Handy & Harman v. Commissioner

HANDY & HARMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Handy & Harman v. Commissioner Docket Nos. 19467, 19837. United States Board of Tax Appeals 17 B.T.A. 980; 1929 BTA LEXIS 2211; October 16, 1929, Promulgated *2211 1. The Commissioner had authority to reconsider and reverse the determination of his predecessor in office that the petitioner and Hamilton & DeLoss, Inc., were affiliated during the year 1918 and the period January 1 to February 1, 1919. 2. The petitioner and Hamilton & DeLoss, Inc., were not affiliated during the year 1918 and the period January 1 to February 1, 1919, within the meaning of section 240 of the Revenue Act of 1918. Hugh S. Williamson, Esq., for the petitioner. Eugene Meacham, Esq., and C. E. Lowery, Esq., for the respondent. MARQUETTE *980 These proceedings, which were duly consolidated for hearing and decision, are for the redetermination of deficiencies in income and profits taxes, asserted by the respondent in the amounts of $25,800.99 *981 for the year 1918, and $3,156.90 for the year 1919. The only issue is whether the petitioner and Hamilton & DeLoss, Inc., were affiliated during the year 1918 and the period January 1 to February 1, 1919, and entitled to file consolidated returns of income and invested capital. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of New York*2212 in the year 1905, with its principal office at New York City. Its factory is located at Bridgeport, Conn. The petitioner, upon its organization, took over the business of the partnership of Handy & Harman, which for many years had been engaged in dealing in gold and silver bullion and specie, but its charter authorized it also to buy, sell and manufacture other metals. Prior to the year 1906 the petitioner and the partnership of Handy & Harman had been supplying the silversmith trade with silver rolled into sheets and coils at their Bridgeport plant. About that time, however, the petitioner began the practice of cutting the silver into flat circles and rectangles so as to minimize the amount of scrap silver which would have to be returned by the silversmiths, thus saving in investment and in transportation and packing costs, and enabling the corporation to operate on a lesser amount of raw materials than theretofore carried. About 1912 or 1913 the officers of the petitioner conceived the idea of not only stamping out the flat circles and rectangles, but of partially shaping them, thus saving the silversmiths' part of the hand labor required to shape the blanks on lathes, besides*2213 further reducing the amount of scrap. This, however, would have required the installation by the petitioner of large double-action presses which in one operation would cut out the flat pieces and stamp them into the preliminary shapes. For a year or two the petitioner's officers discussed whether this additional work should be undertaken and, if so, whether it should be handled by the petitioner or by a separate corporation formed for the purpose. A strong reason for the adoption of the latter course was that because of the limited amount of silver business available it would be necessary, in order to keep the new equipment busy and justify the expense of installing it, to use it on the base metals as well as on silver, and the petitioner's officers desired to limit its operation to the precious metals. Harry H. DeLoss, vice president of the petitioner, discussed the matter at great length with Harold H. Hamilton, a man of many years experience in the silversmithing business, and it was finally decided to organize a new corporation, with Hamilton at its head. Accordingly, on December 23, 1916, the new corporation, Hamilton & DeLoss, Inc., was organized under the laws of Connecticut, *2214 with *982 Hamilton as president and DeLoss as vice president. It was the intention at the time Hamilton & DeLoss, Inc., was organized, that the petitioner should continue to mill and roll silver, but that Hamilton & DeLoss, Inc., should take over the stamping operation and should extend the operation to the point of giving preliminary shape to the pieces, and in addition should operate in other metals. The petitioner continued to manufacture flat circles and rectangles after the organization of Hamilton & DeLoss, Inc., but it was the intention of the officers of both corporations that Hamilton & DeLoss, Inc., should take over all of that part of the business. The capital stock of the petitioner and of Hamilton & DeLoss, Inc., was $650,000 and $300,000, respectively, divided into shares of $100 each, and at the beginning and the end of the year 1918 the stock was held as follows: Jan. 1, 1918 Dec. 31, 1918 Handy & Harman Hamilton & DeLoss (Inc.) Handy & Harman Hamilton & DeLoss (Inc.) Per cent Per cent Per cent Per cent Parker W. Handy 28.25 21.28 28.25 16.67 John L. Harman 18.40 10.64 18.40 8.33 Harry H. DeLoss 28.23 22.13 28.23 33.34 William B. Sewell 15,75 14.89 15.75 11.66 George C. Gerrish 1.54 3.40 1.54 3.33 Robert H. Leach 1.54 3.40 1.54 3.33 Minority - scattered 6.29 6.29 H. H. Hamilton 20.43 20.00 John M. Blackburn 2.13 1.67 Alfred C. Fones 1.70 1.67 100.00 100.00 100.00 100.00 *2215 The minority interest in the petitioner, consisting of 409 shares, was held in small lots by sixteen employees, and 300 of these shares, or 4.61 per cent, were held under an agreement, a notation