American Printing Co. v. Commissioner

AMERICAN PRINTING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. American Printing Co. v. Commissioner Docket No. 39721. United States Board of Tax Appeals 27 B.T.A. 1270; 1933 BTA LEXIS 1225; April 26, 1933, Promulgated *1225 Under date of December 31, 1917, petitioner acquired all the assets of its wholly owned subsidiary in liquidation and thereby realized a profit on the disposition of its stock in the subsidiary in an amount equal to the difference between the March 1, 1913, value of the stock and the fair market value of the assets at the date they were acquired by the petitioner. Held, under the principles enunciated in Burnet v. Aluminum Goods Mfg. Co.287 U.S. 544, affiliation was not necessarily terminated by liquidation of the subsidiary in 1917, and, in any event, the liquidation of the subsidiary in 1917 was not such an "intercompany" transaction under either the regulations or statutes then in force or under section 1331 of the Revenue Act of 1921, as was required to be eliminated from the consolidated return required to be filed for excess profits tax purposes. Therefore, the cost to the petitioner of the assets thus acquired from its subsidiary was their pair market value as of December 31, 1917, and such cost is the basis to be used in determining the allowance for depreciation of the assets in 1918 and for valuing the petitioner's opening inventory for 1918. *1226 James F. Jackson, Esq., Charles W. Mulcahy, Esq., and Robert N. Miller, Esq., for the petitioner. F. L. Van Haaften, Esq., and A. H. Fast, Esq., for the respondent. MATTHEWS *1270 This is a proceeding for a redetermination of a deficiency in income and profits tax for the year 1918 in the amount of $954,824.99, not all of which is in controversy. The issues giving rise to the deficiency in controversy involve the correct basis to be used by the petitioner in determining the amount of the depreciation deduction upon assets acquired from the Fall *1271 River Iron Works Company, and the basis to be used in determining the opening inventory. There is also an issue involving the correct closing inventory for 1918 which has been settled by stipulation. The parties have filed a stipulation of facts with accompanying exhibits, which from the basis for our findings of fact. FINDINGS OF FACT. The petitioners, the American Printing Company, is a corporation organized and existing under the laws of the State of Massachusetts, with its principal office in Fall River. It was incorporated in 1890 for the purpose of printing, dyeing*1227 and finishing textile fabrics, and later, in December 1917, its purposes were enlarged so as to include the manufacture of such fabrics. The Fall River Iron Works Company, hereinafter referred to as the Fall River Company, was incorporated under the laws of Massachusetts in 1825 and was engaged in the manufacture of cotton cloth, with its principal place of business at Fall River. For some time prior to the calendar year 1913 and at all times prior to the dissolution of the Fall River Iron Works Company, the petitioner was the owner of all of the outstanding shares of stock of the Fall River Iron Works Company. Prior to December 31, 1917, all of the stock certificates of the Fall River Iron Works Company, with the exception of the qualifying shares held by directors, were issued in the name of petitioner. During the period from December 31, 1917, until the dissolution of the Fall River Iron Works Company, the 10 shares of stock then outstanding were held by nominees of the petitioner. Prior to the latter part of December 1917, the total outstanding stock of the Fall River Iron Works Company was 20,000 shares of a par value of $100 a share. On December 20, 1917, corporate*1228 resolutions were adopted (see infra ) to reduce the number of such outstanding shares from 20,000 to 10. The new issue was to be of a par value of $100 per share. The article of amendment so reducing the number of shares to 10 was filed with the Secretary of the Commonwealth of Massachusetts on December 28, 1917, and approved by the Commissioner of Corporations on the same date. The old stock certificates were surrendered and canceled on December 31, 1917, and the new certificates were thereupon issued pursuant to the resolutions and article of amendment mentioned above. The petitioner and the Fall River Company originally filed separate income and excess profits tax returns for the year 1917. The respondent thereafter required these companies to file a consolidated return of their net incomes for 1917 for excess profits tax purposes. *1272 He computed and assessed the income tax of each of said companies upon the basis of their separate returns. The income and excess profits tax liability of the Fall River Company for 1917, as disclosed by its original return filed in March or April 1918, was $481,378.79, which amount was paid by check of the petitioner on June 15, 1918. *1229 The remainder of the tax liability as finally determined by the respondent