Cortez Oil Co. v. Commissioner

CORTEZ OIL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Cortez Oil Co. v. Commissioner Docket No. 22233. United States Board of Tax Appeals 20 B.T.A. 462; 1930 BTA LEXIS 2115; August 4, 1930, Promulgated *2115 Where a corporation organized under the laws of Oklahoma owned a majority of the stock of another corporation, also organized under the laws of Oklahoma, and actually voted through its own officer such stock at stockholders' meetings, held that the minority stockkholders did not own or control substantially all the stock of the second corporation by reason of the provisions of section 49 of article 9 of the Constitution of Oklahoma. Lyle Alverson, Esq., and Wayne Johnson, Esq., for the petitioner. Harry LeRoy Jones, Esq., for the respondent. PHILLIPS *462 The respondent determined deficiencies aggregating $17,974.58 in income and profits taxes against the petitioner for the period from January 1 to August 24, 1919, and for the period from August 25 to December 31, 1919. The errors alleged are (1) that for the period January 1, 1919, to August 24, 1919, respondent failed and refused to hold that petitioner was affiliated with Alvarado Oil Co., hereafter referred to as Alvarado, and the Balboa Oil Co., hereafter referred to as Balboa, for the purpose of computing income and profits taxes on the basis of a consolidated return; (2) that*2116 respondent subjected to tax the income derived during 1919 from the sale of oil and gas produced from restricted Indian lands; and (3) that respondent reduced petitioner's invested capital on account of depletion and depreciation sustained in years prior to 1919. At the hearing petitioner waived errors 2 and 3 and by amendment to its petition alleged that respondent erred in reducing the amount of current earnings available for the payment of dividends by the amount of a tentative tax for the current year. FINDINGS OF FACT. Petitioner was incorporated under the laws of Oklahoma on May 29, 1912, with an authorized capital stock of $50,000 divided into 5,000 shares of $10 par value and was, during the taxable years, engaged in the business of producing and selling crude oil. Its principal office is at Tulsa, Okla. During the period January 1, 1919, to *463 August 24, 1919, and for several years prior thereto the entire issued and outstanding capital stock of petitioner was owned as follows: Stockholders: Shares owned Hugh King, Jr 1,075 Father of Hugh King, Jr [60] Wife of Hugh King, Jr [53] Brothers of Hugh King, Jr [159] Sisters of Hugh King, Jr [265] Charles G. Meyer [788] Indiahoma Refining Co 2,600 5,000 *2117 The brothers and sisters of Hugh King, Jr., referred to herein were three brothers and five sisters each of whom owned 53 shares of stock in petitioner. Alvarado was organized under the laws of Oklahoma in February, 1914, with an authorized capital stock of $15,000, divided into 150 shares of the par value of $100 each, and was engaged in the same business as petitioner. At all times during the period January 1, 1919, to August 24, 1919, and for several years prior thereto its stock was owned as follows: Stockholders: Shares owned Hugh King, Jr [49] Father of Hugh King, Jr [1] Charles G. Meyer [50] Indiahoma Refining Co [150] Balboa was organized under the laws of Oklahoma in October, 1915, with an authorized capital stock of $50,000, divided into 500 shares of a par value of $100 each, and was engaged in the same business as petitioner. At all times during the period from January 1, 1919, to August 24, 1919, and for several years prior thereto its stock was owned as follows: Stockholders: Shares owned Hugh King, Jr [88] Father of Hugh King, Jr [16] Brothers of Hugh King, Jr [124] Wife of Hugh King, Jr [12] Sisters of Hugh King, Jr [60] Charles C. Meyer [500] *2118 The shares of stock owned by Indiahoma Refining Co. (hereafter referred to as Indiahoma) in petitioner and Alvarado stood in the names of E. M. Schock and A. W. Gieske, who were respectively the president and vice president of that company. At the *464 annual meeting of petitioner's stockholders held March 10, 1919, there were present, by person or proxy, stockholders owning or representing 4,675 shares, as follows: Shares A. W. Gieske and E. E. Schock, by E. E. Schock, proxy 2,597 E. E. Schock, in person [1] A. W. Gieske, E. E. Schock, proxy [1] Charles G. Meyer, Hugh King, Jr., proxy [788] Margaret Zimmermann, Hugh King, Jr., proxy [53] Geraldine King Benziger, Hugh King, Jr., proxy [53] Caroline D. King, Hugh King, Jr., proxy [53] Hugh King, Jr., in person 1,075 Randolph Shirk, in person [1] John King, in person [53] At the annual meeting of the