of which appeared on the certificate, that if the holder should leave the employ of the petitioner, the petitioner would have the right to buy back the stock at par. When Hamilton & DeLoss, Inc., was organized, Hamilton had no money to purchase stock therein. The purchase price of the 20 per cent interest standing in his name was financed by promissory notes endorsed by Harry H. DeLoss, and although the stock was issued to Hamilton, he assigned it to DeLoss, who deposited it as collateral security for the notes. Hamilton never paid anything on the notes. In 1919 he became insolvent and on February 1, 1919, DeLoss paid the notes and took over the stock. During the period of his ownership of the stock Hamilton attended all meetings of the stockholders of Hamilton & DeLoss, Inc., and voted his stock, but never voted in opposition to Handy, Harman, Sewell, and DeLoss. John M. Blackburn *983 and Alfred C. Fones took no active part in the business of Hamilton & DeLoss, Inc. They*2216 were close friends of DeLoss and their stock was voted for them by proxies given to DeLoss. Hamilton received a salary of about $10,000 a year from Hamilton & DeLoss, Inc., but the other officers and directors, who were also officers, directors or employees of the petitioner, received no compensation from Hamilton & DeLoss, Inc., but were paid entirely by the petitioner. DeLoss, who was vice president of both corporations, devoted about one-third of his time to Hamilton & DeLoss, Inc., and Robert H. Leach, who was technical adviser and administrative assistant of the petitioner, devoted his entire time to Hamilton & DeLoss, Inc., but received his entire salary from the petitioner. George C. Gerrish was manager of the petitioner's Bridgeport plant and secretary of Hamilton & DeLoss, Inc. The plant of Hamilton & DeLoss, Inc., was erected in Bridgeport, Connecticut, about 100 or 150 yards distant from the petitioner's plant, and silver production machinery costing $47,000 was installed. However, on account of war conditions, work was so slow that at the end of January, 1918, the output of the plant had been small, the total sales thereof amounting only to $6,295.35. At the*2217 beginning of the year 1918 the petitioner and Hamilton & DeLoss, Inc., were facing a difficult situation. The silver business had declined greatly. The officers were apprehensive that both corporations, they being in the class of nonessential industries, would be commandeered by the Government and disorganized. They were also encountering difficulty in obtaining labor and raw material. After numerous discussions, both at board meetings and among the individuals who controlled the two corporations, it was decided that Hamilton & DeLoss, Inc., should not for the present proceed with the silver-stamping business for which it had been organized and equipped. It therefore became necessary, in order to continue the operation of the plant, to secure work from the Government, and the corporation then went into production as subcontractors on Government work. The petitioner also secured some subcontracts, which were of benefit in placing it among the essential industries of the country. In August, 1918, an officer connected with the gas mask division of the United States Army called on Harry H. DeLoss at the petitioner's Bridgeport plant to ascertain whether that plant could mill brass*2218 for making eye pieces for gas masks. On being informed that it could, he inquired whether the plant could also stamp out the eye pieces. DeLoss informed him that the work could not be done by the petitioner's plant alone, but that the petitioner also controlled the plant of Hamilton & DeLoss, Inc., and that the work could be *984 done in the two plants. After discussion among the officers and directors of the two corporations, and after several visits had been made to Washington by DeLoss, with reference to the matter, it was decided to take the contract for the manufacture of eye pieces in the name of Hamilton & DeLoss, Inc., principally because the billing work could be more conveniently handled through the offices of that company than through the New York office of the petitioner. However, the petitioner financed the contract, melted the metal, Hamilton & DeLoss not being equipped for that work, rolled the metal and furnished it to Hamilton & DeLoss, Inc., which stamped out the eye pieces and returned the scrap metal to the petitioner for remelting. The entire contract was performed in that manner. The contract called for 1,000,000 eye pieces at 1 1/2 cents each, *2219 and it necessitated the installation by Hamilton & DeLoss, Inc., of machinery and equipment costing $32,000. The machinery that had been installed for silver production was not adapted to use on the eye piece contract, and it stood idle while that contract was being performed. Neither the petitioner nor Hamilton & DeLoss, Inc., made any profit from the eye piece contract. Hamilton & DeLoss, Inc., sustained a net loss in the year 1918 and during January, 1919. The petitioner and Hamilton & DeLoss, Inc., originally filed separate returns for the year 1918, but subsequently filed a consolidated return for that year, and on April 10, 1920, the then Commissioner of Internal Revenue accepted the consolidated return and ruled that the two companies were affiliated during the year 1918 within the meaning of section 