Petitioners Reply Brief — Interstate Transit Lines v. Commissioner

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Supreme Court of the United States

Ocroper Tzam, 1942.

No. 352

INTERSTATE TRANSIT LINES,

Petitioner,

GUY T. HELVERING, COMMISSIONER OF

INTERNAL REVENUE,

Respondent.

ON WRIT OF CERTIORARI TO THE CIRCUIT COURT

OF APPEALS FOR THE EIGHTH CIRCUIT

REPLY BRIEF OF PETITIONER.

JoserH F. Mann,

Darwin P. Krxoaey, Jr.,

120 Broadway,

New York City.

Nxe_son TRoTTMAN,

400 W. Madison Street,

Chicago, [linois.

Attorneys for Petitioner.

ee ——

Midwest Law Printing Co., 340 W. Huron 8t., Chicago

TABLE OF CONTENTS.

PAGE

Summary of Argument in Reply ...........................-..0- 1-3

BIE s.cisni 0s cise pl cacceesdennaah eadadiadcandininabestia lioaheetinicsniniileaptinhaicaniits 3

No Question Involved of Any Attempt to File

NN i csincecasscctetnnniienck 3

Analysis of Respondent’s Argument that the

Deficit May Not Have Resulted from Charges

Deductible Otherwise from Gross Income.......... 4

Discussion of Respondent’s Argument Concern-

ing the Agency Relationship ......................0...0....... 8

Respondent’s Treatment of Southern Pacific v.

Lowe, and Gulf Oil Corporation v. Lewellyn...... 11

Reply to Respondent’s Discussion of Question

Whether Payment of Scbsidiary’s Loss is Or-

dinary and Necessary Expense | ............00.0.0......-. 13

Reply to Respondent’s Suggestion that the De-

duction Claimed Was Mere Book Entrv.............. 20

ONIN, Seiden eaccxac chaih alc agacalaliclamhersscummamsasceniiccsns 22

SII. -sassessissnniens Acasa basiedusatacanedbaaleabadalanaaiesadmedcocaiaed pocindesaiaen-c 23

TABLE OF Cases.

American Package Corporation v. Commissioner, 125

me, Ce em, RO i Bn, hs I rrassiceittttsstrnteeernrne 19

Burnet v. Clark, 287 U. S. 410, 53 S. Ct. 207, 77 L.

ST TU nseeianisioeiesebakaseidunhlesibiotanscsiactintaeicinaaiaeanilins 10, 17

Burnet v. Commonwealth Improvement Company, 287

U.S. 415, 53 S. Ct. 198, 77 L. Ed. 399... Me. 10

tna

Dalton v. Bowers, 287 U. S. 404, 53 S. Ct. 205, 77 L.

NAR eat ie nen Nia rome cent dE A Beane ee 17, 18

Deputy v. DuPont, 308 U. S. 488, 60 S. Ct. 363, 84 L.

cs asada snaeninamenininseeiameroaimenes 18

Esmond Mills, et al. v. Commissioner, 132 Fed. (2d)

api eet oda RE FRE el A OO ee RS ER 19

Gulf Oil Corporation v. Lewellyn, 248 U. S. 71, 39 S.

eB III nee ee ee ee 2,11

Helvering v. Wood, 309 U. S. 344, 60 S. Ct. 551, 84

ia: SEE MEE -<icsctsicaoneemecnien, Seemeokiicsnarasonnelieiencnamiabnomiudcccutbisens 8,9

Higgins v. Smith, 308 U. S. 473, 60 S. Ct. 355, 84 L.

& paaaenun UR ONOMIET Re Se PON: ORME TE PT 10, 11, 12

Inland Development Co. v. Commissioner, 120 Fed.

(3a) SES ............ aeiie sadhtaciciaieaouniaashont ald eddedpiepasante 48, 1§

Lynch v. Hornby, 247 U. S. 339, 38'S. Ct. 543, 62 L.

id. 1149. ............ eildiinkd biibieshabunedabicedcataemanlbantalaanmsaaeniucaiaal 2,12

Nationa) Piano Manufacturing Company v. Burnet,

I, I cr emis 16

New Colonial Tee Company v. Helvering. 292 U. S.

