Petition for Review from Decision of Board of Tax Appeals.
Before BIGGS, MARIS, and CLARK, Circuit Judges.
The case at bar is summed up in the language of the Prentice Hall Service as follows: "4831-A. Dividend of personal holding company held not paid within taxable year. - A personal holding corporation on a cash basis declared a dividend one day prior to the close of its fiscal year. Its sole stockholder, who alone had authority to pay out funds, was in a distant state and was not informed of the dividend until after the close of the fiscal year. He then wrote and cashed a check for the dividend. Held, the corporation did not pay the dividend within its taxable year and is not entitled to a deduction under section 351(b)(2)(C) of the Revenue Act of 1934, 26 U.S.C.A. § 331(b)(2)(C) (The Sanford Corp. v. Commissioner, 38 B.T.A. 139 (No. 19) pending before C.C.A., 3rd Circuit)". Vol. 2, Prentice Hall 1939 Federal Tax Service, Personal Holding Companies, sec. 405, p. 4816.
We use this reference, first, because of its, as we think, accurate and succinct phraseology and, second, because we are reasonably assured thereby that our own research has not lagged in our (as well as counsels') failure to produce any binding precedent. The case is then one of first impression.
The provision of the Revenue Act under which it arises is decidedly not a matter of first impression. We have spoken elsewhere, Rothensies v. Cassell, 3 Cir., 103 F.2d 834, of what might be called the reverse patriotism of tax avoidance (we use the more polite and therefore maybe less expressive term). One of the earliest methods (again we avoid the harsher word) employed to that end was what came to be known as "the incorporated pocket-book". A partial list of these ghostly receptacles was introduced in the hearings on the Revenue Act of 1937, 50 Stat. 813,Hearings before the Joint Committee on Tax Evasion and Avoidance, Part 1, p. 186, and makes interesting reading. As long ago as the Act of 1913, 38 Stat. 114, the obviousness of putting our old friend, the corporate fiction, to another use having the aroma of impropriety, was envisaged. In 1918 we find the Secretary of the Treasury saying: "The corporate form of organization is now used or abused by wealthy individuals who incorporate their personal business and investments and thus escape surtaxes upon that amount of their income which is reinvested or saved". Sherman, Taxation of Corporation Used to Avoid Taxes Upon Stockholders, Vol. 13, The Tax Magazine, p. 19; and in 1933 the responsible committee of the House of Representatives: "Perhaps the most prevalent form of tax avoidance practiced by individuals with large incomes is the scheme of the 'incorporated pocket-book'. That is, an individual forms a corporation and exchanges for its stock his personal holdings in stocks, bonds or other income-producing property. By this means the income from the property pays corporation tax, but no surtax is paid by the individual if the income is not distributed. * * * there seems no doubt that this form of avoidance is still practiced to a large extent". Preliminary Report of a Subcommittee, transmitted to the Committee on Ways and Means, December 4, 1933, Sherman, Taxation of Corporations Used to Avoid Texes Upon Stockholders, above cited, p. 19.
As a result of this latter opinion, the Congress finally abandoned the milder methods of the earlier revenue acts and enacted the personal holding company section with which we are now dealing, 26 U.S.C.A. § 331. This statute is automatic and supposedly drastic in its operation. It seeks to prevent the method (device) of tax avoidance (evasion) so clearly described in Sherman's article, above cited:
"Essentially this method of tax avoidance does not effect a complete avoidance of tax on the part of the individual stockholder, but merely a postponement or deferment of part of the tax. For, if the holding company should distribute its earnings or surplus in future years, the stockholder would then have to pay a surtax on the dividends that he received. However, a complete or partial avoidance of tax may ensue upon the happening of any of the following events:
"1. If the corporation should spread the distribution of its annual income over a series of years, a real saving in tax would accrue to the stockholder from the mere fact that his distributive share of the income would fall in the lower surtax brackets.
"2. If the corporation should time the distribution of its income so that it is made during a year when the stockholder has personal losses of other deductions to offset against the dividend received, a real saving in tax would result.
"3. If there should be a reduction in tax rates upon individual incomes during any future year, the distribution of the corporate income in such year would result in an actual saving to the stockholder.
"4. If the corporation should incur any losses on its investments or otherwise, which deplete the earnings or surplus accumulated during preceding years, there will be an avoidance of tax, for the Government will be deprived of the surtax which the stockholder would have had to pay, had the corporation made a distribution of its annual incomein the year when the same was earned". Sherman, Texation of Corporations Used to Avoid Taxes Upon Stockholders, Vol. 13, The Tax Magazine, 19, 20.
Mr. Paul, a leading tax specialist, in writing on the Revenue Act of 1937, 50 Stat. 813-818, points out that the ineffectiveness of the 1934 and similar subsequent measures necessitated the final imposition of what he refers to as a "death sentence":
"The personal holding company provision of the statute, in a sense, legitimatized personal holding companies by imposing a penalty tax upon their undistributed adjusted net income. The domestic personal holding company was an 'incorporated pocketbook' in the same manner as a foreign personal holding company; its advantage was, however, not dubious absence from jurisdiction, but an effective rate of tax lower than the individual surtax brackets of ...