Opinion
No. 44071.
March 3, 1941.
Ralph P. Wanlass, of Washington, D.C. (Walter G. Moyle and Earl B. Breeding, both of Washington, D.C., on the brief), for plaintiff.
J.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, LITTLETON, WHITAKER, JONES, and MADDEN, Judges.
Proceeding by the Third Scottish American Trust Company, Limited, against the United States, for refund of alleged over-payment of income taxes.
Judgment for plaintiff in accordance with opinion.
This case having been heard by the Court of Claims, the court, upon the evidence adduced and the report of a commissioner, makes the following special findings of fact:
1. Plaintiff is a corporation organized under the Companies Acts of Great Britain, 1862 to 1867, with its principal place of business at 22 Meadowside, Dundee, Scotland, and without an office, place of business or agent in the United States.
The Government of Great Britain permits citizens of the United States to prosecute claims against it in its courts.
2. On its income-tax return for the calendar year 1933, duly filed with the Collector of Internal Revenue at Baltimore, Maryland, plaintiff reported interest received from sources within the United States of $15,560, and dividends received from domestic corporations of $31,581.61. But it claimed deductions on said return which exceeded the income reported by the amount of $10,674.81, resulting in a net loss from sources within the United States. However, taxes in the total amount of $1,413.71 had been withheld at the source by the parties from whom plaintiff received interest and dividends, and these parties had paid said taxes to the Collector of Internal Revenue.
3. Claiming a net loss and therefore, that no taxes were due the defendant, plaintiff duly filed a claim for refund for the amount of $1,372.11. This claim was allowed by the Commissioner in the amount of $339.11, but the balance was rejected.
On its return plaintiff claimed a deduction of $10,393.86 interest, losses of $3,639.50, dividends of $31,581.61, "appropriate proportion of British income tax applicable to United States income, $11,844.79," "appropriate proportion of rent, rates, charges, etc., to United States income $316.66." The Commissioner disallowed in full the interest claimed as a deduction, and reduced the amount claimed on account of proration of British income tax by the amount of $7,961.99, and he reduced the amount claimed for proration of management expenses by the amount of $134.22.
With reference to the interest claimed as a deduction, which was disallowed by the Commissioner, the Commissioner said: "It is held that interest paid by home office is not an allowable item to be prorated as deduction against taxable income from sources within the United States when such income is entirely interest."
He reduced the deduction for British income taxes and for management expenses because he held that the ratable part of these taxes and expenses which might be deducted was to be ascertained by taking such part thereof as the ratio of the taxpayer's taxable income from sources within the United States bore to its total income; whereas, the taxpayer had taken that part thereof which the ratio of its total income from sources within the United States, including income not subjected to the tax, bore to its total income.
4. During the year 1933 plaintiff paid £14,000 to holders of its 4 percent debenture stock of the par value of £350,000; and £4,951 to holders of its terminable debentures of a par value of £100,000; also British income taxes of £21,669 7s. 10d.; management expenses of £365 2s. 2d.; salaries to clerks of £984 8s. 4d.; and fees to directors of the corporation for services rendered in the sum of £2,604 19s. and Id.
5. Plaintiff's total gross income for 1933 from all sources, including income from sources within the United States, was £85,945 19s. and 8d. At a rate of exchange of $4.15 1/2, this amounts to $357,105.56. Its total income from sources within the United States was $47,141.61, of which $31,581-61 was dividends from corporations chartered under the laws of the United States.
6. The British income taxes paid by plaintiff were computed on the basis of its entire income, including income from sources within the United States.
7. The debentures, upon which a portion of the interest aforesaid was paid, read in part as follows: "We, the Third Scottish American Trust Company, Limited (hereinafter called the Company) incorporated under the Companies Acts, 1862 to 1867, acknowledge that we have borrowed and received from _____ the sum of _____, which sum we bind and oblige ourselves to repay to the said _____, within our Registered Office at Dundee for the time being on the _____ day of _____, Nineteen hundred and _____, or on such subsequent date as may be mutually agreed upon by Minute to be endorsed hereon, with the Interest of the said principal sum at the rate of _____ per centurn per annum from the _____ day of _____, Nineteen hundred and _____, to the date of payment before specified, and thereafter at such rate as may be agreed upon in the event of the Loan being continued by any Minute endorsed hereon as aforesaid, which Interest shall be payable half yearly upon the _____ day of _____ and the _____ day of _____ commencing payment of the said Interest on the _____ day of _____, Nineteen hundred and _____, for the Interest then due."
