A-77753, JULY 9, 1936, 16 COMP. GEN. 12

A-77753: Jul 9, 1936

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CORPORATIONS - LEGAL ENTITY DISREGARDED - CUSTOMS REFUNDS DUE CORPORATION - TAX INDEBTEDNESS OF CORPORATION AND STOCKHOLDERS THE GENERAL RULE THAT A CORPORATION IS TO BE CONSIDERED A LEGAL ENTITY DISTINCT FROM ITS STOCKHOLDERS NOT BEING FOR APPLICATION WHERE RECOGNITION AS SUCH WILL DEFEAT PUBLIC CONVENIENCE. PROTECTION OF THE INTERESTS OF THE UNITED STATES REQUIRES THAT NO PART OF CUSTOMS REFUNDS BENEFICIALLY DUE A CORPORATION SHOULD BE PAID WHERE CIRCUMSTANCES APPEAR TO JUSTIFY A DISREGARD OF THE LEGAL ENTITY THEORY UNTIL INCOME TAX DEFICIENCIES DUE FROM BOTH THE CORPORATION AND ITS STOCKHOLDERS ARE EITHER PAID. OR THE MATTER IS FINALLY DETERMINED BY THE COURTS. INTEREST WHICH HAVE BEEN MADE AGAINST THE NATIONAL SANITARY RAG COMPANY AND ALSO AGAINST ONE JOSEPH ROSENBERG.

A-77753, JULY 9, 1936, 16 COMP. GEN. 12

CORPORATIONS - LEGAL ENTITY DISREGARDED - CUSTOMS REFUNDS DUE CORPORATION - TAX INDEBTEDNESS OF CORPORATION AND STOCKHOLDERS THE GENERAL RULE THAT A CORPORATION IS TO BE CONSIDERED A LEGAL ENTITY DISTINCT FROM ITS STOCKHOLDERS NOT BEING FOR APPLICATION WHERE RECOGNITION AS SUCH WILL DEFEAT PUBLIC CONVENIENCE, JUSTIFY WRONG, PROTECT FRAUD, OR DEFEND CRIME, ETC., PROTECTION OF THE INTERESTS OF THE UNITED STATES REQUIRES THAT NO PART OF CUSTOMS REFUNDS BENEFICIALLY DUE A CORPORATION SHOULD BE PAID WHERE CIRCUMSTANCES APPEAR TO JUSTIFY A DISREGARD OF THE LEGAL ENTITY THEORY UNTIL INCOME TAX DEFICIENCIES DUE FROM BOTH THE CORPORATION AND ITS STOCKHOLDERS ARE EITHER PAID, PROPERLY SECURED, OR THE MATTER IS FINALLY DETERMINED BY THE COURTS.

ACTING COMPTROLLER GENERAL ELLIOTT TO THE SECRETARY OF THE TREASURY, JULY 9, 1936:

THERE HAS BEEN RECEIVED YOUR LETTER OF JUNE 25, 1936, IR:GC:I:MAW, AS FOLLOWS:

QUESTION HAS BEEN RAISED WHETHER ASSESSMENTS OF INCOME TAXES, PENALTIES, AND INTEREST WHICH HAVE BEEN MADE AGAINST THE NATIONAL SANITARY RAG COMPANY AND ALSO AGAINST ONE JOSEPH ROSENBERG, BOTH OF SAN FRANCISCO, CALIFORNIA, MAY PROPERLY BE OFFSET AGAINST CUSTOMS REFUNDS WHICH, IF PAID, WILL BE RECEIVED EVENTUALLY BY THE SAID CORPORATION.