435, 54S. Ct. 788, 78 L. Fd. 1348........ ae Sahmaeioy 17

Odhams Press, Ltd. v. Cook, 56 Times Law Reports,

are cae oe. FP TT Ne sen RTI oat TR Ne 18

Robinson v. Commissioner, 53 Fed. (2d) 810, 79 A.

PE SPARE a Uemibn cage eon aN EB ICT a 16

Southern Pacific Company v. Lowe, 247 U. S. 330, 38

See FF 8 8 Se ne 2,5, 11, 15, 21

Walker v. Gulf & Interstate Ry., 269 Fed. 885.000... 18, 19

Welch v. Helvering, 290 U. S. 111, 54 S. Ct. 490, 78

ies: A SIE xircblntceasasnieinsasunubdeoutiatiaidddamtatsaaiinbninne casas 18

Wiggin v. Commissioner, 46 Fed. (2d) 7430000000000... 17

In Tux

Supreme Court of the United States

Octoser Term, 1942.

No. 352

INTERSTATE TRANSIT LINES,

Petitioner,

GUY T. HELVERING, COMMISSIONER OF

INTERNAL REVENUE,

Respondent.

ON WRIT OF CERTIORARI TO THE CIRCUIT COURT

OF APPEALS FOR THE EIGHTH CIRCUIT

REPLY BRIEF OF PETITIONER.

To the Honorable Chief Justice and Associate Justices of

the Supreme Court of the United States:

SUMMARY OF ARGUMENT IN REPLY.

The question of consolidated returns is not involved

and the legislative history on this subject is immaterial.

Respondent’s argument that the deficit may reflect

items not properly deductible from gross income is a new

contention made here for the first time, and represents

a departure from the cheory on which the case was tried

and on which both tribunals below proceeded. The record

does, however, contain evidence tending to prove that the

deductions were proper as ordinary and necessary ex-

penses. The single item of ‘‘bus rental,’’ which respondent

suggests should, if Stages is Interstate’s agent, be elim-

inated from the computation, is also reflected in Inter-

state’s gross income, so that if the agency relationship is

given effect the items offset each other and Interstate’s

net income is not artificially reduced by an intercompany

account, as respondent suggests.

Respondent concedes the ‘‘necessity;’’ and, the Cali-

fornia operation being a part of Interstate’s business en-

terprise, the expense of such California operation was

‘‘ordinary’’ as well. Especially is this true as to the

interstate portion of the California carriage. Respond-

ent’s assertion that Interstate’s business included neither

interstate nor intrastate carriage in California conflicts

with his own pleading, and is contrary to the assumption

made by the court below and contrary to the evidence.

His contention ignores realities. The fact is that Stages

was but a part, and a small part, of a complete integrated

bus transportation system.

The attempted distinction of the Southern Pacific ( um-

pany and Gidf Ou Corporation cases on the ground that

they were concerned with the question of pre-1913 versus

post-1913 earnings ignores this Court’s conclusions in each

of these cases that what was the subsidiary’s income had,

because of considerations which are the same as those

here urged on petitioner’s behalf, already become the

parent's income. Respondent’s argument ignores the fact

that, under Lynch v. Hornby, 247 U. S. 339, 38S. Ct. 543,

62 L. Ed. 1149, if, because of such considerations, the

income had not already become the parent’s, a dividend

out of such pre-Mareh 1, 1913 income would if declared

after that date have heen taxable.

Respondent inconsistently asserts not only Stages’ sep-

arate entity but the right. in same connection, in effect

to disregard that entity, or at least treat it as of little

significance, in considering the question of the effect of

the contracte His contention appears to be that because

of the sole fact that one of the contracting parties was

the other's only stockholder, the tax consegnences of the

contracts should be different from what they would be if

the parties were entirely independent. There is no ques-

tion of fraud nor is any challenge made to the allocation

provided for by the contracts. Consistency in the matter

of Stages’ separate existence requires recognition of the

contractual arrangement, which in effect was one for an

agency, and strengthens the evidence establishing the

agency.

Respondent’s suggestion that the claimed deduction is

bottomed on a ‘‘mere book entry’’ is not supported by the

record, which on the contrary establishes that it repre-

sents a real economic expense. Both tribunals below pro-

ceeded on the assumption that the item is real, not a

‘*mere book entry.’’ Th °~idence establishes that such is

the fact. "

ARGUMENT.

