Kanawha Gas & Utilities Co. v. Commissioner

Kanawha Gas & Utilities Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Kanawha Gas & Utilities Co. v. Commissioner Docket No. 25715 United States Tax Court 19 T.C. 1017; 1953 U.S. Tax Ct. LEXIS 227; March 9, 1953, Promulgated *227 Decision will be entered for the respondent. In 1929 petitioner and 8 corporations were members of an affiliated group which elected under the provisions of Regulations 75 to file a consolidated income tax return. Petitioner must in 1943 use as a basis for computing profit on the sale of natural gas wells acquired from the corporations during the consolidated return period the basis of the wells in the hands of the 8 corporations. William Bew White, Jr., Esq., and Bernard A. Monaghan, Esq., for the petitioner. S. Earl Heilman, Esq., for the respondent. Arundell, Judge. ARUNDELL *1017 The respondent determined a deficiency in the petitioner's income tax for the calendar year 1943 in the amount of $ 365.07. The petitioner alleges that there is no deficiency and that there is an overassessment in the amount of $ 17,398.26. *1018 The issues relate to the basis of gas producing properties that were acquired by the petitioner in 1929. The principal issue is whether by reason of a consolidated return having been filed for 1929, the petitioner is *229 limited to the basis of properties in the hands of 8 corporations the stocks of which were acquired by the petitioner in that year and which transferred their properties to it in that year. The petitioner also claims error in the determination of the cost of gas properties purchased from individuals and partnerships in 1929. FINDINGS OF FACT. The petitioner is a West Virginia corporation with an office at Birmingham, Alabama. Its income and declared value excess-profits tax return for the calendar year 1943 was filed with the collector of internal revenue for the district of Alabama. It reports its income and files its returns on a calendar year basis and on the accrual method of accounting. It was organized on June 24, 1929. Anderson Development Company, herein sometimes called Anderson, was a corporation organized on February 3, 1928, at the instance of one Rummel who thereafter controlled it. In 1928 or early 1929 Rummel became interested in the purchase and sale of gas producing properties in Lincoln County, West Virginia. Rummel attempted to have Anderson acquire gas leaseholds then owned by 8 corporations and 132 gas wells thereon. The corporations refused to sell their*230 physical properties because of doubts as to the tax consequences. As the result of ensuing negotiations, Anderson entered into contracts dated June 1, 1929, for the purchase of all of the outstanding stock of 6 of the 8 corporations. 1 On the same date, Anderson entered into agreements to purchase leases and leasehold interests owned by several individuals and partnerships and which included 62 gas wells. 2 A typical agreement for the purchase of stock was the one between Anderson and the stockholders of Ray Gas Company which provided in material part as follows: The purchaser [Anderson] agrees to pay for all of said capital stock of the Ray*231 Gas Company, the sum of Sixty Thousand Dollars, ($ 60,000) * * *. Provisions were made for installment payments, one of which was due on or before September 1, 1929, and the final payment on or before December 1, 1929. There were provisions for title search and the retention by Ray Gas Company of possession of and the operation *1019 of its properties until the installment due on September 1, 1929, was paid. At that time, full possession and control were to pass to the purchaser. On the same date, June 1, 1929, the stockholders of Laurel Development Company gave a written option to Anderson to purchase all of their stock for the sum of $ 299,000. The option was to run until August 1, 1929. All money of Laurel on hand at August 1, 1929, and proceeds from gas sales prior to that date were to be the property of the stockholders, and they were liable for taxes up to that date. Income and taxes thereafter were to be those of Anderson. On June 3, 1929, and thereafter throughout 1929, North American Water Works & Electric Corporation (herein referred to as "North American") was a subsidiary corporation of Atlantic Public Utilities Corporation. North American was a holding company*232 holding stock in corporations that were engaged in the business of operating and developing electric, gas, and water properties. Chase and Gilbert, Inc., a Boston investment firm, controlled, operated, and managed Atlantic Public Utilities throughout the year 1929. On June 3, 1929, Anderson and North American entered into a written agreement whereby Anderson agreed to sell to North American the stocks of the several corporations, and the leases and leasehold estates, that it had agreed to purchase. The agreed price for the stocks and leasehold interest was $ 1,300,000, of which $ 100,000 was to be deposited by June 5, 1929, $ 300,000 on or before August 1, 1929, $ 450,000 on or before September 1, 1929, and $ 450,000 on or before December 1, 1929. The petitioner was organized on June 24, 1929, as an affiliate of the North American and Atlantic Public Utilities group. On July 3, 1929, North American assigned to the petitioner its agreement with Anderson for the purchase of stocks of the several corporations and leases and leasehold