National Iron Works v. Commissioner

NATIONAL IRON WORKS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. National Iron Works v. Commissioner Docket No. 36909. United States Board of Tax Appeals 22 B.T.A. 382; 1931 BTA LEXIS 2128; February 26, 1931, Promulgated *2128 Where in 1922 a national bank acquired at foreclosure sale the plant of an iron company and operated it until January 17, 1923, and where the bank caused to be organized under the laws of California a corporation to take over the plant, and where the organization of the corporation had proceeded no further in 1923 than the filing of the articles with the Secretary of State, and where no permit was secured authorizing the issuance of any stock until January, 1923, and where thereafter on January 17, 1923, the corporation acquired from the bank the property acquired by it at the foreclosure sale it then for the first time issued its stock, and where through error an income tax return for 1922 was filed in the name of the corporation, returning income all of which was the income of the bank, held, that the corporation and the bank became affiliated for the first time on January 17, 1923, and the filing of an erroneous return for 1922 in petitioner's name did not preclude the filing of a consolidated return for the period January 17, 1923, to December 31, 1923. James G. Pfanstiel, Esq., for the petitioner. Mason B. Leming, Esq., for the respondent. PHILLIPS*2129 *382 Respondent has determined a deficiency in income tax for the calendar year 1923 in the amount of $1,062.48. The only issue is whether respondent erred in determining that petitioner and the United States National Bank of San Diego (hereafter referred to as the Bank), did not have the right to file a consolidated return for the year 1923 on the ground that these corporations had filed separate returns for the year 1922. *383 FINDINGS OF FACT. The Bank, in 1922, owned certain mortgage bonds issued by the California Iron Works on which default had been made in the payment of both principal and interest. At a public sale by the trustee under the mortgage, the Bank, in 1922, purchased the plant and all of the assets of the California Iron Works, which was then a going concern. Thereafter, and until January 17, 1923, the Bank operated the plant so acquired. On September 1, 1922, James R. Russell, the president of the Bank, C. H. Martin, vice president of the Bank, and Leo G. Moore, a mechanical structural engineer, signed and acknowledged the articles of incorporation of petitioner, and on September 5, 1922, filed the same in the office of the Secretary*2130 of State of the State of California. Among other things the articles recited that the capital stock of petitioner was $100,000, divided into 1,000 shares of the par value of $100 each; that its directors appointed for the first year were its three incorporators; and that the amount of its capial stock then actually subscribed was $300, each incorporator subscribing for one share. The first directors' meeting of petitioner was held on December 7, 1922. At this meeting Russell was elected president, Martin, vice president, and Moore, secretary and ex officio treasurer. In this meeting there was submitted an offer of the Bank to sell and convey to petitioner all the assets acquired at the trustees' sale in consideration of the issue to it of all of petitioner's capital stock authorized to be issued by the Commissioner of Corporations for the State of California (hereafter referred to as the Commissioner). The offer of the Bank was accepted, subject to the approval of the Commissioner. The president and secretary were directed to prepare and forward to the Commissioner an application for a permit to issue petitioner's capital stock. On December 8, 1922, petitioner forwarded to the*2131 Commissioner its application for a permit to issue its stock in which it stated that it was organized for the purpose of taking over all the assets purchased by the Bank at the foreclosure sale; to operate the plant, and that it proposed to issue its capital stock; one share to each of its subscribers and 797 shares to the Bank. Under date of January 15, 1923, the Commissioner issued his permit to petitioner authorizing it to issue said 800 shares as requested in consideration of the transfer and assignment to petitioner "first to be made" of the property and assets described in the application. On January 17, 1923, petitioner's board of directors met and accepted a conveyance of the same date from the Bank of all the assets mentioned in the original offer of the Bank and then and for the first time issued its stock, one share to each of its incorporators and 797 shares to the Bank. Moore was appointed *384 general manager upon a salary plus a commission on the net profits and he was given power to fix all corporate salaries. He was also empowered to sign checks, same to be countersigned by certain other officers. The Bank, on March 6, 1923, filed its separate income*2132 tax return for 1922 showing a loss of $19,161.68. Acting under the advice of an alleged income tax expert, on March 15, 1923, it filed a separate return in petitioner's name for the period August 22, 1922, to December 31, 1922, in which it reported that petitioner's articles were filed September 5, 1922; that its permit to issue stock was issued January 17, 1923; that it began operations August 22, 1922, and further reported gross sales of $41,899.27, and net income in the amount of $3,279.65, subject to a credit of $866, being the proportion of the credit of $2,000 for the 4 1/3 months during which it operated. On March 3, 1924, petitioner and the Bank filed a consolidated income tax return for 1923, which was rejected by respondent. On March 31, 1924, petitioner and the Bank filed an amended consolidated return for 1922, which was rejected by respondent. OPINION. PHILLIPS: Respondent has determined that since the Bank filed a separate income tax return for the calendar year 1922, and since a separate income tax return executed in the name of petitioner was filed for the period August 22, 1922, to December 31, 1922, petitioner and the Bank are precluded from filing a consolidated*2133 return for 1923; they not having secured his consent. The correctness of this determination depends upon the application to the facts of this proceeding of section 240 of the Revenue Act of 1921, the pertinent parts of which read: (a) That corporations which are affiliated within the meaning of this section may, for any taxable year beginning on or after January 1, 1922, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is granted by the Commissioner. (b) In any case in which a tax is assessed upon the basis of a consolidated return, the total tax shall be computed in the first instance as a unit