Golden Cycle Corp. v. Commissioner

THE GOLDEN CYCLE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Golden Cycle Corp. v. Commissioner Docket No. 16378. United States Board of Tax Appeals 18 B.T.A. 118; 1929 BTA LEXIS 2135; November 9, 1929, Promulgated *2135 On January 15, 1917, corporation A formed corporation B with a capital stock of $100,000, and transferred to it a part of its (A's) assets having a value of $1,344,355.28, in consideration for the issuance to A corporation of the entire capital stock of B corporation, thereby creating an affiliation of the two corporations. The statutory cost for invested capital purposes to A corporation of the assets transferred to B corporation was much less than their value on January 15, 1917. Held that by the transaction in question the consolidated group merely acquired a part of its own capital stock and, therefore, in a determination of consolidated invested capital for 1918 and 1919 such invested capital may not be considered as having been affected thereby. William V. Hodges, Esq., and D. Edgar Wilson, Esq., for the petitioner. J. E. Mather, Esq., for the respondent. LITTLETON *118 This proceeding involves deficiencies in income and profits tax as determined by the Commissioner for 1918 and 1919. The issue involved is the cost or value at which the assets acquired by the Pikes *119 Peak Consolidated Fuel Co. from the Golden Cycle*2136 Mining & Reduction Co. on January 15, 1917, may be included in the consolidated invested capital of the two companies. The facts were stipulated. FINDINGS OF FACT. The Golden Cycle Mining & Reduction Co. (hereinafter sometimes referred to as the Golden Cycle Company) is a West Virginia corporation with its principal office in Colorado Springs, Colo. The Pikes Peak Consolidated Fuel Co. (hereinafter sometimes referred to as the Consolidated Fuel Co.) is a Colorado corporation. The Golden Cycle Mining & Reduction Co. was organized and in existence prior to March 1, 1913, and its principal business other than holding all of the capital stock of its subsidiaries consisted in gold ore reduction. The Pikes Peak Fuel Co. (hereinafter sometimes referred to as the Fuel Company) was incorporated in 1904 and continued in business down to January 15, 1917. It had outstanding 45,000 shares of common stock and 5,000 shares of preferred stock and $246,500 par value of 20-year, 6 per cent mortgage gold bonds. During the years 1909 to 1916, 42,434 1/2 shares of the common and all of the preferred capital stock and $244,500 par value of the mortgage bonds of the Pikes Peak Fuel Co. were*2137 acquired by the Golden Cycle Mining & Reduction Co. The Pikes Peak Consolidated Fuel Co. was organized on or about the 15th day of January, 1917, with an authorized stock issue of $100,000 par value, and ever since its organization has been engaged solely in the mining and sale of coal. On January 16, 1917, the Pikes Peak Consolidated Fuel Co. entered into a contract with the Golden Cycle Mining & Reduction Co. under the terms of which the coal used by the latter corporation in its operations during 1917, 1918, and 1919 was sold and delivered to it. Prior to March 1, 1913, the Golden Cycle Mining & Reduction Co. bought certain lands reputed to be coal lands, consisting of 1,000 acres which were purchased at a total cost of $56,139.22, and for the purposes of this proceeding the value of said acreage as of March 1, 1913, is stipulated to be $156,153.55. For the shares of capital stock and mortgage bonds of the Pikes Peak Fuel Co. purchased prior to March 1, 1913, by the Golden Cycle Mining & Reduction Co., the latter corporation paid $99,351.63, and for the shares and mortgage bonds purchased subsequent to March 1, 1913, $39,999.82. The value on March 1, 1913, of such shares*2138 and mortgage bonds purchased prior to March 1, 1913, was $400,763.83, which added to the cost of such shares and mortgage bonds so purchased subsequent to March 1, 1913, plus a note due the *120 Golden Cycle Mining & Reduction Co. of $11,000, was $451,763.65 on January 15, 1917. Prior to January 15, 1917, the Pikes Peak Fuel Co. being in default in the payment of its interest due the Golden Cycle Mining & Reduction Co. under its mortgage bonds, and for the purpose of securing the reorganization of said company, proceedings were had in the District Court of El Paso County, Colorado, for the foreclosure of said mortgage bonds, which proceedings matured in a foreclosure sale on January 15, 1917, at which sale all of the assets of the Pikes Peak Fuel Co. were purchased by the Golden Cycle