interests. In addition to the corporate stocks above mentioned, Anderson elected to deliver to the petitioner the stock of Maul Rock Gas Company. All*233 of the terms and conditions of the contract between Anderson and North American dated June 3, 1929, were performed by Anderson, seller, and by North American and by the petitioner, as assignee of North American, purchaser, respectively. Anderson received, in the aggregate, for all the interests and stocks transferred to the petitioner the full $ 1,300,000 agreed upon between it and North American. In the early part of 1929, Chase & Gilbert, Inc., employed a consulting engineer and geologist to examine the 194 operating gas properties that were owned by the corporations and others above mentioned. He was employed to investigate the gas reserves and to make a recommendation to Chase & Gilbert, Inc., as to whether or not to *1020 purchase the stocks and properties. The desire of Chase & Gilbert, Inc., was to purchase producing properties. Because of the scattered ownership, through corporations, individuals, and partnerships, Chase & Gilbert's representative deemed it advisable to purchase the stock of those corporations that owned producing gas properties. The result of the foregoing transactions was that the petitioner in 1929 acquired the stocks of 8 corporations which owned*234 132 natural gas wells, and properties used in connection therewith, and 62 natural gas wells and properties used in connection therewith, all of which at June 3, 1929, and prior thereto, had been owned and operated by others than the petitioner. On July 31, 1929, certificates evidencing all of the capital stock of Laurel Development Company, duly endorsed, were delivered to or for the account of the petitioner. On December 28, 1929, certificates for all of the shares of Laurel were issued to nominees of the petitioner. On December 2, 1929, the petitioner made payment of the final installment of the purchase price of the stocks of the 7 corporations above named, other than Laurel Development Company, and the escrow agents surrendered to the petitioner certificates, duly endorsed in blank, for all of the issued and outstanding stock of the 7 corporations. On the same date the resignations of all officers and directors of the 7 corporations, previously deposited in escrow, were accepted, and new officers and directors who were nominees of the petitioner were elected. On December 19, 1929, all of the 8 corporations above named, whose stocks had been acquired by the petitioner, adopted*235 resolutions to transfer to the petitioner all of their oil and gas leases and all contracts and equipment appertaining to them. Pursuant to such resolutions, deeds of assignment to those properties were executed and recorded in accordance with the law of West Virginia. Of the above 8 corporations whose stocks were acquired by the petitioner, all but Laurel Development Company were dissolved on or about June 25, 1930. Laurel Development Company was dissolved on or about March 18, 1938. As of the effective dates of the sales of stocks of the 8 corporations (June 1, 1929, in the case of 7, and August 1, 1929, as to Laurel Development Company), all assets of those corporations except operating assets had been distributed to their stockholders. As of the effective sales dates, the properties were operated for the benefit of North American and/or the petitioner. After those dates no entries were made on the books of the 8 vendor corporations with the possible exception of a minor entry on the books of Laurel Development Company. *1021 For the year 1929, Atlantic Public Utilities, Inc., and North American Water Works and Electric Corp. and/or their affiliated companies filed a consolidated*236 tax return. Included therein was a "Statement of Profit and Loss," reporting gross income and deductions from gross income for "Kanawha Gas & Utilities Company and Subsidiaries (6/1 to 12/31/29)." For the period from June 1, 1929, to December 31, 1929, petitioner, Bear Branch Gas Company, Union Oil & Gas Company, Ray Gas Company, West Side Gas Company, Foote Oil & Gas Company, McClure Gas Company, Maul Rock Gas Company, and for the period from August 1, 1929, to December 31, 1929, Laurel Development Company each filed an "Authorization and Consent of Subsidiary Corporation Included in a Consolidated Income Tax Return and Return of Information," Form 1122, authorizing the parent corporations to make a consolidated return on its behalf and consenting to and agreeing to be bound by the provisions of Treasury Regulations 75 prescribed prior to the making of the consolidated return. In 1941, 1942, and 1943, the petitioner sold some of the gas properties that it had acquired in 1929. The petitioner's unadjusted basis in 1941, 1942, and 1943 with respect to the 132 gas properties that it acquired from the 8 corporations in 1929 was the same as it was in the hands of those corporations. *237 OPINION. These proceedings involve the question of basis with respect to gas properties that were sold by the petitioner in 1943, and incidentally some that were sold in 1941 and 1942 because of loss carry-overs from those years to 1943. In 1929 the petitioner corporation acquired 194 operating gas properties, of which 62 were acquired by purchase from individuals and partnerships and 132 through the liquidation of 8 corporations whose stocks it had purchased. Of the total of $ 