Oil City Nat. Bank v. United States

Full title: OIL CITY NAT. BANK et al. v. UNITED STATES

Court: United States Court of Claims.

Date published: Oct 5, 1942

46 F. Supp. 886 (Fed. Cl. 1942)

Opinion

46 F.Supp. 886 (Ct.Cl. 1942) OIL CITY NAT. BANK et al. v. UNITED STATES No. 44623 United States Court of Claims. Oct. 5, 1942

        MADDEN, Judge, dissenting.

        Action by Harry Heasley against the United States to recover back part of income taxes paid by plaintiff for the year 1934. Upon death of the plaintiff, the Oil City National Bank and L.P. Heasley, executors of the estate of Harry Heasley, deceased, were substituted as parties plaintiff.

        Judgment for plaintiff.

        This case having been heard by the Court of claims, the court, upon the evidence and the report of a commissioner, makes the following special findings of fact:

        1. March 2, 1939, a petition in this case was filed by Harry Heasley of Emlenton, Pennsylvania, as plaintiff, who died on April 19, 1941. Oil City National Bank of Oil City, Pennsylvania, and Nell P. Heasley of Emlenton, Pennsylvania, executors of the estate of Harry Heasley, deceased, were duly substituted as parties plaintiff.

        2. March 15, 1935, the decedent filed an income tax return for the calendar year 1934 with the Collector for the Twenty-third District of Pennsylvania. The return disclosed a taxable net income of $49,462.75, and a tax liability of $6,899.32. The tax was duly paid by decedent in installments during the year 1935.

        3. After 1935, additional income taxes for the year 1934 were assessed against the decedent, which were paid in 1936 and 1937. The total income taxes and interest paid by the decedent for the year 1934 are as follows:

Date	Tax	Interest
---------------	---------	----------------
Mar. 15, 1935 ..	$1,724.83	................
June 5, 1395 ...	1,724.83	................
Sept. 4, 1935 ..	3,449.66	................
Oct. 19, 1936 ..	9,304.96	................
Dec. 11, 1936 ..	.........	$883.97
Mar. 24, 1937 ..	18,827.17	2,271.64
	---------	----------------
Total .......	35,031.45	3,155.61

        4. In the year 1934, Harry Heasley, the decedent, received dividends from the Devonian Oil Company amounting to $124,505.

        The Commissioner of Internal Revenue determined that 74.0548% of the $124,505, or $92,201.93, was taxable, and that the balance, representing return of capital, was nontaxable. The Commissioner included the $92,201.93 in decedent's income for 1934 as part of the total taxable dividends of $112,742.32.

        5. June 7, 1938, the decedent filed a claim for refund of $18,525.92 of the taxes paid by him for the year 1934. In support of this claim decedent stated that "of the dividends received from the Devonian Oil Company in the year 1934 aggregating $124,505, the taxable portion under the law was $54,010.27, or $43.38% of the aggregate." The claim for refund, Exhibit E to the stipulation of facts, was rejected on March 19, 1939.

        All exhibits herein referred to are made a part of this report by reference.

        6. In a letter to the Devonian Oil Company dated January 20, 1938, plaintiff's Exhibit 1, the Commissioner of Internal Revenue set out the computation of the net income or loss of that company for the period June 3 to December 31, 1920, and for each of the years 1921 to 1934, inclusive. The letter also set forth the Commissioner's determination of distributions made to stockholders of the Devonian Oil Company for each of the years involved and the amounts of such distributions which were paid out of earnings and the amounts which were paid out of capital.

        7. From 1920 to 1934, inclusive, the Devonian Oil Company was engaged in the buying and selling of oil and gas leases and in the production and sale of crude oil. During the years 1925 to 1934, inclusive, it disposed of numerous capital assets. The following is a summary for each of these years of the number of transactions, the cost of such assets, the accrued depreciation, the accrued depletion, the selling price, and the profit or loss realized:

        NOTE--Some parts of this form are wider than one screen. To view material that exceeds the width of this screen, use the right arrow key. To return to the original screen, use the left arrow key.