and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income properly assignable*2134 to each. There shall be allowed in computing the income tax only one specific credit computed as provided in subdivision (b) of section 236. (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 *385 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 stok of two or more corporations is owned or controlled by the same interests. The question presented is not whether petitioner, which upon the filing of its articles with the Secretary of State of California became "a party politic and corporate" (sec. 296 of the Civil Code of California), should have filed an income tax return for 1922 (sec. 239 of the Revenue Act of 1921 and article 621 of Regulations 62), but whether it and the Bank were affiliated during any part of that year. Until they were affiliated within the meaning of section 240(c) they could not have filed consolidated returns and until they were so affiliated there was no occasion for the exercise of their right of election. Under the facts of this proceeding there*2135 was no such affiliation until the Bank owned or controlled substantially all of petitioner's stock. It is obvious that if during the period involved petitioner had no stock, outstanding or otherwise, if by law it was prohibited from issuing any stock, the Bank could not own or control that which had no existence either in fact or in law, with the result that there could be no affiliation as required by the section. It is true that one may be a stockholder even though no certificate has been issued to him (), but in such a case the person must be entitled to a certificate. In the instant case no stock was issued by petitioner in 1922 and under the laws of California none of the subscribers could have demanded nor could petitioner have issued to them certificates. Such are the provisions of the California Corporate Securities Act of 1917, the material parts of which are: SEC. 2. The word "security" includes: All shares or other interests or rights into which the capital, capital stock, or property of companies or rights of stockholders or members thereof are divided, including all treasury shares and shares of*2136 their own capital stock purchased or otherwise acquired by companies upon delinquent assessment sales or in any other lawful manner, and all certificates and other instruments issued by them or their authority, evidencing or representing such shares, interests, or rights: SEC. 3. No company shall sell, except upon a sale for a delinquent assessment made in accordance with the provisions of Article II of Chapter II of Title I of Part IV of Division First of the Civil Code; or offer for sale, negotiate for the sale of, or take subscriptions for any security of its own issue until it shall have first applied for and secured from the Commissioner a permit authorizing it so to do. SEC. 12. Every security issued by any company, without a permit of the commissioner authorizing the same then in effect, shall be void, and every security issued by any company, with the authorization of the commissioner but not conforming in its provisions to the provisions, if any, which it is required by the permit of the commissioner to contain, shall be void. *386 SEC. 25. Neither this act nor any provision hereof shall be deemed to prohibit subscriptions for shares of a domestic corporation*2137 made prior to the incorporation thereof and set forth in the articles of incorporation; but such subscription shall be deemed to have been made and accepted upon the condition that such corporation shall be incorporated within ninety days thereafter and, when incorporated, shall with reasonable diligence apply for and secure from the commissioner a permit authorizing the issue of the shares so subscribed for, in accordance with such subscriptions. The directors or trustees named in the articles of incorporation may, prior to the issue of any shares, organize by the election of a president, who must be one of their number, a secretary and a treasurer; and such directors, or a majority of them or such president and secretary may, in the name of and in behalf of the corporation, present an application to the commissioner as herein provided. Sections 13 and 14 of the above act provided penalties of fine or imprisonment or both for the violation of the act, by any company or by any of its officers, agents or employees. Under the provisions of this act it was held by the California District Court of Appeals in *2138 , that not only was stock issued without a permit void, but a contract to sell such stock was also void and could not be ratified. In , the same court held that where one had purchased stock so issued without a permit from another holder the stock was void, the sale was void, and "in reality the plaintiff and her assignor never became stockholders in the corporation." In each of the above cases hearing was denied by the Supreme Court of California. Under the above statute and decisions it seems clear that not only did petitioner have no outstanding stock during the period August 22, 1922, to December 31, 1922, but that if it had issued such stock the issue would have been void. Applying the letter of section 240(c), we are compelled to hold that the Bank not only did not own substantially all of petitioner's stock during this period, but that it neither owned, nor controlled any stock of petitioner for the reason that petitioner had no stock which could be owned or controlled. Applying the spirit of section 240, we arrive at the same conclusion. That*2139 section requires a consolidated return of net income and for the year 1921 (not involved here) of invested capital. Here we have a corporation in embryo which had no stock, owned no property, and had no income, gross or otherwise. There was nothing to consolidate. The income returned for 1922 in its name was the income of the Bank derived from the property of the Bank - property which was not acquired by petitioner until January 17, 1923. Here it is pertinent to point out that the Bank reported a loss of over $19,000, and that by reporting net income in the name of petitioner it suffered a detriment. This so-called return made under erroneous advice should be disregarded in so far as this proceeding is concerned. *387 Under the facts presented it is clear that petitioner and the Bank were not affiliated within the meaning of section 240 during any part of 1922; that during that year they could not have filed a consolidated return, and, further, that since the Bank owned in its own name 797 out of 800 shares of petitioner's stock during 1923, the corporations were affiliated from January 17, 1923, to the end of that year, and properly filed a consolidated return for that*2140 period. Decision will be entered under Rule 50.