Peerless Pattern Co. v. Commissioner

THE PEERLESS PATTERN COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ILLUSTRATED FASHION FEATURES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Peerless Pattern Co. v. Commissioner Docket Nos. 54291, 59360, 59361. United States Board of Tax Appeals 29 B.T.A. 767; 1934 BTA LEXIS 1486; January 16, 1934, Promulgated *1486 1. The same individual owned all the outstanding voting stock of one corporation in the years 1926, 1927, and 1928, and over 95 percent of the outstanding voting stock of a second corporation from October 18, 1926, during the remainder of that year and throughout 1927 and 1928. The two corporations filed returns on a separate basis for 1926. The aforesaid same individual became the owner of all the stock of a third corporation at the date of its organization, May 10, 1927, and continued to own it through 1927 and 1928. Held, the corporations were not entitled to file consolidated returns for the years 1927 and 1928 without first obtaining permission of the Commissioner. 2. Life insurance premiums paid by petitioner in 1928 on the life of its president held not deductible. Noah A. Stancliffe, Esq., and Theodore L. Harrison, Esq., for the petitioners. O. J. Tall, Esq., for the respondent. SEAWELL *767 These proceedings, which have been consolidated for hearing and decisions, involve the income tax liability of the petitioners as determined by the Commissioner for the years and amounts, as follows: Docket Year Amount No. Peerless Pattern Co 54291 [1927] $1,120.38 Do 59361 [1928] 2,832.64 Illustrated Fashion Features, Inc 59360 [1928] 1,863.69 *1487 The questions for determination are (1) should the tax liability of the Peerless Pattern Co. and Illustrated Fashion Features, Inc., be determined on the basis of consolidated returns with To-day's Housewife, Inc., for the years 1927 and 1928, and (2) is the Peerless Pattern Co, entitled to a deduction of $3,540, in computing taxable net income for the year 1928, expended for insurance premiums upon policies of insurance on the life of its president under *768 the circumstances hereinafter set forth. The facts are largely stipulated. FINDINGS OF FACT. The Peerless Pattern Co. was incorporated December 3, 1902, under the laws of the State of New York, and throughout the years 1926, 1927, and 1928 that company had outstanding 2,000 shares of 6 percent preferred stock and 3,000 shares of common stock, all of the par value of $100 each. The preferred stock had no voting rights. To-day's Housewife, Inc., was organized under the laws of the State of New york on July 22, 1922, and throughout the years 1926, 1927, and 1928 that company had outstanding 600 shares of no par value common stock and 400 shares of 7 percent cumulative preferred stock, having a par value of $100*1488 each. The preferred stock had no voting rights. The Illustrated Fashion Features, Inc., was organized under the laws of the State of New York on May 10, 1927, and for the years 1927 and 1928 that company had outstanding 200 shares of no par common stock. No preferred stock was authorized by its charter. On October 18, 1926, John H. Wright, who was then the record holder of 1,517.5 shares, or 50.58 percent, of the outstanding common, and the only voting stock of the Peerless Pattern Co., acquired by purchase 1,334 additional shares of common stock of that company, bringing his total holdings to 2,851.5 shares, or 95.05 percent. The balance of the common stock and all the preferred stock was owned by miscellaneous investors, who had no other connection with the company. On April 3, 1923, Wright acquired all of the outstanding common stock of To-day's Housewife, Inc., and continued to own 100 percent of that stock throughout the years 1926, 1927, and 1928. Wright also acquired 100 percent of the outstanding capital stock of the Illustrated Fashion Features, Inc., at the time of its incorporation May 10, 1927, and continued to own 100 percent of the outstanding capital*1489 stock of that company throughout the years 1927 and 1928. For the year 1926 separate returns were filed by the Peerless Pattern Co. and To-day's Housewife, Inc. For the years 1927 and 1928 a consolidated return was filed, including the operations of the Peerless Pattern Co. and To-day's Housewife, Inc., for the full calendar years, and the Illustrated Fashion Features, Inc., from May 10, 1927, the date of its incorporation. The gross amount of the sales of the Peerless Pattern Co. for the period October 19, 1926, to the end of that year was $40,758.54, or only 7.58 percent of its total sales for the entire year. *769 The Commissioner held that the filing of separate returns for the year 1926 by the Peerless Pattern Co. and To-day's Housewife, Inc., constituted an election to file on the separate basis, and, in the absence of permission from the Commissioner to change the basis of filing the returns, it was mandatory that the returns for the years 1927 and 1928 be audited on the separate basis. The record indicates there would have been no advantage for tax purposes in the filing of a consolidated return for 1926. No permission was obtained of the Commissioner*1490 for filing consolidated returns in the years 1927 and 1928. All the aforesaid three affiliated companies were engaged in the same or similar line