No Question Involved of Any Attempt to File

Consolidated Returns. —

(Numerals in Parentheses Refer to Pages of Transcript.)

Much of respondents’ brief is devoted to a discussion

of propositions not in controversy. Concededly mere

stock ownership, which prior to 1934 would alone have

entitled any two or more corporations to file consoli-

dated returns, did not in 1936 have that effect. Respond-

ent's extended summary of the legislative history of the

1934 change in regard to consolidated returns amounts to

no more than saying that it was the intent of Congress that

every corporation (except railroads) file returns of and

pay taxes on its own income. This proposition, which is not

disputed bv petitioner, does not, however, reach the prob-

jem in the present case. The statute is plain enough in this

respect, and the legislative history adds nothing by way of

aid to its construction. Neither a holding that payment of

the deficit is an ordinary and necessary expense of the

parent nor one that Stages is Interstate’s agent (either as

to all California business or as to the interstate portion

only) can affect Stages’ obligation to return sts net income

for taxation, and pay a tax thereon if any tax is due.

Payment hy Interstate of Stages’ deficit automatically

must he reflected in Stages’ gross income. No question

is involved here of any income which may escape tax, nor

of duplicate deductions. Interstate does not claim that a

consolidated return be permitted in spite of the statute.

It is contending that it should pay a tax on its net income

only, and that respondent is attempting to tax it on

$28,100.66 mere of net income than it actually obtained.

Respondent avoids discussing the unrealitv of treating

Stages as anvthing but an agent, for a legitimate business

purpose, of Interstate. The legislative hisiorv of the

amendment abolishing the consolidated return privilege

has nothing, to do with this matter, and is beside the point.

Analysis of Respondent’s Argument That the Deficit May

Not Have Resulted from Charges Deductible Otherwise

from Gross Income.

Although he admitted in his answer (13) that Stages’

deficit was $28,100.66, as alleged in the petition (4), re-

spondent now, for the first time, advances the argument

that the deficit may have resulted from improper charges.

-— ww

Heretofore in this litigation there has been no question of

this sort suggested, so that it is not surprising that the

Board of Tax Appeals, as respondent states (Brief, p.

13), made no findings ‘‘respecting the nature or deductibil-

ity of the items that produced Stages’ net operating loss.”’

if respondent is correct in contending that the items go-

ing into the calculation of the deficit should be scrutinized

(although this aspect of the matter was never in contro-

versy, so far as the record discloses), then, in the interest

of justice, the cause might well be remanded for appro-

priate findings on the subject, and, if necessary, for fur-

ther evidence. The record in its present shape does,

however, contain evidence tending to establish that the

claimed deduction is correct in amount and refleets only

proper items of deductions. Respondent’s emphasis on

this new proposition makes necessary some mention of

the evidence on this branch of the case.

After suggesting (Brief, p. 11) the possibility that

the deficit may have resulted from non-deductible items,’

respondent refers specifically to the expense item ‘‘bus

rental,’’ and then says that ‘‘a principal could not directly

claim a deduction fer rent charged by him against his

arent,’’ in which connection he cites Southern Pactfic Co.

v. Lowe, 247 U. S. 330, 38'S. Ct. 540, 62 L. Ed. 1142. mx-

hibit ( (66, 67) shows a complete itemization of expenses,

totaling $211,470.59, of which ‘‘rent of equipment’’ ap-

pears to be the only item not of the kind that would in-

volve cash payment to outside parties. Respondent is cor-

rect in pointing out that a mere inter-company charge

1. Respondent suggests Federal income taxes as an ex-

ample of such items. Taxes shown in the revenue state-

ment (Exhibit C) are $12,007.61. This is the amount re-

flected in the deficit. Taxes shown in the ledger account

(Exhibit A), when added, come to $14,739.98. The differ-

ence which is not reflected as a deduction, of $2,732.37

may well have represented Stages’ income taxes for prior

vears paid in 1936, although the record does not disclose

what is the fact in this regard, except that a small item of

* back Federal income taxes shown in the ledger account

acta ge mmant far thic inforonra

<—*

would not, standing alone, constitute a proper factor in

swelling the expense deductions, and therefore tne deficit.

But the argument proves too much. It also proves that the

inclusion in Interstate’s gross revenues of the correspond-

ing ‘‘bus rental’’ item should not have been reflected in

Interstate’s net income.' The items eliminate one another.