stockholders of Alvarado held March 10, 1919, there were present stockholders owning or representing 150 shares as follows: Charles G. Meyer, Hugh King, Jr., proxy [50] Hugh King, Hugh King, Jr., proxy [1] Hugh King, Jr., in person [48] John King, in person [1] E. E. Schock, in person [1] A. W. Gieske and E. E. Schock, E. E. Schock, proxy [49] *2119 At the annual meeting of the stockholders of Balboa for the year 1919 there were present stockholders owning or representing 424 shares as follows: Hugh King, Jr., in person [99] John King, in person [100] H. W. Randolph, in person [1] Charles G. Meyer, Hugh King, proxy [200] Margaret Zimmerman, Hugh King, Jr., proxy [12] Patrick Harry King, Hugh King, Jr., proxy [12] Hugh King, Jr., was president and treasurer of petitioner, of Alvarado, and of Balboa, all of which companies had common offices. Petitioner and Alvarado paid the office rent and office salaries of all the three corporations, except that Hugh King, Jr., and his brother, John King, received salaries from Balboa. Whenever one of these three corporations needed money it borrowed it from the others. Equipment was frequently borrowed by one from the others. In such cases neither interest nor rent was charged. Balboa did not have as much production as the other two and was the poorest of the three corporations. The father of Hugh King, Jr., and Charles G. Meyer had been intimately associated from about 1865 to 1870 in the oil business. So intimate was this association that when Meyer's father died*2120 there was not in existence and had never existed any written evidence of *465 his ownership in the business. The social relationship between the families of Meyer and Hugh King, Jr., had for many years been intimate. In 1907 and shortly after leaving school, Hugh King, Jr., went to Oklahoma and started as a roustabout in the oil fields. He worked up to the charge of the leasing department of the Dominion Oil Co. In 1911 he started out for himself. With the assistance of his father he secured several oil leases in Oklahoma. Being in need of further capital, he went back to New York, where both his father and Meyer resided. He secured from his father between $10,000 and $15,000. He then solicited aid from Meyer, who had never seen an oil field and who invested about the same amount. Subsequent to this, petitioner was organized. Further funds were obtained from Mayer and Hugh King's father and Alvarado and Balboa were organized. Mugh King's father had furnished most of the money representing the interest of Hugh King, Jr., and it was the father's desire that his other children should share in the venture. Thereupon 53 shares of petitioner's stock were given to each*2121 of the brothers and sisters of Hugh King, Jr. Hugh King, Jr., gave his wife the same number of shares. The brothers and sisters also received shares of Alvarado under like circumstances and his father owned shares in both corporations as above set forth. None of the brothers and sisters of Hugh King, Jr., had ever been engaged in the oil business. His brothers and sisters and his father trusted their interests to Hugh King, Jr., as the man who was on the spot and the only one conversant with the needs of the corporations. The brothers and sisters of Hugh King, Jr., always gave to him proxies for the voting of their shares. The King family acted as a unit. Meyer left the control of his interests in the hands of Hugh King, Jr., as well as the voting of his stock, except when occasionally on a trip to Oklahoma he might be present at a stockholders' meeting. There had never been any difference between them as to the business policies of these corporations. Indiahoma was incorporated under the laws of Oklahoma in May, 1919, with an authorized capital stock of $150,000. By various amendments to its charter its authorized capital stock has been increased until during the taxable*2122 year it was $3,300,000. It was engaged in the business of producing, transporting, refining and marketing oil. In 1919 the production of Indiahoma was much larger than that of petitioner. Indiahoma never asked for or received permission from the Corporation Commission of Oklahoma to acquire or vote any of the capital stock of petitioner or of Alvarado. The president of petitioner was advised that the voting of such stock by Indiahoma was in violation of the Constitution of Oklahoma. *466 In computing petitioner's invested capital for the period ending August 24, 1919, the Commissioner reduced the amount of current earnings available for dividends by $26,887.44, being the tentative computation of the amount of tax for the current year to the date of payment. On