1,300,000 paid by the petitioner, the respondent has determined that $ 435,500 represents the cost, and basis, of 62 properties purchased. He has further determined that $ 132,000, or $ 1,000 for each of the other 132 properties, is the depreciated cost to the 8 former corporate owners and the basis to the petitioner. The respondent's position is that section 141 of the Revenue Act of 1928 required as a condition of the privilege of filing consolidated returns that all members of the affiliated group consent to the consolidated return regulations prescribed by the Commissioner, with the approval of the Secretary, and that those regulations, and similar regulations subsequently promulgated, require the petitioner*238 to use *1022 the basis of the 8 transferor corporations. Both parties quote from Regulations 75, which were applicable to the taxable year 1929 and subsequent years, as follows: Art. 37. -- Dissolutions -- Recognition of Gain or Loss. (a) During Consolidated Return Period. Gain or loss shall not be recognized upon a distribution during a consolidated return period, by a member of an affiliated group to another member of such group, in cancellation or redemption of all or any portion of its stock; and any such distribution shall be considered an intercompany transaction. Art. 38. -- Basis of Property. (a) General Rule. Subject to the provisions of paragraph (b), the basis during a consolidated return period for determining the gain or loss from the sale or other disposition of property, or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed, shall be determined and adjusted in the same manner as if the corporations were not affiliated (see sections 111 to 115, inclusive, of the Act), whether such property was acquired before or during a consolidated return period. Such basis immediately after a consolidated return period (whether*239 the affiliation has been broken or whether the privilege to file a consolidated return is not exercised) shall be the same as immediately prior to close of such period. (b) Intercompany Transactions. The basis prescribed in paragraph (a) shall not be affected by reason of a transfer during a consolidated return period (whether by sale, gift, dividend, upon dissolution, or otherwise) from a member of the affiliated group to another member of such group. The respondent further quotes from Internal Revenue Code section 113 (a) (11), which provides in material part that: The basis in case of property acquired by a corporation during any period, in the taxable year 1929 or any subsequent taxable year, in respect of which a consolidated return is made by such corporation under section 141 of * * * the Revenue Act of 1928, * * * shall be determined in accordance with regulations prescribed under section 141(b) of * * * the Revenue Act of 1928 * * * The petitioner's position is that it was the intended objective of Chase & Gilbert, Inc., to acquire all of 194 operating properties and place them in one corporation, and that the preceding transactions were interrelated and interdependent*240 steps in a unitary plan. It says that where such facts exist the intended and attained objective of a series of transactions should be given that effect for tax purposes which the plan and objective require when viewed as a whole; that the several steps should not be treated as independent transactions at the cost of distorting the clear effect of the plan. There are many decisions which, in the abstract, support the petitioner's argument. See, for example, Schumacher Wall Board Corporation, 33 B. T. A. 1211, where the question of basis depended on whether there was control in the same persons before and immediately after the transfer of assets. Control did exist in an investment banking house, but at the time it received the stock it was bound by *1023 contract to convey it to others. In holding for the taxpayer in that case, we said, quoting from Wilbur F. Burns, 30 B. T. A. 163, that "the question of control is to be determined by the situation existing at the time of the completion of the plan rather than at the time of fulfillment of one of the intermediate steps." The language was quoted with approval by *241 the Ninth Circuit Court of Appeals in affirming our decision at 93 F. 2d 79. The Circuit Court in that case also quoted the rule often announced by the Supreme Court that in matters of taxation it recognized the "importance of regarding matters of substance and disregarding forms * * *." See United States v. Phellis, 257 U.S. 156. In the application of such general rules, proper regard must be had for the provisions of the particular statute and regulations under consideration and the facts of the case being decided compared with those in which the rules were announced. When this is done here, we think the issue in these proceedings must be decided for the respondent. Under Revenue Acts prior to that of 1928, affiliated corporations were either required or permitted to file consolidated returns. However, none of the prior acts required consent to the regulations prescribed for the filing of such returns, nor specifically delegated to administrative officers the authority to prescribe such regulations as they might deem necessary in order to determine the tax liability of the group and of each corporation in the group both*242 during and after the period of affiliation. Section 141 of the Revenue Act of 1928 