UNITED STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT
June 24, 1966
KNOWLES ELECTRONICS, INC., PLAINTIFF-APPELLANT,
UNITED STATES OF AMERICA, DEFENDANT-APPELLEE
Hastings, Chief Judge, Duffy, Circuit Judge, and Beamer, District Judge.
HASTINGS, Chief Judge.
Appellant, Knowles Electronics, Inc., brought this action in the district court for a refund of taxes alleged to have been erroneously and illegally assessed and collected. The Government, prior to answer, filed a motion to dismiss under Rule 12(b)(6), Federal Rules of Civil Procedure, 28 U.S.C.A., for failure to state a claim upon which relief could be granted. After consideration, the district court entered an order, without opinion, dismissing Knowles' complaint on the ground that it was barred by the applicable statutes of limitation,*fn1 which had not been affected by the statute of limitations mitigation provisions of §§ 1311-1315 of the Internal Revenue Code of 1954.
On appeal, Knowles contends that the facts alleged in its complaint state a cause of action not barred by the statutes of limitation because of the mitigation provisions of §§ 1311-1315.
Briefly stated, the facts are as follows. In its fiscal year 1955, Knowles engaged in a "Livingstone" transaction, a device used to reduce taxes by claiming deductions for alleged payment of interest on loans financing the purchase of government securities. The Livingstone transaction, which this circuit has discussed in Dooley v. C.I.R., 7 Cir., 332 F.2d 463 (1964); Lewis v. C.I.R., 7 Cir., 328 F.2d 634 (1964); and Rubin v. United States, 304 F.2d 766 (1962), is in substance a sham transaction lacking commercial reality, the only purpose and effect of which is to reduce taxes. Tax deductions claimed on account of such transactions have not been allowed. See Dooley, Lewis, and Rubin, supra.
In this particular case, Knowles, in its fiscal year 1955, "purchased" $4,200,000 face value 2 1/2 per cent U.S. Treasury bonds from M. Eli Livingstone & Co. for a promissory note payable to Corporate Finance & Loan Corp. in the amount of $4,037,250. Finance received the bonds from Livingstone against purported payment to Livingstone of $4,037,250. Livingstone received $10,500 as consideration for an irrevocable offer to buy back the Treasury Bonds on May 15, 1956 at a price of 99 5/8. Knowles prepaid Finance $151,396.88 as interest on its promissory note.
In May of 1956, Livingstone "purchased" back the bonds for $4,184,250, satisfied Knowles' promissory note, and paid the remaining $147,000 to Knowles.
Over the whole transaction, Knowles paid out or lost approximately $15,000, but was able to claim on its tax return for fiscal 1955 a deduction of $151,396.88 with respect to the prepaid interest and, on its return for fiscal 1956, to report a capital gain of $136,500.
In April, 1959, the Commissioner of Internal Revenue disallowed the deduction for fiscal 1955. On July 20, 1955, Knowles filed a petition with the Tax Court contesting, inter alia, the disallowance. On or prior to September 26, 1962, Knowles and the Commissioner filed a stipulation with the Tax Court that Knowles was not entitled to an interest deduction with respect to the prepaid interest. On September 26, 1962, the Tax Court entered a decision and order, Docket No. 81971, determining a deficiency for Knowles for fiscal 1955 in the amount of $78,726.38.
On January 16, 1963, Knowles filed a claim for a tax refund of $34,125, the amount of capital gains tax paid for fiscal 1956 attributable to the $136,500 Knowles "realized" in the disposition of the Treasury bonds. Knowles, in effect, based its claim on the ground that since the whole Livingston transaction was in effect a nullity, and since, for taxation purposes, the whole transaction should have been taken into account, it had made an error in reporting the $136,500 as a capital gain. Since the statute of limitations had run on fiscal 1956, Knowles relied on the statute of limitations mitigation provisions of §§ 1311-1315 of the Code.
Knowles' refund claim was disallowed on the ground that the Tax Court decision and order did not constitute a determination of deficiency within § 1313(a) and, alternatively, if it did constitute a determination, it was not a determination described in any of the subparagraphs of § 1312.
The essential problem before us is to determine whether Knowles' "error" is an error under the particular circumstances set forth in detail in § 1312. Specifically, Knowles argues that the circumstances of adjustment specified in § 1312(4) is applicable to the facts of this case.