The debenture stock certificates, upon which a portion of the aforesaid interest was paid, read in part as follows: "This is to certify that William Robert Anderson, Clerk, Ivybank, Montague Street, Barnhill, Broughty Ferry, is the holder of One Hundred Pounds Debenture Stock of the Third Scottish American Trust Company, Limited, bearing interest at the rate of four percent per annum payable by equal half yearly instalments on the first day of January and the first day of July in each year and issued upon and subject to the conditions printed on the back hereof."
The agreement, under which these debentures and debenture stock certificates were issued, recites, among other things: (1) it was issued pursuant to the power granted plaintiff in its charter to borrow money; (2) the right of both the holders of the debentures and of the debenture stock certificates to interest was not dependent upon whether or not the company had earnings or whether or not there was a surplus sufficient to pay the interest; (3) on default in the payment of interest the holders of both the debentures and debenture stock certificates could force collection of both principal and interest "by summary diligence or otherwise in the manner hereinafter provided." After so providing, the instrument, in articles 6, 7, and 13 thereof, provides as follows:
"6. When and so soon as the Stock and Debentures shall become payable in terms of the preceding Article, the Trustees may, in their discretion, and on the facts in respect of which such Stock and Debentures shall have become payable coming to their knowledge (without any request or assent), and shall, upon the request, in writing, of the holder or holders of one-half of the Stock and Debentures at the time being issued and outstanding (and without any consent on the part of the Company or its successors) take such steps as the Trustees think fit to enforce the payment by the Company of the principal moneys and interest outstanding and to become due in respect of the Stock and Debentures. A Certificate under the hand of a majority of the Trustees if more than one, or, if a Company is Trustee, under the hand of any two of its Directors, or of their law agent, shall be final and conclusive evidence of the occurrence of any of the events specified in the preceding Article.
"7. Before taking any legal proceedings to enforce payment as aforesaid, the Trustees shall (except when in their opinion further delay would imperil the interests of the Stockholders or Debentureholders, or in the event of an order being made or an effective resolution being passed for the winding-up of the Company) give to the Company written notice of their intention to proceed, and shall not take any legal proceedings if, in the event of any default in payment of any principal moneys or interest, the Directors shall satisfy the Trustees that payment of the principal or interest so in arrear will be made within one calendar month next after such notice shall have been given to the Company.
* * * * * *
"13. The Trustees in entering into these presents shall be held to do so as representing the whole body of Stockholders and Debentureholders, and the obligations undertaken by the Company under these presents and any Personal Bonds shall, except as aftermentioned, only be enforceable at the instance of the Trustees, and individual Stockholders shall not have any right of action against the Company except through the Trustees. But notwithstanding the preceding part of this clause and in addition to the provisions of Article 5 hereof, each individual Debentureholder shall be entitled to enforce the obligations contained in his Debenture and under these presents in any of the events specified in Article 5 hereof."
I. The plaintiff is a foreign corporation chartered under the laws of Great Britain. During the year 1933 it derived income from sources within the United States consisting of interest and dividends. It seeks to deduct from such gross income a "ratable part" of its home office expenses, interest and British income taxes. The first question presented is the proper method of determining this "ratable part."
The plaintiff says that this ratable part is the ratio between all of its gross income in the United States, including dividends, and its total gross income from all sources. The defendant says that the ratable part is the ratio between plaintiff's income from sources within the United States, exclusive of dividends, and its total income from all sources — in the latter of which, strangely enough, it includes the same dividends which it excludes in determining income from sources within the United States.
Section 119(b) of the Revenue Act of 1932, 47 Stat. 209, 26 U.S.C.A. Int.Rev. Acts, page 527, is the basic section to be considered. It reads: "(b) Net Income from Sources in United States. From the items of gross income specified in subsection (a) of this section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the United States.
The items of gross income specified in subsection (a) are items to be included in determining "income from sources within the United States." From these items subsection (b) permits the deduction of expenses, etc., "properly apportioned or allocated thereto"; that is to say, expenses incurred in the earning of the income specified. Further, it was recognized that the taxpayer would incur expenses attributable to the earning of both its United States and its other income, and that it would not be possible to say with any degree of accuracy just how much of it was incurred in the earning of United States income and how much in the earning of other income. So, in such case it was provided that the taxpayer might deduct a "ratable part" thereof. This meant, of course, such part as the ratio of its gross income from United States sources bore to its total gross income. All that it is necessary for us to do, therefore, to decide the issue between the parties is to look to the Act to see if dividends are included in what the statute defines as gross income from sources within the United States. We find they are specifically included.
But the defendant says Congress could not have intended to include dividends because they are not subject to the tax. Be that as it may, Congress nevertheless explicitly did include them. The Act says: "The following items of gross income shall be treated as income from sources within the United States." It first lists interest, and then dividends from two classes of corporations — and it is conceded the corporations from which these dividends were received come within one of the classes named — and then other items with which we are not concerned.