THE CORPORATION WAS ORGANIZED IN 1927 UNDER THE LAWS OF CALIFORNIA, SUCCEEDING A PARTNERSHIP WHICH HAD BEEN OPERATED PRIOR THERETO UNDER THE SAME NAME. JOSEPH ROSENBERG AND HIS BROTHER, ISADORE ROSENBERG, EACH ACQUIRED 50 PERCENT OF THE STOCK OF THE CORPORATION AT THE DATE OF ITS ORGANIZATION. THE PRINCIPAL BUSINESS OF THE CORPORATION IS THE IMPORTATION OF RAGS FROM JAPAN. THE COMPANY IS NOW INSOLVENT.

DEFICIENCIES HAVE BEEN DETERMINED AGAINST THE NATIONAL SANITARY RAG COMPANY AS FOLLOWS:

TABLE

5 PERCENT PENALTY UNDER

THE PROVISIONS OF INTEREST

YEAR DEFICIENCY IN SECTION 293 (A), COMPUTED TO

INCOME TAX REVENUE ACT OF 1928 MARCH 18, 1936 1929 ------------- $13,107.41 $655.37 $4,725.13

TOTAL DEFICIENCY IN TAX, PENALTY, AND INTEREST, $18,487.91.

THE TAXPAYER CORPORATION, THROUGH ITS DULY AUTHORIZED REPRESENTATIVE, HAS AGREED TO THE IMMEDIATE ASSESSMENT AND COLLECTION OF THE TOTAL DEFICIENCY IN TAX, PENALTY, AND INTEREST SHOWN IN THE ABOVE SUMMARY, WHICH AMOUNTS HAVE BEEN DULY ASSESSED.

THE FOLLOWING DEFICIENCIES IN TAX AND PENALTIES HAVE BEEN DISCLOSED AGAINST JOSEPH ROSENBERG:

TABLE

PROVISIONS OF THE REVENUE ACTS

YEAR DEFICIENCY 50 PERCENT UNDER WHICH THE PENALTIES HAVE

IN TAX PENALTY BEEN ASSERTED 1920 --- - $653.94 $351.02 SECTION 250 (B), 1921 ACT. 1926 ----- 3,784.00 2,106.26 SECTION 275 (B), 1926 ACT. 1927 - ---- 8,303.42 4,151.71 SECTION 275 (B), 1926 ACT. 1928 ----- 10,870.22 5,435.11 SECTION 293 (B), 1928 ACT. 1929 ----- 2,439.36 1,219.68 SECTION 293 (B), 1928 ACT.

TOTAL ----- 26,050.94 13,263.78

TOTAL DEFICIENCY IN TAX AND PENALTY, $39,314.72.

JOSEPH ROSENBERG, THROUGH HIS DULY AUTHORIZED REPRESENTATIVE, HAS AGREED TO THE ASSESSMENT OF THE DEFICIENCY IN TAX AND PENALTIES SHOWN ABOVE, TOGETHER WITH INTEREST COMPUTED UNDER THE APPROPRIATE PROVISIONS OF THE LAW, AND THE AMOUNTS SHOWN IN THE ABOVE SUMMARY HAVE BEEN ASSESSED. ADDITION TO THE DEFICIENCY IN TAX AND PENALTY, INTEREST, AS PROVIDED BY THE VARIOUS REVENUE ACTS, HAS BEEN COMPUTED ON THE DEFICIENCIES TO MARCH 18, 1936, IN THE APPROXIMATE AMOUNT OF $13,610.56.

IN ADDITION TO THE ASSESSMENT MENTIONED ABOVE WHICH HAS BEEN MADE AGAINST MR. JOSEPH ROSENBERG, THIS OFFICE PROPOSES TO MAKE AN ASSESSMENT OF THE SAME AMOUNTS OF INCOME TAXES, PENALTIES, AND INTEREST FOR THE SAME YEARS AGAINST MRS. MABEL ROSENBERG, WIFE OF JOSEPH ROSENBERG, AS TRANSFEREE OF THE ASSETS OF JOSEPH ROSENBERG.

