Carnie-Goudie Mfg. Co. v. Commissioner

CARNIE-GOUDIE MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Carnie-Goudie Mfg. Co. v. Commissioner Docket Nos. 20074, 27095. United States Board of Tax Appeals 24 B.T.A. 679; 1931 BTA LEXIS 1612; November 6, 1931, Promulgated *1612 Held, that a branch business capitalized and conducted by the petitioner was not a separate taxable entity in any of the taxable years. Phil D. Morelock, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON *679 This proceeding was first heard on May 6, 1929. Findings of fact, opinion, and a decision under Rule 50 therein were promulgated on January 21, 1930 (18 B.T.A. 893). At the original hearing four issues were presented for the consideration of the Board, viz: (1) The failure of the respondent to allow as invested capital for the year 1921, paid-in surplus in the amount of $16,372.67; (2) Whether the petitioner was affiliated with the Lux-Fibre Furniture Company in the taxable years; (3) Whether a penalty for delinquency in filing a return for 1922 should be imposed; and (4) Whether a retail store conducted throughout the taxable years at 804-806 Walnut Street, Kansas City, Mo., was taxable as a separate taxpayer or was merely a branch or department of the operations of the petitioner. At the hearing the respondent confessed error as to the first issue. In its report the Board decided the*1613 second and fourth issues adversely to the contentions of the petitioner and the third in its favor. *680 On February 13, 1930, counsel for petitioner moved to set aside the decision of the Board as to the fourth issue and for a rehearing on that question. This motion was argued by counsel for the parties, and, after due consideration, was granted on March 3, 1930, and the proceeding was restored to the calendar for the sole purpose of taking additional testimony in conformity therewith. On October 1 and 2, 1930, new evidence was adduced and the proceeding was resubmitted. Based upon the entire record and pertinent only to the single question now at issue, and in lieu of all the facts in connection therewith set out in our original report of January 21, 1930, we make the following findings of fact. FINDINGS OF FACT. The petitioner is a Missouri corporation, with its principal office at Kansas City. It was incorporated in July, 1907, for purposes declared in its articles of association as follows: Seventh. The purposes for which this corporation is formed are to manufacture tents, awnings, screens, bags, flags, decorations, tent furniture, implements, canvas*1614 and leather goods, and other like or appurtenant commodities, and to deal in the same for themselves or on commission and in the materials thereof; and to that end and in connection therewith to acquire, hold, lease, and dispose of real estate, buildings and factories; to acquire, hold, use and dispose of, patents and territorial rights therein; to borrow money upon security, and in general to do each and every thing which is requisite or necessary for carrying out the purposes and powers of this corporation. Throughout the taxable years 1921, 1922, 1923 and 1924 the stock was closely held by four persons, to wit: H. G. Carney, L. R. Goudie, Charles R. Goudie and George A. Goudie, in the respective proportions of 10, 30, 30 and 30 per cent. In the latter part of 1920, the petitioner found itself possessed of a large surplus stock of secondhand army goods not readily salable, at its regular place of business on Grand Avenue in Kansas City. To relieve this situation it opened branch sales rooms in its warehouse at Fifteenth and Highland Avenues, and removed some of its surplus stock there. It also leased premises at 804-806 Walnut Street, on which was located a three-story brick*1615 building suitable for merchandising purposes, which it remodeled and stocked with goods, taken in part from its main store and in part purchased in the market. This lease was for a term of five years beginning January 1, 1921, and provided for an annual rental of $9,600, to be paid by petitioner in monthly installments, with renewal privileges. It was executed by the petitioner in due corporate form, on November 24, 1920, and, although the rentals provided for did not begin to run until January 1 following, it included a proviso which allowed the petitioner to take immediate possession of the premises. *681 Immediately following the execution of the lease, the petitioner announced its plans with respect to the character of the mercantile business to be carried on by it there in a full-page advertisement which it caused to be inserted in the Kansas City Star on November 26, 1920. This advertisement carried a photographic cut of the building, showing location, etc., and of numerous articles of army goods, blankets, shoes and children's toys. At the top of this page was the following announcement, to wit: GREATEST MONEY SAVING SALE IN HISTORY OF KANSAS CITY! America's*1616 Greatest Merchants Are Forced To Turn Immense Stocks Of Brand New Shoes, Toys, Etc., Into Quick Cash! They investigated scores of concerns throughout the country to determine the best possible connection. These progressive merchants decided only one could handle such an enormous sale. Other merchants would not handle because the low prices would demoralize their regular stocks, bought at high prices. The Carnie-Goudie Co. was selected because of reputation, financial responsibility, square business methods, location and ability to dispose of merchandise in any quantity in their wholesale and retail business. Never before in the history of Kansas City has there been such a remarkable offer on dependable merchandise at such money-saving prices. See the goods! Note our prices! Nobody will even attempt to dispute our claims. Money Back Guarantee on each and every item offered for sale. (Signed) CARNIE-GOUDIE CO. The retail store was opened for business about December 1, 1920, and was in charge of one, Howell, whose prior connections are not disclosed by the record. L. R. Goudie, treasurer of the petitioner, edited all advertising matter, devoted much of his time to the*1617 new store, and in very large measures directed and managed its operations. C. R. Goudie also gave some personal attention to the new store. During busy