Brief for the Respondents in Opposition — Haffenreffer Brewing Co. v. Commissioner

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By ERO SA EEN, IP GIL BLS PL EEO PRE AL OE MSS SBD ST

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INDEX

Page

RE ee Seine Cac on mack uratut ube ws 2

Jurisdiction. ___- a atc es etl ke ci x ec neers ideas ]

Question presented. ithe Sewakeecues Keaucun 2

Statute and regulations inv olved. mes ‘i Sees ES 2

Statement--_-__---.- : ee hte A cine inven 2

ATSUMONG.. ww ws ARSE : 4

Conclusion. ___ - ng Ee OUR = et i 7

Pementis a ck cme aDee ie wese ie awk wick 6 9

CITATIONS

Cases:

Commissioner v. O. P. P. Holding Corp., 76 F. (2d) 11_._- 4

Commissicner v. Schmoll Fils Associated, 110 F. (2d) 611 4

Commissioner v. Tennessee Co., 111 F. (2d) 678____- a xf

Elko Lamoille Power Co. v. Commissioner, 50 F. (2d) 595__- - 5

Finance & Investment Corp. v. Burnet, 57 F.(2d) 444_____- 5

Hamlin v. Toledo, St. L. & K. C. R. Co., 78 Fed. 664- ce 5

Hazel Atlas Glass Co. v. Van Dyk & Reeves, 8 F. (2d) 716,

certiorari denied, sub nom. Van Dyk v. Young, 269 U.S.

Cae a ae ede Sta ha et Vek es taw beak Ges 5

Jewel Tea Co. v. United States, 90 F. (2d) 451______- eke 4

United States v. South Georgia Ry. Co., 107 F. (2d) 3_____- 4

einuin. eine, 108 U.S. 389 ye is arate 5

Statutes:

Revenue Act of 1934, c. 277, 48 Stat. 680, Sec. 351 (U. 8. C.,

Title 26, See. 331) Rup owes 9

Revenue Act of 1936, ¢. 690, 49 Stat. 1648, See. 351- 6

Revenue Act of 1937, c. 815, 50 Stat. 813, See. 355. 6

Revenue Act of 1938, c. 289, 52 Stat. 447, See. ett 6

Miscellaneous:

T. D. 4777, 1937-2 Cum. Bull. 196

Treasury Regulations 86, Art. 351-4__....._....--.-..-. 5,9

(1)

3085090—41

Gnthe Supreme Court of the Wnited States

OcToBER TERM, 1940

No. 865

HAFENREFFER BREWING COMPANY, PETITIONER

Vv.

Guy T. HELVERING, COMMISSIONER OF INTERNAL

REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS FOR THE FIRST

CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The opinion of the Board of Tax Appeals

(R. 23-41) is reported in 41 B. T. A. 443. The

opinion of the Circuit Court of Appeals (R. 50-63)

is reported in 116 F. (2d) 465.

JURISDICTION

The judgment of the Circuit Court of Appeals

was entered on December 23, 1940 (R. 64). A

petition for rehearing was denied on January 7,

1941 (R. 64). The petition for a writ of certiorari

(1)

2

was filed on March 22, 1941. The jurisdiction of

this Court is invoked under Section 240 (a) of the

Judicial Code as amended by the Act of February

13, 1925.

QUESTION PRESENTED

Whether in computing the taxpayer’s personal

holding company surtax a certain sum which was

used during 1934 to retire part of the taxpayer’s

preferred stock, pursuant to-a contract entered

into in 1930, is deductible as an amount ‘‘used or

set aside to retire indebtedness incurred prior to

January 1, 1934,’’ within the meaning of Section

351 of the Revenue Act of 1934 and the applicable

Treasury Regulations.

STATUTE AND REGULATIONS INVOLVED

The statute and regulations involved will be

found in the Appendix, infra, pp. 9-12.

STATEMENT

The facts as found by the Board of Tax Appeals

(R. 24-30) may be summarized as follows:

The taxpayer, a Massachusetts corporation or-

ganized in 1930, is a personal holding company

within the meaning of Section 351 (b) (1) of the

Revenue Act of 1934 (R. 24). At the time of its

organization the taxpayer had a capitalization con-

sisting of 7,000 shares of common stock of no par

value and 5,900 shares of preferred stock of a par

value of $100 each (R. 25).

