Opinion
Docket Nos. 29244 29245.
1953-04-10
O. FALK'S DEPARTMENT STORE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.FRANKLIN POLK CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Cody Fowler, Esq., and John J. Trenam, Esq., for the petitioners. Ralph V. Bradbury, Jr., Esq., for the respondent.
1. P corporation owned improved realty which it leased to F corporation for a period of 10 years, extending from October 9, 1939, to October 9, 1949. F operated a department store on the leased premises until August 1, 1944, when it subleased the property to a partnership for a period of 5 years, ending August 1, 1949. F owned all the stock of P. F had a total of 1,200 shares of stock outstanding, of which David Falk, his mother, Emma Falk, his sister, Annie F. Mandel, and his sister's husband, Frank Mandel, respectively, owned 701, 97, 201, and 1 shares. On August 1, 1944, David, Annie and Frank formed a partnership, with equal interests therein. The partnership purchased the merchandise inventory of F, subleased the improved realty of P, leased F's furniture, fixtures and equipment, entered into an agreement with F for the use of its trade name and good will, and began operating a department store on the property owned by P. The partners agreed to pay F a rental of $30,000 annually, plus 4 per cent of their gross sales in excess of $750,000. A similar rental had been provided in the original lease between F and P, which original lease was amended on August 1, 1944, so that the maximum annual rent to be paid by F to P would not thereafter exceed $75,000. David and Frank were the principal officers of both P and F corporations, the petitioners, from 1940 through the taxable years. Held, petitioners were personal holding companies during the taxable year 1945, within the meaning of section 501 of the Internal Revenue Code.
2. Petitioners, relying on the advice of certified public accountants of reputed ability and experience in the Federal tax field, to the effect that they would not be personal holding companies after the department store business and operation was taken over by the partnership, failed to file personal holding company returns for 1945. Held, petitioners' failure to file the required returns was due to reasonable cause and was not due to willful neglect, and they are not subject to additions to tax therefor. Cody Fowler, Esq., and John J. Trenam, Esq., for the petitioners. Ralph V. Bradbury, Jr., Esq., for the respondent.
The respondent determined deficiencies and additions to tax for failure to file personal holding company tax returns against the petitioners as follows:
+---------------------------------------------------------------------+ ¦ ¦ ¦ ¦Personal ¦ ¦ +------+-------------------------------+-----+----------+-------------¦ ¦ ¦ ¦ ¦holding ¦ ¦ +------+-------------------------------+-----+----------+-------------¦ ¦Docket¦ ¦ ¦company ¦25% additions¦ +------+-------------------------------+-----+----------+-------------¦ ¦No. ¦Name ¦Year ¦surtax ¦to tax ¦ +------+-------------------------------+-----+----------+-------------¦ ¦ ¦ ¦(1945¦$23,012.68¦$5,753.17 ¦ +------+-------------------------------+-----+----------+-------------¦ ¦29244 ¦O. Falk's Department Store, Inc¦(1946¦38,966.14 ¦9,741.53 ¦ +------+-------------------------------+-----+----------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +------+-------------------------------+-----+----------+-------------¦ ¦ ¦ ¦(1945¦19,335.19 ¦4,833.80 ¦ +------+-------------------------------+-----+----------+-------------¦ ¦29245 ¦Franklin Polk Corporation ¦(1946¦20,076.39 ¦5,019.10 ¦ +---------------------------------------------------------------------+
The issues presented are (1) whether both petitioners were personal holding companies during the calendar year 1945 and subject to the personal holding company surtax, under the provisions of the Internal Revenue Code, and (2) whether each petitioner is subject to the 25 per cent addition to tax for failure to file personal holding company tax returns for the taxable year 1945. The respondent has conceded, by stipulation, that there is no personal holding company surtax, or addition to tax for failure to file a personal holding company tax return, due by either petitioner for the taxable year 1946.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
Petitioners are Florida corporations, and each has its principal place of business in Tampa, Florida. They filed their corporation income and declared value excess-profits tax returns and excess profits tax returns for the years involved with the collector of internal revenue at Jacksonville, Florida.
Petitioner Franklin Polk Corporation was the owner of certain improved real estate located in the business district of Tampa. It leased this real estate to O. Falk's Department Store, Inc., the other petitioner herein, for a term of 10 years extending from October 9, 1939, to October 9, 1949. O. Falk's Department Store, Inc., owned and operated a department store in the city of Tampa and the property in question was leased as a site for its operations. Pursuant to the terms of the lease, it was to pay to Franklin Polk Corporation a fixed rental of $21,000 for the first year, and $30,000 for each of the remaining 9 years, plus 4 per cent of its gross sales in excess of $750,000.