------------------------------------------------------------------------------------------------------------------
Year	Number of transactions	Total cost	Accrued depreciation	Accrued depletion	Selling price	Profit	Loss
--------		----------	----------	---------	------------	------	------------
1925....	19	$68,409.59	$8,187.03	$1,548.34	$12,683.81	......	$45,990.41
1926....	26	115,040.98	24,224.10	7,297.72	106,750.00	......	23,230.84
1927....	33	124,899.93	42,222.07	20,968.18	9,380.00	......	52,329.68
1928....	64	314,181.63	62,807.71	31,331.48	193,124.35	......	26,917.69
1929....	39	309,832.10	137,891.49	72,155.37	118,325.97	$18,540.73	............
1930....	25	87,289.66	24,300.19	36,932.07	53,660.66	27,603.24	............
1931....	45	173,421.79	31,565.00	69,317.46	193,634.46	121,095.13	............
1932....	36	175,831.95	135,472.80	8,553.41	37,776.48	5,97074	............
1933....	26	220,187.81	174,088.25	9,357.40	19,002.98	......	17,739.18
1934....	34	439,060.98	158,505.03	50,446.96	1,479,858.48	1,249749.49	............
------------------------------------------------------------------------------------------------------------------

        8. During 1934 the Devonian Oil Company made 34 different sales or dispositions of assets. There were disposals of assets in every month of that year except June and August. Among these 34 transactions was the sale of the Alford lease, the Ingram lease, and the Milstead lease, hereinafter referred to as the "three leases." The receipts from sales of the 34 transactions amounted to $1,479,858.48, and of this amount $1,419,311.61 was received from the sale of the three leases. The profit from the sale of the three leases was $1,270,998.57. Due to losses on some of the sales the profit from all the sales, including the sale of the three leases, was $1,249,749.49 (in plaintiff's Exhibit 1 this profit was adjusted by the Commissioner to $1,239,166.79).

        9. In arriving at decedent's total tax liability of $35,031.45, the Commissioner of Internal Revenue determined that decedent's correct net income was $116,354.23, which amount included taxable dividends in the sum of $112,742.32; that plaintiff had a personal exemption of $2,500 and an earned income credit of $300; that the total tax liability was $35,236.68; that there were credits against said tax of $172.43 representing tax paid at the source and $32.80 as foreign tax paid; leaving a total amount of tax due exclusive of interest of $35,031.45.

        10. During the year 1934 the Devonian Oil Company had outstanding in the hands of its stockholders 321,805 shares of stock at $10 per share; an additional 6,995 shares were held in the company's treasury, making a total of 328,800 shares. In that year the Company made five distributions to its stockholders, four of which were: 25 cents per share on January 20, April 20, July 20, and October 20, making a distribution on each of said dates of $80,451.25.

        On April 1, 1934, the Devonian Oil Company sold the three leases, received payment on May 15, 1934, and on June 11, 1934, made a distribution to its stockholders of $5 per share, or a total of $1,009,025. None of the five distributions or dividends to its stockholders in 1934 were liquidating dividends in the sense that capital stock was called in and canceled. The Devonian Oil Company would not have had enough cash with which to make the distribution of $1,609,025 to its stockholders on June 11, 1934, without the money received from the sale of the three leases on April 1, 1934.

        11. In determining the amount of earnings and profits available for dividend payments to be distributed to stockholders from 1920 to 1933, inclusive, the Commissioner of Internal Revenue averaged the Devonian Oil Company's total income from all sources for each particular year and treated the dividends as paid from earnings or as representing returns from capital on the basis of an annual ratable accrual of income. The four dividends of 25 cents per share distributed in 1934 were treated the same way. The dividend of $5 per share paid on June 11, 1934, was chiefly paid out of cash received from the sale of the three leases, and the Commissioner allocated the cash from the sale of the three leases to the payment of this dividend and did not prorate it over the year's earnings or returns of capital.

