Helvering v. Ohio Leather Company/Opinion of the Court

Mr. Donald J. Lynn, of Youngstown, Ohio, for respondent Ohio Leather co.

Mr. Raymond S. Powers, of Youngstown, Ohio, for respondent Strong Mfg. Co.

Mr. Raymond T. Sawyer, Jr., of Cleveland, Ohio, for respondent Warren Tool Corporation.

[Argument of Counsel from page 103 intentionally omitted]

Mr. Justice MURPHY delivered the opinion of the Court.

The issue is whether respondents are entitled to certain claimed credits against their undistributed profits tax for the 1936 taxable year by virtue of § 26(c)(2) of the Revenue Act of 1936, 49 Stat. 1648, 26 U.S.C.A. Int.Rev.Acts, page 836.

In each of these cases the taxpayer corporation contracted prior to May 1, 1936, by a written agreement to apply a percentage of its net earnings of a particular calendar year to an indebtedness of the corporation; in each case the agreement expressly provided only that the payment of the specified percentage was to be made on or before a certain date-April 1 in the case of The Ohio Leather Company and Warren Tool Corporation and April 15 in the case of The Strong Manufacturing Company-in the year following the calendar year during which the net earnings arose. However, the specified percentage was actually paid during the taxable year in each case. By reason of these contracts and payments, taxpayers have sought to avail themselves of the credit authorized by § 26(c)(2), which relieves from the tax on undistributed profits, imposed by § 14 of the 1936 Act, 26 U.S.C.A. Int.Rev.Acts, page 823, any profits which may not be distributed because of a contract requiring that a portion of earnings of the taxable year be paid or irrevocably set aside within the taxable year for the discharge of a debt. The Commissioner of Internal Revenue determined that the credits claimed should not be allowed, and assessed deficiencies in each case. The Board of Tax Appeals overruled the Commissioner, and the Circuit Court of Appeals affirmed. We granted certiorari, 316 U.S. 651, 62 S.Ct. 945, 86 L.Ed. 1723, because of an asserted conflict with Antietam Hotel Corp. v. Commissioner, 4 Cir., 123 F.2d 274.

Since § 26(c)(2) grants a special credit in the nature of a deduction, the taxpayer must sustain the burden of showing compliance with its exact terms. Helvering v. Northwest Steel Rolling Mills, 311 U.S. 46, 49, 61 S.Ct. 109, 111, 85 L.Ed. 29; White v. United States, 305 U.S. 281, 292, 59 S.Ct. 179, 184, 83 L.Ed. 172; New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 790, 78 L.Ed. 1348. We agree with the Commissioner that taxpayers have not carried that burden.

Section 26(c)(2) expressly sets up three specific conditions precedent with which a corporation devoting part of its earnings to the payment of debts rather than the payment of dividends must comply before it is entitled to relief from the tax on undistributed profits-(1) there must be a written contract executed by the corporation prior to May 1, 1936; (2) this contract must contain a provision expressly dealing with the disposition of earnings and profits of the taxable year; and, (3) this contract must contain a provision requiring that a portion of such earnings and profits either (a) 'be paid within the taxable year in discharge of a debt' or (b) 'be irrevocably set aside within the taxable year for the discharge of a debt'. A taxpayer whose contract satisfies each of these three requirements is entitled to a credit to the extent of the amount which has been so paid or irrevocably set aside.

While taxpayers have met the first two statutory requirements the written contracts antedate May 1, 1936, and contain provisions expressly dealing with the disposition of earnings for the taxable year-, they have not met the third one. The contracts clearly contain no provision requiring the payment of earnings 'within the taxable year in discharge of a debt'. Nor do they, contrary to taxpayers' assertion, require the irrevocable setting aside of earnings 'within the taxable year for the discharge of a debt' within the meaning of § 26(c)(2). The contracts are wholly silent in respect of any setting aside; they do not in terms require taxpayers to set aside the amount due, nor do they direct any segregation or physical retention whatsoever. The only requirement is that taxpayers pay on or before a date after the close of the taxable year. This is not enough. Until that date taxpayers were free to use the specified percentages as they pleased, so far as the agreements were concerned. That prudent business judgment, or the possibility of fiduciary liability imposed by operation of law might have constrained taxpayers to refrain from using these percentages and actually to set them aside is immaterial; such setting aside was not required by the terms of the written contracts, and therefore did not satisfy § 26(c)(2). Cf. Helvering v. Northwest Steel Rolling Mills, 311 U.S. 46, 52, 61 S.Ct. 109, 113, 85 L.Ed. 29. Likewise the fact that taxpayers actually irrevocably set the funds aside by anticipatory payments within the taxable year is of no moment, because these payments were voluntary and not pursuant to the command of the agreements.