During 1945 the entire 50 shares of common stock outstanding of Franklin Polk Corporation were owned by O. Falk's Department Store, Inc. There were no other classes of capital stock outstanding during that year.
Also during 1945, the common stock of O. Falk's Department Store, Inc., was owned as follows:
+---------------------------------------------------------+ ¦Stockholders ¦No. of shares ¦ +-----------------------------------------+---------------¦ ¦Emma Falk (mother of David and Annie) ¦97 ¦ +-----------------------------------------+---------------¦ ¦David A. Falk (son of Emma Falk) ¦701 ¦ +-----------------------------------------+---------------¦ ¦Annie Falk Mandel (daughter of Emma Falk)¦201 ¦ +-----------------------------------------+---------------¦ ¦Frank E. Mandel (son-in-law of Emma Falk)¦1 ¦ +-----------------------------------------+---------------¦ ¦Franklin Polk Corporation ¦200 ¦ +-----------------------------------------+---------------¦ ¦Total shares issued and outstanding ¦1,200 ¦ +---------------------------------------------------------+
There were no other classes of capital stock outstanding during the year 1945.
From 1940 to 1951, the principal officers of both petitioners have been David A. Falk, president, and Frank E. Mandel, vice president and treasurer.
David A. Falk has been a member of the bar of the State of Florida since 1917. He practiced law only a few months in 1917, before being inducted into the Armed Forces of the United States. Upon leaving the service, he did not resume the practice of law, but entered into the department store business in Tampa, and has continued to be engaged in such business. His father had established the department store in 1894 or 1895. David did not keep himself versed in the law, and for over 25 years has relied on an attorney for legal advice, but as to tax matters, he relied primarily on Rex Meighen, a certified public accountant.
Frank E. Mandel is a certified public accountant, and was engaged in the active practice of his profession in the State of New York from 1917 to July 1925. He taught the subject of accounting in the City College of New York from 1916 to 1920. He married Annie Falk in 1923, and in 1925 he became associated with his father-in-law and brother-in-law in the department store business in Tampa. After David Falk's father became inactive in the business, in 1931, because of heart trouble, David Falk and Frank Mandel operated the business, and continued to do so after the death of the senior Falk in 1941. The Falks had often discussed the question of taking Mandel into the business, as he had been very instrumental in building up the store, and in the spring of 1944 decided to form a partnership to operate the store, so as to include Mandel. The parties, including Mandel himself, felt that Mandel was not entitled to a material interest in the corporations, as he had not contributed anything to the acquisition of or ownership in the real property. Mandel, like David Falk, relied on Rex Meighen, or his accounting firm, for advice in tax matters.
A partnership was organized, with David A. Falk, Frank E. Mandel, and Annie Falk Mandel being the partners and having equal interests therein. On August 1, 1944, the partnership purchased the merchandise inventory of O. Falk's Department Store, Inc., subleased from O. Falk's Department Store, Inc., the improved real estate owned by Franklin Polk Corporation, leased the furniture and fixtures of O. Falk's Department Store, Inc., entered into an agreement for the use of the trade name and good will of O. Falk's Department Store, Inc., and began operating a department store business on the improved real estate owned by Franklin Polk Corporation, which operations were conducted under the name O. Falk's Department Store.
The sublease of the real estate from O. Falk's Department Store, Inc., was for a term of 5 years from August 1, 1944, to August 1, 1949, and under the terms thereof the partnership was to pay to O. Falk's Department Store, Inc., a fixed rental of $30,000 a year, plus 4 per cent of its gross sales in excess of $750,000. On the same date the sublease was executed, namely, August 1, 1944, a supplemental lease agreement was executed between Franklin Polk Corporation and O. Falk's Department Store, Inc., amending the original lease agreement of October 9, 1939, to limit the rental thereunder to a maximum of $75,000 a year for the remaining life of the lease, as against the former provision of a fixed rental of $30,000 a year, plus 4 per cent of gross sales in excess of $750,000 a year without limitation.