1. Gross revenues allocated to Stages were $183,365.60.

This is shown on the first page of respondent’s Exhibit C

(66), which is a statement of revenues and expenses of

Stages, Interstate, and another subsidiary (Interstate

Transit Lines, Inc.) which is not involved here. This total

of revenues includes $12,073.76 of ‘‘bus rentals.’’ Re-

spondent refers to page 62 of the record, on which page

there is shown his Exhibit A, which is the ledger account

showing monthly totals of cash payments by Interstate for

Stages, and monthly credits representing revenues allo-

cated to Stages. The ‘‘bus rental’’ credits, when added,

total $12,073.76, which is also the figure shown on the

revenue and expense statement; the ‘‘operating revenues”’

on this exhibit total $171,291.84; and the combined total

of both equals $183,365.60 of revenues, as shown on Exhibit

C. The debits of ‘*bus rentals’’ on the exhibit referred

to by respondent total $63,136.92, which represent charges

against Stages. On Exhibit C, the corresponding item

(shown under transportation expenses, at item 43 as ‘‘rent

for equipment’’) is shown, but as $63,226.92. (No explana-

tien appears for the $90 discrepancy.) The same exhibit

also shows a large item of ‘‘rent for equipment’’ received

by Interstate (at item 13 under operating revenues),

amounting to $149,941.37. This of course includes the

rentel charges against Stages. (The anditor, Hall, tes-

tified [48] that the item in favor of Stages designated as

‘‘rent for equipment”’ ‘‘represents the use of other com-

panies’ equipment—the use of the California Company’s

equipment on the properties of the otner lines,’’ and that

‘equipment rental which is shown here as being earned

by the Nebraska Coinpany [petitioner] is the rent of

If the expenses, which total $211,470.57, are reduced by

the ‘‘bus rental’’ item (or ‘‘rent for equipment,’’ as it is

termed in Exhibit C, which is shown on that exhibit as

heing $63,226.92),' automatically there must be eliminated

the same amount from Interstate’s gross income. The

other expenses shown on the revenue and expense state-

ment all appear to be out of pocket expenses actually paid

by Interstate. None of them appears to be of a character

that ix non-deductible. The elimination of this accounting

charge against Stages and of the corresponding credit to

Interstate would have the arithmetica! result of altering

the deficit figure and converting it to a profit, but it also

automatically would reduce Interstate’s gross income by

the same amount, and so would not affect the net result.

No question has been made heretofore of the propriety of

the accounting allocations as between the two companies.

While Stages’ expenses should not he inffted by a uni-

lateral charge representing, what would, in respondent’s

language, ‘‘simply be a transfer from the taxpayer's

right hand to its left,”’ (Brief, p. 12) this is no such case.

Here the charge is reflected by a corresponding increase in

Nebraska ears operated in California and Illinois terri-

tory.”’ The inference is plain that the $63,136.92 (or

$63,226.92, whichever is right) is included ax a part of the

$149,941.37 shown as an operating revenue item of Inter-

state; and that the $12,073.76 of ‘trent for equipment’”’

nominally credited to Stages is correspondingly reflected

as a charge against Interstate (at item 43). The net

result is of course that the $12,073.76 of bus rentals

‘*received’’ by Stages (and included in the $183,365.60 of

revenues) and the $63,136.92 (or $63,226.92) of similar

rentals ‘‘paid’’ hy Stages and included in the $211,470.59

of expenses shown on Exhibit (' were respectively re-

flected as expenses and receipts of Interstate.

1. The figure is badly blurred in some of the copies

attached to the transcript, but it can he demonstrated by

reference to the original record and by arithmetic that

the figure is $63,226.92.

tenets

Interstate’s gross income. The parties have tried the

cause on the theory’ that the deficit, of which ‘‘bus rental’’

constituted an item, was properly computed. The respond-

ent’s answer specifically admits (13) the allegation of

sub-paragraph 7 of paragraph V of the petition (5) that

the deficit amounted to $28,100.66. If respondent’s argu-

ment in this respect at this stage of the litigation has any

validity, it at most shouid caii for a remand to the Board

for further findings and if necessary further evidence.

Helvering v. Weod, 309 U. S. 344, 60 S. Ct. 551, 84 L. Ed.