        12. The defendant adheres to the computation made by the computation made by the Commissioner of Internal Revenue in his letter of January 20, 1938, plaintiff's Exhibit 1, which, beginning on top of page 13 thereof, is as follows:

Total income for 1934............................		$1,432,333.54
Net profits realized from sale capital assets asreported in corporation return......	$1,249,749.49
Deduct excess cost depletion erroneously charged toreserves to December 31, 1933, Depletion account bytaxpayer, Schedule "B" of return.....	10,582.70
	---------------	1,239,166.79
		-------------
Earnings of year 1934 or 365 days................		193,166.75
Earnings available one day $529.223973. Earnings fromOctober 20, 1933, through December 31,1933...............................		44,806.77
Earnings from January 1, 1934, to January 20, 1934, or:19 daysX$529.223973.......		10,055.26
		-------------
		54,862.03
Deduct distribution made January 20,1934............................................		80,451.25
		-------------
Amount paid from other thanearnings.....................................		25,589.22
		-------------
Earnings from January 20, 1934, to April 20, 1934, or90 daysX$529.223973................		47,630.16
Applied to distribution made April 30,1934............................................		80,451.25
		-------------
Amount paid from other thanearnings.....................................		32,821.09
		-------------
Earnings from April 20, 1934, to June 11, 1934, or 52daysX$529.223973................		27,519.65
Profit realized from sale of capital assets aspreviously shown in this letter.......		1,239,166.79
		-------------
Earnings available June 11, 1934..............		1,266,686.44
Distribution made June 11, 1934..................		1,609,025.00
		-------------
Amount paid from other thanearnings.....................................		342,338.56
		-------------
Earnings from June 11, 1934, to July 20, 1934, or 39daysX$529.223973....................		20,639.73
Deduct distribution made July 20, 1934...........		80,451.25
		-------------
Amount paid from other thanearnings.....................................		59,811.52
		-------------
Earnings from July 20, 1934 to October 20, 1934, or 92daysX$529.223973................		48,688.60
Deduct distribution made October 20,1934............................................		80,451.25
		-------------
Amount paid from other thanearnings.....................................		31,762.65
		-------------
Balance of unused earnings October 20, 1934, toDecember 31, 1934, or 73daysX$529.223973..........................		38,633.35

Recapitulation
----------------------------------------------------------------------------------------------------------------------
Date of distribution in 1934	Amount distributed	Amount from earnings	Percent taxable	From other than earnings	Percent non-taxable
--------------	------------	------------	-------	----------	-------
January 20 ......	$80,451.25	$54,862.03	68.1929	$25,589.22	31.8071
April 20 .........	80,451.25	47,630.16	59.2038	32,821.09	40.7962
June 11 .......	1,609,025.00	1,266,686.44	78.7239	342,338.56	21.2761
July 20 ..........	80,451.25	20,639.73	25.6550	59,811.52	74.3450
October 20 .......	80,451.25	48,688.60	60.5194	31,762.65	39.4806
--------------	------------	------------	-------	----------	-------
	1,930,830.00	1,438,506.96	74.5020	492,323.04	25.4980
----------------------------------------------------------------------------------------------------------------------

        13. Plaintiffs' computation which begins with the same income for 1934 as appears on top of page 13 of plaintiff's Exhibit 1, but by prorating the profit realized from sale of capital assets over the entire year the same as the Commissioner did with other earnings as the basis for arriving at the earnings of one day, is as follows:

Earnings for 1934 ............................	$ 193,166.75
Profit realized from sale of capital assets ...	1,239,166.79
	-------------
Total income for 1934 .....................	1,432,333.54
	-------------
Earnings for 1 day ($1,432,333.54/365) ............	3,924.20

        14. Decedent's ownership of stock in the Devonian Oil Company in 1934 and the distributions received by him were as follows:

-------------------------------------------------------------------------
Date	Shares owned	Distribution received
--------------	----------------	------------
January 20....	20,430	$5,107.50
April 20......	20,430	5,107.50
June 11.......	20,780	103,900.00
July 20.......	20,780	5,195.00
October 20....	20,780	5,195.00
	----------------	------------
Total......	................	124,505.00
-------------------------------------------------------------------------

[Copyrighted Material Omitted] [Copyrighted Material Omitted]         Helen Goodner, of Washington, D.C. (Geo. E.H. Goodner and D.F. Prince, both of Washington, D.C., on the brief), for plaintiff.