DURING 1927, 1928, AND 1929 JOSEPH ROSENBERG TRANSFERRED VARIOUS SHARES OF THE COMMON STOCK OF THE NATIONAL SANITARY RAG COMPANY WHICH HE OWNED TO HIS WIFE, MABEL, AS THE RESULT OF WHICH, AT THE END OF 1929, MABEL ROSENBERG OWNED ALL BUT ONE SHARE OF THE COMMON STOCK OF THE NATIONAL SANITARY RAG COMPANY WHICH JOSEPH ROSENBERG HAD PREVIOUSLY OWNED. THE ONE SHARE HAS BEEN RETAINED BY JOSEPH ROSENBERG UP TO THE PRESENT TIME.

ISADORE ROSENBERG TRANSFERRED HIS ENTIRE HOLDINGS OF THE COMMON STOCK OF THE CORPORATION TO HIS SON, JOSEPH (JOEY) ROSENBERG IN 1928 AND 1929. OR ABOUT JANUARY 31, 1934, JOSEPH (JOEY) ROSENBERG ASSIGNED ALL THE COMMON STOCK OF THE CORPORATION WHICH HE HAD RECEIVED FROM HIS FATHER TO HIS AUNT, MRS. MABEL ROSENBERG. FROM THAT DATE ON MABEL ROSENBERG OWNED ALL OF THE COMMON STOCK OF THE NATIONAL SANITARY RAG COMPANY, WITH THE EXCEPTION OF ONE SHARE, WHICH WAS OWNED BY HER HUSBAND, JOSEPH.

ALL OF THE TRANSFERS OF STOCK MENTIONED IN THE TWO PRECEDING PARAGRAPHS WERE MADE WITHOUT ANY FINANCIAL CONSIDERATION AND WERE APPARENTLY GIFTS.

FROM A CAREFUL CONSIDERATION OF EVIDENCE ON FILE, IT SEEMS EXTREMELY DOUBTFUL THAT COLLECTION MAY BE MADE BY ORDINARY METHODS OF ALL THE TAXES, PENALTIES, AND INTEREST DUE EITHER FROM THE SAID CORPORATION OR FROM THE SAID JOSEPH ROSENBERG BECAUSE BOTH OF THEM ARE REPORTED TO BE INSOLVENT. HOWEVER, IT APPEARS FROM THE RECORDS OF THE DEPARTMENT THAT APPROXIMATELY $117,000 IS BENEFICIALLY DUE THE CORPORATION ON ACCOUNT OF CUSTOMS DUTIES COLLECTED BY THE UNITED STATES AND ORDERED RETURNED BY A UNITED STATES CUSTOMS COURT.

UNDER THE REGULAR PROCEDURE REFUND OF THIS SUM WILL NORMALLY BE PAID, IN THE FIRST INSTANCE, TO A FIRM OF CUSTOMHOUSE BROKERS IN SAN FRANCISCO, WHO ARE THE IMPORTERS OF RECORD, BUT IT WOULD APPEAR THAT THE CORPORATION IS BENEFICIALLY ENTITLED TO RECEIVE THE MAJOR PORTION OF THE PROCEEDS BECAUSE UNDER DATE OF MARCH 23, 1936, THE ATTORNEY FOR THE COMPANY, MR. CLYDE C. SHERWOOD, SAN FRANCISCO, CALIFORNIA, ADDRESSED A LETTER TO THE COLLECTOR OF INTERNAL REVENUE AT THAT PLACE READING AS FOLLOWS:

"THIS WILL ACKNOWLEDGE RECEIPT BY THE NATIONAL SANITARY RAG COMPANY OF A NOTICE AND DEMAND FOR INCOME TAX DATED MARCH 18, 1936. THE TAXPAYER IS VERY ANXIOUS TO AVOID THE ACCRUAL OF ANY FURTHER INTEREST AND WILL APPRECIATE THE ASSISTANCE OF YOUR OFFICE IN ARRANGING FOR PAYMENT WITHIN THE TEN DAYS SPECIFIED IN THE NOTICE.

