Opinion
No. 45431.
May 1, 1944.
Howe P. Cochran, of Washington, D.C. (Margaret F. Lours and Betty Cochran Stockors, both of Washington, D.C. on the brief), for plaintiff.
Daniel F. Hickey, of Washington, D.C. and Samuel O. Clark, Jr., Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington, D.C. on the brief), for defendant.
Before WHALEY, Chief Justice, BOOTH, Chief Justice (retired) recalled, and LITTLETON, WHITAKER, and MADDEN, Judges.
Action by Greene County Farmers Sales Association against the United States to recover additional taxes assessed as a result of the disallowance of deductions of sums distributed to members of an association who made purchases from plaintiff, and as a result of disallowance of a deduction of a bad debt.
Order in accordance with opinion.
This case having been heard by the Court of Claims, the court, upon the evidence and a report of a commissioner, makes the following special findings of fact:
1. Plaintiff, a corporation, having its office in Springfield, Missouri, was organized under the laws of the State of Missouri on February 20, 1919. Its charter was amended December 5, 1919, under a state law enacted that year which authorized the organization of agricultural and mercantile cooperative associations. Plaintiff has an authorized capital stock of $40,000, divided into shares of the par value of $10 each. During all of the time material to this action approximately $19,900 of the authorized capital stock was outstanding and was held entirely by 235 of the members of the Missouri Farmers Association.
2. At all times herein mentioned the Missouri Farmers Association was a statewide organization of some 2,000 farmers. To become a member of the Missouri Farmers Association an applicant had to be eligible under the rules of that organization and pay annual dues. Farmers who dealt with plaintiff and who were members of the Missouri Farmers Association in some instances paid their dues directly to the state organization, and in other instances paid them to plaintiff for transmission to the state office of the Missouri Farmers Association at Columbia, Missouri.
3. Plaintiff's by-laws from 1919 through the taxable years here involved provided that plaintiff's annual net income was to be disposed of as follows: (a) Ten percent to a reserve fund until the fund equaled 50 percent of the outstanding capital stock (the reserve fund reached this amount long before the taxable years in question); (b) a dividend of not to exceed 8 percent to stockholders; (c) the balance of the net income to be distributed to all persons who transacted business with plaintiff who were members in good standing of the Missouri Farmers Association in proportion to the amount of business which each such member had with plaintiff.
4. During the taxable years 1933, 1934, and 1935 plaintiff's business consisted in general of the following: (a) Purchases of farm products from farmers and the resale of such products in the open market, some being sold over the counter to towns-people who were not members of the Missouri Farmers Association, and some shipped for sale in city markets; (b) purchases of goods and supplies in the open market for resale; and (c) a small amount of grain business handled on a cost basis separately from other enterprises as an accommodation to members of the Missouri Farmers Association.
Plaintiff did not restrict its business to members of the Missouri Farmers Association. It dealt with anyone who desired to transact business with it.
5. During the taxable years involved in this action plaintiff's stockholders received an annual dividend from it of 8 percent of the par value of the outstanding stock. This was the maximum dividend to which they were entitled. The balance of plaintiff's net profit was distributed to members of the Missouri Farmers Association in proportion to the total amount of business done with each member. Although plaintiff transacted business with the general public, only those of its patrons who were members of the Missouri Farmers Association shared in the distribution of its surplus profits. Profits which plaintiff realized from business with patrons who were not members were included in the total net profit distributed to members of the Missouri Farmers Association. These distributions were made pursuant to promises made by plaintiff to farmers who did business with it as an inducement to them to join the Missouri Farmers Association and as an inducement to deal with and through the plaintiff.
6. At all times herein mentioned plaintiff kept its books and filed its tax returns on the accrual basis. For the taxable years 1933, 1934, and 1935 plaintiff deducted $7,000, $6,000, and $3,079.80, respectively, from its gross income in its Federal income tax returns for those years as rebates on purchases made by members of the Missouri Farmers Association.
The Commissioner of Internal Revenue disallowed the deductions to the extent of $2,596.93 for the year 1933, $1,375.88 for 1934, and $1,154.95 for 1935, on the ground that the amounts disallowed were derived from business with nonmembers of the Missouri Farmers Association.
