Conley Tin Foil Corp. v. Commissioner

CONLEY TIN FOIL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Conley Tin Foil Corp. v. Commissioner Docket No. 15693. United States Board of Tax Appeals 17 B.T.A. 65; 1929 BTA LEXIS 2356; August 6, 1929, Promulgated *2356 1. A certain contract involved herein held to have cost the petitioner nothing and the petitioner is, therefore, not entitled to any deduction from income for the exhaustion of said contract. 2. The petitioner and the Aluminum Rolling Mills, Inc., were not affiliated during the year 1923. 3. Under the evidence, held that the petitioner is entitled to deductions in each of the years 1920 to 1923, inclusive, on account of obsolescence of certain of its buildings, machinery, and equipment. Mark J. Ryan, Esq., for the petitioner. Stanley Suydam, Esq., for the respondent. MARQUETTE *65 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $1,794.75 for the year 1920, $2,882.26 for the year 1921, $3,932.97 for the year 1922, and $11,324.64 for the year 1923. The issues are (1) whether the petitioner is entitled to deduct from income any amount for the amortization of the alleged cost of a certain contract; (2) whether the petitioner was affiliated during the year 1923 with the Aluminum Rolling Mills, Inc.; and (3) whether for each of the taxable years*2357 the petitioner is entitled to a deduction for the obsolescence of certain of its buildings, machinery, and equipment. FINDINGS OF FACT. The petitioner was incorporated in the year 1919 under the laws of the State of New York. It was a holding company and during the years 1920 to 1924, inclusive, it owned all of the capital stock of two other corporations, namely, the Conley Foil Co., which was an operating company engaged in manufacturing tin foil, and the Marginal Realty Corporation, which held title to the real estate used by the petitioner and the Conley Foil Co. The principal customers for foil were the larger tobacco companies, and business with them was done under long-term contracts. The largest and most important customer of the Conley Foil Co. was the American Tobacco Co., which took more than 30 per cent of the entire output of the Conley Foil Co. In 1920 the existing foil supply contract between the Conley Foil Co. and the American Tobacco Co. had but one year more to run. The officers of the Conley Foil Co. knew at that time that the American Tobacco Co. had recently acquired control of another foil company, known as the Standard Tin Foil Corporation, and they*2358 considered it certain that *66 unless the Conley Foil Co.'s contract with the American Tobacco Co. was renewed, the American Tobacco Co. would in the future purchase its requirements of foil from its newly acquired subsidiary. The officers of the Conley Foil Co. also knew in 1920 that the Duke and Reynolds tobacco interests were backing another foil company, the United States Foil Co. at Louisville, Ky., and they had reason to believe that the British-American and Reynolds tobacco foil business would soon be lost as customers of the Conley Foil Co. It was, therefore, of the greatest importance to the Conley Foil Co. that its contract with the American Tobacco Co. be renewed. Negotiations were, therefore, begun by the Conley Foil Co. in the year 1920 looking to a renewal of said contract on the best terms available. The best terms obtainable by the Conley Foil Co. from the American Tobacco Co. were as follows: The American Tobacco Co. would contract to take all of its foil requirements, with a minor exception, from the Conley Foil Co. for a period of ten years on a cost-plus basis, provided the Conley organization would take over from the American Tobacco Co. all of the capital*2359 stock of the Standard Tin Foil Corporation and issue to the American Tobacco Co. 42,000 shares of the capital stock of the Conley Tin Foil Corporation, the petitioner herein. These negotiations culminated in the execution of two contracts on January 19, 1921. By one of these contracts the American Tobacco Co. agreed to purchase all the foil required by it, with minor exceptions, from the Conley Foil Co., on a cost-plus basis for a period of ten years. By the other contract the Conley Tin Foil Corporation, the petitioner herein, agreed to issue 42,000 shares of its capital stock to the American Tobacco Co., and the American Tobacco Co. agreed to assign to the petitioner all of the capital stock and $150,000 in obligations (bills payable) of the Standard Tin Foil Corporation. The sole purpose of the Conley organization in entering into the two contracts was to obtain the supply contract from the American Tobacco Co. The contract between the