        John W. Hussey, 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, and LITTLETON, WHITAKER, JONES, and MADDEN, Judges.

        JONES, Judge.

        The sole question in this case is what part of a dividend received by Harry Heasley in the year 1934 from the Devonian Oil Company is taxable and what part is not taxable.

        During the years 1920 to 1934, inclusive, the Devonian Oil Company was engaged in the buying and selling of oil and gas leases and in the production and sale of crude oil. Between the years 1925 and 1934 it disposed of a great many of its capital assets. There were gains and losses in the sales of the various properties. The total operations showed a net gain for some years and a net loss for others.

        The issue in this case grows out of a transaction during the year 1934, the taxes for that year being paid in the year 1935, with additional special assessments for 1934 paid in 1936 and 1937.

        During the year 1934 the Company made 34 different sales of assets. Sales were made in every month of the year except June and August. Among the 34 transactions was the sale of the Alford, Ingram and Milstead leases, which will be referred to as the three leases. Total sales for the year amounted to $1,479,858.48. Of this amount $1,419,311.61 was received from the sale of the three leases. The profit from the sale of the three leases was $1,270,998.57. Due to losses on some of the sales the profit from all the sales during 1934, including the sale of the three leases, was $1,249,749.49.

        During 1934 the Company paid four regular quarterly dividends of 25 cents per share, thus making a distribution of $80,451.25.

        On April 1, 1934, the Company sold the three leases, receiving payment May 15, 1934. On June 11, 1934, it made distribution to its stockholders of $5.00 per share, or a total of $1,609,025.

        On June 11, 1934, Harry Heasley owned 20,780 shares out of a total of 321,805 outstanding in the hands of stockholders. He received dividends thereon in the total amount of $124,505 during 1934.

        In arriving at the amount of earnings available for dividend payments in each of the years 1920 to 1933, inclusive, the Commissioner of Internal Revenue averaged the Devonian Oil Company's total income from all sources for the year, treating the income as accruing ratably throughout the year. For the year 1934 he used the same method as to the four regular quarterly dividends, but applied a different method for determining the operating income for the profit from the sale of the three leases. The profits from the sale of these three leases he did not treat as having accrued ratably.

        The defendant contends that the profits from the sale of the major capital asset need not be prorated over the year as ordinary income, but as profits available for a special dividend distribution.

        In the light of the peculiar facts of this case, we do not think that the Commissioner of Internal Revenue was justified in departing from the method which he had used during the previous years. During the previous years as well as during the year 1934 there had been numerous sales of leases and other assets. Some of these showed gains, some of them showed losses. It was practically impossible to tell until the end of the year whether there would be a gain or a loss for the year. In treating this particular transaction separately and in arriving at his determination the Commissioner of Internal Revenue did not take into consideration overhead and other operating costs. He did not take into consideration either depreciation or depletion for the year 1934, though these had been taken into account in previous years.

        True, this was a large transaction and undoubtedly showed a profit, but with all these factors present, we do not see how the Commissioner could know just what that profit would be until the end of the year when the various factors and the amount involved in such factors could be known and until the further losses and profits for the year had been ascertained. In the sale of numerous assets in the oil business it is always possible that profits will be almost if not completely absorbed by other losses during the operating year.

        Practically the same question was considered by the Board of Tax Appeals in the case of Gardner Governor Co. v. Commissioner, 5 B.T.A. 70, except in that case the position of the parties was reversed, the Government contending for and securing a decision to the effect that the losses should be prorated through the year in order to determine whether there was a net gain or a loss. The Board in that case commented upon the endless confusion and disputes that would arise if an arbitrary method were to be used as to isolated transactions. In a memorandum opinion by the Board of Tax Appeals entered November 6, 1941, in Boylston Market Association C.C.H. (1941, par. 7769-B), it was held that a method used consistently over a period of years should be continued.

        The Government having taken one position in the Gardner case, supra, and having prevailed, it does not seem just that it should now be permitted to take a directly opposite position and prevail again merely because it would mean more money in the individual case, especially in view of the confused consequences that would necessarily follow. We do not think the cases of Mason v. Routzahn, 275 U.S. 175, 48 S.Ct. 50, 72 L.Ed. 223 or Edwards v. Douglas, 269 U.S. 204, 46 S.Ct. 85, 70 L.Ed. 235, applicable to the facts of this case. Entirely different questions were presented in those cases.

