Vermont Hydro-Electric Corp. v. Commissioner

VERMONT HYDRO-ELECTRIC CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Vermont Hydro-Electric Corp. v. Commissioner Docket No. 59638. United States Board of Tax Appeals 29 B.T.A. 1006; 1934 BTA LEXIS 1444; February 2, 1934, Promulgated *1444 1. Held, in determining whether preferred stock under the provisions of section 240(d) of the Revenue Act of 1926 is "nonvoting stock which is limited and preferred as to dividends," it is the situation actually existing with respect to such stock during a taxable period that is controlling rather than the possibility that under certain circumstances nonexistent during such period it might have become voting stock or might have received larger dividends than ordinarily. 2. Held, that the petitioner and the National Light, Heat & Power Co. were affiliated for the period January 1 to March 31, 1926. 3. Held, for lack of evidence, that the petitioner and the Middle West Utilities Co. were not affiliated for the period April 1 to December 31, 1926. Everett H. Maxcy, Esq., for the petitioner. Harold Allen, Esq., for the respondent. TRAMMELL *1007 This proceeding is for the redetermination of a deficiency in income tax of $13,801.22 for 1926. The only issues presented for determination are the correctness of the respondent's action (1) in determining that the petitioner was not an affiliated subsidiary of the National Light, *1445 Heat & Power Co. for the period January 1 to March 31, 1926, and (2) in determining that the petitioner was not an affiliated subsidiary of the Middle West Utilities Co. for the period April 1 to December 31, 1926. Another issue relating to the inclusion of certain estimated and unbilled income has been conceded by the respondent. The proceeding was submitted upon a stipulation of facts and certain documentary evidence, from all of which we make our findings. FINDINGS OF FACT. The petitioner was organized on February 14, 1913, under the laws of Vermont. It was in existence and engaged in business throughout the calendar years 1926 and 1927 and is still in existence. The petitioner and its affiliated subsidiary, the Black River Power Co., filed income tax returns for the calendar year 1926 as affiliated subsidiaries of the National Light, Heat & Power Co. for the three months ending March 31, 1926. They filed income tax returns as affiliated subsidiaries of the Middle West Utilities Co. for the nine months ending December 31, 1926. In determining the deficiency in controversy the respondent determined that the petitioner was not affiliated in 1926 with either the National*1446 Light, Heat & Power Co. or with the Middle West Utilities Co., on the ground that the preferred stock of the petitioner was not limited as to dividends and was not owned by either of the foregoing companies. The authorized capital stock of the petitioner on November 1, 1919, consisted of $1,000,000 of 7 percent cumulative preferred stock or 10,000 shares of a par value of $100 each, and $1,000,000 of common stock or 10,000 shares of a par value of $100 each. During the period January 1 to December 31, 1926, the issued and outstanding stock of the petitioner consisted of $757,500 or 7,575 shares of 7 percent cumulative preferred stock and $650,000 or 6,500 shares of common. During the year 1926 the National Light, Heat & *1008 Power Co. owned 100 percent of the outstanding common stock of the petitioner. The certificates of preferred stock contained the following provisions respecting the shares of such stock: The holders of Preferred Stock shall be entitled to, out of the suuplus or net profits of the corporation, cumulative dividends at the rate of seven per centum (7%) per annum in preference and priority to any payment of dividends on the Common Stock payable quarterly*1447 on the first days of January, April, July and October in each year. Whenever all accumulated dividends on all the issued and outstanding Preferred Stock shall be fully paid, and the Board of Directors shall thereafter, out of the surplus or net profits of the corporation, declare dividends on the Common Stock, there shall be left remaining in the surplus of the corporation earned from and after December 31, 1919 an amount equal to the amount of dividends so declared until such amount so left remaining in the surplus of the corporation shall be at least twenty per centum (20%) of the Preferred Stock at any time outstanding, providing, however, that this provision shall not apply to the first four per centum (4%) of dividends declared on the Common Stock in any calendar year. No amount so left remaining in the surplus under the foregoing provision shall ever be declared or paid out as dividends, except in the case of liquidation or dissolution. Whenever in any calendar year there shall have been declared dividends of seven per centum (7%) on the Preferred Stock and ten per centum (10%) on the Common Stock, any additional amount declared as dividends during the same calendar year*1448 shall be divided equally between Preferred Stock and Common Stock. Upon any liquidation