petitioner and the American Tobacco Co. was carried out and the American Tobacco Co. assigned to the petitioner all of the capital stock of the Standard Tin Foil Corporation, together with bills payable of that company in the amount of $150,000. *2360 At that time the book value of the capital stock of the Standard Tin Foil Corporation was $459,446.45, which amount, together with the $150,000 of assigned obligations, a total of $609,446.45, was at least the value to the petitioner of the stock and the obligations of the Standard Tin Foil Corporation. The petitioner issued to the American Tobacco Co. as of the close of business on January 31, 1921, 42,000 shares of the petitioner's capital stock. The book value of said 42,000 shares of the petitioner's stock was at that *67 time $923,984.13, or about $22 per share. The transactions in the petitioner's stock on the New York Curb Market showed an average price per share as follows: Sales of Conley Tin Foil Corporation stock on the New York curb market Week ended - High Low Average Number of shares [1920] Jan. 9 29.00 27.25 28.125 2,200 Jan. 16 28.25 28.25 28.25 [300] Jan. 23 28.00 28.00 28.00 [200] Jan. 30 25.25 24.50 24.875 [500] Feb. 6 25.00 23.50 24.25 2,300 Feb. 13 25.50 22.00 23.75 2,000 Feb. 20 24.00 22.50 23.25 [800] Feb. 27 23.50 23.50 23.50 [100] Mar. 5 23.00 22.50 22.75 [400] Mar. 12 26.50 25.50 26.00 1,000 Mar. 19 26.00 25.50 25.75 1,000 Mar. 26 Apr. 2 25.00 25.00 25.00 [100] Apr. 9 Apr. 16 27.25 25.00 26.125 3,400 Apr. 23 25.50 22.00 23.75 2,300 Apr. 30 23.50 22.00 22.75 2,000 May 7 23.00 20.50 21.75 1,600 May 14 24.00 21.00 22.50 [900] May 21 27.00 25.25 26.125 3,400 May 28 27.00 23.50 25.25 2,000 June 4 26.75 25.75 26.25 [500] June 11 27.75 26.00 26.875 3,900 June 18 26.00 23.00 24.50 [500] June 25 26.00 25.00 25.50 1,100 July 2 25.25 25.00 25.125 [500] July 9 25.00 25.00 25.00 [200] July 16 25.00 24.00 24.50 [400] July 23 24.50 23.50 24.00 [700] July 30 24.00 23.625 23.81 [300] Aug. 6 23.50 20.00 21.75 1,200 Aug. 13 22.00 20.00 21.00 [900] Aug. 20 21.00 18.00 19.50 [600] Aug. 27 20.50 19.50 20.00 [600] Sept. 3 21.00 21.00 21.00 [200] Sept. 10 21.00 20.50 21.00 [400] Sept. 17 21.625 21.00 21.31 [400] Sept. 24 21.875 21.625 21.75 [400] Oct. 1 21.75 21.75 21.75 [100] Oct. 8 21.75 20.25 21.00 [200] Oct. 15 20.125 20.00 20.06 [200] Oct. 22 Oct. 29 19.00 18.00 18.50 [500] Nov. 5 17.25 17.25 17.25 1,083 Nov. 12 17.00 16.125 16.56 3,883 Nov. 19 16.25 14.50 15.375 1,100 Nov. 26 16.50 16.00 16.25 [200] Dec. 3 16.00 11.00 13.50 1,900 Dec. 10 12.25 12.00 12.125 1,800 Dec. 17 12.00 11.00 11.50 3,050 Dec. 24 11.25 11.00 11.125 [950] Dec. 31 11.75 11.375 11.56 3,500 Average for 1920 21.18 [1921] Jan. 7 12.50 11.50 12.00 1,050 Jan. 14 12.625 12.00 12.31 [850] Jan. 21 17.00 12.25 14.625 1,300 Jan. 28 18.00 16.00 17.00 [800] Feb. 4 19.50 18.00 18.75 2,500 Feb. 12 17.75 17.75 [100] Feb. 19 (1) (1) (1) (1) Feb. 26 16.00 15.00 [300] Mar. 5 16.00 14.00 1,000 Mar. 12 15.00 14.00 [500] Mar. 19 14.125 14.00 [200] Mar. 24 14.00 14.00 [100] Apr. 1 14.25 13.875 [300] *2361 In the year 1921 the Conley Foil Co. determined to engage in the manufacture of aluminum foil as well as tin foil. In order to do so, however, it was necessary for the Conley Foil Co. first to acquire the rights to certain patents, processes and secret formulae which were owned by one Dr. Lauber of Switzerland. As a result of negotiations with Dr. Lauber an agreement was reached in the year 1921, as follows: The Conley Foil Co. agreed to organize and finance a new corporation to handle the aluminum business. To this corporation Dr. Lauber was to assign the patents and processes mentioned and the exclusive right to their use in the United States and certain other countries. The corporation was to have two classes of stock, class A, representing 75 per cent of the total authorized stock, and class B representing the remaining 25 per cent of the authorized stock. The class A stock was to be subscribed to at par, $100 per share, by the Conley Foil Co., and the class B stock, together with $50,000 in cash, was to be issued to Dr. Lauber or his nominees as a consideration for the use of the patents and secret processes. *68 The charter of the corporation*2362 was to provide that the class b stock would be redeemable at par, $100 per share, by the corporation when the dividends thereon or the royalties paid in lieu of dividends to the class B stockholders amounted to $285,000. Under the charter the class A stock was first to be entitled to 7 per cent accumulative dividends, after payment of which the class A stock and the class B stock would participate equally in the profits. The Conley Foil Co. also