        In the instant case the special dividend distribution was considerably more than the profits from the sale of the three leases and considerably more than the total profits from the entire year. In the many sales that were being made involving both profits and losses, it was impossible to determine at the time of the special distribution or at the time of the sale of the property or at any period during the operating year just what the profits, if any, would be during that year. If a separate method is to be used in reference to a transaction simply because it is large, then there is no logical dividing line and there would be no sure method by which the taxpayer could know in advance into just what classification any individual item would fall. Numerous lawsuits and consequent uncertainty would inevitably result.

        In the facts of this case the taxpayer was entitled to the usual method of prorating the profits over the year and to have the tax levied on the basis of the net earnings for the year in accordance with the method used by the Commissioner of Internal Revenue in calculating the tax of the same company for the previous several years.

        Plaintiffs are entitled to recover the sum of $18,525.92, with interest thereon at the rate of 6 percent per annum from March 24, 1937.

        It is so ordered.

        WHALEY, Chief Justice, and WHITAKER and LITTLETON, Judges, concur.

        MADDEN, Judge (dissenting)

        The question is whether a $1,239,166.79 profit received on May 15, 1934, by Devonian Oil Company from the sale of three leases, and distributed to its stockholders in a special dividend on June 11, 1934, should be treated as having been earned by Devonian before, or after, June 11. The mere statement of the question would seem to answer it. It was in fact earned and received on May 15.

        Plaintiff argues that we should treat the profit as if it had been received a little at a time throughout the entire year 1934, one three hundred and sixty-fifths of it on each day. The effect of our indulging in this fiction would be to make more than half of this sum nontaxable to the stockholders, including plaintiff, who received the profit by way of a special dividend, since, upon our assumption, we would have to regard more than half of the distribution of this profit as a distribution of capital.

        The statutes are plain. Dividends paid to a stockholder constitute income in his hands for income tax purposes, if they are paid out of earnings or profits of the corporation and not out of its capital. The Revenue Act of 1934, c. 277, Sec. 115, 48 Stat. 680, 26 U.S.C.A.Int.Rev.Acts, page 703, provides as follows: "(b) Source of Distributions. For the purpose of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. * * * " By this statute the Commissioner of Internal Revenue was, I think, required to treat this distribution on June 11 as having been made from the May 15 profit.

        Plaintiff urges that because the Commissioner had, in other years, and in 1934, apportioned the Devonian Company's ordinary profits over its fiscal year in determining what proportion of its regular quarterly dividends came from income and not from capital, he must do the same with this special distribution of an extraordinary profit. The process of apportioning the earnings over the year is in the ordinary case a convenience to the corporation, the taxpayer-stockholder, and the Government. It saves the corporation the expense and trouble of making accountings at the several times in the year at which it pays its dividends, and permits it instead to have one accounting to show how its affairs stood for the entire year. It saves the Government the expense and trouble of checking and verifying four accounts per year instead of one. Hence the practice seems to have been put into effect by the Commissioner by common consent and in the interest of efficient administration.

        The practice of apportionment would have served no purpose of convenience in the case before us. Both the profit and the distribution were so extraordinary, in comparison with the regular business of the Devonian Company that a single look at the books shows where the money that was distributed came from, and when.

        In Edwards v. Douglas, 269 U.S. 204, 46 S.Ct. 85, 70 L.Ed.235, the Supreme Court of the United States approved the practice of apportionment, when there was no showing that the practice operated to the prejudice of the taxpayer. In Mason v. Routzahn, 275 U.S. 175, 48 S.Ct. 50, 72 L.Ed. 223, that Court refused to sanction apportionment when its effect was to impose the higher tax rates of a later year upon income that had in fact been earned before that year. I think we should not require the Commissioner to use apportionment when it is demonstrable that it deprives the Government of revenue due it under the plain terms of the statute. I would dismiss plaintiff's petition.