was paid from the funds of the petitioner after the dissolution of the Fall River Company. On November 28, 1917, the stockholders of the Fall River Company held a special meeting for the purpose of considering and acting upon the sale and conveyance by the Fall River Company of all its property and assets to the American Printing Company. At this meeting it was unanimously voted by ballot: That this corporation sell, transfer and convey to the American Printing Company all of its real and personal property, easements, rights, privileges and assets of every description in consideration of the payment therefor of the valuation of the same as it appears this day upon the books of this Company with such adjustment of personal assets and liabilities as shall become necessary by reason of transactions in the usual course of business between this day and the thirty first day of December, 1917, on or before which day said sale is to be perfected by completed deliveries, and in further consideration of the payment or assumption by the American Printing Company in connection therewith of all liabilities and obligations*1230 of this Company as they shall exist on the said thirty first of December, a deed of the said real estate of this corporation with all easements, rights and privileges appurtenant thereto, machinery and mill equipment to be executed and delivered by the President to the American Printing Company on or before the Thirtieth day of this month with the understanding that until said Thirty-first day of December this Corporation shall have the right to use all real estate, buildings, machinery and mill equipment conveyed by said deed in connection with the continuation of its usual business. And further voted that the Directors be hereby authorized to prepare a deed of all the real estate, machinery and mill equipment of this Corporation for immediate execution by the President in its behalf: to arrange for transfer and delivery of the remaining assets of the Company; and to take all necessary and proper steps for carrying into effect the provisions of the foregoing vote; and for winding up the business of the Corporation as of the day above named. At a directors' meeting of the Fall River Company held on the same date it was voted to convey, pursuant to the above stockholders' vote, *1231 all of its real estate, buildings, machinery and mill equipment to the petitioner. Pursuant to the votes, the Fall River Company conveyed on March 28, 1918, to the petitioner, all of its real estate, buildings, machinery and mill equipment by deed. On the same day, November 28, 1917, at a meeting of the stockholders of petitioner, it was voted to purchase all of the property and assets of the Fall River Company, said vote containing the following provision: *1273 * * * it being understood that until said thirty-first day of December [1971] the Fall River Iron Works Company shall have the right to use in connection with the continuation of its usual business all real estate, buildings, machinery and mill equipment which shall have been conveyed to this corporation in accordance with this vote. The directors of petitioner also met on November 28, 1917, and took the necessary action to carry out the provisions of the resolution passed at the stockholders' meeting held on the same date. On December 20, 1917, the stockholders of the Fall River Company held a meeting for the purpose of taking action upon the reduction of the capital stock of the corporation. At this*1232 meeting all the capital stock of the corporation was represented and it was unanimously voted: That in view of the transfer of the assets of this Corporation to the American Printing Company and assumption by that Corporation of all outstanding indebtedness of this Corporation and of the distribution of all assets except the franchise right to do business, the capital stock of this Corporation be and the same is hereby reduced from two million dollars ($2,000,000) at par value, the amount now outstanding, to one thousand dollars ($1,000) at par value and the number of shares from twenty thousand (20,000) to ten (10), and that all proper steps be taken to carry into effect this reduction of capital stock in accordance with law. On December 20, 1917, the directors of the Fall River Company voted to authorize the president to execute in behalf of the corporation a bill of sale conveying to the petitioner all of the assets of the Fall River Company not theretofore conveyed by said deed of November 28, 1917, "including cotton, cotton goods, stock in process, materials, supplies and personal property of every kind; * * * the grantor hereby meaning to complete and hereby completing the*1233 sale and delivery to the American Printing Company of all of its property of whatsoever name and nature, except the franchise right to be and remain a business corporation." It was voted at that meeting that, notwithstanding the execution of the bill of sale and transfer thereby of the assets of the Fall River Company to the