National Carbide Corporation v. Commissioner of Internal Revenue/Opinion of the Court

Petitioners are three wholly owned subsidiaries of Air Reduction Corporation (Airco). They seek a determination of the question whether deficiencies in income and declared value excess profits taxes for the year 1938 found by the Commissioner of Internal Revenue are properly chargeable to them. Their contention is that they are corporate agents of Airco, that the income from their operations is income of Airco, and that income and excess profits taxes must be determined on that basis.

By a series of combinations and dissolutions of previously acquired subsidiary companies, Airco had, prior to 1938, reduced the number of its subsidiaries to four. All operated strictly in accordance with contracts with Airco. The subsidiaries were utilized by Airco as operating companies in the four major fields of operation in which it was engaged. Air Reduction Sales Company carried on the manufacture and sale of the gaseous constituents of air; National Carbide Corporation, the manufacture and sale of calcium carbide; Pure Carbonic, Inc., the manufacture and sale of carbon dioxide; and Wilson Welder & Metals Co., the manufacture and sale of welding machines, equipment and supplies.

The contracts between Airco and its subsidiaries provided, in substance, that the latter were employed as agents to manage and operate plants designed for the production of the products assigned to each, and as agents to sell the output of the plants. Airco was to furnish working capital, executive management and office facilities for its subsidiaries. They in turn agreed to pay Airco all profits in excess of six percent on their outstanding capital stock, which in each case was nominal in amount. Title to the assets utilized by the subsidiaries was held by them, and amounts advanced by Airco for the purchase of assets and working capital were shown on the books of the subsidiaries as accounts payable to Airco. The value of the assets of each company thus approximated the amount owed to Airco. No interest ran on these accounts.

Airco and its subsidiaries were organized horizontally into six overriding divisions: corporate, operations, sales, financial, distribution, and research. Officers heading each division were, in turn, officers of the subsidiaries. Top officials of Airco held similar positions in the subsidiary companies. Directors of the subsidiaries met only to ratify the actions of the directors and officers of Airco.

Airco considered the profits turned over to it by the subsidiaries pursuant to the contracts as its own income and reported it as such. Petitioners reported as income only the six per cent return on capital that each was entitled to retain. Similarly, in declaring the value of their capital stock for declared value excess profits tax purposes, the subsidiaries reported only the nominal amounts at which the stock was carried on the books of each. The Commissioner notified petitioners of substantial income and excess profits tax deficiencies in their 1938 returns, having taken the position that they are taxable on the income turned over to Airco as well as the nominal amounts retained. The Tax Court held, however, that the income from petitioners' operations in excess of six per cent of their capital stock was income and property of Airco. 8 T.C. 594. Three judges dissented. The Court of Appeals for the Second Circuit reversed. 167 F.2d 304. We granted the petition for a writ of certiorari, 335 U.S. 810, 69 S.Ct. 44, because of this conflict of opinion and the disagreement between courts as to the continuing vitality of Southern Pacific Co. v. Lowe, 1918, 247 U.S. 330, 38 S.Ct. 540, 62 L.Ed. 1142.

Petitioners' contention is, in substance, that our decision in Moline Properties, Inc., v. Commissioner of Internal Revenue, 1943, 319 U.S. 436, 63 S.Ct. 1132, 1135, 87 L.Ed. 1499, which held that the tax laws require taxation of the corporate entity if it engages in 'business activity,' expressly excepted the situation in which the corporation is the agent of its owner; that Southern Pacific Co. v. Lowe, supra, defines the content of 'agency' for tax purposes; and that, as the Tax Court found, this Court's characterization of the relationship between the corporations in the Southern Pacific case is 'aptly descriptive' of the relationship between Airco and petitioners. It must follow, according to petitioners, that income received by them and transmitted to Airco is taxable only to Airco.

Respondent does not quarrel with the first and third propositions. The collision occurs at the second. The issue as presented by petitioners is, therefore, whether the principal-agent relationship described in the Southern Pacific case-and the similar arrangement between Airco and petitioners contains the 'usual incidents of an agency relationship,' as that phrase was used in Moline roperties, Inc., v. Commissioner, supra.

