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Rhombar Co. v. Commissioner of Internal Revenue

decided: November 16, 1967.


Friendly, Kaufman and Anderson, Circuit Judges.

Author: Kaufman

IRVING R. KAUFMAN, Circuit Judge:

This petition to review a decision of the Tax Court, Atkins, J., reported at 47 T.C. 75 (1967), holding Rhombar Co., Inc. liable for the accumulated earnings tax imposed by Section 531 of the Internal Revenue Code of 1954 for the taxable years ending January 31, 1960, 1961, and 1962,*fn1 presents what may be the first instance in which a taxpayer's counsel has had the "abnormally strong nervous system"*fn2 necessary to risk his entire accumulated earnings tax case on the burden of proof issue under § 534. The Tax Court held that Rhombar had the burden of proving it was not a "mere holding or investment company" within the meaning of § 533(b), and that it had failed to introduce any evidence to support its position; accordingly, it held against taxpayer. We affirm the decision of the Tax Court.

The facts are fully set out in the Tax Court's opinion, and we need recite them here only briefly. Rhombar Co. is a closely held corporation owned almost entirely by the family of Herbert M. Rothschild. Before 1952 it engaged in the furniture distribution business under the name of John Stuart Inc. In that year it sold all its business assets, including the right to use the John Stuart corporate name, to John Widdicomb Co., Inc. (New York) [Widdicomb], another closely held corporation in which the Rothschilds had, after the sale, a controlling interest.*fn3 Since that time Widdicomb has operated Rhombar's former business and has adopted Rhombar's old name, John Stuart Inc. Rhombar, on the other hand, has not re-entered the furniture business; instead it has steadily accumulated its income, which is derived entirely from dividends, interest, and capital gains from the sales of securities and from installment payments it receives from Widdicomb. As a result its surplus has more than doubled, rising to over $2,000,000, but only de minimis dividends of $700 annually were paid.*fn4


The accumulated earnings tax is imposed on corporations "formed or availed of for the purpose of avoiding the income tax with respect to its shareholders * * * by permitting earnings and profits to accumulate instead of being divided or distributed." Code, § 532(a). In this connection, two statutory presumptions have long been spelled out in the Code. The first of these, found in § 533(a), provides that "the fact that the earnings and profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders, unless the corporation by the preponderance of the evidence shall prove to the contrary." The second, contained in § 533(b) states: "The fact that any corporation is a mere holding or investment company shall be prima facie evidence of the purpose to avoid the income tax with respect to shareholders." Accordingly, the forbidden purpose of avoiding income tax may be established by either of these statutory presumptions.

Ordinarily, the burden of proving that the Commissioner's determination is wrong rests on the taxpayer, because the Commissioner's deficiency assessment is considered presumptively correct.*fn5 But Congress recognized this rule might have "several undesirable consequences"*fn6 when the Commissioner sought to assess an accumulated earnings tax. As a result, in 1954 it enacted § 534.*fn7 This section sets forth the procedures, followed by the Commissioner and the taxpayer in this case, for switching the burden of proof. The Commissioner notified Rhombar on July 23, 1964 that he proposed to issue a statutory notice of deficiency based on the accumulated earnings tax. In response, on September 3, 1964, Rhombar submitted to the Commissioner a 13-page statement setting forth in detail a recitation of its efforts since it sold its business to Widdicomb to acquire another furniture company. The statement claimed that "the reasonable needs of the business of Rhombar required it to set aside and maintain a reserve at least equal to its entire net worth and to build up such reserve out of its earnings and profits, as soon as feasible, to a minimum of at least $3,500,000 in order to finance an acquisition program (adopted in 1952 under circumstances more fully described below) or purchasing interests in businesses engaged in the manufacture of furniture and/or furniture manufacturing facilities. At no time during the years at issue had Rhombar accumulated sufficient amounts for this purpose." Accordingly, Rhombar claimed it had not accumulated its earnings beyond its reasonable business needs.