required such consent and granted such authority. The provisions of section 141 were given careful consideration by the Congress in the enactment of the Revenue Act of 1928. The Senate Finance Committee, after referring to the history of consolidated return provisions under prior acts, said in part (S. Rept. No. 960, 70th Cong., 1st sess., p. 15; 1939-1 C. B. (Part 2) 409, 419): Many difficult and complicated problems, however, have arisen in the administration of the provisions permitting the filing of consolidated returns. It is, obviously, of utmost importance that these questions be answered with certainty and a definite rule be prescribed. Frequently, the particular policy is comparatively immaterial, so long as the rule to be applied is known. The committee believes it to be impracticable to attempt by legislation to prescribe the various detailed and complicated rules necessary to meet the many differing and complicated situations. Accordingly, it has found it necessary to delegate power to the Commissioner to prescribe regulations legislative in character covering*243 them. The standard prescribed by the section keeps the delegation from being a delegation of pure legislative power, and is well within the rules established by the Supreme Court. (See Hampton, Jr., & Co. v.United States, decided by the Supreme Court on April 9, 1928, and cases there cited.) Furthermore, the section requires that all the corporations joining in the filing of a consolidated return must consent to the regulations prescribed prior to the date on which the return is filed. *1024 Among the regulations which it is expected that the Commissioner will prescribe are: (1) The extent to which gain or loss shall be recognized upon the sale by a member of the affiliated group of stock issued by any other member of the affiliated group or upon the dissolution (whether partial or complete) of a member of the group; (2) the basis of property (including property included in an inventory) acquired, during the period of affiliation, by a member of the affiliated group, including the basis of such property after such period of affiliation; * * * The House agreed with the proposed section 141, as presented by the Senate Committee on Finance, with a clarifying amendment*244 as to insurance companies, Amendment No. 91, H. Rept. No. 1882, 70th Cong., 1st sess., p. 16, 1939-1 C. B. (Part 2) 444, 448. In view of such specific delegation of power to administrative officers to promulgate regulations, and which has been continued in successive revenue acts, a clear showing must be made of authority to cut across such regulations and to reach a result other than that spelled out by the regulations. General rules which under some facts and some statutes might permit the disregard of intermediate steps in a so-called step plan are not sufficient to permit the disregard of any step in a case like this where the regulation is specific and the power to make it is as specific as it is in the Revenue Act of 1928. The cases cited by the petitioner are not persuasive authority for its position. A case strongly relied on by the petitioner is Muskegon Motor Specialties Co., 35 B. T. A. 851. In that case, a Delaware corporation organized late in 1928 acquired the stock of two existing Michigan corporations. It was contemplated by the organizers and the bankers that the Delaware corporation would as soon as practicable*245 acquire the assets of the Michigan corporations. The transfer of assets took place on January 23, 1929. All three corporations filed separate income tax returns for the year 1929. In each of the three returns it was stated that it was not a consolidated return. Upon the foregoing facts, we held that the basis of the depreciable assets acquired by the Delaware corporation from the Michigan corporations was not limited to the latters' basis. We said in part: The filing of a consolidated return is a matter of election by affiliated corporations. Oklahoma Contracting Corporation, 35 B. T. A. 232, 237. The regulations lay down detailed instructions as to the formalities to be complied with by corporations seeking the privilege of making a consolidated return. Among other things, the consolidated return must be made by the parent for the group. The parent must prepare and file form 851 and the subsidiaries must prepare and file form 1122 consenting to the regulations and authorizing the parent to file for them. These formalities were not met. Each corporation filed its own return and neither form 851 nor form 1122 was filed. What is more important*246 is that according to the evidence these matters were considered and a deliberate election was made not to file a consolidated return and not to meet the conditions which were necessary to the filing of such a return. On the contrary, it was intended that separate returns be filed and that was done. Consequently, it can not be held that a consolidated return was filed. *1025 We also discussed in the opinion arguments as to whether the dissolution of the old companies and the acquisition of their assets by the new was part of the original plan, but the real basis for our holding is in the language above quoted. The fact that in the Muskegon case no consolidated return was filed, and there was a deliberate election not to file such a return, readily distinguishes that case from the present one. The case of Ruth M. Cullen, 14 T. C. 368, is