Petitioners' contention that the Southern Pacific case established a concept of agency that has survived our later decisions may be dealt with rather summarily. That case treated income earned by a wholly owned subsidiary before March 1, 1913, the effective date of the Income Tax Act of 1913, as having accrued to its parent prior to that date despite the fact that the actual transfer of funds by declaration of dividends occurred subsequent thereto. The theory of the case was that the two corporations could be treated as identical, for the purposes of the 1913 Act, because of the complete domination and control exercised by the parent over its subsidiary.

By this decision, this Court is said to have 'looked beyond the corporate form,' and 'ignored the separate entity of a corporation.' Whatever the dialectics employed, courts and commentators have agreed that parent and subsidiary were treated as one corporation for the purposes of the taxes there in question; transfer of earnings to the parent was merely 'a paper transaction.' (247 U.S. 330, 38 S.Ct. 543) The Southern Pacific case did not, and did not purport to rest on any principle of agency. The only reference to the subsidiary (Central Pacific) as an agent is made in this context:

' * *  * the Central Pacific and the Southern Pacific were in substance identical because of the complete ownership and control which the latter possessed over the former, as stockholder and in other capacities. While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control.' 247 U.S. at page 337, 38 S.Ct. at page 542, 62 L.Ed. 1142. It is thus clear beyond doubt that the subsidiary was not referred to as an agent of the parent in the usual or technical sense. 'Agency' and 'practical identity,' as those words are used in the Southern Pacific case, are unquestionably opposite sides of the same coin. The close relationship between corporations because of complete ownership and control of one by the other was the basis for the result reached, whatever its articulation.

That basis has been repudiated by subsequent decisions of this Court. Whatever the vitality of Southern Pacific Co. v. Lowe on its special facts, we have held that a corporation formed or operated for business purposes must share the tax burden despite substantial identity, in practical operation, with its owner. Complete ownership of the corporation, and the control primarily dependent upon such ownership-the important ingredients of the Southern Pacific case-are no longer of significance in determining taxability. Moline Properties, Inc., v. Commissioner, supra; Burnet v. Commonwealth Improvement Co., 1932, 287 U.S. 415, 53 S.Ct. 198, 77 L.Ed. 399.

In both of the cases last cited, the agency argument now urged upon us was made and rejected. In both cases, Southern Pacific Co. v. Lowe, supra, was relied upon by the taxpayers. In both, we found that the contention that the corporation was the agent of its owner was simply the argument that the subsidiary had no corporate identity distinct from its stockholders in a different form. It is true that petitioners here do not ask that they be ignored completely for tax purposes. They are willing to pay taxes on the nominal amounts they retain as Airco's 'agents.' But this fact serves to emphasize the inapplicability of the Southern Pacific case, upon which they rely. There, as in Commonwealth Improvement Co. and Moline Properties cases, the decision turned upon the question whether the corporate entity was or was not to be completely ignored for tax purposes. If the Central Pacific had been accorded any tax status in the Southern Pacific case, it unquestionably would have been taxed on the entire income it received. In fact, it was so taxed upon all income received after March 1, 1913; only income received prior thereto was considered income of the parent directly.

We think, therefore, that petitioners' argument is without merit because based on an erroneous interpretation of Southern Pacific Co. v. Lowe, supra. The agency argument, to quote the opinion in Moline Properties, 'is basically the same argument of identity in a different form * *  * the question of agency or not depends upon the same legal issues as does the question of identity previously discussed.' Ownership of a corporation and the control incident thereto can have no different tax consequences when clothed in the garb of agency than when worn as a removable corporate veil.