The gross income of O. Falk's Department Store, Inc., for the taxable year 1945 was $132,437.51, which amount was made up of the items shown in the following schedule:
+-----------------------------------------------------------------------------+ ¦Rent, including compensation for use of or right to use property:¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Rent paid or accrued on real estate of Franklin Polk Corporation ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦subleased to O. Falk's Department Store, a partnership ¦$99,199.49 ¦ +-----------------------------------------------------------------+-----------¦ ¦Compensation paid or accrued for use of trade name and good ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦will by O. Falk's Department Store, a partnership ¦22,629.17 ¦ +-----------------------------------------------------------------+-----------¦ ¦Rent paid or accrued on furniture and fixtures leased to O. ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Falk's Department Store, a partnership ¦5,992.77 ¦ +-----------------------------------------------------------------+-----------¦ ¦Total Rent ¦$127,821.43¦ +-----------------------------------------------------------------+-----------¦ ¦Interest Received ¦4,616.08 ¦ +-----------------------------------------------------------------+-----------¦ ¦Total Gross Income ¦$132,437.51¦ +-----------------------------------------------------------------------------+
The entire gross income of Franklin Polk Corporation for the taxable year 1945 was $75,345, of which amount $75,000 represented rent paid by petitioner O. Falk's Department Store, Inc., for use of its improved real estate.
On August 1, 1946, all of the assets of the partnership, O. Falk's Department Store, including the rights to the use of the above-mentioned property, were transferred to a newly organized corporation, O. Falk's, Inc., and the partnership was liquidated and dissolved.
Rex Meighen is a certified public accountant, who has actively practiced his profession in Tampa since receiving his certificate in 1927, and prior to that, had been in the accounting business. He has been admitted to practice before the United States Treasury Department and The Tax Court of the United States for the past 25 years. He is and has been generally recognized in the Tampa area as a tax expert.
He has been connected with petitioners since the 1930's. He first prepared a financial statement of O. Falk's Department Store, Inc., for bankers, and he, or his firm, has continued to make its annual audits. During 1944, 1945, and 1946, Meighen was not in close touch with the company's audits. William H. Stafford, a member of Meighen's organization, and also a certified public accountant, was giving his personal supervision in the examination of the accounts of petitioners and, with Meighen, advised the officers of petitioners on their accounting and tax problems. Both accountants were familiar with the business of each petitioner, the corporate structure of each and the interest of each individual in the corporations.
Early in 1944, Falk and Mandel conferred with Meighen and Stafford in Meighen's office with respect to organizing the proposed partnership and the taxes that might be entailed from the transaction. The accountants advised that O. Falk's Department Store, Inc., would have income from subleasing the real property, from renting its fixtures and other personal property, from compensation for the use of its store name, and from capital gain, if any, on the sale of its inventory. Mandel asked if the corporations would become personal holding companies and if they would be subject to such tax. He had asked Stafford previously if Franklin Polk Corporation was a personal holding company. When the personal holding company question was raised Meighen referred to the Internal Revenue Code, read the sections therein relating to personal holding companies, and advised that the formation of the partnership and the consummation of the proposed transaction would not constitute petitioners as personal holding companies within the meaning of the Federal tax laws.
On March 15, 1946, both petitioners filed tentative corporation income and declared value excess-profits tax and corporation excess profits tax returns, and on May 15, 1946, all returns, as prepared by Mandel, were filed by petitioners. They were signed and sworn to by the president, David Falk. No other officer of either petitioner signed the returns.
‘No‘ was given as the answer to the following question on the corporation income and declared value excess-profits tax return of each petitioner:
9. Is the corporation a personal holding company within the meaning of section 501 of the Internal Revenue Code? . . . (If so, an additional return on Form 1120H must be filed.)
No answer was given to the following questions:
11. If this is not a consolidated return: (a) did the corporation own at any time during the taxable year 50 percent or more of the voting stock of another corporation either domestic or foreign? . . . ; or (b) did any corporation, individual, partnership, trust, or association own at any time during the taxable year 50 percent or more of the corporation's voting stock? . . . (If either answer is ‘yes,‘ attach separate schedule showing: (1) Name and address; (2) percentage of stock owned; (3) date stock was acquired; and (4) the collector's office in which the income tax return of such corporation, individual, partnership, trust, or association for the last taxable year was filed.)
Falk and Mandel had relied on the advice of their accountants that neither corporation was a personal holding company.
Petitioners were personal holding companies during the taxable year 1945, but neither of the petitioners filed a personal holding company tax return for that year.
The failure to file personal holding company tax returns for 1945 was due to reasonable cause and not due to willful neglect, and petitioners are not liable for the respective additions to tax therefor determined by the respondent.
OPINION.
