[825] OPINION.
Phillips:
In addition to oral testimony the parties have submitted a voluminous stipulation. A substantial part of the stipulation is of evidence which it seems unnecessary to detail in formal findings of fact, the substance thereof or conclusion reached therefrom being stated. These proceedings involve the construction and application of sections 220 of the Revenue Act of 1918 and of the Revenue Act of 1921. This section of the 1918 Act reads :
Sec. 220. That if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, such corporation shall not be subject to the tax imposed by section 230, but the stockholders or members thereof shall be subject to taxation under this title in the same manner as provided in subdivision (e) of section 218 in the case of stockholders of a personal service corporation, except that the tax imposed by Title III shall be deducted from the net income of the corporation before the computation of the proportionate share of each stockholder or member. The fact that any corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax; but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the tax in such case unless the Commissioner certifies that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner, or any collector, every corporation shall forward to him a correct statement of such gains and profits and the names and addresses of the indi[826] viduals or shareholders who would he entitled to the same if divided or distributed, and of the amounts that would be payable to each.
Section 220 of the 1921 Act reads:
Sec. 220. That if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 25 per centum of the amount thereof, which shall be in addition to the tax imposed by section 230 of this title and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax: Provided, That if all the stockholders or members of such corporation agree thereto, the Commissioner may, in lieu of all income, war-profits and excess-profits taxes imposed upon the corporation for the taxable year, tax the stockholders or members of such corporation upon their distributive shares in the net income of the corporation for the taxable year in the same manner as provided in subdivision (a) of section 21S in the ease of members of a partnership. The fact that any corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax; but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the tax in such case unless the Commissioner certifies that in his opinion such accumulation is unreasonable for the purposes of the business. When requested by the Commissioner, or any collector, every corporation shall forward to him a correct statement of such gains and profits and the names and addresses of the individuals or shareholders who would be entitled to the same if divided or distributed and of the amounts that would be payable to each.
These sections are highly penal. Section 220 of the Revenue Act of 1918 imposes a tax upon the stockholders of a corporation, which falls within its terms, on income which they have not received. Section 220 of the Revenue Act of 1921 imposes, in addition to the tax imposed by section 230, a tax which is two and one-half times the tax imposed by that section for the year 1921 and twice the tax imposed by it for subsequent years. The severity of this penalty appears when it is contrasted with the penalty provided by section 250 (b) of the same act. There it is provided that if any part of a deficiency is “ due to fraud with intent to evade tax * * * there shall be added as part of the tax 50 per centum of the total amount of the deficiency in the tax.” In the case of section 220 the penalty for the year 1921 is equal to two and one-half times the tax, while the penalty for a fraudulent deficiency is but one-half, not of the tax, but of the deficiency in tax.
While the plain intent of such a statute must be given full effect, it should be strictly construed and should not be extended to cover cases which do not fall within its letter.