This being true, we have no option but to apply the Act as it is written. If Congress failed to provide for a contingency for which it should have provided, the courts are powerless to supply the omission. If the statute is plain and unambiguous, it must be enforced as written, although the result be illogical.
In support of its position the defendant cites London and Lancashire Ins. Co., Ltd. v. Commissioner, 34 B.T.A. 295. The question there was the same as the question here, but it arose not under the sections of the Act we have under consideration, but under those sections applicable to insurance companies. Section 204(a) of the Revenue Act of 1928, 26 U.S.C.A. Int.Rev. Acts, page 412, included dividends within an insurance company's gross income, but subsection (c) permitted the deduction of "the amount received as dividends from corporations as provided in section 23(p)." There is no such provision in section 119(b) of the Revenue Act of 1932; nor was there any such provision in section 119(b) of the Revenue Act of 1928, 26 U.S.C.A. Int.Rev. Acts, page 391. Furthermore, subsection (e) of section 204 of the Revenue Act of 1928 provided that "Nothing in this section shall be construed to permit the same item to be twice deducted," and the Board expressly rested its decision on this subsection, holding that to permit dividends to be taken into consideration in determining the ratable part of expenses, etc., to be deducted would be tantamount to permitting them to be deducted twice. This subsection relates alone to insurance companies and has no application to a taxpayer of the character of plaintiff in the case at bar.
The language of the sections before us is so explicit that we have no option but to hold that in determining the ratable part of the deductions to which plaintiff is entitled, we must take that part of them which plaintiff's total gross income from sources within the United States, including dividends, bears to its total income from all sources.
II. The defendant in its brief says that the plaintiff has not shown that the following claimed deductions "are connected with income from sources within the United States," to wit: (1) home office general expenses; (2) British income tax; (3) interest paid to debenture holders and debenture stockholders.
1. It is no doubt true that the general expenses of the home office were incurred primarily in the carrying on of the business of the company outside of the United States, but it cannot be said that some part of these expenses were not spent in connection with the making and supervision of the plaintiff's investments in this country, from which it received interest and dividends. Just what part was spent in connection with United States investments it is impossible to say. This contingency was recognized by Congress when provision was made for the deduction of a "ratable part of any expenses, losses, or other deductions which can not definitely be allocated to some item or class of gross income." The plaintiff is entitled to this deduction.
2. The defendant concedes that the British income tax was levied on the plaintiff's entire income, including its income from sources within the United States. It is, therefore, manifestly proper that a ratable part of these taxes should be deducted from United States income in determining the tax to be paid the defendant.
3. The defendant concedes in its brief that the interest paid the debenture holders and debenture stockholders were interest payments, rather than distributions in the nature of dividends. We have carefully examined the debenture certificates and the debenture stock certificates and the instrument securing them. We have no doubt that the payments made on the debenture certificates were interest, but the nature of the payments on the debenture stock certificates is not so easy to determine. After careful consideration, however, and upon the authority of the cases cited on this point in the plaintiff's excellent brief, we hold that the returns on the debenture stock were also interest and not dividends.
In so holding we are influenced primarily by the fact that interest on these certificates was payable irrespective of the sufficiency of the earnings or of the surplus of the company, and also by the fact that both the principal and interest due on these certificates were entitled to share in the assets of the company on liquidation pari passu with unsecured creditors. It is true that the holders of these certificates could not demand a return of the principal so long as the company was not in default in the payment of interest and so long as it complied with the other conditions of the indenture securing them; but this alone is not sufficient to characterize the transaction as a purchase of shares in the company rather than a loan of money to it. The holder risked neither his capital nor the return thereon on the fortunes of the company. His return was payable whether the company made profits or not, and he secured the return of his principal on a parity with other unsecured creditors of the company. Such are the characteristics of a loan to the company, rather than of a purchase of a proprietary interest in it. See in particular the opinion of the 4th Circuit Court of Appeals in Helvering v. Richmond, Fredericksburg Potomac Railroad Co., 90 F.2d 971; and also of the 2nd Circuit Court of Appeals in Commissioner v. O. P. P. Holding Corporation, 76 F.2d 11; and of the Chancery Division of the Supreme Court of Judicature of Great Britain in In re Bodman, L.R.(1891), 3 Ch. Div. 135.
Interest paid on borrowed money, of course, has a connection with all of the company's investments, including its investments in the United States, and, therefore, plaintiff is entitled to deduct a ratable part of this interest.
Entry of judgment will be delayed 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.
MADDEN, JONES, and LITTLETON, Judges, concur.
WHALEY, Chief Justice, concurs in the conclusion.