agreed to finance the new corporation to the extent of its requirements up to the amount of $500,000, at a cost to the new corporation of not more than 7 per cent of such financing. Each class of stock was to have voting rights. The said contract with Dr. Lauber was carried out according to its terms and the new corporation was organized under the laws of Delaware, under the name of Metal Products Manufacturing Co., which was later changed to Aluminum Rolling Mills, Inc. The Conley Foil Co. financed the new corporation entirely, paying all of its bills and advancing to it by the end of 1924 more than $950,000, for which no interest was ever charged. The Aluminum Rolling Mills, Inc., never had any separate organization. It had no plant*2363 or machinery other than that furnished by Conley, no sales force or other employees, and it did not have a bank account. All functions of the corporation were carried on by the Conley organization at its place of business, and by its employees, in the same manner as if the Aluminum Rolling Mills, Inc., were but the aluminum department of the Conley Foil Co. Orders for the aluminum products were taken by salesmen of the Conley Foil Co. and executed by the Conley organization. The proceeds of the sales of the aluminum products were taken directly into the treasury or bank account of the Conley Foil Co. All of the administrative, clerical, and accounting work was carried on by the force of the Conley Foil Co. All of the officers and directors, save one, were officers and directors of the Conley Foil Co. and the Conley Tin Foil Corporation. The Aluminum Rolling Mills, Inc., was unknown and had no credit standing in the trade. The class B stock was never voted at stockholders' meetings. All voting was done by the class A stock, owned by the petitioner, which controlled and dominated the policies and conduct of the Aluminum Rolling Mills, inc. Early in the year 1920 a change was*2364 made in the management of the Conley Foil Co. and one Egbert Moxham was placed as executive in charge of operations, and was elected vice president and a director. Moxham had had twenty years experience as an engineer in connection with various manufacturing enterprises, and immediately upon assuming charge of the operations of the Conley Foil Co. he, together with his assistant, William G. Golden, an experienced engineer, *69 made a careful survey of the new plant with a view to determining its physical and economic condition. As a result of this survey the management concluded during the summer of 1920, and so reported to the board of directors of the Conley Foil Co., that the buildings and certain of the machinery and equipment at the 25th Street, New York, plant, and all of the machinery and equipment at the 18th Street plant, were obsolescent on account of conditions resulting from the entry of new and aggressive competitors in the foil business. One of these competitors, the United States Foil Co. of Louisville, Ky., had in the year 1919 entered the field with a new, modern, one-story plant with machinery and equipment of the very latest design, which was capable of*2365 operating more efficiently than the plant of the Conley Foil Co. The United States Foil Co.'s one-story building maintained a layout of machinery so as to permit continuous operation and eliminated the necessity present in the Conley plant, of carrying and hoisting foil in process. Also the machinery of the United States Foil Co.'s plant rolled foil in wider strips and at greater speed and economy than did the machinery at the Conley plant. In 1920 it was realized by the management of the Conley Foil Co. that the United States Foil Co. would be a serious competitor when it became established in the trade and that when that time came, which was estimated to be three years, the Conley Foil Co. would be unable to meet the competition unless its plant were modernized and equipped with wider machinery of greater speed and otherwise arranged for more efficient operation. It was the opinion of the Conley management in 1920, after a careful survey and estimate, that these obsolescent buildings and machinery and equipment would be obsolete at the end of three or four years, and would then have to be abandoned and replaced with modern buildings and machinery if the Conley Foil Co. intended*2366 to continue in subiness. With the authority of the board of directors of the Conley Foil Co. active steps were taken in 1920 and continuously throughout the years 1921, 1922, and 1923, to effect a modernization of the plant. Additional engineers were employed, architects were retained, estimates were made, and programs and plans