240 of the Revenue Act of 1918. On January 19, 1924, Commissioner Blair reversed the ruling made by his predecessor in office and held that the two companies were not affiliated, and he subsequently asserted deficiencies in tax against the petitioner in the amounts of $25,800.99 for the year 1918, and $3,156.90 for the year 1919. OPINION. *2220 MARQUETTE: The first issue raised by the pleadings herein is whether Commissioner Blair had authority to reverse and set aside the finding of his predecessor in office that the petitioner and Hamilton & DeLoss, Inc., were affiliated during the year 1918 and the period January 1 to February 1, 1919, and entitled to file consolidated returns of net income and invested capital. This issue must be resolved in favor of the respondent, on the authority of Yokohama Ki-Ito Kwaisha, Ltd.,5 B.T.A. 1248; Estate of W. S. Tyler,9 B.T.A. 255; James Couzens,11 B.T.A. 1040; Rosetta V. Hauss,12 B.T.A. 755; Estate of John F. Dodge,13 B.T.A. 201; and Anna T. Dodge et al., Executors,13 B.T.A. 223. *985 Our decision on the first issue makes it necessary for us to determine whether the petitioner and Hamilton & DeLoss, Inc., were affiliated during the year 1918 and the period January 1 to February 1, 1919, and entitled to have their tax liability computed on the basis of consolidated returns, within the meaning and under the authority of section 240 of the Revenue Act of 1918. The petitioner*2221 claims affiliation and the right to file consolidated returns, while the position of the respondent is, first, that affiliation did not exist because the necessary conditions relative to ownership or control of the capital stock of the two corporations were not present; second, that even if the two corporations were affiliated, their tax liability should not be computed on the basis of consolidated returns, for the reason that Hamilton & DeLoss, Inc., was a "corporation organized after August 1, 1914, and not a successor to a then existing business, 50 per centum or more of whose gross income consists of gains, profits, commissions, or other income derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918." There is no claim made, nor does the record disclose, that either one of the two corporations owned or controlled directly or indirectly, any of the capital stock of the other. If affiliation existed, it was because substantially all of the capital stock of both corporations was owned or controlled by the same interests. The evidence herein establishes that six men, Handy, Harman, DeLoss, Sewell, Gerrish, and Leach, owned outright 93.71*2222 per cent of the capital stock of the petitioner and 76.66 per cent of the capital stock of Hamilton & DeLoss, Inc., and it may be assumed for the purpose of this opinion that they controlled 4.61 per cent of the capital stock of the petitioner which was held by employees of the petitioner under an agreement that if they should leave the petitioner's employ the petitioner would have the right to purchase the stock. But did they control the 20 per cent interest in Hamilton & DeLoss, Inc., owned by Hamilton? The evidence shows that when Hamilton & DeLoss, Inc., was organized, Hamilton did not have sufficient money to purchase stock in the corporation. He secured the money from a bank pursuant to arrangements made by DeLoss and DeLoss endorsed his notes. Hamilton assigned his stock to DeLoss, who placed it with the bank as collateral security. On or subsequent to February 1, 1919, DeLoss paid the notes and took over the stock. The evidence also shows that as long as Hamilton owned the stock he attended the stockholders' meetings and voted the stock. It appears that he did not vote in opposition to Handy, Harman, DeLoss, and Sewell, but there is no evidence that he could not have*2223 done so if he had desired. So far as we know he voted with them of his own volition and not because they had *986 any control over his stock. Handy, Harman, DeLoss, and Sewell undoubtedly controlled Hamilton & DeLoss, Inc., and Hamilton apparently was a satisfied and tractable minority, who was content that the Handy & Harman organization should control and operate Hamilton & DeLoss, Inc. 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. Ice Service Co. v. Commissioner, 30 Fed.(2d) 230; Commissioner v. Adolph Hirsch & Co., 30 Fed.(2d) 645; and Conley Tin Foil Corporation,17 B.T.A. 65. In Ice Service Co., supra, 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*2224 to voting stock, as was held in 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 subsidiary 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; Alameda Inv. Co. v. McLaughlin, 28 Fed.(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 *2225 Adolph Hirsch & Co., supra, the same court said: 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. We are of opinion that the same interest that owned or controlled the capital stock of the petitioner, did not own or control substantially all of the capital stock of Hamilton & DeLoss, Inc. Therefore, the quantum of ownership or control required by the statute for affiliation of the two corporations does not exist in this case and we must affirm the action of the respondent in refusing to determine the tax liability of the petitioner and Hamilton & DeLoss, Inc., on the basis*2226 of consolidated returns. Judgment will be entered for the respondent.