7. Plaintiff had a balance of $8,022.30 on deposit in the Queen City Bank of Springfield, Missouri in 1933 when the Missouri State Finance Department assumed control of the bank and operated it on a restricted basis. The bank was placed in the hands of a liquidator in 1934. During 1933 and 1934 plaintiff was unable to obtain from either the Banking Commissioner or his agent in charge of the bank's liquidation a statement as to the approximate amount plaintiff would be paid on final liquidation of the bank's assets.
In 1933 plaintiff decided to write off the bank deposit over a period of five years. Plaintiff's Federal income tax return for that year claimed one-fifth of the bank deposit ($1,604.46) as a deduction from gross income. The deduction was disallowed on the ground that there had been no charge-off of the amount on plaintiff's books and no ascertainment of the loss.
In 1934 the liquidator of the bank's assets could not give plaintiff a definite statement regarding payment of the account, but he informed plaintiff that he probably would not be able to pay it. Plaintiff decided that the entire account was bad, and in 1934 charged $3,208.92 of the deposit to surplus and credited that amount to a special reserve for loss on the bank account. In its Federal income and excess profits tax return for 1934 plaintiff again deducted onefifth of the bank deposit from its gross income, but the deduction was disallowed on the same ground as in the previous year.
The deposit was carried on plaintiff's books among its assets during the taxable years in question. In the balance sheets attached to its income tax returns, plaintiff listed the bank deposit as an asset valued at $6,417.84 at the end of 1933, $4,813.38 at the end of 1934, and $4,813.38 at the end of 1935. The special reserve was carried on plaintiff's books during the years 1934 and 1935. In the final liquidation of the bank's assets plaintiff received approximately 12 percent of the bank deposit, but there is no proof as to the year in which the bank made its final payment to plaintiff or as to when the amount of the loss was definitely ascertained.
8. As a result of the disallowances mentioned in the foregoing findings and other adjustments not in dispute, the Commissioner sent deficiency notices to plaintiff showing additional taxes due as follows: For 1933, income tax of $520.99; for 1934, $543.77 income tax and $69.93 interest, and $53.44 excess profits tax and $6.87 interest; and for 1935, income tax of $59.99.
Plaintiff paid the additional taxes as follows: for 1933, $520.99 plus $68.93 interest paid on June 12, 1936; for 1934, $597.21 plus interest of $76.80 paid on May 15, 1937; and for 1935, $59.99 plus interest of $5.23 paid on August 30, 1937. Previously on March 28, 1936, plaintiff had paid $309.69 as income taxes for the year 1935.
9. June 10, 1938, plaintiff filed with the Commissioner claims for refund in the amounts of $357.07 for 1933, $597.21 for 1934, and $369.68 for 1935. In its claims for refund plaintiff contended that it was entitled to deduct from its gross income the entire amount which it distributed to members of the Missouri Farmers Association during each of the three years in dispute. It also contended that it was entitled to deduct 40 percent of the bank deposit ($3,208.92) from its gross income in 1934, but if disallowed for that year that it was entitled to such deduction for 1935.
The Commissioner rejected all of plaintiff's claims for refund on September 11, 1939.
Plaintiff sues to recover additional taxes assessed as a result of the disallowance of deductions in both of the years in question of sums distributed by it to members of the Missouri Farmers Association who made purchases from it, and as a result of the disallowance of a deduction of a bad debt in the year 1934.
The Missouri Farmers Association was an organization of Missouri farmers. It had about 2,000 members. Some of them decided in 1919 to organize the plaintiff corporation for the purpose of dealing in agricultural products. It was organized in that year with an authorized capital of $40,000. It offered its stock for sale to members of the Missouri Farmers Association. Of the 2,000 members of that organization, 235 subscribed for stock. An amount of $19,900 of the authorized capital stock was sold.
Plaintiff did business with the public generally, but as an inducement to the members of the Missouri Farmers Association to trade with it, and in order to induce farmers to join the Missouri Farmers Association, plaintiff adopted by-laws providing for a distribution of all of its net profits in excess of 18 percent to such members of the Missouri Farmers Association as did business with it in proportion to the business each had done. After a surplus equal to 50 per cent of its outstanding capital stock had been accumulated, it agreed to distribute all its net profits in excess of 8 percent.
The adoption of these by-laws was advertised among the farmers of Missouri, and the members of the Missouri Farmers Association did business with plaintiff on the faith of this promise.