That Congress did not intend that the statutory condition of an irrevocable setting aside would be satisfied by a contract which, without more, merely requires that a percentage of earnings of the taxable year be paid in some future year for the discharge of a debt, is evident because such a construction reduces the alternative condition of § 26(c)(2) relating to actual payment within the taxable year to a meaningless superfluity. The date specified for payment would become immaterial for all purposes if the mere requirement by contract of future payment out of earnings in a given year automatically entails an 'irrevocable setting aside' within that year.

Taxpayers here place great emphasis upon the different prepositions used in the alternative phrases-'to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt'-to show that payment may be made after the taxable year compatibly with § 26(c)(2). True enough, payment can be postponed to a future year and a credit allowed if, but only if, the contract directing such future payments requires in terms the irrevocable setting aside within the taxable year of those future payments. The instant contracts do not so provide.

Respondents, The Ohio Leather Company and Warren Tool Corporation, contend that because they were on an accrual basis of accounting, they were entitled to the credit by virtue of § 43, 26 U.S.C.A. Int.Rev.Acts, page 839, which states that it is to be disregarded in computing the credit provided by § 27, 26 U.S.C.A. Int.Rev.Acts, page 837, and makes no statement with regard to § 26. The contention is without merit because principles of accrual accounting have no bearing on the question of whether a contract in terms requires a payment or an irrevocable setting aside within the taxable year. The question here is not whether taxpayers made payment, either on a cash or an accrual basis, within the taxable year, but whether their contracts required them to pay or irrevocably set aside within the taxable year.

Taxpayers insist that it would be unreasonable to hold that only contracts expressly requiring payment or an irrevocable setting aside of a percentage of earnings within the taxable year satisfy § 26(c)(2) because many corporations are unable to determine their earnings until after the close of their fiscal year, and consequently their contracts disposing of a percentage of earnings in satisfaction of debt customarily allow some short period after the close of the year before payment is required. The legislative history of the 1936 Act reveals that Congress was conversant with the problem of computing earnings before the end of the taxable year, in connection with dividend payments, but declined to act. Corporations with oral contracts, or written contracts executed after May 1, 1936, dealing with the disposition of profits in satisfaction of debts also probably think § 26(c)(2) is a most unreasonable statute. But arguments urging the broadening of a tax deduction statute beyond its plain meaning to avoid harsh results are more properly addressed to Congress than to the courts. White v. United States, 305 U.S. 281, 292, 59 S.Ct. 179, 184, 83 L.Ed. 172.

Finally taxpayers contend that the legislative history of § 26(c)(2) supports the view that their contracts are covered by that section. An examination of the entire legislative background of the undistributed profits tax demonstrates, contrary to taxpayers' contentions, that Congress intended the tax to be imposed primarily upon income not distributed in the form of dividends, rather than only upon corporate income which was not distributed at all and accordingly meant to limit severely credits for a corporation's payment of debts and precisely to define the area in which taxpayers were to be entitled to the credit. Thus, while the original House bill contained complicated provisions affording some relief to corporations with deficits, or contractually obligated either to pay debts or not to pay dividends, the Senate Finance Committee struck them all out, substituting only a provision dealing with a credit for contractual prohibitions against the payment of dividends. An amendment offered from the Senate floor giving a broad credit for all portions of adjusted net income used to purchase or replace machinery, equipment, etc., or 'expended or applied during the taxable year for the liquidation, payment, or reduction of the principal of any bona-fide indebtedness outstanding at the date of enactment of this Act' was rejected. The much narrower amendment which became § 26(c)(2) was then offered with little explanation other than that it was intended to supplement the credit for contractual prohibition against dividend payments, the provision which became § 26(c)(1).

We conclude that the judgments below were erroneous. Accordingly they are reversed, and the causes remanded with directions to uphold the determination of the Commissioner.

Reversed.