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Commissioner of Internal Revenue v. McKay Products Corporation. McKay Products Corp.

decided: December 16, 1949.


Author: Goodrich

Before MARIS and GOODRICH, Circuit Judges, and CLARY, District Judge.

GOODRICH, Circuit Judge.

The controversies between the taxpayer and the Commissioner in these two appeals present three questions for our determination. Reduced to their simplest statement, the facts out of which the controversies arise are these:

People in the community of Sayre, Pennsylvania, sought during the depression to bring industries to town for the obvious purpose of increasing local payrolls and thus to promote general prosperity.To this end, a group of citizens organized Valley Industries, Inc., a Pennsylvania non-profit corporation, and subscribed a sum of money to it. A company which is in fact the taxpayer's predecessor, but will be referred to as the taxpayer,*fn1 moved to town and received a plant for the conduct of its business. Here are the questions which arise from these operative facts:

1. May the cost to Valley of the plant deeded to the taxpayer*fn2 become part of the latter's "equity invested capital" so that it may be taken account of in estimating the taxpayer's excess profits tax for a given period?

2. May the taxpayer include the cost of this plant to Valley in its figures for depreciation in subsequent tax years?

3. Some of the subscribers failed to pay. Did advances made by the taxpayer to Valley create debts which give rise to a bad debt deduction, and if a debt did exist, did it become worthless and when?

I. The Excess Profits Tax Credit.

The Tax Court ruled adversely on the taxpayer's contention that the $310,000 cost of the property to Valley was includible in taxpayer's excess profits tax credit for the fiscal year ending July 31, 1942, computed according to the invested capital method pursuant to Section 718(a) (2) of the Internal Revenue Code, 26 U.S.C.A. ยง 718(a) (2). It was held that there could be no contribution to capital by a non-stockholder. The Court relied upon decisions by that Court, or its predecessor, the Board of Tax Appeals, which applied the statutes applicable to excess profits tax in World War I.*fn3 We think this ruling was incorrect.

Here is the present statutory language. It is found in Section 718 and provides that "The equity invested capital * * * shall be the sum of * * * Property (other than money) previously paid in * * * for stock, or as paid-in surplus, or as a contribution to capital." Can there be a "contribution to capital" by a non-stockholder? If there can, the taxpayer is right and the Commissioner wrong.

The legislative history of the more recent statute casts little light upon the problem. We find only a statement by the Assistant Secretary of the Treasury, whose department played an important role in drafting the Act, explaining the reason for the shift from "value" in the earlier Acts to "cost" in the proposed statute.*fn4 Possibly his statement might bear the implication that no other change was made from the earlier statutes, but there certainly is no forthright declaration to this effect. Then there is a statement by a single member of the Senate Finance Committee, made in a minority report, which may or may not be taken to mean that contributions to capital can come only from stockholders for the purposes of the tax credit.*fn5 It is not clear from this statement whether the Senator is speaking of the draft of the bill which was eventually passed or concerning his own suggested amendment. This is all we have.

As the taxpayer points out, we find the words which are the critical words here used elsewhere in a way contrary to that which the Commissioner urges to us. The term "contribution to capital" was found in the Internal Revenue Code*fn6 and in the Regulations long before it appeared in Section 718. Section 29.113(a) (8)-1 of Regulations 111 makes it clear that a contribution to capital for the purpose of Section 113(a) (8) may come from any person. This has been true of the Regulation going as far back as 1935.*fn7 This use of the term must have been known to those acquainted with the tax law. Congress could have made "contribution to capital" mean one thing in Section 718 and another in Section 113(a) (8). But if such inconsistent meanings had been intended, we think there would appear, somewhere, some evidence to that effect. We have found none.

The taxpayer's position finds support from the Regulations referring to Section 718 itself. They provide that if property is acquired "by a corporation from a shareholder as paid-in surplus or from any person as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor * * * [emphasis added]."*fn8

The Commissioner now suggests that the phrase "from any person" has obviously been employed in the Regulations so as to include contributions to capital by bondholders or holders of "some hybrid security," while excluding contributions from those who have no interest in the corporation. Perhaps; but why is the general language to be limited to that situation? Even if ...

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