Comm'r of Internal Revenue

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Tax Court of the United States.Jun 17, 1954
22 T.C. 581 (U.S.T.C. 1954)

Docket No. 27856.



Robert N. Chambliss, Esq. , for the petitioner. S. Earl Heilman, Esq. , for the respondent.

Petitioner, a corporation manufacturing ladies hosiery, sold silk and nylon hosiery to one of its customers in 1945 under an arrangement whereby the customer remitted the full O. P. A. ceiling price plus five-sixths of his net profit to one of petitioner's officers. The latter turned over 90 per cent of the O. P. A. ceiling price to petitioner and, after deducting his expenses, divided the remainder among the officer-director stockholders of the corporation. Held, the entire profit on the sale represented taxable income to petitioner within the purview of section 22(a), Internal Revenue Code. Robert N. Chambliss, Esq., for the petitioner. S. Earl Heilman, Esq., for the respondent.

Respondent determined a deficiency in petitioner's excess profits tax liability for the year 1945 in the amount of $7,622. The issue for decision is whether respondent was correct in determining that the entire profit on the sale of certain hosiery manufactured by petitioner was taxable to it.


The stipulated facts are so found.

The petitioner is a Tennessee corporation with its principal place of business in Chattanooga, Tennessee. It filed its income and excess profits tax returns for the year 1945 with the collector of internal revenue for the district of Tennessee.

The petitioner has been since 1919, and was in 1945, a manufacturer of ladies hosiery. Its capital stock throughout 1945 was owned by G. B. Smith (486 shares), Felix G. Miller (486 shares), C. U. Smith (58 shares), and Miller Bros. Co. (1,400 shares). During 1945 there were 9,000 shares of Miller Bros. Co. stock outstanding. Felix G. Miller owned 3,000 shares and was the beneficiary of another 1,000 shares, while Mrs. G. B. Smith was the owner of 2,500 shares of the stock of Miller Bros. Co. During 1945, and for some years prior to that time, G. B. Smith, C. U. Smith, and Felix G. Miller were the directors of petitioner and were petitioner's president, vice president, and secretary-treasurer, respectively.

The petitioner was engaged in the manufacture of ladies full-fashioned hosiery, made from silk and nylon, in the summer of 1941, when raw silk stocks were frozen, but it had sufficient hosiery on hand to continue sales until December, when Pearl Harbor occurred, after which silk hose were withdrawn from sale. Early in 1942 the military forces took over the entire production of nylon, and all mills, including the petitioner, were offered allotments of rayon, which created a tremendous demand for hose made of silk or nylon. The petitioner still had on hand eight or nine hundred dozen of silk and nylon hosiery at this time.

In 1943 petitioner decided to dispose of its stock of silk and nylon hosiery. The quantity on hand was too small to allocate among petitioner's more than two thousand retail accounts. After considerable investigation the hosiery was sold in the following manner. J. N. Hartford (hereinafter referred to as Hartford), the proprietor of a retail hosiery outlet in Athens, Georgia, was asked to come to Chattanooga. Hartford was one of petitioner's customers and it was decided that the sale of the hosiery through his store would have the least adverse effect upon petitioner's over-all customer relations. Hartford was also a close personal friend of G. B. Smith and C. U. Smith, and had formerly worked for Felix G. Miller. After some discussion, Hartford orally agreed to purchase the hosiery at petitioner's O. P. A. ceiling prices, to sell the hosiery at O. P. A. ceiling retail prices (which allowed to the retailer a margin of approximately 40 per cent), and to remit to C. U. Smith five-sixths of his net profit.

Under the arrangement with Hartford, petitioner's entire stock of silk and nylon hosiery was sold. The hosiery was boxed and shipped by petitioner to Hartford in various lots beginning in 1943 and continuing through 1945. Petitioner's invoice for the full O. P. A. ceiling price accompanied each order to Hartford. C. U. Smith then had the girl preparing the invoice deduct 10 per cent on the office copy of the invoice and the latter amount was entered on petitioner's books as the invoice price. Hartford sent his check for the full invoice price to C. U. Smith. The latter deposited the check in his personal account, deducted 10 per cent from the amount received, and paid the balance with his own check to petitioner.

After Hartford sold the hosiery he would send five-sixths of his net profit to C. U. Smith, who deposited the sum received in his own personal account. Thus C. U. Smith received 10 per cent of petitioner's O. P. A. ceiling price plus five-sixths of Hartford's net profit. From this figure C. U. Smith deducted a fixed amount as his expenses. (We are unable to fathom what these expenses might have been.) Then, according to an arrangement worked out among petitioner's three directors, one-third of the balance was paid to G. B. Smith, one-third was paid to Elizabeth S. Miller, the wife of Felix G. Miller, and one-third was retained by C. U. Smith.

Practically speaking, C. U. Smith performed all of the operations of the transaction. Except for keeping track of the money received from Hartford, C. U. Smith performed no duties that he would not normally perform without additional compensation as petitioner's vice president in charge of sales. He often took orders on behalf of petitioner for which he received no commission.