of business - the manufacture of paper dress patterns and the publication and sale of a magazine in which such patterns were illustrated. In the latter part of December 1925 it was agreed between Thomas Hunter, a large stockholder of the Peerless Pattern Co., and John H. Wright that Wright would purchase or take over from Hunter his interest in the Peerless Pattern Co. The Peerless Pattern Co. at that time owed Hunter an amount in excess of $100,000. To secure the payment of this sum, it was agreed that the Peerless Pattern Co. would issue $100,000 of 6 percent bonds, secured by a first mortgage and deed of trust on all of its property. As additional security for this mortgage Hunter insisted that Wright pledge $100,000 of life insurance, so that in case of Wright's death the life insurance proceeds would stand as additional security for the payment of these bonds. On October 18, 1926, Wright and his wife signed and delivered to a trustee releases of any and every right, title, and interest and to certain policies of life insurance*1491 aggregating $100,000 on the life of Wright. The beneficiary at that time was Wright's wife, Anne Mary Griffin Wright. The policies were for $10,000 each and were delivered by Wright to the officer of the Chatham Phenix National Bank & Trust Co. as trustee under the mortgage, for the purpose of furnishing additional security to Hunter. By the delivery of these policies the beneficiary became the Chatham Phenix National Bank & Trust Co. as trustee. The aforesaid deed of trust provides that insurance policies shall from time to time, but not more often than at intervals of six months, be released and retransferred by the trustee to the Peerless Pattern Co. upon its written request, signed by its president or treasurer, to the extent that the policies of insurance at the time held by the trustee shall exceed the principal amount of the bonds at the time outstanding. In the event of Wright's death the proceeds of the policies would go to the trustee to guarantee the payment of the corporation's bonds. During the year 1928 Wright's salary was $10,400, or at the rate of $200 per week. *770 The respondent disallowed as a deduction in computing taxable net income of the Peerless*1492 Pattern Co. for the year 1928 the amount of $3,540, the aggregate of premiums paid by it in 1928 on the $100,000 of insurance on the life of Wright. OPINION. SEAWELL: The record shows that the same individual, John H. Wright, owned all the outstanding common stock of To-day's Housewife, Inc., during the years 1926, 1927, and 1928, and also owned, from October 18, 1926, during the remainder of that year and throughout 1927 and 1928, over 95 percent of the outstanding common stock of the Peerless Pattern Co. It is further shown that at the time of its incorporation, May 10, 1927, he acquired and continued to own through 1927 and 1928 all the outstanding capital stock of the Illustrated Fashion Features, Inc. It is seen, therefore, that all three companies after May 10, 1927, were affiliated throughout the years 1927 and 1928. For the year 1926 separate returns were filed by the Peerless Pattern Co. and To-day's Housewife, Inc., and one of the questions for our determination is whether the filing of separate returns in 1926 as heretofore stated constituted an election to file on a separate basis which was binding with respect to the years 1927 and 1928 for those two companies*1493 and Illustrated Fashion Features, Inc., with which they became affiliated during 1927 and 1928, in the absence of permission from the Commissioner to file on a consolidated basis for those years. The petitioners insist that the filing on a separate basis as stated, in the circumstances disclosed by the record, did not constitute an election to file thereafter on a separate basis; that the period of affiliation of the Peerless Pattern Co. and To-day's Housewife, Inc., during 1926 was an unsubstantial period and that the business transacted by the two companies during such period of affiliation in 1926 was so small in comparison with the total business transacted during the entire year 1926 that it was thought unnecessary to obtain permission from the Commissioner to change from the separate basis on which returns had been made in 1926 to the consolidated basis in 1927 and 1928. The record, however, shows that there was in 1926 no material advantage to the two companies in filing a consolidated return and separate returns were then filed. It was obviously not the purpose of the statute to allow affiliated corporations to change their policy of filing separate returns or consolidated*1494 returns, depending upon the advantage to be derived in a particular year. The fact that in the instant case in the year 1926 the tax would have been practically the same whether the returns *771 were filed on a separate or a consolidated basis, did not in our opinion relieve the then affiliated companies of the necessity of making an election as to how returns would be filed, nor was an election dispensed with because the amount of the business transacted was not larger during the two and one half months in 1926 the Peerless Pattern Co. and To-day's Housewife, Inc., were affiliated. In our opinion, and we so hold, the filing of separate returns in 1926 by these companies constituted an