were drafted for a new plant. Real estate was purchased for a new site and other steps were taken looking to the completion of a modernization program by 1924. By the middle of the year 1924 competition from the United States Foil Co. had become so serious that the management of the Conley Foil Co. reported to the board of directors that they could no longer meet the competition with the existing plant, and that an immediate move was imperative. Rather than expend the additional *70 money necessary to complete the modernization program, the board of directors decided to sell out and liquidate. This was done by a sale in December, 1924, of all the assets of every kind and character, except the real estate at the 25th Street plant, for $450,000. Included in the assets sold were all of the new buildings, machinery, and equipment. The real estate*2367 at 25th Street was sold in March, 1925, for $483,505. The assets which were sold in December, 1924, for $450,000, included not only all of the machinery and equipment which was known to be obsolescent in 1920, but also included an equal amount of other machinery and equipment on hand in 1920 which was not considered obsolete, and all additions and improvements made since 1920, including a new aluminum plant erected in 1923 at a cost of more than $850,000. The assets sold in December, 1924, for $450,000, had cost the Conley Foil Co. more than $2,000,000 and their depreciated cost at the time of sale was $1,769,034.52. The depreciated cost in 1920 of the machinery and equipment which was determined to be obsolescent at that time and was subsequently sold in 1924, was $507,856.72, and the value thereof at the date of sale was not to exceed $50,000. The 25th Street real estate cost the Conley Foil Co. $165,986.95. The depreciated cost of the buildings in March, 1924, was $438,280.76. The petitioner determined that its contract with the American Tobacco Co. cost it $314,537.68, represented by the difference between $923,984.13, the book value of the 42,000 shares of the petitioner's*2368 stock issued to the American Tobacco Co. and $609,446.45, the value of the Standard Tin Foil Corporation stock and bills payable received by the petitioner from the American Tobacco Co. Therefore, the petitioner entered in its books of account the amount of $314,537.68 as "Unamortized Cost of Contract," and, in its returns for the years 1921, 1922, and 1923, deducted allowances for the amortization of said contract in the amounts of $28,862.62, $31,453.77, and $31,453.77, respectively. The petitioner in its return for 1923 reported that it was affiliated with the Aluminum Rolling Mills, Inc., and the return included the income and invested capital of that company. In its returns for the years 1921 to 1923, inclusive, the petitioner did not take any deduction for obsolescence of the building and equipment hereinbefore referred to, but a claim for an allowance for obsolescence of said buildings and machinery was made later. The respondent, upon audit of the petitioner's returns, disallowed the deductions claimed for amortization of the contract with the American Tobacco Co., determined that the petitioner and the Aluminum Rolling Mills, Inc., were not affiliated during the year*2369 1923, and disallowed the deductions claimed for obsolescence of buildings and machinery. *71 OPINION. MARQUETTE: We find no error in the respondent's determination that the petitioner is not entitled to any deduction for amortization with respect to its supply contract with the American Tobacco Co. The evidence shows that the 42,000 shares of its capital stock that the petitioner gave to the American Tobacco Co. did not have a market value in excess of the value of the property acquired in exchange for it. Conceding that the petitioner had no use for the Standard Foil Co.'s plant, and also that the petitioner would not have taken over the Standard Foil Co. except as a means of securing the supply contract from the American Tobacco Co., the transaction was, nevertheless, only an exchange of stocks of approximately equal value. The book value of any capital stock may or may not correspond to its market value. The latter, as the term implies, is the value which the stock has on the market - what it will sell for. In the present case the petitioner's stock was actively bought and sold on the Curb Market throughout the year 1920 and the early part of 1921. *2370 It showed a steady decline during the year 1920 and on December 31 of that year, when it is claimed to have had a book value of $22 per share, it sold on the market for not more than $11.75 per share, and during the week of January 19, 1921, when the contracts in question were executed it sold at an average price of $14.625 per share. On that basis, and that is the basis by which we must be guided, the 42,000 shares which the petitioner exchanged for the Standard Foil Co.'s stock and obligations, did not have any value greater than that of the property acquired in exchange for it. Therefore, the supply contract cost the petitioner nothing and there is nothing to amortize. See Kaufmann & Baer Co. v. Heiner, 34 Fed.