"THE NATIONAL SANITARY RAG COMPANY HAS DUE IT FROM THE UNITED STATES GOVERNMENT CERTAIN REFUNDS OF CUSTOMS DUTIES PAID UNDER PROTEST AND NOW ORDERED RETURNED BY THE UNITED STATES CUSTOMS COURT. THE AMOUNT OF THE CUSTOMS REFUNDS EXCEEDS THE AMOUNT OF THE BILL RENDERED BY YOU, AND I SHOULD LIKE TO WORK OUT SOME ARRANGEMENT BY WHICH THE CORPORATION CAN PAY ITS TAX OUT OF THE SAID REFUNDS.

"I UNDERSTAND THAT THE LOCAL DISBURSING OFFICER IN SAN FRANCISCO ISSUES CHECKS FOR REFUNDS AS FAST AS DIFFERENT BATCHES OF PROTESTS ARE RELIQUIDATED AT THE CUSTOMHOUSE. IT OCCURS TO ME THAT THE CORPORATIONS COULD AUTHORIZE THE DISBURSING OFFICER TO DELIVER TO YOU THE FIRST CHECK OR CHECKS ISSUED UNTIL YOU HAVE IN YOUR HANDS CHECKS IN AN AGGREGATE SUM AMOUNTING TO MORE THAN THE TAX. THEN AN OFFICER OF THE TAXPAYER COULD ACCOMPANY YOUR REPRESENTATIVE TO A BANK AND ENDORSE THE CHECKS AND RECEIVE FROM YOUR REPRESENTATIVE ANY SUM RECEIVED FROM THE CHECKS IN EXCESS OF THE AMOUNT OF THE TAX.

"IF THIS PLAN IS FOR ANY REASON IMPRACTICABLE, I SHOULD LIKE TO HAVE YOU SUGGEST SOME OTHER MECHANISM BY WHICH THE CUSTOMS REFUNDS CAN BE RELEASED AND THE NATIONAL SANITARY RAG COMPANY'S TAX LIABILITY PAID.'

ISSUANCE OF REFUND CHECKS TO THE SAID BROKERS ON THIS ACCOUNT HAS BEEN SUSPENDED PENDING YOUR DECISION ON THE QUESTION OF OFFSET RAISED IN THIS CASE.

CONSIDERING ALL THE INFORMATION NOW IN THE POSSESSION OF THIS DEPARTMENT, IT SEEMS EVIDENT, AS HEREINBEFORE EXPLAINED, THAT THE NATIONAL SANITARY RAG COMPANY HAS THE BENEFICIAL INTEREST IN THE REFUNDS IN QUESTION AND THAT IF THOSE REFUNDS SHOULD BE MADE THE PROCEEDS WILL EVENTUALLY BE RECEIVED BY THE CORPORATION AND, IN TURN, BY THE SAID JOSEPH ROSENBERG AND HIS WIFE, MABEL ROSENBERG, AS SOLE STOCKHOLDERS OF THAT COMPANY.

IT IS PRESUMED THAT THERE CAN BE NO SERIOUS QUESTION THAT TAX, PENALTY, AND INTEREST DUE THE UNITED STATES FROM THE CORPORATION MAY PROPERLY BE OFFSET AGAINST THE CUSTOMS REFUNDS BENEFICIALLY DUE THE CORPORATION, BUT THERE IS A SECOND QUESTION INVOLVED, NAMELY, WHETHER, ASSUMING THAT THE WIFE OF THE SAID JOSEPH ROSENBERG IS LEGALLY OR EQUITABLY LIABLE FOR THE TAXES, PENALTY, AND INTEREST DUE FROM HIM AS TRANSFEREE OF HIS STOCK AND ASSETS, SUCH INDEBTEDNESS MAY ALSO PROPERLY BE OFFSET AGAINST THE CUSTOMS REFUNDS IN QUESTION. INASMUCH AS THIS TRANSFER WAS PRESUMABLY MADE WITHOUT CONSIDERATION AT A TIME WHEN THE TRANSFEROR WAS INDEBTED TO THE UNITED STATES, IT IS POSSIBLE THAT IT SHOULD NOT BE RECOGNIZED IN ANY EVENT.