or dissolution of the corporation, or a sale of all of the assets, there shall be paid to the holders of the Preferred Stock one hundred (100) dollars per share, and the amount of all accumulated and unpaid dividends thereon, before any sum shall be paid to or any assets distributed among the holders of the Common Stock, and, after such payment to the holders of the Preferred Stock, all remaining assets and funds shall be paid to the holders of the Common Stock. The Preferred Stock may be called for redemption, in whole or in part, on any dividend date, at the option of the Board of Directors, by mailing notice thereof to the holders of record of the shares to be redeemed at least thirty (30) days prior to the date fixed for redemption, and such shares shall be redeemed by paying for each share of the Preferred Stock so redeemed the sum of One Hundred and Ten (110) Dollars and all accumulated and unpaid dividends thereon to the date fixed for such redemption. If any such redemption is made of a part of such preferred stock, the method of selection of the shares to be redeemed shall be such*1449 as the Board of Directors shall determine. The holders of the preferred stock shall not be entitled to vote at any stockholders meeting, except as otherwise required by statutes, and as hereinafter provided, unless there shall be a default in the payment of four (4) quarterly dividends existing at any one time on any of the preferred stock issued and outstanding, in which event the holders of the preferred stock shall be entitled to vote at all stockholders meetings, which right, however, shall cease when all accumulated and unpaid dividends on the preferred stock are paid in full. Dividends at the rate of 7 percent per annum were regularly paid by the petitioner on its outstanding preferred stock during 1926 and as a consequence the holders of such stock did not become entitled *1009 to vote it during that year. The preferred stock during 1926 did not participate in the earnings of the petitioner in excess of the ordinary dividend requirements. OPINION. TRAMMELL: The petitioner contends that it was affiliated with the National Light, Heat & Power Co. during the period January 1 to March 31, 1926, and was affiliated with the Middle West Utilities Co. during the*1450 period April 1 to December 31, 1926. In support of its contention it urges that for the purpose of determining the question of affiliation its cumulative preferred stock is to be considered as nonvoting stock which was limited and preferred as to dividends. The respondent contends that the petitioner was not affiliated with either of the companies as contended by it and urges that the preferred stock of the petitioner is to be considered in determining the question of affiliation. The Revenue Act of 1926 provides in part as follows: SEC. 240. (a) Corporations which are affiliated within the meaning of this section may, for any taxable year, 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. * * * * * * (d) 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*1451 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 preferred as to dividends. This subdivision shall be applicable to the determination of affiliation for the taxable year 1926 * * *. While the parties have stipulated that all of the petitioner's outstanding common stock was owned by the National Light, Heat & Power Co. during the year 1926, the record is entirely silent as to the ownership of the petitioner's preferred stock during that year or as to the ownership of the stock of the National Light, Heat & Power Co. or of the stock of the Middle West Utilities Co. Since the petitioner has failed to establish any basis for a holding that it was affiliated with the Middle West Utilities Co., the respondent's action in determining that the two corporations were not affiliated during the period April 1 to December 31, 1926, is sustained. There remains for determination the question of whether the petitioner and the National Light, Heat & Power Co. were affiliated for the three-month period ending March 31, 1926. During this period the National Light, Heat & Power Co. owned all of*1452 the 6,500 shares of the petitioner's outstanding common stock, while the 7,575 shares *1010 of preferred stock were owned by some undisclosed party or parties and apparently other than the National Light, Heat & Power Co. If the preferred stock of the petitioner was "nonvoting stock which is limited and preferred as to dividends" within the meaning of such designation as used in the act, the petitioner and the National Light, Heat & Power Co. were affiliated corporations. If the preferred stock did not come within such designation as used in the act, then the two corporations were not affiliated, since the National Light, Heat & Power Co. owned less than 95 percent of the petitioner's total outstanding stock. The controversy in , involved the same provisions of the Revenue Act of 1926 as quoted above and presented a question somewhat the converse of that now under consideration. In that case the petitioner contended that