petitioner, the Fall River Company should have the full use and benefit of the assets therein described in connection with the continuation of its business until and upon the 31st day of December, 1917. It was also voted that "a distribution be made among the stockholders of this corporation in proportion to their respective rights of the proceeds of the sale of the corporate property to the American Printing Company and that upon surrender of the old certificates new certificates be issued in accordance with the rights of parties in the reduced capital stock of this corporation." On December 20, 1917, the Fall River Company, pursuant to the foregoing vote, conveyed to the petitioner, by bill of sale, all of its property and assets as therein referred to. *1274 On December 20, 1917, the directors of the American Printing Company voted to accept the*1234 conveyance from the Fall River Company, "with the understanding that the company [Fall River Company] have the use and benefit of the property described in it until and upon the thirty-first day of December 1917, and that in connection with the transfer of assets and the reduction of the capital stock of the Fall River Company and issue by it of shares of the reduced capital stock the certificates of shares of that corporation now held by this corporation be duly transferred and surrendered." Notwithstanding the recital in the foregoing votes with reference to the consideratiov payable, no consideration was in fact paid by the petitioner to the Fall River Company for the transfer and conveyance of any of the assets except the surrender for cancellation of the capital stock of the Fall River Company owned by petitioner and the assumption by petitioner of all liabilities and obligations of the Fall River Company. The Fall River Company, in accordance with the right reserved to it by the foregoing votes, continued to use all of the property in the conduct of its usual business until the close of business on December 31, 1917, at which time possession of the same was delivered to*1235 the petitioner. After December 31, 1917, Fall River Company had no property or assets except its corporate franchise, and did no further business unless the acts set forth in these facts be construed as doing business after that date. On March 5, 1918, the stockholders of Fall River Company held a meeting at which the minutes of the last meeting were read and approved, the report of the board of directors for the twelve months ending December 29, 1917, accepted and officers elected. On that same date the directors of Fall River Company met and elected officers, no other business being transacted. On March 20, 1918, the directors held another meeting, at which it was unanimously voted: That whereas pursuant to the votes of stockholders the affairs of this corporation have been closed and the title to all of its property passed to and all its obligations assumed by the American Printing Company, the same taking effect at the close of the year 1917, it is appropriate that proceedings be now taken for the dissolution of the corporation and that counsel be hereby directed to take the necessary and proper steps to that end. On March 28, 1918, at a meeting of the stockholders, *1236 it was voted that pursuant to the recommendation of the directors quoted above the general counsel of the corporation be directed to execute and present to the proper court a petition for the dissolution of the corporation. *1275 The Fall River Company was dissolved on November 7, 1918, by decree of the Superior Court upon petition filed April 4, 1918. On account of the above transaction the Commissioner of Internal Revenue computed a profit to the petitioner in 1917 and assessed and collected income tax from the petitioner on such profit under the provisions of the Revenue Act of 1916, as amended, upon the ground that the excess of the value of the property at the date of transfer over the March 1, 1913, value of the stock surrendered was realized by petitioner as taxable income in 1917. The Commissioner took the position that the companies were consolidated for excess profits tax purposes only, and not income taxes, under the revenue laws governing the year 1917, and the profit on the transfer computed and used by the Commissioner for income tax purposes was not used nor was any tax computed thereon for excess profits tax purposes. Thereupon suits at law were instituted*1237 by the petitioner in 1925 in the United States District Court for the District of Massachusetts for recovery of income taxes collected from the American Printing Company in connection with the above transaction for the calendar year 1917, which suits are still pending. The depreciable assets acquired by petitioner from the Fall River Company, as above set forth, were used by petitioner in its business durivg the entire year 1918, and the fair market value thereof when acquired by petitioner, as herein set forth, was greater than the original cost thereof to the Fall River Company. The