796.

Discussion of Respondent’s Argument Concerning

the Agency Relationship.

Respondent, (Brief, p. 14) stresses the necessity of

organizing Stages to obtain the permit for intrastate

operation. He ignores completely the fact that in 1936

there was no legal obstacle to direct operation by Inter-

state of the local business. He makes the assertion (ibid)

that ‘‘had the application been made by Stages as agent

for the taxpaver the permit would not have heen granted ;’’

but the only requirement of local law as construed by the

Commission was that the certificate must run to a domes-

tic company. The operation in California was a part of

Interstate’s business enterprise. Respondent at the outset

of his argument (Brief. p. 8) concedes the ‘‘business neces-

sity.’’ This in effect is saving that the expense was

1. In Helvering v. Wood, the following appears in the

opinion: *‘For a wholly different reason, petitioner's (the

Commissioner) argument hased on § 22 (a) must fail. The

Board of Tax Appeals purported to place its decision

solely on § 166 and § 167 of the Act. Petitioner in his as-

signinents of error specifically mentioned only § 166 and

€ 167 not § 22 (a). In his brief before the Circuit Court of

Appeals petitioner expressly waived reliance upon any

section other than $166. Though petitioner in his peti-

tion for certiorari relied on § 22 (a), 1espondent in oppo-

‘‘necessarv.’’ Interstate, in the ordinary course of its

business, was engaged in bus transportation of which the

California interstate operation had been a part ever since

the trans-continental operation commenced. The limited

intrastate business was of the same general nature and a

part of the operation, as & whole, of a complete integrated

bus transportation business. Accordingly, the expense was

‘‘ordinary’’ as well and was an expense of petitioner’s

business. Certainly this is true as to the interstate portion

of it, which accounted for all of the expense, 4 circum-

stance which is also ignored by respondent, although

accepted as a fact by the court below (75).

—————————————

sition thereto took the position that that point was not

available to petitioner here as it was not raised below.

In view of these facts, especially the express waiver be-

low, we do not think that petitioner should be allowed to

add here for the first time another string to his bow. As

we have indicated, the issues under § 166 and § 22 (a)

are not coterminous. Though both deal with concepts of

ownership, the range of inquiry under the latter is broad,

under the former confined. To open here for the first

time and in face of the express disclaimer an inquiry

into the broader field is not only to deprive this Court of

the assistance of a decision below but to permit a xhift to

ground which the taxpayer had every reason to think was

ahandoned in the earlier stages of this litigation.”’

While in the present case there was no affirmative ‘‘dis-

claimer”’ of the point now advanced, yet the respondent’s

brief in the court below recognizes the deductibility, in

general, of the expense items and treats the deficit as a

true operating deficit. The brief contains no hint of his

present argument on this point, nor did either opinion

helow make the slightest reference to it.

Elsewhere in his argument (Brief, p. 30) respondent

makes the assertion that ‘‘the business of the taxpayer

included neither interstate nor intrastate carriage in

California.’’ This assertion is in direct conflict with his

own admission (13) that petitioner during 1936 ‘‘was en-

gaged in the operation of motor buses for the transporta-

tion of passengers between Chicago, Illinois, and Los

Angeles, California.’” It is also in conflict with the

assumption made by the court below (75) that Stages

was ‘‘an agent of the petitioner as a carrier of its

interstate traffic in California.’’ In spite of the plead-

ings, in spite of the close integration of the parties

(which alone has in many cases been sufficient to establish

the fact of agency), in spite of express recitals in the

absorption contract (57) that the operations were con-

ducted ‘‘solely for the benefit’’ of Interstate (Isnguage

which when construed in the light of the surrounding facts

and circumstances merely states in different words the

concept of an agency relationship), respondent either

ignores these realities, or treats them as of no significance.

Where the interests of the parties are reversed, respond.

ent customarily stresses the realities, and the necessity

of stern dealing with tax avoidance schemes, as he did in

Higgins v. Smith, 308 U. S. 473, 60 S. Ct. 355, 84 L. Ed.

