Modern Tailoring Co. v. Commissioner

THE MODERN TAILORING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Modern Tailoring Co. v. Commissioner Docket No. 40041. United States Board of Tax Appeals 25 B.T.A. 489; 1932 BTA LEXIS 1520; February 9, 1932, Promulgated *1520 Petitioner and Farr's Clothes, Inc., held not affiliated under section 240 of the Revenue Act of 1926, where less than 95 per cent of the voting stock of both companies was owned by the same interests. W. E. Lewis, C.P.A., for the petitioner. O. W. Swecker, Esq., for the respondent. SMITH *489 The respondent has determined a deficiency in petitioner's income tax for the calendar year 1926 in the amount of $348.50. The petitioner alleges that the respondent erred in refusing to determine its tax liability for that year upon the basis of a consolidated return filed by it and Farr's Clothes, Inc. The essential facts have been stipulated by the parties. FINDINGS OF FACT. About the year 1900, William Schnurmacher and Adolph Liebenthal, as equal partners, under the firm name of The Modern Tailoring Company, began the business of manufacturing men's suits and overcoats, for wholesale only, at Cleveland, Ohio. Liebenthal died in 1916 and his widow, Rose Liebenthal, and his son, Howard Liebenthal, inherited equally his interest in The Modern Tailoring Company partnership. Howard Liebenthal thereafter became active in the business. *1521 In 1917 the petitioner was incorporated under the laws of the State of Ohio and took over the business of the partnership, for which it issued capital stock. Thereafter, and during the year 1926, the petitioner continued to manufacture men's suits and overcoats for wholesale only. Certificates of common capital stock of the petitioner representing 460 shares were issued in 1917, subject to an agreement which in substance provided that no stockholder should dispose of his shares of stock to an outside interest before first offering them to the other stockholders at their book value. Thereafter, and prior to 1926, 40 additional shares of stock were issued subject to the same agreement. On January 22, 1926, Farr's Clothes, Inc., was organized under the laws of the State of Ohio by William Schnurmacher, Howard Liebenthal, and Rose Liebenthal, for the purpose of selling, at retail only, suits and overcoats manufactured by and purchased at wholesale from the petitioner. *490 The voting capital stock of the petitioner during the entire year 1926 and the voting capital stock of Farr's Clothes, Inc., from January 22, 1926, to December 31, 1926, was owned as follows: Modern Tailoring Company Farr's Clothes, Inc. Total Stockholders Shares Per cent Shares Per cent Shares Per cent Wm. Schnurmacher (president) [220] 45.8 [248] 49.6 [477] 47.7 Howard Liebenthal (secretary) [249] 49.8 [379] 37.9 Rose Liebenthal (mother) [99] 19.8 [1] .2 [10] Frank Cerney (factory superintendent) [4] Subtotal [498] 99.6 [498] 99.6 [996] 99.6 Leon Schaffner [1] .2 [1] .1 Edgar Hahn [1] .2 [1] .1 Sanford Schnurmacher [1] .2 [1] .1 Morris Schaffner [1] .2 [1] .1 Subtotal [2] .4 [2] .4 [4] .4 Total [100] 1,000 [100] *1522 Frank Cerney, a minority stockholder of the petitioner company, was employed by the petitioner's predecessor in 1905 and has been employed in the business continually since that time. He is at present the petitioner's "head designer and factory superintendent." All of the petitioner's stockholders were elected directors and no dissenting votes were ever cast. All the stockholders of Farr's Clothes, Inc., were elected directors and no dissenting votes were ever cast. The petitioner and Farr's Clothes, Inc., during 1926, had the same officers, namely, William Schnurmacher, president and treasurer, and Howard Liebenthal, secretary. All of the preferred capital stock of Farr's Clothes, Inc., is owned by William Schnurmacher and Howard Liebenthal in equal shares. The preferred stock has no voting rights. The selling price of the manufactured articles and the margin of profit for each company was determined by the "same interests" and the accounting records of both companies were kept in the same office. The petitioner billed all merchandise sold to Farr's Clothes, Inc., at cost, plus 18 per cent profit. The petitioner had a net profit in 1926 of $4,581.51 and Farr's*1523 Clothes, Inc., had an operating loss for the period January 22, 1926, to December 31, 1926, of $5,588.55. At the close of 1926, Farr's Clothes, Inc., had accounts payable to the petitioner in the amount of $32,394.50, while the petitioner had accounts receivable from Farr's Clothes, Inc., in the same amount. *491 OPINION. SMITH: The petitioner's sole contention in this proceeding is that it is entitled to have its income tax for the calendar year 1926 computed upon the basis of a consolidated return filed by it and Farr's Clothes, Inc., for that period. The respondent has ruled that petitioner and Farr's Clothes, Inc., were not affiliated in 1926 within the meaning of section 240(d) of the Revenue Act of 1926. The wording of this section of the statute referred to is as follows: For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subdivision the term "stock" does not include nonvoting stock which is limited and*1524 preferred as to dividends. This subdivision shall be applicable to the determination of affiliation for the taxable year 1926 and each taxable year thereafter. Since the petitioner did not own any of the stock of Farr's Clothes, Inc., the question to be determined is whether at least 95 per cent of the voting stock of both companies was owned by the "same interests." The stipulated facts as to stock ownership in the companies are that the three individuals, William Schnurmacher, Howard Liebenthal, and Rose Liebenthal, who owned 99.6 per cent, all but four qualifying shares, of the voting stock of Farr's Clothes, Inc., owned only 91.6 per cent of the petitioner's voting stock, and a fourth individual, Frank Cerney, owned 8 per cent of petitioner's voting stock and no stock in Farr's Clothes, Inc. The petitioner urges, however, that in the circumstances of this case, its minority stockholder, Cerney, comprised the "same interests" with the majority stockholders. Unquestionably, there was a very close business relationship between them. Cerney was a salaried employee, as well as a stockholder of the petitioner. He had been employed by the petitioner and its predecessor for many*1525 years. He was also a director of the petitioner and was in complete harmony with the majority stockholders. He held his stock in the petitioner under an agreement which prohibited him from disposing of it without first offering it to the other stockholders at its book value. Notwithstanding these considerations, however, we can not agree that Cerney and the petitioner's other stockholders, who owned 99.6 per cent of the stock of Farr's Clothes, Inc., constituted the same interests within the meaning of the statute. The courts have construed the words "same interests" as meaning the same "benefic al interests." ; Handy & *492 . In the latter case the Supreme Court said: The purpose of Sec. 240 was, by means of consolidated returns, to require taxes to be levied according to the true net income and invested capital resulting from and employed in a single business enterprise even though it was conducted by means of more than one corporation. Subsection (b) clearly reflects the intention, by means of such returns, to secure substantial equality as*1526 between shareholders who ultimately bear the burden. That intention is shown by the legislative history and was given effect by the regulations contemporaneously promulgated. It requires no discussion to show that such returns will not make against inequality or evasion unless the same interests are the beneficial owners in like proportions of substantially all of the stock of each of such corporations. . . . . * * * Cf. also ; certiorari denied, . Obviously, the conditions existing with respect to the ownership of the voting stock of the petitioner and Farr's Clothes, Inc., in 1926 do not meet the test laid down by the Supreme Court for affiliation. Cerney, not being a stockholder in Farr's Clothes, Inc., would neither have benefited by a gain nor shared a lows of that company. *1527 See also ; . Judgment will be entered for the respondent.