Mining & Reduction Co. for $124,000. The certificate of sale issued in such foreclosure proceedings to said Golden Cycle Mining & Reduction Co. as purchaser of the assets of said Pikes Peak Fuel Co. was thereafter and on the 15th day of January, 1917, assigned to the Pikes Peak Consolidated Fuel Co., thereby conveying, assigning, and transferring to said Pikes Peak Consolidated Fuel Co. all*2139 of the right, title, and interest in and to said assets. The said certificate of sale so acquired by said Golden Cycle Mining & Reduction Co. thereafter and within the time required by law ripened into deed. All of the assets transferred by the Golden Cycle Mining & Reduction Co. to the Pikes Peak Consolidated Fuel Co. on January 15, 1917, were as follows: 1. All of the assets, real, personal, and mixed acquired from the Pikes Peak Fuel Co. at said foreclosure sale and then owned by it. 2. The 1,000 acres of reputed coal land heretofore referred to as having been acquired by the Golden Cycle Mining & Reduction Co. prior to March 1, 1913. The consideration for such conveyance was the transfer of all of the capital stock of the Pikes Peak Consolidated Fuel Co. to the Golden Cycle Mining & Reduction Co., amounting to $100,000 par value. The value of the assets so transferred to the Pikes Peak Consolidated Fuel Co. on the 15th day of January, 1917, was as follows: 1. The 1,000 acres of reputed coal lands $291,945.81 2. Pikes Peak Fuel Co.'s lands, improvements, and miscellaneous assets 1,052,409.47 Total 1,344,355.28 The Commissioner computed a*2140 profit on the aforementioned transaction of $736,438.08 and assessed an income tax thereon for 1917 in the amount of $44,818.69, which tax has been fully paid and suit is now pending in the courts for the recovery thereof. The said profit was not taxed for excess-profits-tax purposes for the reason that the three corporations heretofore mentioned were held by the Commissioner to be affiliated for such purposes in 1917. The Golden Cycle Mining & Reduction Co. filed consolidated income and profits-tax returns for the calendar years 1918 and 1919. *121 The consolidated income of the Golden Cycle Mining & Reduction Co. and all subsidiaries, including the Pikes Peak Consolidated Fuel Co., for the calendar year 1918 was $275,427.52. The consolidated income of the Golden Cycle Mining & Reduction Co. and all subsidiaries, including the Pikes Peak Consolidated Fuel Co., for the calendar year 1919 was $192,365.32. In the determination of the consolidated invested capital of the Golden Cycle Mining & Reduction Co., Pikes Peak Consolidated Fuel Co., and other subsidiaries for 1918 and 1919, the Commissioner refused to include in such consolidated invested capital the agreed value*2141 of the assets on January 15, 1917, which were transferred on that date by the Golden Cycle Mining & Reduction Co. to the Pikes Peak Consolidated Fuel Co. in consideration for the issuance to the former of the entire capital stock of the latter company at that date. In lieu of such value the Commissioner permitted these assets to be included in the consolidated invested capital at their cost to the Golden Cycle Mining & Reduction Co. OPINION. LITTLETON: The issue in this case arises as the result of events which occurred substantially as follows: The Golden Cycle Co. and the Fuel Company were in existence prior to 1917 and between 1909 and 1916 the former company acquired almost all the capital stock and bonds of the latter. On January 15, 1917, as the result of the Fuel Company being in default on the payment of interest on its bonds and for the purpose of securing a reorganization of that company, the Golden Cycle Co. foreclosed on the bonds of the Fuel Company and purchased the assets of the Fuel Company for $124,000, an amount less than the face value of the bonds and also much less than the agreed value of the assets on that date. On or about the same day the Consolidated*2142 Fuel Co. was organized with a capital stock of $100,000, all of which was issued to the Golden Cycle Co. in consideration for the transfer to it of all the assets acquired by the Golden Cycle Co. from the Fuel Company and certain other assets theretofore owned by the Golden Cycle Co. The value of the foregoing assets on the date of transfer was $1,344,355.28. The Commissioner determined that a profit of $736,438.08 resulted on account of the transfer of assets for stock and an income tax was computed and assessed thereon for 1917, but since the corporations were considered by the Commissioner to be affiliated for excess-profits-tax