August 24, 1919, the other stockholders of petitioner, Alvarado and Balboa purchased the stock owned by Indiahoma in petitioner and Alvarado. The money used for this purchase was raised on a note of Balboa for $334,000 endorsed by Meyer and Hugh King, Jr. Thereafter respondent determined that petitioner, Alvarado, and Balboa were affiliated, and in computing the consolidated invested capital of the group he*2123 reduced the amount of current earnings available for dividends by $24,979.59, being the tentative computation of tax for the current year to the date of payment. OPINION. PHILLIPS: Petitioner contends that Alvarado and Balboa were affiliated with it during the period January 1, 1919, to August 24, 1919, within the meaning of section 240(b) of the Revenue Act of 1918, which provides: 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 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 first provision is inapplicable, since none of these corporations owned or controlled any part of the stock of the others. Assuming that Meyer and the King family constituted the "same interests," it appears that these interests owned but 48 per cent of the stock of petitioner, while Indiahoma, which held 52 per cent, owned no stock in Balboa, and, therefore, petitioner and Balboa were not affiliated unless the stock*2124 held by Indiahoma was controlled by the minority and should be wholly disregarded. With respect to the stock held by Indiahoma, petitioner makes several contentions. It is alleged in the petition that Indiahoma was prohibited by the Constitution of Oklahoma from voting its stock in petitioner and in Alvarado and, further, that the stock owned by Indiahoma was at all times voted in accordance with the wishes of Hugh King Jr., pursuant to an agreement whereby King substantially controlled said stock. Petitioner's contention that the stock held by Indiahoma was nonvoting stock, or, as termed by petitioner's counsel, "non-effective *467 stock," rests upon the provisions of section 41 of article 9 of the Constitution of Oklahoma, the pertinent parts of which read: No corporation chartered or licensed to do business in this State shall own, hold, or control, in any manner whatever, the stock of any competitive corporation or corporations engaged in the same kind of business, in or out of the State, except such stock as may be pledged in good faith to secure bona fide indebtedness acquired upon foreclosure, execution sale, or otherwise for the satisfaction of debt. In all*2125 cases where any corporation acquires stock in any other corporation, as herein provided, it shall be required to dispose of the same within twelve months from the date of acquisition; and during the period of its ownership of such stock, it shall have no right to participate in the control of such corporation, except when permitted by order of the Corporation Commission. Petitioner asserts that by the above provisions Indiahoma was prohibited from voting the stock held by it, with the result that all the voting stock was held by Meyer and the King family. It relies upon Schlafly v. United States, 4 Fed.(2d) 195, where it was held that nonvoting preferred stock should be disregarded in a case where all the voting stock was owned by another corporation. Unless the stock held by Indiahoma was destroyed by the constitutional provision, the most that can be said of petitioner's contention is that the right to vote such stock was suspended during the time it was so owned. The same would be equally true of stock owned by an incompetent during the period he had no guardian. It would be an extremely broad construction of section 240(b) to apply the rule laid down*2126 in the Schlafly case to a situation where the same interests owned only a minority of the voting stock and where the right to vote the majority was temporarily suspended during the period of a certain ownership. Whatever may be the answer, the case presented by the record goes far beyond that question. Here it is alleged in the petition and admitted in the answer that Indiahoma owned this stock during the period in question and for several years prior thereto. This was no temporary ownership. Not only was this stock owned by Indiahoma; it was voted. On August 24, 1919, this stock was purchased by the minority at a price far in excess of its par value. The Constitution of Oklahoma does not declare such ownership and voting void. It imposes neither forfeiture nor penalty. No legislation has been enacted to carry it into effect. It lays down a rule of public policy and not of property. Only the State could question the validity of the transaction. Groves v. Slaughter,15 