Commissioner on May 17, 1928, mailed a notice of deficiency to the petitioner. In this notice the Commissioner used, as the basis for determining the allowance for depreciation for the year 1918 of the depreciable assets acquired from the Fall River Company, the original cost of such assets to the Fall River Company and not as claimed by petitioner their fair market value at the date acquired by petitioner. The fair market value of the inventories of raw cotton and cotton in process at the date acquired by petitioner in the transfer of assets from the Fall River Company was $369,387.53 in excess*1238 of the cost to the Fall River Company of said inventories. The respondent in the notice of deficiency covering the calendar year 1918 valued the raw cotton and cotton in process acquired by petitioner from the Fall River Company, as set forth above, at the fair market value thereof at the date so acquired in computing the inventory as of December 31, 1917, for the purpose of determining the net income of the petitioner for the calendar years 1917 and 1918 subject to income tax. In computing the inventory as of December 31, 1917, for the purpose of determining the net income of petitioner for the calendar years 1917 and 1918 subject to excess and war *1276 profits taxes, respondent valued the raw cotton and cotton in process at the cost thereof to the Fall River Company. The increase in valuation of petitioner's inventory as of December 31, 1918, of $1,465,370.05, determined by respondent in the notice of deficiency, is $287,951.42 in excess of the correct valuation of the inventory as of December 31, 1918, and petitioner is thereby entitled to a reduction in its net income for 1918, as shown by the notice of deficiency, in the amount of $287,951.42. The petitioner*1239 in its original return valued its inventories as of December 31, 1918, at $7,433,873.56. The respondent determined the valuation of the inventories to be $8,899,243.61. The correct value of the inventories as of December 31, 1918, was $8,611,292.19. If petitioner is entitled to use as a basis for determining the allowance for depreciation for the year 1918, with respect to the depreciable assets acquired from the Fall River Iron Works Company, as above set forth, the fair market value of such assets at the date acquired by petitioner, petitioner is entitled to an additional allowance for depreciation for 1918 in the amount of $177,800.43 over and above the amount of the allowance for 1918 determined by respondent in the notice of deficiency, On March 14, 1919, the Fall River Company applied for and received from the collector of internal revenue at Boston, Massachusetts, an extension of 45 days time or until April 29, 1919, in which to file its 1918 return. The final return of that company for the year 1918 was sworn to and filed with the collector on June 16, 1919. This return, other than the verification by the president, was blank except for the following statement: *1240 The Fall River Iron Works Company transferred all of its property to the American Printing Company on December 31, 1917. Steps were immediately taken to dissolve the Fall River Iron Works Company and a decree of dissolution was granted November 7, 1918. No income or expense transactions occurred during 1918. On April 25, 1918, the Fall River Company filed a "Certificate of Condition" as of December 31, 1917, with the Commonwealth of Massachusetts pursuant to the requirements of the state law, showing total assets of $1,000 under profit and loss, and total liabilities of $1,000, capital stock. The $5 fee required by the state in connection with the filing of this certificate was paid on April 13, 1918, by a check made in the name of the American Printing Company. On October 9, 1918, Parker & Rawson received by check of the petitioner $1,782.50 for an audit which they were authorized to make on March 5, 1918. The various books of the Fall River Company each contained the following statement: "On April 8, 1918, Audited, Parker & Rawson, Auditors." *1277 On March 26, 1918, while prepaing the 1918 income and profits tax return of the Fall River Iron Works Company, Parker*1241 & Rawson, a firm of certified public accountants, by letter advised the Fall River Iron Works Company that they should file a second amended income tax return for the calendar year 1916, the first amended return having been filed July 19, 1917. Pursuant to this advice the company on March 29, 1918, filed an amended income tax return for the calendar year 1916 showing an additional tax liability of $4,075.92. OPINION. MATTHEWS: The year before us is 1918. The petitioner alleges in the petition that the respondent erred in determining depreciation on assets acquired by it from the Fall River Company on the basis of cost to Fall River Company instead of fair market value at the time the assets were acquired from Fall River Company; that he erred in determining the opening inventory of raw cotton and cotton in process acquired by petitioner from Fall River Company on