But it is necessary to go farther. The Tax Court did not, as petitioners seem to think, consider the argument that they were agents of Airco as different from or having any greater validity than the argument of identity of Airco and its subsidiaries. The court, in characterizing petitioners as Airco's agents, used that term exactly as it had been used in the Southern Pacific, Commonwealth Improvement Co., and Moline Properties cases. According to the Tax Court's opinion:

'The issue which (was decided) in this proceeding is: Whether, as the respondent has determined, the income from the operations of the three petitioners belonged not to Airco, the parent but to the petitioners and was taxable to them; or whether, as the three petitioners contend, the income from the operations of the petitioners in 1938, exclusive of the small amounts paid to petitioners under the contracts, belonged and was taxable to Airco, the parent company, both because the petitioners were in fact incorporated departments, divisions or branches of Airco's business and because the petitioners operated pursuant to express contract with Airco.'

The theory upon which the Tax Court expunged the deficiencies apparently was that since the Southern Pacific Co. case was not expressly overruled by Moline Properties, the 'business purpose' rule laid down in the latter is not absolute, but that the corporate entity may be disregarded (or the corporation treated as an agent of its owner) for tax purposes when the facts of ownership and control of the corporation approximate those presented by the Southern Pacific case. The Court of Appeals disagreed. It held that under our decisions, when a corporation carries on business activity the fact that the owner retains direction of its affairs down to the minutest detail, provides all of its assets and takes all of its profits can make no difference tax-wise. The court concluded that 'Even though Southern Pacific Co. v. Lowe, supra, set up a different test, we regard it as pro tanto no longer controlling.'

The result reached by the Court of Appeals is clearly required by our later decisions. Our reluctance to erase Southern Pacific from the books has been due not to any belief that it lays down a correct rule for tax purposes generally, but to the fact that it concerns 'very peculiar facts' which make it clearly distinguishable from later cases involving the tax status of a subsidiary or other wholly owned corporation. For that reason, we have, instead, held that it lays down no rule for tax purposes. Burnet v. Commonwealth Improvement Co., supra, 287 U.S. at page 419, 53 S.Ct. at page 199, 77 L.Ed. 399; Moline Properties, Inc., v. Commissioner of Internal Revenue, supra, 319 U.S. at page 439, 63 S.Ct. at page 1134, 87 L.Ed. 1499. That the concept of identity of the corporation with its owner set out in the Southern Pacific case is incompatible with later decisions of this Court may be demonstrated by a consideration of the facts enumerated and relied upon by the Tax Court, which based such reliance on the emphasis placed upon similar facts in the Southern Pacific case. These facts relate to the ownership, control, and right to income reserved by the parent.

So far as control is concerned, we can see no difference in principle between Airco's control of petitioners and that exercised over Moline Properties, Inc., by its sole stockholder. Undoubtedly the great majority of corporations owned by sole stockholders are 'dummies' in the sense that their policies and day-to-day activities are determined not as decisions of the corporation but by their owners acting individually. We can see no significance, therefore, in findings of fact such as, 'The Airco Board held regular meetings and exercised complete control over Airco and each of the petitioners,' and 'The chairman, vice chairman and president of Airco were in charge of the administration and management of the activities of each petitioner and carried out the policies and directives with respect to each petitioner as promulgated by the Airco board.' We reversed the Board of Tax Appeals in Moline Properties in the face of its finding that 'Full beneficial ownership was in Thompson (the sole stockholder), who continued to manage and regard the property as his own individually.'

Some stress was placed by the Tax Court, and by petitioners in argument here, upon the form of ownership of assets adopted by Airco and its subsidiaries. Petitioners' capital stock was, as has been stated, nominal in amount. Assets of considerable value, to which title was held by the subsidiaries, were balanced by accounts payable to Airco on the books of each. The Tax Court thought it material that 'All assets held by petitioner were furnished to it by Airco, which paid for them with its own cash or stock. Airco supplied all the working capital of each petitioner.'