It is conceded that the petitioner corporation was not a “mere holding company ” and the evidence fails to support the respondent’s [827] contention that it was formed for the purpose of evading surtax. The testimony shows that in the early part of 1920 Burns Smith, a resident of Syracuse, N. Y., was the owner of two pieces of real estate in Seattle, Wash. On one of these lots was a six-story office building which had been erected in 1891 and on the other a very handsome 42-story office building, completed in 1914, which was one of the show places of the Pacific Coast. While the record is not sufficiently complete to permit precise determination of the results of the operation of these two office buildings, there is sufficient to indicate that there were losses of approximately $120,000, $110,000, $90,000, and $30,000 during the years 1915, 1916, 1917, and 1918, respectively, and a gain of $40,000 in 1919. By 1920 the war activities which had filled the office buildings of Seattle had started to subside and the future was uncertain. These buildings represented an investment by Smith of approximately $2,000,000 in excess of a mortgage thereon of $700,000 and comprised over two-thirds of his property. Smith was in ill health. His family then consisted of his wife and two infant daughters. Having observed the difficulty which arose in the partition of his father’s real estate, he wished to avoid any such trouble in the event of his own death and particularly any situation which might make necessary a forced sale of this property. He was also desirous of being able to sell, in case of an emergency, undivided interests in his realty. He communicated his views to his attorney, who had also been attorney for his father and his father’s estate, and who was thoroughly conversant with the situation. His attorney advised that a corporation be formed to which the realty should be transferred in exchange for shares of its capital stock. The petitioner corporation was thereupon organized and on April 1, 1920, Burns Smith transferred to it the office buildings in Seattle, at a value of $1,947,527.89, in consideration of 19,475 shares of its capital stock, the sum of $27.89 being credited to surplus. All of the evidence is to the effect that at the date of organization the only purpose in the mind of Burns Smith was to place his investment in the two office buildings in corporate form and thus make these assets more available for the purpose of sale or, in case of his death, of partition. The question of taxation, Federal or otherwise, was not discussed in the interviews between Smith and his attorney. It was not until later that Smith conceived the idea of transferring other investments to the corporation. It seems reasonably clear that the corporation was formed for perfectly sound reasons other than to permit Smith to avoid payment of surtax.
Since the corporation does not fall within the classification of a mere holding company or of one formed for the purpose of pre[828] venting the imposition of surtax upon its stockholders, we need not consider in what circumstances corporations which do fall within such classification are within the provisions of section 220 of the two revenue acts. It becomes necessary to determine only whether the petitioner corporation was availed of during the years before us for the purpose stated in the statute.
The section in question recognizes the right of every corporation to keep its capital intact and provide a surplus for its reasonable needs. No corporation which is actively engaged in business is to be subjected to the penalty of the statute unless and until it permits its course of conduct to be diverted from its normal business interests by a purpose to save its stockholders from surtax. The emphasis in the statute is placed upon the purpose and if this purpose clearly appears the corporation is subject to the tax, whether the accumulation be large or small. Accumulations in excess of the needs of the business are evidence of the purpose but are not necessary to subject the corporation to the tax. This seems to us to be the necessary construction of the statutory language. To bring any case within the statute the evasion of surtax must, of course, be accomplished by means of permitting gains and profits to accumulate instead of being divided or distributed. In the inst ant case it seems clear that gains and profits were accumulated instead of being distributed, and that if the purpose was to use the corporation to prevent the imposition of surtax, the medium used was that set out in the statute. We think the ultimate question presented in the instant proceeding is whether this purpose existed.
Although the statute provides that certain facts shall be prima facie evidence of the purpose, the same purpose may appear from other facts. In the instant case the purpose to use the corporation to prevent the imposition of surtax upon its stockholder appears from the character of the transactions between it and its stockholder.
The corporation was organized for the purpose of operating the two office buildings in Seattle. Had.it confined its activities to the operation of these buildings, declaring no dividend during the years 1920 and 1921, but permitting the surplus income to be accumulated, it would seem clear that upon the record made before us with respect to real estate conditions in Seattle affecting these buildings, the corporation would not have fallen within the provisions of section 220. But we find that in 1920 the sole stockholder of the corporation transferred to it shares of stock having a value of approximately $450,000 and in 1921 transferred other shares having a value of over $400,000. The dividends upon this stock were taxable to Smith so long as he continued to hold them, but were not taxable when received by the corporation. Instead of dividends of some $80,000 [829] which Smith reported in 1919 before the transfer was made, we find him reporting some $3,500 as dividends in 1921. Clearly the effect was to reduce the amount of income upon which Smith was subject to surtax. It is urged that these securities were transferred to the corporation in order to improve its financial condition and increase the salability of its capital stock, but in the face of this argument we find that at the close of 1920 Smith had borrowed from the corporation some $236,000 and that at the close of 1921 his borrowings totaled some $600,000. Nor is this all. In order to provide funds to make these loans the corporation was obligated on notes payable at the close of 1920 in the amount of $165,000 and at the close of 1921 in the amount of $456,000. There were similar manipulations of the funds of the corporation in subsequent years. These were not transactions designed to build up the corporation, but were perfectly designed for the purpose of evading surtax upon the income from the stocks transferred to the corporation while at the same time permitting the sole stockholder to enjoy the use of such income and substantial parts of the principal. The manner in which the corporate funds were handled seems to us to establish that, for the year 1921, the corporation was availed of for the purpose of preventing the imposition of surtax upon its stockholder through the medium of permitting its gains and profits to accumulate. We shall hereafter state the reasons which lead us to a different conclusion as to the year 1920.