(2d) 698. The second issue raised herein is whether the petitioner was, during the year 1923, affiliated with Aluminum Rolling Mills, Inc., within the meaning of section 240(c) of the Revenue Act of 1921, which provides that: (c) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially*2371 all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. The petitioner owned outright 75 per cent of the capital stock of the Aluminum Rolling Mills, Inc. The petitioner financed the latter company, furnishing it all the money for its operations, without interest; did all the buying and selling for it, and furnished all the officers and office organization. The Aluminum Rolling Mills, Inc., banked through the petitioner, having no separate account of its own, and was unknown to the trade and had no credit standing. *72 It was, in fact, the aluminum foil branch of the Conley organization. The 25 per cent of the capital stock not owned by the petitioner was the class B stock held by Dr. Lauber in Switzerland. This stock was never voted and it appears that Lauber was a quiescent minority and was content that the Conley organization should control and operate the corporation. This control, however, is not the control contemplated by the statute, and where there is a substantial minority, unless there is a control of the stock of such minority, there is no affiliation of the corporation. *2372 In Ice Service Co. v. Commissioner, 30 Fed.(2d) 230, it was stated: Congress has declared that two corporations shall be treated as one for tax purposes when one corporation owns or controls substantially all the stock of the other or when substantially all the stock is owned or controlled by the same interests. Judicial interpretation may perhaps limit the statutory language to voting stock, as was held In Re Temtor Corn Etc., Products Co.,299 Fed. 326 [U.S. Tax Cases, 2nd Supp. 1325] aff'd. sub. nom. Schafly v. United States, 4 Fed.(2d) 195 (C.C.A. 8), but we are not to confuse control of the corporation with control of the stock. The test is not declared to be control of the business or the policies of the subsid ary corporation but substantial identity of interest in the enterprise. The theory of affiliation, resulting in a consolidated return for taxes, is that the income and invested capital are really the income and capital of a single enterprise though carried on through the instrumentality of several corporations. See Art. 631, Treasury Regulations, 1920 Edition; Holmes, Fed. Taxes, 6th Ed. 281; *2373 Alameda Inv. Co. v. McLaughlin,28 F.(2d) 81 (N.D. Cal.). Only when the outside interest, that is, the interest of the minority, is so small as to be practically negligible, are the two corporations to be treated as in receipt of a single income requiring a consolidated return. Again, in Commissioner v. Adolph Hirsch & Co., 30 Fed.(2d) 645, the same court stated: The management of the business of the corporation is not the control required by the statute. It refers to stock control. The fact that the minority is acquiescent and permits the majority to manage the business does not prove actual control over the minority interest. Nor does a control based upon friendship or professional relations satisfy the statute. The control of the stock owned by the same interest refers to beneficial interest. This meaning is consistent with the purpose of the statute to extend to those subject to the hazard of the enterprise, when they are substantially one and the same, the benefit of the consolidated reports. These excerpts set forth what we conceive to be the theory of affiliation, and in the instant case the ownership of 75 per cent of the*2374 capital stock of the Aluminum Rolling Mills, Inc., by the petitioner with no control over the minority stock does not constitute the ownership or control of substantially all of the stock of the two corporations, as required by the statute, and we must therefore confirm the of the respondent in denying the right to file consolidated returns. Goldstein Bros. Amusement Co.,3 B.T.A. 408. *73 The third and last issue is whether the petitioner is entitled to deductions in the years 1920 to 1923, inclusive, for obsolescence