If Airco had supplied assets to its subsidiaries in return for stock valued at amounts equal to the value of the assets, no question could be raised as to the reality of ownership of the assets by the subsidiaries. Airco would then have been in a position comparable, so far as ownership of the assets of petitioners is concerned, to that of the sole stockholder in Moline Properties. We think that it can make no difference that financing of the subsidiaries was carried out by means of book indebtednesses in lieu of increased book value of the subsidiaries' stock. A corporation must derive its funds from three sources: capital contributions, loans, and profits from operations. The fact that Airco, the sole stockholder, preferred to supply funds to its subsidiaries primarily by the second method, rather than either of the other two, does not make the income earned by their utilization income to Airco. We need not decide whether the funds supplied to petitioners by Airco were capital contributions rather than loans. It is sufficient to say that the very factors which, as petitioners contend, show that Airco 'supplied' and 'furnished' their assets also indicate that petitioners were the recipients of capital contributions rat er than loans.

Not do the contracts between Airco and petitioners by which the latter agreed to pay all profits above a nominal return to the former, on that account, become 'agency' contracts within the meaning of our decisions. The Tax Court felt that the fact that Airco was entitled to the profits by contract shows that the income 'belonged to Airco' and should not, for that reason, be taxed to petitioners. Our decisions requiring that income be taxed to those who earn it, despite anticipatory agreements designed to prevent vesting of the income in the earners, foreclose this result. Lucas v. Earl, 1930, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731; Helvering v. Clifford, 1940, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788; United States v. Joliet & Chicago R. Co., 1942, 315 U.S. 44, 62 S.Ct. 442, 86 L.Ed. 658; Commissioner v. Sunnen, 1948, 333 U.S. 591, 68 S.Ct. 715. Of course one of the duties of a collection agent is to transmit the money he receives to his principal according to their agreement. But the fact that petitioners were required by contract to turn over the money received by them to Airco, after deducting expenses and nominal profits, is no sure indication that they were mere collection agents. Such an agreement is entirely consistent with the corporation-sole stockholder relationship whether or not any agency exists, and with other relationships as well.

What we have said does not foreclose a true corporate agent or trustee from handling the property and income of its owner-principal without being taxable therefor. Whether the corporation operates in the name and for the account of the principal, binds the principal, by its actions, transmits money received to the principal, and whether receipt of income is attributable to the services of employees of the principal and to assets belonging to the principal are some of the relevant considerations in determining whether a true agency exists. If the corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned by the principal, if such is the case. Its business purpose must be the carrying on of the normal duties of an agent. Absence of the factors mentioned above, and the essentiality of ownership of the corporation to the existence of any 'agency' relationship in the Moline Properties, Commonwealth Improvement Co., and Southern Pacific cases indicates the fallacy of the agency argument made in those case.

The same fallacy is apparent in the contention that petitioners are agents of Airco. They claim that they should be taxable on net income aggregating only $1,350, despite the fact that during the tax year (1938) they owned assets worth nearly 20 million dollars, had net sales of approximately 22 million dollars, and earned nearly four and one-half million dollars net. Their employees number in the thousands. We have passed the question whether Airco's interest in these assets is that of owner of the subsidiaries or lender, but whatever the answer, they do not belong to Airco as principal. The entire earnings of petitioners, except for trifling amounts, are turned over to Airco not because the latter could command this income if petitioners were owned by third persons, but because it owns, and thus completely dominates the subsidiaries. Airco, for sufficient reasons of its own, wished to avoid the burdens of principalship. See Moline Properties, Inc., v. Commissioner of Internal Revenue, supra; Sheldon Building Corporation v. Commissioner of Internal Revenue, 7 Cir., 1941, 118 F.2d 855. Compare Forshay v. Commissioner of Internal Revenue, 1930, 20 B.T.A. 537. It cannot now escape the tax consequences of that choice, no matter how bona fide its motives or longstanding its arrangements. When we referred to the 'usual incidents of an agency relationship' in the Moline Properties case, we meant just that-not the identity of ownership and control disclo ed by the facts of this case.

We have considered the other arguments made by petitioners and find them to be without merit. The judgment of the Court of Appeals is affirmed.

Affirmed.