IN CONSIDERING THE QUESTION PRESENTED, IT WOULD SEEM THAT A DETERMINATION MUST BE MADE WHETHER THE GENERAL RULE THAT A CORPORATION AND ITS STOCKHOLDERS ARE SEPARATE LEGAL ENTITIES PRECLUDES AN OFFSET OF THE INCOME TAXES, PENALTIES, AND INTEREST DUE FROM THE ROSENBERGS AGAINST THE CUSTOMS REFUNDS TO WHICH THE COMPANY OF WHICH THEY ARE THE SOLE STOCKHOLDERS IS BENEFICIALLY ENTITLED. SEE PITTSBURGH AND BUFFALO CO. V. DUNCAN (232 FED. 584, 587); PETERSON V. CHICAGO, ROCK ISLAND AND PACIFIC RAILWAY (205 U.S. 364, 392); CONLEY V. MATHIESEN ALKALI WORKS (190 U.S. 406, 409); PULLMAN'S PALACE CAR CO. V. MISSOURI PACIFIC RY. CO. (115 U.S. 587, 597); UNITED STATES V. MILWAUKEE REFRIGERATOR TRANSIT CO. (142 FED. 247, 255); ANDERSON V. MORRIS (216 FED. 83); HAMILTON, ETC., CORPORATION V. WILSON (25 FED./2D) 592).

NOTHING HAS BEEN FOUND OF RECORD TO ESTABLISH CONCLUSIVELY THAT THE ROSENBERGS ORGANIZED THE NATIONAL SANITARY RAG COMPANY FOR ANY FRAUDULENT PURPOSE. HOWEVER, THE RECORDS SHOW THAT FRAUD HAS BEEN IMPUTED TO ONE OR MORE MEMBERS OF THE FAMILY IN CERTAIN OTHER TAX MATTERS AND IT IS POSSIBLE THAT THE SAID JOSEPH ROSENBERG TRANSFERRED SHARES OF STOCK AND OTHER ASSETS TO HIS WIFE IN THE HOPE OF DEFRAUDING HIS CREDITORS, INCLUDING THE UNITED STATES GOVERNMENT IN THE MATTER OF TAXES DUE AND TO BECOME DUE.

THE QUESTION WHETHER THE OFFSETS MAY PROPERLY BE MADE IN THIS CASE IS BROUGHT TO YOUR ATTENTION FOR SUCH ACTION AS YOU MAY DEEM TO BE PROPER.

WHILE THE GENERAL RULE IS THAT A CORPORATION WILL BE CONSIDERED A LEGAL ENTITY DISTINCT FROM ITS STOCKHOLDERS, AND PROPERTY OR RIGHTS ACQUIRED BY IT OR LIABILITIES INCURRED ARE THOSE OF SUCH LEGAL ENTITY AS DISTINGUISHED FROM MEMBERS COMPOSING IT, IT IS EQUALLY WELL SETTLED THAT WHERE RECOGNIZING A CORPORATION AS A DISTINCT LEGAL ENTITY WILL DEFEAT PUBLIC CONVENIENCE, JUSTIFY WRONG, PROTECT FRAUD, OR DEFEND CRIME, THE LAW WILL REGARD THE CORPORATION AS AN ASSOCIATION OF PERSONS. SEE MCCASKILL CO. V. UNITED STATES, 216 U.S. 504; UNITED STATES V. MILWAUKEE REFRIGERATOR TRANSIT CO., 142 FED. 247; CALLAS V. INDEPENDENT TAXI OWNERS' ASSN., 66 FED./2D) 192. COURTS WILL LOOK BEYOND CORPORATE ENTITY WHENEVER JUSTICE REQUIRES, THOUGH ACTS INVOLVE CONSTRUCTIVE FRAUD, ONLY, HAMILTON RIDGE LUMBER SALES CORPORATION V. WILSON, 25 FED./2D) 592, AND COURTS MAY GO BEHIND THE APPARENT LEGAL ENTITY AND DETERMINE WHETHER CIRCUMSTANCES PROVE A DEVICE TO EVADE TAXATION. PALMOLIVE CO. V. CONWAY, 43 FED./2D) 226.