TURNER, Judge:
The petitioners were holding companies in 1945 and subject to the surtax on personal holding companies under section 500 of the Internal Revenue Code, provided their income was personal holding company income to the extent prescribed by section 501(a)(1)
and more than 50 per centum in value of their outstanding stock was owned, directly or indirectly, by or for not more than five individuals, as prescribed in section 501(a)(2)1 of the Code.
SEC. 501 DEFINITION OF PERSONAL HOLDING COMPANY.(a) GENERAL RULE.— For the purposes of this subchapter and chapter 1, the term ‘personal holding company‘ means any corporation if—(1) GROSS INCOME REQUIREMENT.— At least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 502; but if the corporation is a personal holding company with respect to any taxable year beginning after December 31, 1936, then, for each subsequent taxable year, the minimum percentage shall be 70 per centum in lieu of 80 per centum, until a taxable year during the whole of the last half of which the stock ownership required by paragraph (2) does not exist, or until the expiration of three consecutive taxable years in each of which less than 70 per centum of the gross income is personal holding company; and(2) STOCK OWNERSHIP REQUIREMENT.— At any time during the last half of the taxable year more than 50 percentum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.
By section 503(a)(1) of the Code,
it is provided that for the purpose of determining stock ownership under section 501(a)(2), ‘stock owned, directly or indirectly, by or for a corporation * * * shall be considered as being owned proportionately by its shareholders.‘ It is thus apparent that for the purposes of applying section 501(a)(2), supra, the stock of Franklin Polk Corporation must be considered as having been owned by the stockholders of O. Falk's Department Store, Inc., and in the end, that means that the stock was owned proportionately by the four individual stockholders of the latter corporation. As to the applicability of section 501(a)(2) to O. Falk's Department Store, Inc., we need only to note that it had four individual stockholders and that David A. Falk alone, owning directly 701 out of the 1,200 shares outstanding, owned more than 50 per cent in value of its outstanding stock.
SEC. 503. STOCK OWNERSHIP.(a) CONSTRUCTIVE OWNERSHIP.— For the purpose of determining whether a corporation is a personal holding company, insofar as such determination is based on stock ownership under section 501(a)(2), section 502(e), or section 502(f)—(1) STOCK NOT OWNED BY INDIVIDUAL.— Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries.
It is equally clear, we think, that the income of each of the petitioners was personal holding company income to the extent required by section 501(a)(1), supra. In section 502(f),
it is provided that the gross income of a corporation is personal holding company income if it consists of ‘amounts received as compensation (however designated and from whomsoever received) for the use of, or right to use, property of the corporation in any case where, at any time during the taxable year, 25 per centum or more in value of the outstanding stock of the corporation is owned, directly or indirectly, by or for an individual entitled to the use of the property; whether such right is obtained directly from the corporation or by means of a sublease or other arrangement,‘ and in that connection, it is to be noted that stock ownership under section 502(f) is also to be determined under the provisions of section 503(a)(1), supra. The facts show that in the case of each corporation substantially more than 80 per cent of its income consisted of rents received by the leasing and subleasing of its property; and further, that the use of the property by and through the leasing and subleasing arrangements was in a partnership composed of individuals who owned slightly more than 75 per cent of the stock of each corporation, either directly or within the meaning of section 503(a)(1). It is argued, however, that, even so, the use of the corporate property was not in any individual who owned 25 per cent or more in value of the outstanding stock, since the sublease was to the partnership and not to a stockholder or stockholders individually. The question whether individual stockholders may be insulated against the applicability of section 502(f) by taking the use of or right to use the corporate property in a partnership, of which they are members, is not now an open question in this Court, and the argument advanced must be resolved against the petitioners. Western Transmission Co., 18 T.C. 818, and Furniture Finance Corporation, 46 B.T.A. 240. To the same effect is Randolph Products Co. v. Manning, 176 F.2d 190.
SEC. 502. PERSONAL HOLDING COMPANY INCOME.For the purposes of this subchapter the term ‘personal holding company income‘ means the portion of the gross income which consists of:(f) USE OF CORPORATION PROPERTY BY SHAREHOLDER.— Amounts received as compensation (however designated and from whomsoever received) for the use of, or right to use, property of the corporation in any case where, at any time during the taxable year, 25 per centum or more in value of the outstanding stock of the corporation is owned, directly or indirectly, by or for an individual entitled to the use of the property; whether such right is obtained directly from the corporation or by means of a sublease or other arrangement.