the basis of cost to Fall River Company in determining net income for excess profits tax purposes; and that he erred in ascertaining and determining the net income of the petitioner for excess and war profits tax purposes upon a different basis from that was used for income tax purposes. The respondent, by amended*1242 answer, alleged that from January 1, 1918, to November 7, 1918, the petitioner and Fall River Company were affiliated; averred that he erred in determining the 1918 income for excess and war profits tax purposes and income tax purposes upon different bases; that as a result of such error the income as computed in the deficiency notice for income tax purposes should be increased by the amount of $369,387.03, being the difference between the cost of the raw cotton and cotton in process to Fall River Company and its fair market value at the time acquired, asserting a claim for an increased deficiency, if any should result from such increase in income. The petitioner in reply to this amended answer denied that it and Fall River Company were affiliated in 1918 and denied that the respondent erred in the amount used as an opening inventory in determining the tax for income tax purposes. A third issue, involving the correct closing inventory for the year 1918, has been settled by stipulation as set forth in our findings of fact and effect will be given thereto in the recomputation under Rule 50. The parties are now agreed that under the 1918 Act net income for income tax and excess*1243 and war profits tax purposes should be computed *1278 on the same basis. This is in accordance with section 320(a)(3) of the 1918 Act, which provides that for excess and war profits tax purposes the net income shall be ascertained and returned for the taxable year upon the same basis and in the same manner as is provided for income tax purposes in Title II of the act. Respondent's brief is largely devoted to arguments in support of his contention that the petitioner and Fall River Company were affiliated not only during all of 1917 but also from January 1, 1918, to November 7, 1918, the date of the formal dissolution of the Fall River Company. Being affiliated, he argues that the two companies should have filed a consolidated return for 1918, and, therefore, that the basis for depreciation and determination of the inventory is the cost to the subsidiary, inasmuch as cost to the subsidiary was the basis used in the consolidated return for 1917, in determining depreciation allowable to the subsidiary, and for the further reason that the acquisition of the assets of its subsidiary by petitioner was an intercompany transaction occurring during affiliation, and gave petitioner*1244 no new basis. The petitioner contends that the liquidation of the Fall River Company in 1917 terminated the affiliation; that the petitioner at that time acquired the assets in exchange for stock in the subsidiary, and therefore that the fair market value of such assets at that date, which is cost to petitioner of such assets, should be used as a basis for inventory and depreciation purposes in 1918. Under the Revenue Act of 1918, the basis for determining depreciation is the same as the basis for determining gain or loss, namely, cost or March 1, 1913, value, and the basis for valuing the inventory is (1) cost, or (2) cost or market, whichever is lower. The real question to be decided is, What was the cost of the assets to petitioner? In determining this question, we must first determine whether the fact that petitioner acquired the assets in liquidation of a wholly owned subsidiary affects the general rule applicable under the statutes in force in 1917 governing the sale or other disposition of property and the basis for computing gain or loss thereon. Under the Revenue Act of 1916, as amended by the Revenue Act of 1917, which was in force in the year 1917, gross income*1245 included the gain derived from the sale or other disposition of property, and in the case of property acquired before March 1, 1913, the fair market value of such property as of that date was the basis to be used in determining the amount of gain derived. Section 2(a) and (c) of the Revenue Act of 1916, as amended. Section 206 of the Revenue Act of 1917 provides that for the purpose of Title II, War Excess Profits Tax, the net income of a corporation shall be ascertained and returned for the taxable year upon the same basis and in the same manner as is provided in Title I of the Revenue Act of *1279 1916, as amended, except that amounts received by it as dividends from other corporations subject to the tax imposed by the Revenue Act of 1916 shall be deducted. The profit realized in 1917 by a corporation upon the sale or other disposition of property was, therefore, subject to both income and profits taxes. And where property was disposed of in exchange for other property, the fair market value of the property received represented the selling price of the property disposed of and in turn was the cost of the property acquired