IN NEW COLONIAL CO. V. HELVERING, 292 U.S. 435, 442, DECIDED MAY 28, 1934, THE SUPREME COURT SAID---

AS A GENERAL RULE A CORPORATION AND ITS STOCKHOLDERS ARE DEEMED SEPARATE ENTITIES AND THIS IS TRUE IN RESPECT OF TAX PROBLEMS. OF COURSE, THE RULE IS SUBJECT TO THE QUALIFICATION THAT THE SEPARATE IDENTITY MAY BE DISREGARDED IN EXCEPTIONAL SITUATIONS WHERE IT OTHERWISE WOULD PRESENT AN OBSTACLE TO THE DUE PROTECTION OR ENFORCEMENT OF PUBLIC OR PRIVATE RIGHTS. * * *

IN OSBURN CALIFORNIA CORPORATION V. WELCH, 39 FED./2D) 41, 43, THE CIRCUIT COURT OF APPEALS, NINTH CIRCUIT, SAID---

* * * TRUE, THE FEDERAL GOVERNMENT USUALLY RECOGNIZES RULES OF PROPERTY IN THE STATE, BUT IT IS NOT COMPELLED TO RECOGNIZE TRANSFERS WHICH RESULT IN NO SUBSTANTIAL CHANGE IN BENEFICIAL OWNERSHIP. THE NOTION THAT A CORPORATION IS AN ENTITY SEPARATE AND DISTINCT FROM ITS STOCKHOLDERS IS A FICTION OF LAW WHICH THE COURT WILL REGARD FOR SOME PURPOSES AND DISREGARD FOR OTHERS. FOR TAX PURPOSES, THIS FICTION IS OFTEN DISREGARDED. * * *

IN PALMOLIVE CO. V. CONWAY, 43 FED./2D) 226, 229, THE COURT SAID---

* * * THOUGH TAX COMMISSIONS ARE ORDINARILY NOT CONCERNED WITH THE QUESTION AS TO THE WISDOM OF SUCH CONTRACTS, AND MAY NOT GENERALLY OBTRUDE THEIR JUDGMENT AS TO THE WISDOM OF SUCH CONTRACTS UPON SUCH CORPORATIONS * * *, YET COMMISSIONS AS WELL AS COURTS MAY LEGITIMATELY LOOK BEYOND THE CORPORATE ENTITIES AND DETERMINE THE FACTS AS THEY ARE. * * *

SEE, ALSO, CONDON V. TAIT, 56 FED./2D) 208, AND LAW V. MCLAUGHLIN, 2 FED.SUPP. 601.

IN VIEW OF THE CIRCUMSTANCES REPORTED IN YOUR LETTER, THE PROTECTION OF THE INTERESTS OF THE UNITED STATES WOULD APPEAR TO REQUIRE THAT NO PART OF THE CUSTOMS REFUND BENEFICIALLY DUE THE NATIONAL SANITARY RAG COMPANY SHOULD BE PAID UNTIL THE TAXES DUE FROM BOTH THE CORPORATION AND JOSEPH ROSENBERG ARE PAID, OR ADEQUATE SECURITY IS TAKEN FOR THEIR PAYMENT, OR UNTIL THE QUESTIONS INVOLVED AS TO THE RIGHTS OF THE PARTIES ARE FINALLY DECIDED BY THE COURTS.