it was entitled to file a consolidated return for the period January 1 to June 29, 1926, with another corporation, 99.55 percent of the common stock and 22.82 percent of the preferred stock of which it*1453 owned. Considering the two classes of stock together, the petitioner there owned only about 55.56 percent of the outstanding shares. The preferred stock had no voting rights except those provided by law. The statute of the state in which the other corporation was organized granted to the holders of the preferred stock an equal right with the holders of the common stock, share and share alike, to participate in the election of directors and control of the corporation when any dividend due on the preferred stock had remained unpaid for 60 days. Due to the omission of dividends in 1925 and the failure to resume them again, the holders of the preferred possessed and most of them exercised equal voting rights with the common stock during the period for which affiliation was sought. The petitioner there sought to have the amount of the outstanding preferred stock excluded for the purpose of determining affiliation. In denying the petitioner's contention we said: We think the provisions of section 240(d) of the Revenue Act of 1926 are both mandatory and explicit. By its terms "stock does not include nonvoting stock which is limited and preferred as to dividends." The definitions*1454 of affiliation and of "stock" given in this section were designed, we believe, to establish a definite inflexible standard, to remove the uncertainties and obviate the variables constantly impeding efficient administration of prior statutes governing affiliation. In our opinion, this is the only construction compatible with the purpose and the intent of the Congress in enacting the statute in the terms it used and in the light of previous legislation on the subject. We think that for any period under this statute during which a claim for affiliation is not predicated upon ownership of at least 95 percent of the actual outstanding voting stock, the claim must fail. In the instant case it is agreed that the holders of the preferred stock were not entitled to vote it during 1926. If, as we held in *1011 the Pantlind Hotel case, preferred stock which during a taxable period actually has voting rights is to be included for the purpose of determining affiliation for that period, then we think that preferred stock which during a taxable period did not have voting rights is not to be included in determining affiliation for such period. Since the preferred stock involved in*1455 the instant case did not have voting rights during the period in controversy, January 1 to March 31, 1926, it is not to be included as voting stock in determining affiliation. The respondent urges that in determining whether the preferred stock was "nonvoting stock which is limited and preferred as to dividends" we should find that it was not limited as to dividends, since the preferred stock, after having received dividends of 7 percent in any calendar year and the common stock having received dividends of 10 percent, was entitled to share equally with the common stock in any additional dividends declared during the same calendar year. It is agreed that during 1926 the preferred stock did not participate in the earnings of the petitioner in excess of the ordinary dividend requirements, which were 7 percent. Under these circumstances we think the stock is, for the period in controversy, to be treated as stock limited as to dividends. The mere possibility that the stock in some particular taxable period might be entitled to dividends in excess of 7 percent no more makes it unlimited as to dividends than the possibility that in some particular taxable period it might be entitled*1456 to voting rights makes it voting stock. It is the situation actually existing during the period in controversy that is determinative and not a situation that might have existed upon the happening of a certain contingency. In view of the foregoing we conclude that the petitioner and the National Light, Heat & Power Co. were affiliated during the period January 1 to March 31, 1926, and so hold. While the stipulated facts show that the National Light, Heat & Power Co. owned all of the petitioner's common stock throughout the year 1926 and that certain conditions respecting the petitioner's preferred stock during the period January 1 to March 31, 1926, likewise existed throughout the remainder of 1926, the petitioner has raised no issue as to whether it and that corporation were affiliated for the period April 1 to December 31, 1926; consequently, we express no opinion as to whether they were affiliated during such period. At the hearing the parties agreed that if our decision should be for the respondent there is a deficiency in tax of $11,490.77 and that if it should be for the petitioner there is no deficiency. Since our decision is for the petitioner on one issue and the respondent*1457 on the other, a recomputation of the deficiency will be made accordingly. Judgment will be entered under Rule 50.