Pet. 449; National Bank v. Matthews,98 U.S. 621; *2127 Whitney v. Wyman,101 U.S. 392; National Bank v. Whitney,103 U.S. 99; National Bank of Xenia v. Stewart,107 U.S. 676; St. Louis Railroad v. Terre Haute Railroad,145 U.S. 393; Thompson v. Saint Nicholas*468 National Bank,146 U.S. 240; Scott v. Deweese,181 U.S. 202; Kerfoot v. Farmers' & Merchants' Bank,218 U.S. 281. Tax matters are controlled by what actually took place and not by what might have occurred. Petitioner or its officers might have taken steps through the proper public officials to require Indiahoma to sell its stock or to stop it from voting, but neither was done. Unquestionably a majority of petitioner's stock was owned by Indiahoma and it was in fact voted and upon its vote is based the entire superstructure of corporate affairs. The legal and practical situations are such that we must hold that in determining the question of affiliation the stock owned by Indiahoma must be treated as any other stock. The next question is whether Meyer and the King family controlled the voting of the stock held by Indiahoma. *2128 The only witness introduced on this issue was Hugh King, Jr., who, after stating that he had been advised that Indiahoma could not legally vote its stock, testified: Q. In view of the fact that you had such advice, and that they purported to represent the Indiahoma, why were they listed as voters at this meeting and recognized as such? A. Well, from the beginning, when they bought the stock, up to and including this time, we had always gotten along with them very well. We had a distinct understanding with them, in the first place, that they would not interfere at all in the management of the company. They put in my brother as general manager. They raised my salary from $2,000 to $7,500; and all of the time we did business with them, we never had any criticism about the work, but on the other hand they complimented us very highly. We had absolutely no reason to believe that they would oppose our wishes, because they continued to pat us on the back; and since I saw no reason why we should stop them from voting, I let them vote, that is all. Q. Did you have any reason to believe that they were going to vote with you? A. Oh yes, they told us beforehand that everything*2129 was all right; they approved of the management of the company. Q. And under those circumstances, didn't you object to their voting; why didn't you object to their voting? A. Why should I? They weren't opposing us. Q. Well, would your attitude have been any different if you had reason to believe that they were going to oppose you? A. Oh yes, I would have stopped it. In this testimony appears the gratitude of a minority stockholder to the majority for favors conferred upon him and upon his brother coupled with the threat that if Indiahoma had opposed his wishes, King would have prevented the voting of its stock. There is a flat statement of an understanding that Indiahoma should not interfere in the management followed immediately by statements so phrased as to unmistakably disclose that, in some respects at least, Indiahoma *469 took an important part in the management. The testimony, while indicating the acquiescence on the part of Indiahoma in the management of petitioner, also indicates that it suggested and carried into effect certain policies. It did not entrust the voting of its stock to King, but had its own officer present at stockholders' meetings*2130 to represent it. Under these circumstances we are not impressed with the thought that King controlled the stock owned by Indiahoma. It is urged that the King family and Meyer were "the same interests," within the meaning of section 240(b), supra. Assuming without deciding that this is so, we have stock owned or controlled as follows: Petitioner Alvarado Balboa Per cent Per cent Per cent King family and Meyer [48] 66.7 [100] Indiahoma Refining Co [52] 33.3 [0] Petitioner does not contend that the King family and Meyer are "the same interests" as Indiahoma Refining Co., nor is there anything in the record which suggests that they are. The case made by petitioner rests upon either eliminating the stock of Indiahoma Refining Co., because of the constitutional provision, or showing control of that stock to have been in King. These points having been decided adversely to petitioner, the action of Commissioner in denying affiliation is approved. Upon authority of the decision in L. S. Ayers & Co.,1 B.T.A. 1135, we hold that respondent erred in reducing the amount of current earnings available for dividends by the amount of a*2131 tentative tax for the current year. Decision will be entered under Rule 50.