In both of the years in question plaintiff deducted the sums so distributed as an expense of doing business.
We think it is entitled to the deduction. The amounts distributed were rebates to purchasers and reduced by the amount of them the total amount received for goods sold.
This is plain, if we keep in mind that plaintiff was an entity separate and distinct from the Missouri Farmers Association. The moving spirits behind its organization were some of the members of that Association, but all members of that Association did not participate in the organization of nor own stock in plaintiff; only those members of the Missouri Farmers Association who subscribed for stock became stockholders in plaintiff and were entitled to the 8 percent dividend. Plaintiff had 235 stockholders, but there were 2,000 members of the Missouri Farmers Association that did business with it. The Missouri Farmers Association and plaintiff were separate and distinct entities. Plaintiff was not even a subsidiary of this Association.
These rebates were not given to stockholders, but only to those purchasers whose contract of purchase entitled them to it. Stock holding had nothing to do with one's right to the rebate.
Plaintiff's by-laws promised such rebates to members of the Missouri Farmers Association and these people bought on the faith of this promise and, so, could have enforced the payment of the rebate in a court of law. The obligation to pay it was an enforceable legal liability. As such plaintiff was entitled to deduct it, as a reduction of the amount which it in fact received for its goods sold. Uniform Printing Supply Co. v. Commissioner, 7 Cir., 88 F.2d 75, 109 A.L.R. 966; Plymouth Brewing Malting Co. v. Commissioner, 16 B.T.A. 123; Mertens Law of Federal Income Taxation, Vol. 4, par. 25.111.
Defendant in its brief refers to several cases dealing with farmers' cooperative associations, but these are inapplicable because plaintiff clearly was not a cooperative, but a corporation organized for profit. The persons to whom the rebates were paid were not "members" of plaintiff — the word used in referring to cooperatives; that they may have been "members" of the Missouri Farmers Association, or of the Knights of Pythias, or of the Methodist Church, makes no difference.
We are of opinion that plaintiff is not entitled to the deduction in the year 1934 of any part of its deposit in the Queen City Bank of Springfield, Missouri. Control of this bank had been assumed by the Missouri State Finance Department in 1933, and in 1934 the bank was placed in the hands of a liquidator, but at no time during the year did plaintiff, nor indeed the liquidator, know whether or not depositors would be paid in full or what percentage of the deposits would be paid. The liquidator informed plaintiff that he could make no definite statement as to the amount they would be paid, and that all he could then say was that he probably would not be able to pay depositors in full. His mere statement that he probably would not be able to pay the depositors in full is not sufficient to establish that the debt was worthless either in whole or in part. The record does not show when the bank was finally liquidated, but it was sometime after 1935. A total of 12 percent was paid to the depositors.
On the facts we must hold that the debt was not ascertained to be worthless in the year in which a portion of it was deducted and that, therefore, plaintiff is not entitled to the deduction. Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 54 S.Ct. 644, 78 L.Ed. 1200.
The entry of judgment will be deferred until the filing of a stipulation by the parties, or, in the absence of a stipulation, until the incoming of a report by a commissioner as to the correct amount due plaintiff computed in accordance with this opinion. It is so ordered.
BOOTH, Chief Justice (retired) called and MADDEN, Judge, concur.
As shown by the findings, the Missouri Farmers Association was a state-wide organization of farmers. Plaintiff was a stock corporation organized under the laws of Missouri to act as business or sales agent of the Missouri Farmers Association. To become a member of the Missouri Farmers Association it was necessary that an applicant be eligible under its rules and regulations and that such applicant pay annual dues to the Association. Plaintiff had no such members. There was no connection between plaintiff's stockholdings and the distribution by plaintiff of patronage dividends in the manner hereinbefore stated in the findings, since a stockholder of plaintiff was not entitled to receive such patronage dividends unless he was a farmer-patron of plaintiff and was also a member of the Missouri Farmers Association.
As used hereinafter the term "member" refers only to patrons of plaintiff who were members in good standing of the Missouri Farmers Association, and the term "non-member" refers to other persons who transacted business with plaintiff.