It appears, therefore, that under § 534, the burden of proof under § 533(a) (accumulation beyond reasonable needs of business) was shifted to the Commissioner if Rhombar's statement contained "sufficient" facts.*fn8 Rhombar makes the novel claim -- rejected by the Tax Court -- that the statement submitted to the Commissioner under § 534 also shifted the burden of proof to the Commissioner with respect to § 533(b) (mere holding or investment company).

Reference to the language of § 534 should be sufficient to refute Rhombar's argument. It provides that when a notice of deficiency is based on the allegation that "the earnings and profits have been permitted to accumulate beyond the reasonable needs of the business," the burden of proof "with respect to such allegation" shall be shifted if the taxpayer submits an appropriate statement showing the facts and grounds on which he relies to establish that earnings and profits "have not been permitted to accumulate beyond the reasonable needs of the business." Thus, § 534 echoes the exact language of § 533(a), but does not give the slightest indication that it is applicable to § 533(b). The maxim expressio unius est exclusio alterius is not without relevancy under these circumstances.

Moreover, this is not a situation in which a straight-forward reading of the Code does violence to the Congressional purpose. Sections 533(a) and 533(b) are alternative presumptions which can be used to prove the ultimate objective of tax avoidance. In fact, when first enacted in the Income Tax Act of 1913, they were explicitly treated in the disjunctive.*fn9 And, the Revenue Act of 1938 increased the strength of the presumption to be given an accumulation beyond the reasonable needs of the business, but left unchanged the force of the presumption that a holding or investment company was a tax avoidance device.*fn10 Thus, when § 534 was enacted in 1954, Congress was well aware of the distinction between § 533(a) and § 533 (b). That § 534 affects only § 533(a) is not surprising nor inconsistent, for the Committee Reports indicate that Congress was concerned in the main with the difficulty taxpayers faced in proving that their accumulations were not in excess of the reasonable needs of their businesses. The Reports are barren of any indication that Congress had any concern with the distinctly different problems taxpayers faced when proving that they engaged in activities beyond "holding property and collecting the income therefrom or investing therein,"*fn11 i. e., that they were not mere holding or investment companies.

Rhombar contends, however, that the credit provisions of § 535 support its argument that the burden of proving it was a mere holding or investment company rested on the Commissioner. Section 535, like § 534, was added to the Internal Revenue Code in 1954. It provides, inter alia, a credit for that portion of a corporation's earnings and profits which were accumulated for the reasonable needs of the business. The tax is thus imposed only on that portion of the accumulation which exceeds the reasonable needs of the business. Specifically, the statute provides, "in the case of a corporation other than a mere holding or investment company the accumulated earnings credit is (A) an amount equal to such part of the earnings and profits for the taxable year as are retained for the reasonable needs of the business * * *" Code, § 535(c)(1) (emphasis added). For most corporations this credit is potentially unlimited in amount, but in the case of mere holding or investment companies, credit is limited by § 535(c)(3) to a maximum of $100,000.

It is conceded that if a proper § 534 statement had been submitted, the Commissioner had the burden of proving the amount of the credit to which the taxpayer was entitled, i. e., the amount of the accumulation retained for reasonable business needs. Rhombar argues from this that if the credit is to be limited because a taxpayer is a mere holding or investment company, the burden of proving this must be on the Commissioner "since it is a necessary part of the [Commissioner's] admitted burden of proving the amount of the credit to which a taxpayer is entitled under § 535(c)(1)."

The difficulty with this contention is that a basic maxim of tax law interpretation is that rarely are there occasions when each provision of the Code can be interpreted as if existing in a vacuum. In any event, it is hardly likely that Congress intended that § 534 and § 535, enacted at the same time, would work at cross purposes. Indeed, to permit the credit section to overpower or submerge and dilute the burden of proof section would be to permit the tail to wag the dog.

The question of the reasonable needs of the business about which § 534 speaks is not relevant to § 533(b) for, as Congress was informed by a Secretary of the Treasury, "it is questionable whether any investment company could have a surplus beyond the reasonable needs of its business, since its sole business was to invest."*fn12 Thus, the most intelligible reading of the italicized words in § 535(c)(1) ...

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