Sections 1311 and 1312 of the Code, which are relevant here and which are set out in the margin,*fn2 were considered by this court in Olin Mathieson Chemical Corp. v. United States, 7 Cir., 265 F.2d 293 (1959). There, at 296, we stated:
"Of course, Congress did not intend by §§ 1311-1315 to provide relief for inequities in all situations in which just claims are precluded by statutes of limitations. This is no more than a truism. Statutes of limitations are an indispensable element of practical tax administration, and both hardships to taxpayers and losses of revenue may and do result from their application in the field of taxation. 'Such periods [of limitations] are established to cut off rights, justifiable or not, that might otherwise be asserted and they must be strictly adhered to by the judiciary.' Kavanagh v. Noble, 1947, 332 U.S. 535, 539, 68 S. Ct. 235, 237, 92 L. Ed. 150; Rahr Malting Co. v. United States, 7 Cir., 1958, 260 F.2d 309, 312.
"In order to obtain relief under §§ 1311-1315 taxpayer must demonstrate that it meets the specific requirements of those sections. Sections 1311-1315, though complicated and technical in their wording, have the clear purpose of providing for adjustments to correct errors only under particular circumstances set forth in detail in Section 1312, which adjustments would otherwise not be made due to the 'operation of any law or rule of law.' Section 1311(a). Moreover, these adjustments are to be allowed only under conditions delineated in Section 1311(b)."
The purpose of the mitigation provisions has been stated to be:
"to provide a fair and workable formula under which taxpayers and the Government would be given relief from the unfair and unjust results occasioned by corrections, by final determinations, of errors of either the taxpayer or the Commissioner of Internal Revenue, or both, in connection with proper treatment of items affecting taxable income and tax liability in more than one year." United States v. Rosenberger, 8 Cir., 235 F.2d 69, 73 (1956), quoting Gooch Milling & Elevator Co. v. United States, 78 F. Supp. 94, 100, 111 Ct. Cl. 576 (1948).
Under the facts, the particular inequity which Knowles has suffered is a result of its own mistake, originally caused by its engaging in a simulated commercial transaction. To describe such transactions, we have in the past quoted the statement of the Tax Court in MacRae v. Commissioner, 34 T.C. 20, aff'd, MacRae v. C.I.R., 9 Cir., 294 F.2d 56 (1961):
"The steps taken, each in itself a legitimate commercial operation, were here each mirror images, and add up to zero. The various purchases and sales, each real without the other, neutralize one another and fairly shout to the world the essential nullity of what was done. No purchase and no sale is essentially identical with what was done here, i. e., identical and virtually simultaneous purchases and sales. The choice of the more complicated and involved method of doing nothing had no purpose, save the erection of the facade upon which petitioners now seek to rely." Quoted in Rubin, supra, 304 F.2d at 770.
While Knowles does not seek to rely upon the facade of the Livingstone transaction in which it engaged, and agrees that the transaction was a nullity, we point out that notwithstanding the fact that the transaction was admittedly hollow, a legal and commercial nullity may yet have legal consequences.
We have often leveled a skeptical eye at Livingstone transactions, and we do not perceive that such a transaction, reported on a tax return according to plan, having as its sole purpose the circumventing of taxation, involves the kinds of error §§ 1311-1315 were intended to alleviate. Indeed, it is almost euphemistic to refer to the reporting of the steps involved in the carefully calculated hollow circularity of Livingstone transactions as errors.
The true character of Livingstone transactions for tax purposes was resolved in a series of decisions handed down between 1959 and 1964.*fn3 In a sense Knowles may have been "caught" unawares in failing to make a claim for refund for fiscal 1956 because it was not notified of its 1955 deficiency until April, 1959, within a few months of the running of the § 6511 three year statute of limitations on its claims for refunds for its fiscal 1956. Nonetheless, while Livingstone transactions had not been adjudicated for what they are, no one participating in such a transaction could fail to see that it had no investment or commercial meaning and that, instead, it was clearly and solely a tax escape device.
Comparing the manner of reporting the transaction involved in this case with the manner in which it should have been reported, it is plain that Knowles has been doubly taxed. As we remarked in Olin, supra, however, the mitigation provisions were not designed to correct every inequity of double taxation. We cannot conceive Congress intended by such provisions that the United States should bear the risk involved in Livingstone transactions. The party seeking the benefit of §§ 1311-1315 of the Code is required to establish clearly the applicability of the specific statutory requirements to its situation. Olin, supra, 265 F.2d at 296; C.I.R. v. Goldstein's Estate, 2 Cir., 340 F.2d 24, 27 (1965); United States v. Rigdon, 9 Cir., 323 F.2d 446, 449 (1963); Taxeraas v. United States, 8 Cir., 269 F.2d 283, 289 (1959). Knowles has not done so.
For the foregoing reasons, we hold that the claim for refund asserted in the taxpayer's complaint was barred by the applicable statutes of limitation.
The judgment appealed from is affirmed.