It is urged that since Smith had not been subject to surtax in years prior to 1920 and to a surtax of only $3,176.15 in 1920, he had no reason to suppose there was a surtax to be avoided at the time the corporation was organized. We see no merit in this suggestion. During the years prior to 1919 the two office buildings had been operated at substantial losses and these losses had been available to Smith in preparing his tax returns. In 1919 it would appear that it was operated at some profit, but by reason of deductions of some $135,000 taken on his tax return Smith did not become subject to surtax. The nature of these deductions is unexplained, but it will be noted that the amount was substantially greater than in any period or subsequent year of which we have evidence. The reasonable conclusion is that there was a deduction in 1919 in some substantial amount which was not of a recurring nature. Except for the loss at which the building had been operated in years prior to 1919 and the substantial deduction taken in 1919, Smith would have been subject to surtax and it must have been evident to him at the time the 1919 return was prepared that he faced substantial surtaxes if he continued to hold the building and his corporate stocks and the operation of the building in 1920 resulted in any profit. The decision [830] which we have reached is not influenced by this probability and we speak of it only for the purpose of disposing of petitioner’s argument based upon the fact that Smith paid no surtaxes in prior years.
It is urged that the securities were paid in to the corporation for its stock and thereby became capital assets. It is also urged that the loans to Smith did not affect the surplus or profits and gains of the corporation. These arguments are beside the point unless the sole evidence' of purpose is that a surplus was built up which was unreasonable for the needs of the business. We have already stated that the purpose may be shown by other evidence and have already indicated that we believe these transactions constitute valuable evidence of the intention to use the corporation to avoid surtax. We may say here that we appreciate the administrative difficulties involved where purpose or intention is made the basis for levying taxes. However, the provision in question is penal in character, as we pointed out above, and the issue of intent is one which is common in such cases.
The record discloses that on May 1, 1920, Smith turned over to the corporation for its stock, stock of the Syracuse Trust Co. having a value of $254,000; that on December 20,1920, there was a like transaction in which the corporation acquired stock of the Great Lakes Steamship Co. valued at $159,075. The dividends paid to the corporation upon this stock during 1920 appear to have been some $8,040. In view of the fact that the corporation had outstanding a mortgage of $700,000, there is some basis for the argument of petitioners that the transfer of these securities served a purpose other than merely to permit Smith to avoid surtax upon the dividends. Considering also the comparatively small amount of dividends upon which tax was thus avoided, and the penal nature of the tax imposed by section 220, we are of the opinion that there is sufficient doubt respecting the purpose of the 1920 transactions to require us to resolve that doubt against the imposition of the tax for that year under section 220. As we have pointed out above, however, no such doubt remains with respect to the purposes of the transactions which took place in 1921.
The petitioners contend that an authorized “ return or its equivalent ” is a prerequisite to any assessment of tax under the Revenue Act, that section 220 provides that a statement of its gains and profits may be required of any corporation, that such statement is the equivalent of a return and the only provision for making a return under section 220, that no such statement was requested of the petitioner corporation or furnished by it, that until there is a failure on its part to make such a statement no such statement may be made on its behalf by any other person and that therefore “the procedure followed by the Commissioner in reaching his determination of an occasion for tax under section 220 is unauthorized and is a denial of due [831] process of law.” We do not understand that the law requires that a return or statement be filed under section 220 before the Commissioner may determine or assess the tax. The procedure followed, which is outlined in our findings of fact, appears to provide adequate opportunity for hearing and we fail to see wherein there was any denial of due process of law.