purposes, the profit was eliminated from income in determining the excess-profits tax of the affiliated group. The controversy before us arises in determining the consolidated invested capital in 1918 and 1919, where the Golden Cycle Co. and *122 the Consolidated Fuel Co. are members of an affiliated group, and the question is as to the effect of the aforementioned transaction of January 15, 1917, on invested capital. In contending that the entire value of $1,344,355.28 must be recognized for invested capital purposes, the petitioner says that*2143 the corporations who were parties to the transaction were not affiliated when such transaction occurred, and therefore we must look on the transaction as one occurring between nonaffiliated corporations. An examination of the record, however, shows that the deficiency letter which forms the basis of this proceeding included 1917, 1918, and 1919, and that in such letter the Commissioner, in determining a deficiency for 1917, held that the Fuel Company was a member of the affiliated group to January 15, 1917, and that the Consolidated Fuel Co. was likewise a member from the date of its organization. The petitioner elected to file a petition only with respect to 1918 and 1919 and, therefore, 1917 is before us only in so far as it may be necessary for a determination of the deficiencies for 1918 and 1919. In such consideration the determination made by the Commissioner for 1917 and accepted by the petitioner without appeal must be accepted by us, as at least prima facie correct. The evidence before us on which the petitioner relies to show that the Golden Cycle Co. and the Consolidated Fuel Co. were not affiliated is the stipulation to the effect that the latter company was engaged*2144 "solely in the mining and sale of coal" and that as to the former company "its principal business other than holding all of the capital stock of its subsidiaries consisted in gold ore reduction." It is true, as petitioner points out, that under the 1917 Act two corporations are not to be affiliated merely because one corporation owns or controls substantially all of the stock of the other corporation, but there is a further condition to the same section as follows (sec. 1331, Revenue Act of 1921): * * * provided, That such corporations or partnerships were engaged in the same or a closely related business, or one corporation or partnership bought from or sold to another corporation or partnership products or services at prices above or below the current market, thus effecting an artificial distribution of profits, or one corporation or partnership in any way so arranged its financial relationships with another corporation or partnership as to assign to it a disproportionate share of net income or invested capital. * * * If, therefore, we were to accept the aforementioned descriptions of the business done by each corporation as sufficient to show that they were not engaged*2145 in the "same or a closely related business," we should still be without evidence as to the second part of the provision quoted above. In fact, the one bit of evidence we have as to their corporate relationship is a contract under which the Consolidated Fuel Co. would furnish to the Golden Cycle Co. all lignite coal required in the latter's reduction operations. The evidence is insufficient *123 to show whether this was an arm's-length transaction. In view of the foregoing consideration, we shall proceed on the basis of a transaction which occurred in 1917 (but prior to March 3, 1917) between two corporations which were affiliated for such year. Had the Golden Cycle Co. retained the assets in question and carried on its business activities without the formation of the Consolidated Fuel Co., certainly there would have been no basis for the increase now sought, and our question is whether the situation is changed by the formation of the latter corporation and the paying in to it of these assets by the former for its entire issue of capital stock, thereby creating an affiliated status for the two corporations. We think not. By the act in question, the group merely acquired*2146 a part of its own capital stock and did not thereby create an additional investment in the group - the statutory investment or paying in for invested capital purposes was not affected by the transaction. ; ; ; also, cf. ; ; ; and , decided May 6, 1929. Reviewed by the Board. Judgment will be entered under Rule 50. PHILLIPS PHILLIPS, concurring: Section 240 of the Revenue Act of 1918 provides that corporations which are affiliated shall make a consolidated