4%, and Burnet v. Commonwealth Improvement Company,

1. Paragraph V. subparagraph 4 (5) of the petition

alleges that ‘‘since 1932 petitioner’s California business,

both intrastate and interstate, has been conducted by the

Stages Company and petitioner has done no business in

California.’’ This allegation read together with subpara-

graph 2 (4) amounts in effect to saving that Interstate’s

California business was conducted by Stages. Respondent

denied this allegation (13) but admitted (13) the allega-

tion of subparagraph (2) that petitioner was engaged in

the operation of buses hetween Chicago and Los Angeles.

The pleadings therefore establish the direct contrary of

what respondent has asserted (quoted in the text above).

987 U.S. 415, 53 S. Ct. 198, 77 L. Ed. 399." Here, however,

he avoids any attempt to support his position on the basis

of reality, seeks to extend the doctrine of cases aimed at

tax avoidance tc this ease, in which no such question is

present, and, with an emphasis on form instead of sub-

stance that he justly rejects when it is the taxpayer who

urges it, asserts (Brief, p. 15) that ‘‘the taxpayer cannot

now disavow the former’s (Stages’) separate existence or

legal responsibility.’’ It is not the taxpayer that is dis-

avowing Stages’ separate existence. Stages’ separate

existence is consistent with its position as a mere agent or

instrumentality of Interstate. It is respondent who is

insisting on disregard of actualities; for he would disre-

gard the facets evidencing Stages’ agency, and even dis-

avow his own formal admissions in the pleadings, and by

rejecting the actualities would deny to Interstate a dedue-

tion of a part of the actual cost of carrying on its busi-

ness.”

Respondent’s Treatment of Southern Pacific Co. v. Lowe,

and Gulf Oil Corporation v. Lewellyn.

Respondent attempts to distinguish Southern Pacific Co.

y. Lowe and the Gulf Oil Corporation case (248 U. S.

71, 39 8. Ct. 35, 63 L. Ed. 133) by urging that they

were concerned with the question of pre-1913 versus

post-1913 earnings. Yet he concedes (Brief, p. 17) that the

1. Respondent’s policy of attempting to extend the

principle of such cases, which tern largely upon the ques-

tion of tax avoidance devices, is in striking contrast to the

emphasis he placed on this aspect of Higgins v. Smith.

Excerpts from his brief in that case which illustrate that

emphasis are set out below in the Appendix p. 24}.

2. He also, in denying the significance of the absorp-

tion contract as one for an agency relationship, refuses

himself to accept the full significance of his own conten-

tion that Stages’ separate entity shonld he respected.

Infra, p. 13. te

haw.

decision in those cases ‘‘ was that the taxpayer’s relation to

their wholly owned subsidiaries was such that the income

accrued to the former before the 1913 tax date.’’ Pre-1913

income was not taxable; but that circumstance had nothing

to do with the question whether or not it was the parent’s

income, nor whether or not the subsidiary was the parent’s

agent. The considerations which led to the conclusion

that the pre-1913 income had already come into the par-

ent‘s hands are the same as those here urged on petition-

er's behalf. Under respondent's argument the Central

Pacifie’s pre-1913 income continued to be its, not South-

ern Pacifie’s, ineome on March 1, 1913. This, if true, would

have subjected a dividend out of that income to tax, as

this court held in Lynch v. Hornby, 247 U. S. 339, 38 S.

('t. 543, 62 L. Ed. 1149, a case ignored by respondent but

which demonstrates that it was not the fact that Central

Pacific had earned the income before 1913 that was sig-

nificant; it was the ‘‘ peculiar circumstances,’’ which before

the dividend was declared and before March 1, 1913 made

this income for all practical purposes that of Southern

Pacific, that led to the result. Courts which have cited

these two cases in support of the agency doctrine have

not attached any significance to the supposed distinction

because the earning of the income antedated 1913. Nor

does respondent do so when this suits his purpose.’

Respondent in this connection refers (Brief, p. 18) to

the identification of wholly owned corporations with their

owners as something to be done for tax purposes only

1. In his brief in this Court in Higgins v. Smith, he

twice cites these same cases for the proposition urged

herein by petitioner. See Appendix, txfra, p. 23. Except

for the fact that the present is a converse case, the quoted

excerpts are equally pertinent here.

‘when required to effectuate an expressed Congressional

poliey.’’* The policy expressed in section 13 of the statute

is that every corporation be taxed on no more than its

true net income. If the fact of a subsidiary’s agency for

its parent exists, that fact should, to effectuate that policy,

be recognized just as in the case of any agent.