of certain of its buildings and equipment. The deductions are claimed under section 234(a)(7) of the Revenue Act of 1921, which provides that there shall be allowed as a deduction, "A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." Obsolescence is a state or process of becoming obsolete. It is a process more or less gradual and a deduction therefor is spread over the years from the time the process begins until the property becomes obsolete. *2375 Jackson County State Bank,2 B.T.A. 1100. However, whether or not property belonging to a taxpayer is obsolete is a question of fact to be determined from the evidence in each case. In Columbia Malting Co.,1 B.T.A. 999, we had occasion to pass upon the question of obsolescence of property used in a trade or business and the discussion therein is applicable here. In that case we said: In order that the taxpayer may be entitled to the obsolescence deduction in the years involved, there must have been substantial reasons for believing that the assets would become obsolete prior to the end of their ordinary useful life, and, second, it must have been known, or believed to have been known, to a reasonable degree of certainty, under all the facts and circumstances, when that event would likely occur. The purpose of the statute is to permit the capital invested in assets to be returned to a taxpayer out of earnings over the life of the property in the business. A reasonable deduction is allowed on account of the exhaustion, wear and tear of property. This includes obsolescence, if the property is becoming obsolete, so that by the time it reaches that*2376 state the entire cost thereof will be restored. While it is known that physical property is ordinarily subject to exhaustion, wear and tear, from use in the business, it may not be known that it is also becoming obsolete. Whether it is, is a question of fact in each case. When it is found that property is becoming obsolete, a deduction on that account can only be determined by ascertaining, as accurately as possible, when the property may be expected, under the circumstances, to be no longer commercially useful notwithstanding its physical condition. In the case of a deduction on account of exhaustion, wear and tear of property used in the business, if it can not be determined that the property is subject to wear, tear and exhaustion, or what the approximate life of the property, under all the facts and circumstances, is, there is no basis for determining the deduction. With respect to obsolescence, if it can not be determined that the assets will become obsolete prior to the estimated date of the physical exhaustion thereof, or if a reasonably definite date can not be ascertained, there are no means of determining what is a reasonable allowance on that account. *2377 See, also, Corsicana Gas & Electric Co.,6 B.T.A. 565. We are satisfied from the evidence that it was known to the petitioner's officers as early as the year 1920 that certain of the petitioner's buildings and equipment were obsolescent and that they would become obsolete in the year 1924 and would have to be sold or otherwise disposed of. The evidence also shows that the buildings and equipment *74 in question did become obsolete in 1924, and we are of opinion that the petitioner is entitled, in computing its net income for the years 1920 to 1924, inclusive, to deduct a reasonable allowance for such obsolescence. The evidence also shows that the depreciated cost on December 31, 1919, of the equipment which was known to be obsolescent in 1920 and subsequently became obsolete, was $507,856.72. This obsolete machinery and equipment was sold in 1924, together with other property which had cost more than $1,500,000, for a total consideration of $450,000. No part of the purchase price was specifically allocated to the obsolete machinery and equipment, but we are satisfied from the evidence that neither its fair market, nor salvage value, was in excess of $50,000. *2378 The deductions for obsolescence should be computed on that basis. The building on the petitioner's 25th Street real estate was also known to be obsolescent in 1920 and it became obsolete in 1924, and the real estate and buildings were sold in 1925. The difference between the depreciated cost and the sales price was $120,762.75, which shrinkage is attributable entirely to the buildings. The deductions for obsolescence will be computed on that basis. The petitioner's tax liability for the years under consideration should be recomputed allowing deductions for obsolescence for each of the taxable years as above indicated. Judgment will be entered under Rule 50. Footnotes 1. No sales. ↩