in exchange. Under the transactions described*1246 in our findings of fact, the American Printing Company acquired all the assets of its subsidiary the Fall River Company, on December 31, 1917, in liquidation and thereby realized a profit on the disposition of its stock. There is no dispute as to the amount of profit realized. Respondent determined it to be the amount by which the fair market value of such assets exceeded the March 1, 1913, value of the stock surrendered. The cost to the American Printing Company of the assets thus acquired from the Fall River Company, therefore, was their fair market value as of December 31, 1917. This cost, then, became the basis for determining gain or loss on the sale of such assets, and the basis for computing depreciation and valuing the opening inventory for 1918. No question is here raised as to the right of the respondent to have included the profit realized by petitioner in net income of 1917 for income tax purposes. However, in the consolidated return for 1917 which the Commissioner required petitioner and the Fall River Company to file for excess profits tax purposes, the profit was not included for the reason that respondent considered the transaction to be an "intercompany" transaction, *1247 occurring during affiliation, the results of which should not be reflected in the consolidated return. And it is because of this fact and the further fact that from January 1 to November 7, 1918, petitioner owned all of the stock of Fall River Company, that respondent now claims that the cost to petitioner of the assets can not be used in determining the depreciation allowance and the opening inventory for 1918. Under the principles enunciated in Burnet v. Aluminum Goods Mfg Co.,287 U.S. 544, affiliation was not necessarily terminated by liquidation of the subsidiary in 1917, and in any event, the liquidation of the subsidiary in 1917 was not such an "intercompany" transaction under either the regulations or statutes then in force, or under section 1331 of the Revenue Act of 1921, as was required to be eliminated from the consolidated return required to be filed for excess profits tax purposes. As the liquidation of a subsidiary is a taxable transaction to the parent corporation, the assets acquired *1280 in liquidation take a new basis in the hands of such parent corporation. We are not called on to decide whether respondent should have included*1248 the profit in the consolidated return for 1917 for excess profits tax purposes, but the fact that it was not included can not be availed of by respondent as authority for using cost to the Fall River Company instead of cost to petitioner as the basis for determining the depreciation allowance and opening inventory of petitioner for the year 1918. The assets were acquired by petitioner in 1917 at a cost equal to their fair market value. There is no provision in the 1918 Act authorizing or requiring any other basis than cost to the taxpayer of property acquired after March 1, 1913, to be used in computing gain or loss or depreciation. Section 331 of the act relates only to the value at which assets acquired upon reorganization, consolidation or change of ownership can be included in invested capital. The District Court of Massachusetts in the case of this petitioner, American Printing Co. v. United States, 53 Fed.(2d) 98, had before it the same question for 1919 as is involved in this case, that is, the correct basis for depreciation of the assets acquired from Fall River Company. The respondent found an overassessment for 1919, although he determined depreciation*1249 on these assets on the basis of cost to Fall River Company, and the petitioner brought a suit for recovery of the taxes paid resulting from the use of the lower basis. The District Court held that the basis for depreciation was the fair market value of the assets at the time of the transfer to the petitioner. See also Wilmington Steamboat Co. v. Sturgess, 52 Fed.(2d) 510. Both Wilmington Steamboat Co. v. Sturgess and American Printing Co. v. United States, supra, were cited with approval by the Circuit Court of Appeals in Aluminum Goods Mfg. Co. v. Commissioner, 56 Fed.(2d) 568, which decision was affirmed by the Supreme Court in Burnet v. Aluminum Goods Mfg. Co., supra. The basis for determining the depreciation allowance for 1918 of the assets acquired by the petitioner from the Fall River Company is the cost of such assets to petitioner, which cost is their fair market value at the date acquired by petitioner, and the correct basis for valuing the opening inventories of raw cotton and cotton in process is also cost to petitioner, which was the fair market value of the raw cotton and cotton in process*1250 at the date acquired. The parties have stipulated the amount of the depreciation deduction on such basis and also the amount of the inventories. These figures, as set forth in our findings of fact, will be used in the recomputation under Rule 50. Reviewed by the Board. Judgment will be entered under Rule 50.