election. The Courts and this Board have held that, when affiliated corporations elect to file separate returns for years in which an election is granted, consolidated returns may not be filed for succeeding years without the approval of the Commissioner. ; ; *1495 ; ; certiorari denied, . The Board has also held that when two or more affiliated companies elect to file separate returns for a year during which an election might be made, consolidated returns may not be filed by those companies for subsequent years or by other companies with which they might become affiliated during such subsequent years, without permission of the Commissioner. ; ; . Such were our determinations with respect to the Revenue Act of 1921, and the provisions regarding the question of election are practically the same in the Revenue Acts of 1921, 1924, 1926, and 1928, and similar conclusions have been reached in proceedings arising under the Revenue Act of 1926. ; *1496 . In , we held that, where two affiliated corporations elected to file separate returns for the years 1925 and 1926, they might not, without permission of the Commissioner, file a consolidated return for 1927, even though in the taxable year two other corporations were added to the affiliated group. On appeal to the Court of Appeals of the Third Circuit that court reversed the . The facts in that case, however, were different from those in the instant proceedings. In that case the petitioner was a member of a new group with a new dominant parent company and it was held that under the proper construction of section 240(a) of the Revenue Act of 1926 the petitioner had the right to the benefit of a consolidated return to be filed by the parent corporation for the period of affiliation. The court held that the new parent corporation, which was not in existence in 1925 and 1926 (being incorporated in 1927 and in that year becoming the owner of all the stock of all the other companies), had the right in 1927 to determine *772 the kind*1497 of return, whether separate or consolidated, to be filed by the affiliated group in that year. In its opinion the court said: * * * If an affiliated group continues during a taxable year the addition of a corporation to the group or the dropping of a corporation from the group does not destroy the affiliation as a tax computing unit for the purpose of determining income and profits tax, provided the parent company remains the same when the additions and subtractions are made. . * * * In the instant proceedings the same individual, Wright - the same interest - that owned over 95 percent of the voting stock of the Peerless Pattern Co. and To-day's Housewife, Inc., in 1926 owned the same during 1927 and 1928 and in those years also owned all the capital stock of the Illustrated Fashion Features, Inc. There was no new parent corporation or new ownership interest in 1927 and 1928 different from that in 1926, when an election was made and returns on a separate basis were filed. The same individual, Wright, who virtually owned and controlled two of the affiliated companies in 1926 likewise owned and controlled*1498 the three companies in 1927 and 1928. Such being the case and returns on a separate basis having been filed in 1926, the petitioners, in our opinion and we so hold, had no right, without permission of the Commissioner, to file returns on a consolidated basis in 1927 and 1928 and the action of the Commissioner in computing the tax liability of petitioners on the basis of separate returns for those years is approved. Cf. . In the instant proceedings, the Peerless Pattern Co. was obligated to pay the premiums on the ten life insurance policies, aggregating $100,000, on the life of John H. Wright (the president of the company and owner of more than 95 percent of its outstanding voting stock) so long as the bonds secured by the deed of trust remained unpaid. Section 24(a)(4) of the Revenue Act of 1928 (the same provision being found in section 215(a)(4) of the Revenue Acts of 1918, 1921, 1924, and 1926) provides that in computing net income no deduction shall be allowed in respect of "premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or*1499 business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy." In certain contingencies it is obvious that financial benefit might accrue to the petitioner, the Peerless Pattern Co., by reason of the payment of the proceeds of the policies and their application towards payment of petitioner's bond obligations. The Peerless Pattern Co. is, in our opinion, indirectly a beneficiary under the policies and we hold it is not entitled in computing its net income for 1928 to deduct the $3,540 expended by it in that year in the *773 payment of premiums upon the insurance policies taken out and carried on the life of its president, John H. Wright. ; ; ; ; ; . The record fails to show that Wright's yearly salary of $10,400 was not a fair and reasonable salary or that he was entitled to more or an additional amount to the*1500 extent of the life insurance premiums, $3,540, paid as aforesaid. We are, therefore, of the opinion and hold that there is no error in the respondent's determination of the income tax liability of the petitioners for any of the years in issue. Judgment will be entered for the respondent in each of the three dockets.