With respect to O. Falk's Department Store, Inc., a further contention is made, which, if we understand it correctly, is that section 502(f), supra, is not applicable, for the reason that the statute requires that the property which the individual stockholder has the right to use must have been the ‘property of the corporation,‘ and that in this instance, the sublease under which O. Falk's Department Store, Inc., realized a substantial portion of its rent covered the property of Franklin Polk Corporation and not that of O. Falk's Department Store, Inc., although it is admitted that O. Falk's Department Store, Inc., did have a leasehold interest in the real estate subleased by it to the partnership. If, in the circumstances, O. Falk's Department Store, Inc., had seen fit to assign or convey that interest to the partnership and, in so far as the said real estate was concerned, had stepped completely out of the picture, there might well have been some force to the argument that with respect to the real estate, there was no right in the partnership or its members to use the property of O. Falk's Department Store, Inc. It is to be noted, however, that the said corporation did not convey or assign its leasehold interest in the real property which it held under lease from the Franklin Polk Corporation, but granted, by sublease, the use of the property to the partnership and its members. At the same time, its lease with Franklin Polk Corporation was modified so that for the remainder of the term thereof the rent payable under the lease was limited to a maximum of $75,000 per year, whereas it was entitled to receive from the partnership, under the sublease, a fixed rental of $30,000 a year, plus 4 per cent of the gross sales of the department store in excess of $750,000 without any further limitation. It is also to be noted that the term of the sublease to the partnership ended on August 1, 1949, whereas the term of the leasehold which it held from Franklin Polk Corporation ran to October 9, 1949. We are of the opinion, therefore, that petitioners' argument on this point must be rejected.
A further argument is advanced to the effect that the statutory provisions above should not be applied, since Emma Falk, who held 97 shares of the outstanding 1,200 shares of O. Falk's Department Store, Inc., was not a member of the partnership and had no interest in the department store operations and, for that reason, application of the personal holding company surtax to that corporation would, as to her, be inequitable. As noted above, the statute clearly covers the situation where a corporation received compensation for the use of its property by an individual owning 25 per cent or more of its stock. There is no qualification of that provision which could make it inapplicable to cases where there were other stockholders who were not entitled to use the property. The Congress for its own reasons enacted the statute as it is and it is not within our province to amend or revise it. More appropriately, the argument made is one for the ear of Congress. A somewhat comparable argument is also advanced to the effect that, regardless of the plain wording of the statute, Congress did not intend that the provisions of section 502(f), supra, should apply to a bona fide real estate corporation, the main source of the income of which was composed of rent received by reason of its ownership of business properties. The argument so made was considered and decided contrary to the taxpayer's contention in Hatfried, Inc. v. Commissioner, 162 F.2d 628, affirming the Tax Court on that point. In that connection, it is to be noted, also, that by section 223 of the Revenue Act of 1950, Congress has made the provisions of section 502(f), supra, inapplicable ‘to rents received during taxable years ending after December 31, 1945, and before January 1, 1950, if such rents were received for the use by the lessee, in the operation of a bona fide commercial, industrial, or mining enterprise, of property of the taxpayer.‘ Congress made no change, however, as to the applicability of the section to such rents received during years ending prior to January 1, 1946.
The remaining question is whether the petitioners are liable under section 291(a) of the Internal Revenue Code
for the additions to tax prescribed therein, by reason of their failure to file personal holding company tax returns for 1945. Having failed to file such returns, the petitioners are liable for the additions to tax, unless they have shown that such failure was ‘due to reasonable cause and not due to willful neglect.‘
SEC. 291. FAILURE TO FILE RETURN.(a) In case of any failure to make and file return required by this chapter, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the tax: 5 per centum if the failure is for not more than thirty days within an additional 5 per centum for each additional thirty days or fraction thereof during which such failure continues, not exceeding 25 per centum in the aggregate. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which case the amount so added shall be collected in the same manner as the tax. The amount added to the tax under this section shall be in lieu of the 25 per centum addition to the tax provided in section 3612(d)(1).
On the evidence, we have found as a fact that the failure of the petitioners to file personal holding company tax returns for 1945 was due to reasonable cause, and not due to willful neglect. The evidence shows that the officers of both petitioners, David A. Falk and Frank E. Mandel, in failing to file the returns in question, relied upon the advice of a certified public accountant, who has actively practiced his profession in Tampa since 1927 and who is, and has been, generally recognized in the Tampa area as a tax expert. Though it develops that the advice given was in error, we are convinced that the advice was honestly given and was relied on in good faith by the petitioners. See and compare Burton Swartz Land Corporation v. Commissioner, 198 F.2d 558, and Safety Tube Corporation, 8 T.C. 757, affd. 168 F.2d 787.
Decisions will be entered under Rule 50.