not in point as it did not involve either affiliated corporations or consolidated return. In that case, the individual holders of a minority of corporate stock purchased the stock of other stockholders and liquidated the corporation. The questions for decision concerned only the realization of gain or loss*247 by the individuals on the liquidation. The case of Kimbell-Diamond Milling Co., 14 T. C. 74, affd. per curiam, 187 F. 2d 718, likewise did not involve any question growing out of affiliation or consolidated returns. There the taxpayer, following an involuntary conversion, with intent to acquire the assets of another corporation, purchased all of its stock and within a few days liquidated it. It sought a stepped-up basis for the depreciable assets under the provisions of Code sections 112 (b) (6) and 113 (a) (15). Of the cases cited, the one that is most nearly like the present one on the facts is Commissioner v. Ashland Oil & Refining Co., 99 F. 2d 588, which reversed the holding in Swiss Oil Corporation, 32 B. T. A. 777. In that case, Swiss in 1924 obtained an option to purchase all of the stock of Union Gas & Oil Company for cash and notes. The stock was placed in escrow pending the making of certain cash payments. The last required payment was made late in 1925, the escrowed stock was delivered on January 2, 1926, to Swiss which thereupon liquidated Union*248 and acquired its properties. Swiss, Union, and another corporation filed a consolidated return for the year 1925 which included income and deductions of Union for the period February 2, 1925, to December 31, 1925. One of the questions in that case was whether Swiss realized a gain on the liquidation of Union in 1926. The Circuit Court held that it did not on the ground that the entire transaction between the corporations was essentially one for the acquisition of property, and the intervening steps should not be separately regarded either at the instance of the taxpayer or the taxing authority. It also held that the filing of a consolidated return for the year 1925 was unimportant, and for this proposition it cited Muskegon Motor Specialties Co., supra. For the year in suit in the Ashland case, whatever regulations there were as to the filing of consolidated returns did not have the statutory sanction that was given to them by section 141 of the Revenue Act of 1928. It may be that for that reason the Court felt it proper to disregard intervening steps. At any rate, we think that the absence *1026 of legislation on the subject in 1926 is*249 an effective distinction between the Ashland case and the one before us. The petitioner further contends that the consents filed by the 8 corporations whose stock was acquired by the petitioner had no legal effect. This is based on its view that the transfers of properties should be given effect as of August 1, 1929, in the case of Laurel Development Company and as of June 1, in the case of the other 7 corporations. It says that after those dates the 8 corporations could have no income or deductions to be included in a consolidated return. We think that this contention is based on too light a consideration of the existence of the 8 corporations and their continued ownership of properties. All of them continued their corporate existence throughout the year 1929. They continued to be the owners of their properties until December 19, 1929, when they were transferred to the petitioner. During that time, they had income from and expenses with respect to their properties. While such income and expenses became those of the petitioner, that was by reason of contract, and the income and expenses were initially those of the 8 corporations. Accordingly, we cannot say that the consents*250 filed should not be given effect. Finally, the petitioner contends that if its basis as to the 132 operating properties is limited to that of the eight corporations, then its basis as to the 62 properties acquired from individuals and partnerships must be increased. It develops on brief a set of figures, and arrives at an amount of $ 46,124.84 which it says was the portion of Anderson Development Company's profits that is allocable to the 62 properties. The petitioner's position on this point is not based on proof. We do not know what Anderson Development Company agreed to pay for the 62 properties, but what is more important we do not know how much the petitioner paid for them. Certainly we cannot say that the petitioner's basis was greater than cost. An agent of the respondent attempted to ascertain how the total of $ 1,300,000 should be distributed. On the basis of what records were available, he determined that $ 740,000 was the cost of the stock of the 8 corporations and $ 435,500 was the cost of the 62 properties. The remainder of $ 124,500 he reported to be unidentified. On the record before us, we cannot determine what portion, if any, of the $ 124,500 should be allocated*251 to the 62 properties as part of their cost to the petitioner. Decision will be entered for the respondent. Footnotes 1. The 6 corporations were: Bear Branch Gas Company, Union Oil & Gas Company, Ray Gas Company, West Side Gas Company, Foote Oil & Gas Company, and McClure Gas Company.↩ 2. Such individuals and partnerships were: Jaynes & Wysong, G. T. Ray & Son, C. C. Wolfe, W. H. McClung, Linkous and Young, Ray & Osburne, Linkous and McClung, Ray, Ray and Black, and A. F. Morris, Agent.↩