return of net income and invested capital. It further provides that in such case the total tax shall be computed in the first instance as a unit. The total tax can be computed as a unit only by computing income and invested capital as a unit for the affiliated groups. Section 326*2147 of the Revenue Act of 1918 lays down the procedure to be followed in computing invested capital. The problem here is to determine the invested capital of this affiliated group. It is my opinion that, in applying section 326, we must look at the unit and include in invested capital (1) the actual cash bona fide paid in to this unit for stock or shares; (2) actual cash value of tangible property, other than cash, bona fide paid in to this unit for stock or shares; (3) paid-in or earned surplus computed on a consolidated basis; (4) intangible property bona fide paid in to the unit for stock, to the exent permitted by the statute. If this be correct, invested capital is not affected by the sale of assets by one group in this unit to another group in the unit, nor is invested capital affected by the purchase by one corporation in the unit of the capital stock of another, except as all or a part of the purchase price *124 may have gone outside of the unit and serve to reduce invested capital. The primary purpose of the invested capital provision in the statute is to fix an amount upon which the corporation is to be allowed to earn income before the balance is subjected to*2148 tax. Roughly speaking, this amount represents the amount risked in the business, measured by the amount originally invested and accumulated earnings, excluding appreciation in value not realized upon by sale. It is the amount which is so risked upon which income may be earned which will be exempt from excess-profits tax. Where we have a group of corporations and the necessity of computing their invested capital as a unit, we look to see what has been risked and continues to be risked; what has been paid into this group from sources outside the group and not returned to such sources. Transactions within the group, among its members, are to be disregarded, for it is only that which comes into the group from outside sources in payment for its stock or as paid-in or earned surplus that is to be used in measuring invested capital. I am of the opinion that the Commissioner correctly determined invested capital by excluding an appreciation in value of assets which took place while such assets were in the hands of a member of the group and which appreciation represents no new capital put at risk in the business and therefore I concur in the conclusion reached in the prevailing opinion. *2149 TRAMMELL TRAMMELL, dissenting: In my opinion the consolidated invested capital should first be computed separately for each corporation and then elimination made for duplications of investment, as we held in the cases of Grand Rapids Dry Goods Co.,12 B.T.A. 696; Middlesex Ice Co.,9 B.T.A. 156; American Bond & Mortgage Co.,15 B.T.A. 264. Under this theory the new corporation's invested capital would be based on the actual cash value of its assets acquired for stock (sec. 326) and the invested capital of the old company should be determined under section 326 by including the cost of the stock of the new company which is represented by the value of assets exchanged therefor. When the invested capital of the two companies is added together the value of the assets transferred to the new company would in effect be reflected twice. Then when this duplication, that is, the investment of the old company in the stock of the new, is eliminated, there remains in consolidated invested capital the value of the assets at the time of the transfer to the new company. Since the transaction arose prior to March 3, 1917, I see*2150 no reason why the appreciation in value of assets should not be reflected in *125 invested capital as the result of the transfer to the new corporation to the same extent as if they had been transferred to a new corporation in a reorganization where only one corporation remained. If only one corporation had remained, clearly the appreciation in value of assets realized as the result of the transfer would be included. The theory of considering acquisition by a corporation of the stock of another corporation, thereby causing an affiliation of the two, to be acquisition of its own stock, is to my mind clearly erroneous. This fallacy was pointed out by the Circuit Court of Appeals for the Second Circuit in the case of , in which the United States Supreme Court has denied certiorari.