After both parties had submitted their testimony and rested their case counsel for the petitioner suggested that the tax might be barred by the statute of limitations. This question was not raised in either of the petitions and, although counsel asked for and was granted leave to amend his petition to raise another issue, counsel refrained from making a similar motion to raise the issue of the statute of limitations. Where such issue is raised the burden has been placed by the Board upon the Commissioner to show any extension of the statutory period. But there is no such burden and indeed no need to do so where the issue is not raised in the pleadings. In their brief the petitioners concede that waivers of the statutory time within which to assess income taxes were executed and filed by them and set out what they, claim to be the form of waiver executed, and from this they argue that the form so set out in their brief does not apply to a tax assessed under section 220. It is evident that counsel for the petitioners appreciated the necessity of amending their pleadings to raise the issues upon which they relied and that their failure to do so with respect to this issue was intentional. Had the issue been raised, the waivers extending the time would undoubtedly have been placed in the record and we would have been in a position to have passed upon the question. Orderly procedure requires that the issues be clearly framed in the pleadings that both parties may have notice and an opportunity to produce their evidence. An orderly procedure is necessary if the Board is to handle the large number of cases filed with it and if proper records are to be made for review in the courts. To attempt to decide any issue with respect to the statute of limitations upon the basis of an ex farte statement in the brief that a certain waiver in terms therein quoted was filed would be to deny the respondent a hearing upon this issue and an opportunity to produce his evidence. (See Chicago Railway Equipment Co. v. Commissioner, 39 Fed. (2d) 378. In these proceedings argument of the-cases was permitted after briefs were filed and at that time counsel for the petitioner took the position that the statute of limitations was jurisdictional and that if the statute had expired the Board had no jurisdiction of these proceedings. The proposition that a statute of limitations is a defense in bar and not a plea to the jurisdiction would seem to require no citation. However that may be, it is clear that the statute governing the proceedings before the Board treats [832] the statute of limitations as a defense, for it is provided in section 906(e) of the Revenue Act of 1924, as amended by section 601 of the Revenue Act of 1928, that—
If the assessment or collection of any tax is barred by any statute of limitations, the decision of the Board to that effect shall be consideréd as its decision that there is no deficiency in respect of such tax.
It seems clear that when the defense of the statute of limitations is raised the Board is to pass upon the merits and not dismiss for lack of jurisdiction.
At the first hearing held in Seattle, counsel for petitioners stated that he raised no contention relative to the income of the corporation as determined by respondent, either with respect to gross income or deductions. At a continuance of that hearing held in Washington both petitioners filed amended petitions, seeking a deduction for obsolescence. This claim was based upon very general statements made by certain witnesses at the Seattle hearing to the effect that during the years 1920 and 1921 the corporation would have been justified in setting up a reserve for obsolescence. This testimony appears from its context to have been based upon the opinion of these witnesses that in those years real estate values were declining in the neighborhood of the petitioners’ buildings and that the future of those buildings was uncertain. A deduction from income for obsolescence is not granted because of declining values. It is to be granted because property is becoming obsolete. The Smith Building represented the highest known type of construction and, whatever may have been its future prospects with respect to declining value or yield, it was unquestionably one of the least obsolete of the city’s buildings. In the years before us there was no prospect that this building would become useless or would have to be demolished to make way for some more profitable use before the termination of the 60-year life fixed by the Commissioner in allowing depreciation at 2 per cent or that it was in any sense obsolescent. The evidence discloses, however, that the Pacific Building was in a state of obsolescence and we are of the opinion that the deduction allowed by the Commissioner for depreciation of that building should be increased from the 3 per cent allowed to 6 per cent in order to reflect a reasonable allowance.
Reviewed by the Board.
Decision will be entered for the 'petitioner in Docket No. 251⅛9. Decision will be entered under Rule 50 in Docket No.
Marquette dissents.