,1949, in the amount of $374.17.

16. As a result of revenue agents’ recommendations adopted' by the Commissioner of Internal Revenue, additional declared value excess profits and excess profits tax deficiencies for 1944, plus interest, were assessed against plaintiff, by reason of various adjustments, as follows:

Declared value excess profits tax- $60.32'
Plus interest thereon-• 8.26
Excess profits tax deficiency_ 10,976.22
Plus interest thereon_ 1, 503.44
Total_ 12,548.24

Of the total excess profits tax deficiency assessed against plaintiff for 1944, the amount of $10,260 arises from the disallowance of the deduction for rental payments to Delmo, and the interest payment of $1,503.44 should be apportioned accordingly. The deficiencies for 1944 were satisfied by cash payments on November 5,1947, in the aggregate amount of $12,548.24.

17. As a result of the recommendations of the revenue agents adopted by the Commissioner of Internal Revenue,, an additional assessment of excess profits tax plus interest was made against plaintiff for 1945, by reason of the denial of rent deductions for amounts paid to Delmo, and the combining of accounts of the two corporations, in the amount of $8,646.78 plus interest of $1,085.11 — total $9,781.89. The deficiency was satisfied as follows:

September 15,1948, payment_$6,348. 23
September 21, 1948, credit from Delmo’s 1945 income tax overpayment- 1,837.59
September 21,1948, credit from plaintiff’s 1945 income tax overpayment_ 466.41
September 21, 1948, credit from Delmo’s 1946 income tax overpayment_ 1,079.66
Total_ 9,731.89

18. As a result of recommendations of revenue agents adopted by the Commissioner of Internal Revenue, an additional income tax deficiency, with interest thereon, for 1946 was assessed against plaintiff, by reason of various adjustments, in the amount of $2,466.96 plus interest of $161.57— total $2,628.53. The aggregate amount assessed was paid by plaintiff on September 15,1948.

19. After combining the accounts of plaintiff and Delmo for the years here involved, and assessing the tax deficiencies against plaintiff, the Commissioner of Internal Revenue determined and allowed tax overassessments and overpayments to Delmo covering the amounts reported by it in its returns. Refunds and authorized credits were duly made.

20. Plaintiff duly filed its claims for refund for the years 1943 to 1946, inclusive, in 1949, challenging the right of the Commissioner of Internal Revenue to invoke the provisions of Section 45 of the Internal Revenue Code. The claims were disallowed on April 18,1950.

21. Delmo Realty & Investment Company was organized, owned and controlled by the same two stockholders, Messrs. Allina and Walz, who owned and controlled plaintiff. Delmo was used by them simply to hold legal title to the operating plant used by plaintiff and to accumulate the rentals collected from plaintiff for occupancy of the plant for the personal benefit of the stockholders and to reduce the income of plaintiff. In order to reflect clearly and properly the income of the plaintiff, the Commissioner of Internal Revenue correctly allocated all income, deductions, credits and allowances claimed by Delmo, arising from its holding of title to plaintiff’s manufacturing plant, to the plaintiff, in each of the years here involved.

22. The plaintiff’s principal beneficial stockholders, Messrs. Allina and Walz, individually acquired all of the stock of Delmo Realty & Investment Company for the principal purpose of securing rental deductions for the plaintiff which deductions plaintiff would not otherwise enjoy.

CONCLUSION OP LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes that as a matter of law the plaintiff is not entitled to recover, and the petition is therefore dismissed. 
      
       Sec. 45. Allocation of income and deductions.
      In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.
      Sec. 129. Acquisitions made to evade or avoid income or excess profits tax— (a) Disallowance of deduction, credit, or allowance.
      If (1) any person or persons acquire, on or after October 8, 1949, directly or indirectly, control of a corporation, * * * and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income or excess profits tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then such deduction, credit, or other allowance shall not be allowed. * * *
     
      
       Owned beneficially by Herman Walz.
     
      
       Brother-in-law of Alfred Allina.
     
      
       Son of Herman Walz.
     
      
       Son of Alfred Allina.
     