29 T.C. 908 (1958)

Income is not accruable to a taxpayer if it is subject to a substantial dispute and the taxpayer does not have a fixed right to receive the income during the tax year.

Summary

The United States Tax Court considered whether a corporation, All Americas Trading Corporation, should have included in its taxable income certain kickback payments received by its purchasing agent, Avirgan, from the corporation’s suppliers. The Court held that these amounts were not accruable income to the corporation because the corporation’s right to the payments was contested, and Avirgan received the payments under a claim of right. The court found that Avirgan, not the corporation, initially controlled these funds. A state court judgment later awarded these funds to the corporation, but the Tax Court determined that this did not retroactively make the payments taxable to the corporation in earlier years.

Facts

All Americas Trading Corporation (the “Taxpayer”) was a Pennsylvania corporation engaged in exporting automotive parts. Joseph Avirgan, the purchasing agent and nominal president of the Taxpayer, received kickback payments from the Taxpayer’s suppliers. These payments were made to Avirgan, his brother, or his nominee, and were not recorded on the Taxpayer’s books. Tandeter, the other controlling shareholder, directed and controlled the corporate operations. After Avirgan’s employment was terminated, Tandeter and his daughter sued Avirgan in state court to recover the kickback payments, claiming the Taxpayer was entitled to the funds. The state court eventually ruled in favor of the Taxpayer, awarding it a judgment for the kickbacks. The Commissioner of Internal Revenue determined deficiencies in the Taxpayer’s income tax, arguing the kickbacks constituted taxable income to the Taxpayer.

Procedural History

The Commissioner determined deficiencies in the Taxpayer’s income tax for the fiscal years ending March 31, 1949, 1950, 1951, and 1952. The Taxpayer contested the deficiencies in the United States Tax Court. The Tax Court considered two main issues, whether the kickback payments resulted in unreported income to the Taxpayer and whether the failure to report the amounts as income was fraudulent. The Tax Court ruled in favor of the Taxpayer.

Issue(s)

1. Whether certain payments received by Joseph Avirgan as rebates, commissions, or “kickbacks” resulted in unreported income to the petitioner in the years involved.

2. If the first issue is decided against the petitioner, whether the petitioner in not reporting the amounts in question as income did so fraudulently with intent to evade tax within the meaning of section 293(b) of the Internal Revenue Code of 1939.

Holding

1. No, because the Taxpayer did not have an established claim to the payments during the tax years in question, and Avirgan received the payments under a claim of right.

2. The court did not address this issue as the first issue was decided in the Taxpayer’s favor.

Court’s Reasoning

The Tax Court applied the “claim of right” doctrine, focusing on whether the Taxpayer had a fixed right to the payments during the relevant tax years. The court found that the payments originated from the suppliers’ funds and were made to Avirgan, who maintained that he was entitled to these payments based on an agreement with Tandeter. The court emphasized that Avirgan held these payments as his own. The court referenced the case Healy v. Commissioner to support the concept that a later legal judgment does not alter the status of the funds during the original tax year. The court distinguished this case from those where a corporate officer, shareholder, or other person in control of a corporation receives the payments. The court noted that Avirgan was merely a nominal president and purchasing agent, and Tandeter controlled the Taxpayer’s operations. Therefore, the court concluded that Avirgan did not receive the kickbacks on behalf of the Taxpayer.

Practical Implications

This case clarifies that income is not accruable if the right to receive the income is subject to substantial dispute. It emphasizes the importance of determining who has control over funds in determining tax liability, particularly in situations involving corporate officers. This case reinforces that a judgment obtained after the tax year does not retroactively alter whether income was accruable in prior tax years, as the tax consequences are determined at the time of receipt or accrual. Attorneys should carefully examine the relationships among parties and the nature of their claims to determine which party controlled funds and whether a claim of right existed during a taxable year. This case can be distinguished from cases in which payments are controlled by, or made to, a shareholder who effectively controls the corporation.