Reply to Respondent’s Discussion of Question Whether

Payment of Subsidiary's Loss Is Ordinary and Neces-

sary Expense.

Respondent, under Point 1, contends, in effect, that the

contractual arrangement between parent and subsidiary

should be disregarded because of the close relationship,

and therefore that the obligation of the contract be ig-

nored. This contention is in harmony with respondent’s

general philosophy of ‘‘regarding’’ the entity when it

1. Respondent distinguishes Inland Development Com-

pany v. Commissioner, 120 Fed. (2d) 986, on the ground

of this argument based on ‘‘ Congressional poliey.’’ There

the Congressional policy was aimed at preventing tax

avoidance hy personal holding companies. The taxpaver

was literally within the definition of such a company if

a certain so-called ‘‘dividend’’ from a subsidiary were

included in its income. The interrelation was substantially

like the one in the present case. The court there accepted

the taxpayer's contention that the so-called ‘*dividend”’

was not in fact a dividend. In no substantial resnect can

the ease be distinguished froin the present one, unless hy

the circumstance that Interstate had at one time (but not

in 1936) been unable to carry on intrastate operations

directly. Giving effect to such a distinction would exag-

gerate the importance of the limited California intrastate

business and ignore the insignificance of the expenses

allocable to that business; ax’ in any event the payment

was none the less a business expense because it was for

what the foreign corporatior validly contracted to have

done in another jurisdiction, hut which had to be per-

formed for it by a local resident acting in its interest.

(See our original brief, page 22.

tae.

inereases taxes but of ‘‘disregarding’’ it when it operates

the other way. If that is the law, then a further hazard

is added to the conduct of business. Proper and lawful

business arrangements involving subsidiaries would un-

der resporndent’s philosophy expose a business enterprise

to the ever present danger of having one corporate entity

rule applied in the case of profits, and another in case

of loss. Here, however, to sustain the tax, respondent

inconsistently invokes both rules in the same connection.

He says (Brief, p. 24) that ‘‘the contention that an accrual

for a business expense can be taken on the basis of a con-

tractual obligation to make up Stages’ deficits must rest on

recognition that Stages is an entity separate and distinct

from the taxpayer for tax purposes,’’ but then immedi-

ately says (Brief, p. 25) that it ‘‘is certainly not the sort

of an arrangement the taxpaver would have made with an

independent carrier,”’ and that the stock in Stages ‘‘ would

have been worthless to anyone other than the taxpaver;”’

and shortly thereafter he asserts that the contract ‘‘is

one pervaded by the stockholder-corporate relation.’’ A

little farther on (Brief, p. 27} he savs that ‘‘the fact of

the stockholder-corporate relation is the dominant char-

acteristic and certainly the only adequate explanation for

a contract of the sort aere presented.’’ This is stating in

different language that the effect should be materially

discounted because it is between a stockholder and aq con-

trolled corporation.

As a matter of fact the contract emphasizes the agency

relationship. It was in essence, at least as to the inter-

state business, an agency contract.* It is by no means

1. Respondent refers to the Board's observation (18)

that the evidence aid not disclose what portion of the

loss was attributable to this intrastate operation. This, as

pointed out in our original brief (page 4, footnote 1) is

incorrect.