seasons clerical and other help from petitioner's store at Twenty-second and Grand Avenues assisted in taking care of the business of the retail business. All the drayage, trucking and transfer of merchandise from one place of business to another, or from stations or wholesalers was done by the employees of the petitioner, using its equipment. Almost from the first, about one-half the space in the leased building at 804-806 Walnut Street was used by the petitioner for purposes not related to the retail business. The rent for such premises at all times, as well as the wages of its employees detailed for service there, was paid by the petitioner. At the opening of the retail store more than twenty truck loads of merchandise were transferred to it from the petitioner's own warehouse at Twenty-second and Grand Avenues, and during the taxable years new merchandise was bought for it by the petitioner at cost of more than $120,000. At various times merchandise was transferred from the warehouse of the petitioner to the retail store*1618 upon telephone *682 requests from L. R. Goudie and others, with only memorandum records or no records at all of such deliveries. Soon after the opening of the retail store, petitioner concluded that the diversified classes of merchandise required for the new venture and the trade methods necessary to the success thereof involved such radical departures from its established policies that operation of the same under the corporate name would be injurious to its established manufacturing and wholesale business. Accordingly, upon the advise of its advertising counsel, it decided to operate the retail store under the trade name of Goudie Brothers. On December 3, 1921, it inserted a full-page advertisement in the Kansas City Star, similar in form and import to the one heretofore noted, except that the name "Goudie Brothers" appeared in lieu of that of the petitioner. Books of account were separately kept at the retail store but were largely in the shape of the memoranda necessary to the accounting of a branch establishment. It was, at all times, impossible to make a statement reflecting the true worth of the petitioner's business without including the accounts of the retail*1619 store. The cash of the retail store was not deposited to the credit of the petitioner, but was kept in various bank accounts under the name of "Goudie Brothers." None of the Goudie Brothers supplied any capital for the operation of the retail store, which, at all times, was financed by the petitioner. The operation of the retail store for December, 1920, showed a profit of $2,174.35, which was divided equally among the three Goudie Brothers and entered to their credit on the general ledger of the retail business. Neither of the brothers drew any part of this profit and such entries were eventually reversed when the accounts of such business and those of the petitioner were merged in 1926. In March, 1921, a partnership income-tax return was filed for Goudie Brothers in the office of the collector of internal revenue at Kansas City, in which the net income for 1920 and the distribution above set out were reported. This return was signed and sworn to by petitioner's treasurer, L. R. Goudie, as one of the members of the reporting firm. Thereafter, no such returns were made and the income and expenditures of the retail store were reported by the petitioner in each of the taxable*1620 years as its own. Upon the establishment of the retail store an insurance policy covering the stock of the same against loss from burglary was taken out and paid for by the petitioner. Upon renewal of the policy on November 26, 1921, the name of the insured was changed by the insurance agency from Carnie-Goudie Manufacturing Company to Goudie Brothers (Geo. A., Chas. R. and Le Roy). In December, 1922, the retail store was burglarized. In a suit brought in the name of Goudie Brothers against the insurance company for the recovery of the amount of the loss, the plaintiffs, in their petition, *683 described their firm as "Geo. A. Goudie, Charles R. Goudie and Le Roy Goudie, doing business as Goudie Brothers, a co-partnership." This suit resulted in the recovery of $5,292.89, a verdict that was later affirmed by the proper appellate court. The amount of this judgment was paid to the petitioner and deposited in its own bank account. For the years 1921, 1922 and 1923 the operations of the retail store, if considered as a separate business, resulted in losses in the respective amounts of $68,310.83, $43,638.17 and $10,088.08. Such losses were carried forward in the profit*1621 and loss account of each succeeding year and accumulated until 1925 when the petitioner's lease on the premises at 804-806 Walnut Street terminated. At the termination of the lease the retail business was closed and the books and records kept there were transferred to the petitioner's office at Twenty-second and Grand Avenue and such accounts, by appropriate entries, were taken into the books of the petitioner. In making up its income and profits-tax returns for 1921, 1922 and 1923 the petitioner treated the business of the retail store as its own, by including in its gross income from sales all the receipts of such store and deducting therefrom the costs of merchandise sold and the expenses incident to the operation thereof. In auditing such returns the respondent added to petitioner's taxable income in each of the years 1920, 1921 and 1923 the amounts of the losses sustained by the retail business in the several respective years, made other adjustments, and determined the deficiencies now in controversy. OPINION. LANSDON: Having previously decided issues one, two and three of this proceeding as originally filed, and the motion for vacation and rehearing applying only to*1622 issue four, tax liability as to the first three issues will be recomputed in conformity with our report promulgated on January 21, 1930. The petitioner contends that the retail store was a mere branch or department of its operations and that its own tax liability can be determined only by combining the accounts of the main store with the alleged outlet establishment. Apparently the respondent relies on the presumption that by their acts and representations to the public the three