OEM

ao

The taxpayer’s consolidated net earnings for

1933, as defined in its by-laws, were such that the

taxpayer was required by the terms of a contract

which it had entered into in 1930, and by the pro-

visions of its preferred stock which it had issued in

1930, to set aside the sum of approximately $86,000

as a sinking fund for the purchase or redemption

of its preferred stock. This sum was so set aside

and applied to the retirement of the preferred

stock during the taxable year 1934 (R. 29). Also

during that year, the taxpayer paid a dividend out

of its earnings of approximately $39,000 to the

holders of its preferred stock (R. 29).

The taxpayer filed two federal tax returns for

the year 1934, one a corporation income tax re-

turn and the other a personal holding company

surtax return. In its surtax return, the taxpayer

claimed as a deduction the amount which it had

paid out during the taxable year in retirement of

its preferred stock (R. 29-30). This deduction was

disallowed by the Commissioner and a deficiency

was assessed accordingly (R. 6-8). Taxpayer then

filed a petition with the Board of Tax Appeals

and, in an amendment to that petition, asserted that

it was entitled to a deduction of approximately

$39,000 in computing its income tax liability, which

it had failed to assert in its return. This claim was

predicated upon the dividend paid to the preferred

stockholders, petitioner alleging that the dividend

payment was in substance the payment of interest

on indebtedness (R. 9, 30).

4

The Board of Tax Appeals decided that the

holders of the preferred stock were stockholders

rather than creditors and accordingly determined

both issues in favor of the Commissioner (R.

30-39). Upon appeal, the taxpayer abandoned its

claim that the $39,000 dividend payment was de-

ductible as interest on indebtedness and pressed

only its claim with regard to the $86,000 set aside

for retirement of the preferred stock. The court

below affirmed the decision of the Board (R. 64).

ARGUMENT

The decision of the court below that the sum set

aside for the sinking fund was not ‘‘used or set

aside to retire indebtedness incurred prior to Jan-

uary 1, 1934”’, within the meaning of Section 351

(b) (2) (B) of the Revenue Act of 1934, is clearly

eorrect and is not in conflict with the decision of

any other Circuit Court of Appeals.

The preferred stock plainly did not represent

an ‘‘indebtedness” of the taxpayer within the

meaning of the statute. The stock had no fixed

maturity, a feature almost always present where

there is a debtor-creditor relationship and the ab-

sence of which is persuasive evidence that no such

relationship exists. United States v. South

Georgia Ry. Co., 107 F. (2d) 3, 5 (C. C. A. 5th) ;

Jewel Tea Co. v. United States, 90 F. (2d) 451, 453

(C. C. A. 2d) ; Commissioner v. O. P. P. Holding

Corp., 76 F. (2d) 11, 12 (C. C. A. 2d) ; Commis-

sioner v. Schmoll Fils Associated, 110 F. (2d) 611

4s DSS EE ELC OI PER CAEN oe pena a eee -: ay

- PEE ES EN GS PT AE EINE ER Bas Pea ee ERR ere ox A rh

5

(C. C. A, 2d); Finance & Investment Corp. v.

Burnet, 57 F. (2d) 444 (App. D. C.). Further-

more, the dividends on the stock were payable only

out of earnings, a feature tending to show a capi-

tal investment rather than an _ indebtedness.

Finance & Investment Corp. v. Burnet, supra;

Elko Lamoille Power Co. v. Commissioner, 50 F.

(2d) 595 (C. C. A. 9th) ; Warren v. King, 108 U.S.

389, 399; Hamlin v. Toledo, St. L. & K. C. R. Co.,

78 Fed. 664 (C. C. A. 6th) ; Hazel Atlas Glass Co.

v. Van Dyk & Reeves, 8 F. (2d) 716 (C. C. A. 2d),

certiorari denied, sub nom. Van Dyk v. Young, 269

U. S. 570. And the rate of return on the stock

was not even fixed. The rate of seven percent was

to be paid for the years 1930, 1931 and 1932, but in

later years the rate was seven percent or an amount

representing one-half of the net earnings of the

company available for dividends, whichever should

be the lesser amount (R. 25).

