Stevens Bros. & the Miller-Hutchinson Co.
Comm'r of Internal Revenue

Tax Court of the United States.Aug 29, 1955
24 T.C. 953 (U.S.T.C. 1955)

Docket No. 49117.



A. J. Schmitt, Jr., Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.

DIVISION OF PROFITS— MONEY FURNISHED AT RISK OF JOB.— A taxpayer contractor is not taxable with entire profits from a job where, in order to obtain required $75,000 of funds subrogated to the rights of all creditors, it agreed that the corporation furnishing the funds should have one-half of the profits from the job. A. J. Schmitt, Jr., Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.

The Commissioner determined a deficiency in income tax of $24,693.16 for 1948 and one of $37,621.49 for 1949. The issue for decision is whether one-half of the profits from a construction contract was properly a part of the net income of the petitioner although paid to Stevens Brothers Foundation, Inc., under an agreement pursuant to which the Foundation advanced to the petitioner money essential to the earning of the profits.


The petitioner's returns for the taxable years were filed with the collector of internal revenue for the district of Louisiana.

The petitioner was incorporated in 1936 and succeeded to the business formerly carried on by partnerships. The business was that of of heavy construction. The principal office of the petitioner is in New Orleans. The stock of the petitioner was owned two-thirds by Stevens Brothers, a partnership of St. Paul, Minnesota, and one-third by R. C. Hutchinson. The partners of Stevens Brothers were E. F. Stevens, C. R. Stevens and H. O. Stevens, brothers, and S. A. Stevens, the wife of E. F. Stevens. Hutchinson was secretary-treasurer and the active manager of the petitioner. Stevens Brothers did not carry on any business in the Louisiana area.

The United States Engineers of the New Orleans District advertised in the early part of May 1947 for bids for laying reinforced concrete floors for the Algiers Locks. The bids were to be opened on June 3. The petitioner had had prior experiences in such work. Hutchinson anticipated that its equipment would be released from other work about the time it would be needed on this prospective job. He obtained a copy of the plans for the lock floor job, studied them, estimated the cost, realized that it would require more money than the petitioner had available, and consulted the Whitney National Bank of New Orleans about a loan for the purposes of the job. That bank has been lending money to the business for many years. The bank not only refused to lend money for the purpose but requested that existing loans amounting to about $60,000 be reduced. The financial condition of the petitioner was not as good as it had been, due to unprofitable contracts in recent years. Hutchinson also consulted its bonding source, the Maryland Casualty Company, about a bid bond and a construction bond and was told that neither bond would be furnished unless $50,000 of additional capital was put into the petitioner. He then advised the Stevens in St. Paul of the situation and conferred with them in St. Paul. They required that material commitments be obtained and then to him that Stevens Brothers Foundation, Inc., would furnish the additional capital of $50,000 for this job upon condition that it would receive one-third of the net profits from the job. Hutchinson returned to New Orleans where he learned from Maryland that it would require the petitioner to have $75,000, instead of $50,000, of additional capital. Hutchinson again communicated with the Stevenses in St. Paul and was advised that the Foundation would supply the $75,000 provided it would receive one-half of the profits from the job. The Foundation and the petitioner adopted appropriate resolutions and entered into a contract under which the Foundation agreed to furnish the $75,000 immediately which would remain under the complete control of the petitioner until completion of the lock floor contract and the payment of all accounts due. The Foundation was to receive one half of any profit, before income taxes, from the job, and was to share any losses up to the $75,000.

Hutchinson bid on the job for the petitioner, that bid was the lowest of three submitted, and the petitioner was awarded the contract. The petitioner's bid was ‘approximately’ $1,053,409.80. The other two bids submitted were for $1,322,088 and $1,599,994. Maryland furnished the bonds but reinsured 80 per cent of the construction bond because of the lowness of the petitioner's bid. The reinsurers would not have taken any of the risk had the $75,000 not been in as capital.

Foundation loaned $40,000 to the petitioner in 1948. That amount was needed for a short period as a revolving fund with which to pay for steel shipments until promptly reimbursed by the Government after which the money would be used again to pay for another shipment. The bank had refused to lend money for that purpose. Foundation received no additional remuneration for supplying the $40,000. That money was repaid to it by the petitioner.