Goudie Brothers became partners by operation of law, and that the partnership so created operated the store at 804-806 Walnut Street. This position is not well supported by the established rules of partnership law. A partnership between or among two or more individuals is a contractual relation, thus defined by Justice Story: A valuntary contract between two or more competent persons to place their money, effects, labor and skill or some or all of them in lawful commerce or *684 business with the understanding that there shall be a communion of the profits thereof between them. Chancellor Kent sets out an almost identical definition, but adds that the contract should provide for sharing*1623 losses as well as profits. Every definition of a partnership and all decisions in respect thereof are predicated upon these principles and based upon an implied or expressed agreement of the parties. It is now generally held that a partnership can not be formed solely by operation of law. Alger Melton,7 B.T.A. 717. In Citizens National Bank of Chickasaw,24 Okla. 408; 103 Pac. 720, the Supreme Court ofOklahoma said: A partnership exists as a result of a voluntary contract between the parties, and never solely by operation of law. Causler v. Wharton,62 Ala. 358; Cowles v. Garrett,30 Ala. 341; Haycock v. Williams,54 Ark. 384, 16 S.W. 3; Einstein v. Gourdin, 4 Woods, 415, 8 Fed. Cas. No. 4, 320; 22 Am. & Eng. Ency. of Law (2d Ed) p. 14, foot note 3. It is a relation arising out of a contract to do certain things, and exists only where the parties intend to enter into a contract of partnership, and, unless they have estopped themselves by holding themselves out to the world as partners, their intention as derived from the contract is decisive of*1624 the question. To the same effect is the opinion of the Board in Roe Stephens Manufacturing Co.,12 B.T.A. 1254, in which we say: Viewing the facts in the record in their most favorable light, we are of the opinion that they fall far short of establishing the existence of a partnership during the taxable years. * * * It is one of the chief characteristics of the partnership relation that it is created only by the voluntary contract of the parties, and that as between the parties it does not arise in any case by operation of law. Persons can not become partners except by agreement, expressed or implied. Unable, as we are, to find that there was an express agreement, and that facts of record not evidencing an implied agreement, we can not find error in the respondent's action in taxing the petitioner as a corporation during the taxable years in question. [Italics supplied.] The evidence is clear that in 1920, prior to the taxable years, this petitioner represented that the retail store in question was a partnership. Its operations were accounted for in part, at least, in a separate set of books. The earnings for the first short fiscal period were reported*1625 to the respondent on a partnership return and the small profits were distributed on the books to the several alleged partners. An insurance policy was written for the store as a partnership, and a suit to recover losses from underwriters was instituted and won upon pleadings and proceedings in which it was so designated. These facts, all admitted by the petitioner, are the basis of the respondent's determination that the retail store was not operated by the petitioner. In general, a partner must contribute capital or services, one or both, to the partnership business and agree to share in losses as well as profits. Meehan v. Valentine,145 U.S. 711; Ward v. Thompson,22 How. 330; *685 Evans v. Warner,47 N.Y.S. 16. The record is clear that neither of the Goudies ever contributed a dollar of capital to the retail store, nor, except as a stockholder of the petitioner, shared in any of the losses. All of the merchandise offered for sale at 804-806 Walnut Street was either purchased by the petitioner or transferred directly from its own warehouses. There is no record of any accounting, payment or transfer that vested*1626 title in all or any one of the Goudie brothers to the merchandise sold through the retail store, which, in our opinion, was, at all times, the property of the petitioner. Goods were freely and often transferred and retransferred from one place of business to another. Such transfers had no more effect on title than results from moving merchandise from one shelf to another in the same building. There is no evidence that the petitioner ever divested itself either of title to the merchandise sold through Goudie Brothers or of its rights to receive the profit from such sales. Upon this record we conclude that the retail store was operated by the petitioner, which leased the business premises, paid the rent therefor, furnished all the operating capital, supplied the stock in trade, and paid all the expenses and absorbed all the losses. It is clear that any income derived from profits so realized would be taxable to the petitioner and we think any losses resulting from such transactions are its losses. See George M. Cohan,11 B.T.A. 743. In our opinion the retail store was a mere branch of the petitioner's business operation. The respondent put the petitioner's articles*1627 of incorporation in evidence and, on the basis of the paragraph thereof set out above, argues that the operation of a retail store was ultra vires. Careful study of the cited section of the articles of incorporation fails to support this view. In our opinion the purposes therein enumerated are sufficiently broad to include the operation of a retail store. In the light of all the evidence and of the law as interpreted by the courts and this Board, we are of the opinion that the true tax liability of the petitioner for the years under review can be determined only on the basis of the consolidated accounts of the main and branch stores which it operated. The gains or losses of the business at 804-806 Walnut Street were the gains or losses of this petitioner. It follows, therefore, that the respondent erroneously added the amounts of $68,310.38, $43,638.17 and $10,088.08 to the petitioner's income for the respective taxable years. Our opinion on this issue promulgated January 21, 1930, is reversed. Decision will be entered under Rule 50.