Petitioner made two series of shipments to Hartford in 1945. On was made in February and another in September and October. On these shipments C. U. Smith retained 10 per cent of the amount of the invoices paid, or $1,450.89, and received five-sixths of Hartford's net profit, or $7,763.75. He deducted $300 as his expenses, leaving $8,914.64. Of this amount he retained $2,971.56, and distributed $2,971.54 to G. B. Smith and $2,971.54 to Elizabeth S. Miller. Each reported income from the transaction in his or her individual income tax return for 1945 in the amount of $2,971.54.

According to petitioner's records, the transaction was nothing more than a straight sale of the hosiery to Hartford at the O. P. A. ceiling price less a 10 per cent discount. The only records to the contrary were Hartford's penciled memoranda accompanying his rebates to C. U. Smith. In essence the transaction was a sale by petitioner to Hartford with C. U. Smith, G. B. Smith, and Elizabeth S. Miller receiving a part of the purchase price. C. U. Smith, G. B. Smith, and Felix G. Miller were in control of petitioner. At the suggestion of Felix G. Miller, his wife received his share of the distributed profit. The entire profit realized on sale of the hosiery represented income earned by the petitioner.

Respondent determined that the income from the transaction reported on the individual income tax returns of C. U. Smith, G. B. Smith, and Elizabeth S. Miller represented taxable income to petitioner in the amount of $8,914.62.


BRUCE, Judge:

The sole issue for decision is whether the entire profit realized on the sale of silk and nylon hosiery to Hartford in 1945 is taxable to petitioner. The question is essentially one of fact. Petitioner argues that the hosiery was sold through a ‘joint venture’ or a ‘partnership’ whose members were C. U. Smith, G. B. Smith, and Elizabeth S. Miller. Respondent contends that the transaction represented a sale by petitioner.

We have found as a fact that the sale was made by petitioner directly to Hartford, who was one of petitioner's regular customers. The hosiery was boxed and shipped to Hartford by petitioner. Petitioner's invoice was sent directly to Hartford. The entire transaction was handled by petitioner's vice president in charge of sales, who often took orders for petitioner. According to petitioner's records the sale was made directly to Hartford. Petitioner has not shown that the alleged ‘partnership’ or ‘joint venture’ ever acquired title to the hosiery. In fact, petitioner has not shown that a ‘partnership’ or ‘joint venture’ existed. No capital was contributed or risk assumed. There is no showing that Elizabeth S. Miller ever discussed the transaction with her alleged partners, C. U. Smith and G. B. Smith, or that she even knew of the existence of the venture prior to the receipt of income. C. U. Smith was the only one of the three alleged ‘partners' to render any appreciable service to the venture, and, for the most part, he was merely performing his accustomed duties as petitioner's vice president. Petitioner's head bookkeeper did not even know of the existence of the alleged partnership. He considered checks received from C. U. Smith as payments on the account of Hartford.

Petitioner contends that respondent puts form ahead of substance. We do not agree. Petitioner's allegation that the sale was made through the alleged partnership is without merit. The transaction not only took the form of a direct sale to Hartford, but in substance it was a direct sale. It is true that the payments were made directly to C. U. Smith, who in turn paid petitioner. Handling the transaction in this manner eliminated the necessity of recording Hartford's payments in excess of O. P. A. ceiling prices. Also, certain obvious tax advantages might have been achieved. Nevertheless, the sale was made directly to Hartford. Therefore, the full amount of the profit on the sale is taxable to petition, notwithstanding the fact that a portion of the profit was not received by petitioner, but instead was divided among petitioner's office-creditor stockholders or their wives. United States v. Joliet & Chicago R. Co., 315 U. S. 44; Essex Construction Co., 12 T. C. 1212.

There is no merit to petitioner's argument that it was necessary to make the sale through the alleged partnership because a direct sale would create customer dissatisfaction, as the entire transaction was made to appear a direct sale by petitioner to Hartford. Also, there is no merit to petitioner's contention that it cannot be charged with a profit on a sales price in excess of the O. P. A. ceiling. That it was illegal for petitioner to receive an amount in excess of the O. P. A. ceiling does not make the payment of the excess to petitioner's officer-director stockholders (or their wives) any less a subterfuge, or alter the fact that the income was earned by petitioner. L. E. Shunk Latex Products, Inc., 18 T. C. 940, relied upon by petitioner is clearly distinguishable. In that case there was a valid sale to a valid partnership at a sales price fixed prior to the imposition of O. P. A. ceilings, under an arrangement established in accordance with arm's-length negotiations. There the Commissioner was attempting to reallocate income under section 45 of the Internal Revenue Code between commonly controlled businesses. Here he has correctly determined that the entire profit is taxable as petitioner's income under section 22(a) of the Code.

Decision will be entered for the respondent.

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