From the date of its incorporation in 1919 plaintiff's by-laws provided, and so provided during the taxable years 1933 to 1935, inclusive, that all of plaintiff's annual net income was to be distributed as follows: (a) Ten percent to a reserve fund until such fund equaled 50 percent of the outstanding capital stock (the reserve fund reached this amount long prior to the taxable years in question); (b) a dividend of not to exceed 8 percent to plaintiff's stockholders; and (c) the balance of the net income to be distributed to all persons who transacted business with plaintiff who were members in good standing of the Missouri Farmers Association in proportion to the amount of business which each such member had with plaintiff.
During each of the taxable years in question plaintiff paid a dividend of 8 percent to its stockholders and distributed the balance of its net income, as specified in (c) above, to all farmers who transacted business with it who were members in good standing of the Missouri Farmers Association.
Plaintiff did not restrict its business to purchases from and sales to farmers who were members of the Missouri Farmers Association, but it dealt with anyone who desired to do business with it and handled both member and nonmember business on the same basis. However, only those of its patrons or customers who were members of the Missouri Farmers Association shared in the patronage dividends. The profits which plaintiff realized from business done with persons who were not members of the Missouri Farmers Association were included in the total net profits for the year, which it distributed, after payment of the 8 percent dividend to stockholders, as patronage dividends only to farmers who dealt with it and who were members of the Missouri Farmers Association.
Plaintiff does not and, of course, cannot claim exemption from taxation under any provision of the taxing acts as a farmers cooperative association. See sections 103 of the Revenue Act of 1932 and 101 of the Revenue Act of 1934, 26 U.S.C.A. Int.Rev. Acts, pages 506, 688. But it contends that portions of the distributions of its net income remaining after payment of the 8 percent dividend which it made in the taxable years 1933 to 1935, inclusive, to its farmer patrons who were members of the Missouri Farmers Association, representing net profits which plaintiff made during such years from business transacted with persons who were not members of the Missouri Farmers Association, were rebates paid to such "members" and should therefore be excluded from plaintiff's taxable net income.
Upon the facts in this case I think the distributions in question representing profits derived by plaintiff from transactions with persons or patrons who were not members of the Missouri Farmers Association, which the defendant has determined to be $2,596.93 for 1933, $1,375.88 for 1934, and $1,154.95 for 1935, were not rebates of such character as would justify their allowance as a deduction from taxable income as ordinary and necessary expenses under any provision of the applicable taxing statutes or regulations. The defendant has allowed plaintiff to exclude from taxable income the distributions which it made out of its net income in each of the years in question to farmers who dealth with it and who were members of the Missouri Farmers Association to the extent of the net earnings derived by plaintiff from the business which it did with such "members," and those distributions are not in controversy here.
Rebates or discounts allowed and given to specific customers on transactions specifically with them or to customers generally on transactions with them may, in a proper case, be allowable as deductions in determining taxable net income (cf. Uniform Printing S. Co. v. Commissioner, 7 Cir., 88 F.2d 75, 109 A.L.R. 966), but distributions of net profits derived from dealings with certain customers to certain other customers who were in no way connected with the transactions from which such net profits were derived are not rebates or discounts of this character. On the contrary plaintiff's net income was determined after taking into account all expenses and allowable deductions and such net income, from all sources, after payment therefrom of an 8 percent dividend to stockholders, was distributed to a selected group of customers. The taxing acts do not authorize deductions of such distributions in determining taxable income. Claimed deductions from net income which are not authorized specifically, either by the revenue acts or by any regulation applying to them, cannot be allowed. Brown v. Helvering, 291 U.S. 193, 205, 54 S.Ct. 356, 78 L.Ed. 725. The allowance of deductions from gross or net income does not turn on general equitable considerations. Deputy, Administratrix, et al., v. Du Pont, 308 U.S. 488, 493, 60 S.Ct. 363, 84 L.Ed. 416; White v. United States, 305 U.S. 281, 292, 59 S.Ct. 179, 83 L.Ed. 172.
Upon the record in this case I think the portion of plaintiff's net income in each of the taxable years representing profits earned by it from the business which it did with the public generally, that is with persons or customers who were not members of the Missouri Farmers Association and, therefore, not entitled to participate in any distribution of net earnings, constituted taxable income to plaintiff under the income-tax statutes. Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731.
I concur in the opinion of the majority with reference to the bad debt deduction.
I am of opinion that the petition should be dismissed.
WHALEY, Chief Justice, concurs in the foregoing opinion.