inconceivable that such a contract might be made between

independent corporations. Corporation A might well de-

sire that a certain operation appropriate to its business

he carried on by corporation B, and as a price for guar-

anteeing B against loss might obtain the right to B’s

profits. One conceivable motive for B’s entering into such

an arrangement might exist if B were dominated by an

individual who would thereby be enabled to obtain a sal-

ary, or whose salary would be better secured under such

an arrangement. Notwithstanding respondent’s sugges-

tion that such a contract might be worthless to A if A were

not B’s parent, A might have a very definite motive for

such a contract. Arrangements of this sort between inde-

pendent parties are not so anomalous as respondent sug-

gests. All sorts of individual contractual situations exist

in the business world. There is no occasion for specula-

tion as to motives which enter into the making of the

myriad contractual relationships of economic life. Plainly

such an arrangement between independent individuals

would be given effect for tax purposes. Such a situation

would not be one for contributing to the capital of a

corporation, but an expense occasioned in the course of

business operations. Yet here, merely because of the

close relationship, it is argued that the arrangement

should be disregarded. Here again the argument proves

too much. The bona fides of the contract are not chal-

lenged. There is no question of fraud. Disregard of the

contractual relations can be justified, if at all, only on the

ground that Interstate’s domination of Stages is so com-

plete as to make the latter but an agent or instrumental-

ity of the former. Conversely, if the integration of the

parties is not sufficiently close to bring the case within

_ Southern Pacific Co. v. Lowe, and other similar authorities,

such for instance as the Inland Development Company

ease, 120 Fed. (2d) 986, or if the reasoning of those cases

is now to he rejected, then respect must be aceorded a

eontract between legal entities as to which there is no

claim of any fraud, irregularity, or even mistake, under

which one entity performs an operating service for an-

other. The stockholder-corporation relationship does not,

standing alone, convert a payment otherwise an expense

into a capital contribution.

Just what is meant by respondent in saving (Brief, p.

25) that the nature of payments to Stages is shown ‘‘by

the fact that they were not measured by its expenses or

losses incurred in serving the taxpayer, t.e., by coordinat-

ing their schedules,** is not clear. The contract recites

(57) the purpose to give Interstate the greatest benefit

from operation and to arrange for coordinated operation.

The formal promise of Stages is to operate buses upon

routes and schedules directed by Interstate. The latter

agrees to reimburse the former for deficits and the former

agrees to pay the latter any profits. Respondent repeats

(Brief, p. 26) the assertion that the deficit did not result

from this synchronizing service, and asserts further (bid)

that ‘the net loss, rather, was in general one resulting

from all Stages’ operation in intra and interstate as well.”’

Even if true, thix argument is beside the point. As a

matter of fact the loss was incurred in the interstate

operation (as the court below assumed). What intrastate

revenue there was reduced the loss.

An additional significance of the contract is that its

provisions meet the criticism of certain authorities which

have in sunilar situations denied relief because the pay-

ment has been ‘‘voluntary.’’ Nattonal Piano Mfg. Co. v.

Burnet, 00 Fed. (2d) 316; Robinson v. Commissioner, 53

Fed. (2d) 810, 79 A. L. R. 975.

Respondent cites some lower court decisions (Brief, p.

96) for the general proposition that a contribution by a

stockholder to replenish a corporation’s impaired capital

must be treated as a capital expenditure. This general

proposition does not reach the facts of a case like this,

where the activity producing the year’s deficit results

from an excess of expenditures over receipts in the con-

duct of an operation normal to the taxpayer’s regular

business. If lower court decisions are to be cited in con-

nection with a question that has not previously been de-

cided by this court, the reasoning of and decision in

Wiggin v. Commissioner, 46 Fed. (2d) 743, supports

petitioner.

In the same connection respondent says (Brief, p. 29)

that ‘‘business expenses must be allocated so as to be the

expense of the parent or the subsidiary and not the

expense of both.’’ This is undoubtedly correct; but the

form of statement is misleading and suggests that if

petitioner is upheld a duplicate deduction will result in

the form of a tax benefit to both entities. Such is not the

fact; and respondent may not have intended to convey

this impression. Following this observation respondent

refers (ibid) to the general proposition that losses of the

taxpayer are not to be caken by another, even where there

is a close relationship, a proposition that may generally be

conceded. For this he cites four cases, three’ of which

were discussed in our original brief. Two of these

involved tax avoidance schemes, and one a successor en-

tity clearly not an agency, besides also involving a

temporary change of control. The fourth, Burnet v. Clark,

987 U.S. 410, 53 S. Ct. 207, 77 L. Ed. 397, involved a

1. New Colonial Ice Company v. Helvering, 292 U. S.

435. 54S. Ct. 788, 78 L. Ed. 1348; Dalton v. Bowers, 287

U. S. 404, 53 S. Ct. 205, 77 L. Ed. 389; Burnet v. Common-

wealth Improvement, 287 U. S. 415, 53 S. Ct. 198, 77

L. Ed, 399.

* Sa

mayority stockholder of a dredging company. He endorsed

its notes and later paid them and was allowed loss de-

ductions. He sought to earry forward the losses, under

the carry over provision relating to losses in the opera-

tion from a trade or business. He was not in the invest-

ment business. The ease is like Dalton v. Bowers, and no