The Treasury Regulations clearly show that

such stock does not constitute an ‘‘indebtedness.”’

Article 3514 of Regulations 86, relating to the

Revenue Act of 1934, provides in part that the term

‘indebtedness’? means an obligation, absolute and

not contingent, to pay, on demand or within a

given time, in cash or other medium, a fixed

amount; also that the term ‘‘indebtedness’’ does

not include the obligation of a corporation on its

capital stock. Since Section 351 (b) (2) (B) was

reenacted in the Revenue Acts of 1936, 1937 and

6

1938* without substantial change, this Regulation

must be deemed to have received legislative sane-

tion.

There is no merit in petitioner’s alternative con-

tention that, even if the preferred stock does not

constitute an indebtedness, the contractual obliga-

tion to retire some of the stock is such an indebt-

edness and the fulfillment of that obligation consti-

tutes a ‘‘retirement’’ of the indebtedness. With

respect to this contention, the court below stated

(R. 56-57) :

To say that the retirement of the preferred

stock is not the retirement of an indebted-

ness, but that the retirement of the obliga-

tion to retire the preferred is a retirement of

an indebtedness does not seem reasonable.

The argument would seem to involve the ac-

ceptance of the proposition that though the

retirement of preferred stock is not the re-

tirement of indebtedness, still if a board of

directors should adopt an enforceable reso-

lution providing for the retirement of cer-

tain shares, the fulfilling of the resolution

would allow a deduction as the retirement

of an indebtedness: Such a result seems to

indicate that the argument is more ingenious

than sound. Cf. In re Piccadilly Realty Co.,

78 F. (2d) 257, 261 (C. C. A. Tth, 1935).

It miould be noted that if the taxpayer’s posi-

tion were sound, it would mean that, because a divi-

* Section 351 (b) (2) (B) of the Revenue Act of 1936, c.

690, 49 Stat. 1648; Section 355 (b) of the Revenue Act of

1937, c. 815, 50 Stat. 813; Section 405 (b) of the Revenue Act

of 1938, c. 289, 52 Stat. 447.

7

dend declaration creates a debtor-creditor relation-

ship between the corporation and its stockholders,

the payment of the dividend could be treated as a

retirement of an indebtedness and thus serve as the

basis of a deduction. Even the taxpayer does not

go that far; he refrains from urging that a debtor-

creditor relationship arose on account of the divi-

dend of approximately $39,000 paid on the pre-

ferred stock during the tax year.

There is no conflict with Commissioner v. Ten-

nessee Co., 111 F. (2d) 678 (C. C. A. 3d). In that

case the taxpayer issued certain promissory notes

prior to January 1, 1934, which were payable out

of earnings and had no fixed maturity date. The

court held that the notes evidenced an indebtedness

within the meaning of Section 351 (b) (2) (B)

even though the obligation was contingent.? In

this case, the sinking fund was used to retire pre-

ferred stock, not promissory notes, and the provi-

sions relating to the sinking fund are quite differ-

ent from the terms of the promissory notes in the

Tennessee Co. case. Moreover, in the Tennessee

Co. case the interest rate was fixed; the rate of

return in this case was not fixed. (R. 25.)

CONCLUSION

The decision of the court below is correct and

there is no conflict of decisions. The case is not

* Apparently, the court’s attention was not invited to

the amended Treasury ruling (T. D. 4777, infra, p. 10)

which expressly provided that the obligation must be abso-

lute, and not contingent.

8

of general importance because it turns upon its

own particular facts. The petition for a writ of

certiorari should therefore be denied.

Respectfully submitted.

FRaNcis BiwpLe,

Solicitor General.

SAMUEL O. CLARK,

Assistant Attorney General.

SEWALL Key,

RicHarp H. DemMuTH,

Morton K. RoruscHi1bp,

Special Assistants to the Attorney General.

APRIL, 1941.