The petitioner completed the contract in July 1949. Foundation received, as its one-half of the profits from the lock floor contract performed by the petitioner, $34,252.39 in 1948, and $87,203.91 for 1949. Later the $75,000 was returned to Foundation but meanwhile its use was required under similar circumstances and arrangements and it was actually used, on a contract obtained by he petitioner in 1949 and completed in 1950 for the construction of the sidewalls of the Agliers Locks. No profits from that contract were received in 1949.

Hutchinson knew of no other way of obtaining the necessary bonds except through his long-established relations with Maryland and he knew of no other way of obtaining the required $75,000 of funds subrogated to the rights of all creditors, particularly in the short time available. He considered the contract with Foundation a fair one to both parties. That contract was bona fide. Hutchinson had no interest in Foundation and had had no previous dealings with it.

Foundation was a corporation organized in December 1942 by members of the Stevens family. The Commissioner ruled on May 1, 1947, that it was exempt under section 101(6) but reversed that ruling in 1954. Foundation had 10 members during the years 1947 through 1949 including the 4 partners of Stevens Brothers. They took active parts in its affairs and tried to increase its capital. Its net worth was substantially in excess of the $75,000 which it provided for the use of the petitioner. No part of its net earnings inured to the benefit of any stockholder or member. The members served without pay. Foundation was not owned or controlled by the same interests which owned and controlled the petitioner.

The petitioner, on its returns for 1948 and 1949, showed the net profits from the Algiers Locks floor contract, subtracted one-half thereof as belonging to the Foundation, and did not report that one-half of its income. The amounts subtracted were added back to the petitioner's income by the Commissioner in determining the deficiencies. The amounts of $34,252.39 for 1948 and $87,203.71 for 1949 were not a part of the income of the petitioner but belonged to Foundation.



The Commissioner takes the untenable position, under various theories in which he refuses to face the facts that the petitioner owed nothing to anyone for the use of the $75,000 and owned all of the income from the Algiers Locks floor contract, without diminution for any payment of any kind for the use of that money. The facts refute all of those contentions. The need for the money, the difficulty of obtaining it, the source from which it was obtained, the conditions of the contract for the payment of one-half of the net profits, and the actual payment of the agreed amounts to Foundation are clearly established by the evidence. The evidence also shows that the terms of the contract between the petitioner and Foundation were fair to both parties and the contract was bona fide in all respects. There was no tax avoidance scheme. Hutchinson's interests were adverse to those of Foundation and he was satisfied to obtain the $75,000 in the way he obtained it. Hindsight makes the agreement appear very favorable to Foundation but it risked the loss of its $75,000 on a job which the insurers, at least, deemed quite risky. The agreement cannot be ignored or rewritten to suit the Commissioner. Seminole Flavor Co., 4 T.C. 1215, 1235. Nor can the Commissioner apply section 45 under his amended answer since the petitioner and Foundation were not owned or controlled directly or indirectly by the same interests, and there was no evasion of taxes or failures to reflect income clearly. Briggs-Killian Co., 40 B.T.A. 895; Miles Conley Co., 10 T.C. 754, appealed on another issue 173 F.2d 958. Cf. Epsen Lithographers v. O'Malley, 67 F.Supp. 181.

The Commissioner finally suggests that no more than 3 or 4 per cent be allowed as an interest for the use of the $75,000 since Stevens Brothers of St. Paul loaned money to Foundation at lesser rates and could have loaned the $75,000 directly to the petitioner at 3 or 4 per cent. No statutory authority for any such arbitrary action has been disclosed.

The Foundation was entitled to one-half of the income from the job, regardless of what the relationship between it and the petitioner may be called, and that part of the income was not taxable to the petitioner. Cf. Dorzback v. Collison, 195 F.2d 69; Edwin de Reitzes-Marienwert, 21 T.C. 846; Kena, Inc., 44 B.T.A. 217.

Decision will be entered under Rule 59.