Sprague-Sells Corp. v. Commissioner

SPRAGUE-SELLS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Sprague-Sells Corp. v. Commissioner Docket Nos. 42006, 42434. United States Board of Tax Appeals 30 B.T.A. 1165; 1934 BTA LEXIS 1213; July 12, 1934, Promulgated *1213 Corporation A issued a portion of its stock for all of the shares of stock and all of the assets of corporation B. Corporation B was not dissolved although from the time it parted with its assets; it had neither income nor expenses. Held, that the net losses of corporation B may not be deducted from the gross income of corporation A. Harold W. Norman, Esq., and Franklin D. Trueblood, Esq., for the petitioner. Arthur Carnduff, Esq., for the respondent. SMITH *1165 These proceedings, consolidated for hearing, involve deficiencies in income tax as follows: Docket No. Period Deficiency 42006 Nov. 1, 1923, to Sept. 30, 1924 $3,772.12 Fiscal year ended Sept. 30, 1925 12,550.02 42434 Mar. 1 to Sept. 30, 1926 7,745.85 By an amended answer timely filed the respondent has moved to increase the deficiency determined for the fiscal period November 1, 1923, to September 30, 1924, by adding to the net income for the period $13,041.52 representing an amount erroneously allowed as a deduction in his prior determination. The allegations of error stated in Docket No. 42006 are: (1) The Commissioner erred in refusing*1214 to allow Sprague-Sells Corporation and Sprague Canning Machinery Co. to deduct in computing their consolidated net income for the fiscal year beginning October 1, 1923, and ending September 30, 1924, the entire net loss sustained by Sprague Canning Machinery Co. during *1166 the period beginning October 1 and ending November 14, 1923, in the amount of $21,536.45. (2) The Commissioner erred in refusing to allow Sprague-Sells Corporation and Sprague Canning Machinery Co. to deduct in computing their consolidated net income for the fiscal year beginning October 1, 1923, and ending September 30, 1924, the net loss sustained by Sprague Canning Machinery Co. for its fiscal year ended September 30, 1922, in the amount of $75,843.15. (3) The Commissioner erred in failing to allow as a deduction in computing the consolidated net income of Sprague-Sells Corporation and Sprague Canning Machinery Co. for the fiscal year beginning October 1, 1923, and ending September 30, 1924, the net loss sustained by Sprague Canning Machinery Co. for its fiscal year ended September 30, 1923, in the amount of $96,551.25. (4) The Commissioner erred in refusing to allow as a deduction in computing*1215 the consolidated net income of Sprague-Sells Corporation and Sprague Canning Machinery Co. for the fiscal year ended September 30, 1925, the net loss sustained by Sprague Canning Machinery Co. for its fiscal year ended September 30, 1923, in the amount of $96,551.25. The allegations of error stated in Docket No. 42434 are: (1) The Commissioner erred in refusing to allow Sprague-Sells Corporation and Peerless Husker Co., Inc. to deduct in computing their consolidated net income for the period beginning March 1, 1926, and ending September 30, 1926, the net loss sustained by Peerless Husker Co., Inc. during the period beginning October 1, 1925, and ending February 28, 1926, in the amount of $45,468.31. (2) The Commissioner erred in refusing to allow Sprague-Sells Corporation and Peerless Husker Co., Inc. to deduct in computing their consolidated net income for the period begun March 1, 1926, and ended September 30, 1926, $300 paid the Secretary of the State of Illinois for authority to sell 25,000 shares of Class A stock of Sprague-Sells Corporation under the Illinois Securities Act. FINDINGS OF FACT. The Sprague Canning Machinery Co. was an Illinois corporation, which was*1216 organized in 1914 and thereafter engaged in the business of manufacturing and selling machines used in the canning trade. For its fiscal years ended September 30, 1922, 1923, and 1924, it had net losses of $75,843.15, $96,551.25, and $21,536,45, respectively. On October 1, 1923, its indebtedness amounted to approximately $350,000. At that time it became evident that if the business was to be continued it would be necessary that the company be refinanced. By an agreement entered into on October 4, 1923, between the stockholders and creditors of the company and one Ogden S. Sells, the following plan of refinancing was adopted. A new corporation, to be known as the Sprague-Sells Corporation, the petitioner herein, was to be organized under the laws of the State of Delaware on or before November 15, 1923. Its capital stock was to consist of 1,000 shares of first preferred stock of a par value of $100 a share, 1,255 shares of second preferred stock of a like par value, and 4,000 shares of common stock without par value. Ogden *1167 S. Sells agreed to purchase the entire issue of common stock for a cash consideration of $100,000. Sells was to be made a stockholder, director, *1217 and the general manager of Sprague Canning Machinery Co. forthwith for the purpose of acting for the company in carrying out the agreement. The stockholders of Sprague Canning Machinery Co. agreed to place their stock, 4,000 shares, in escrow for delivery to the new corporation when organized and in return therefor the new corporation was to issue to them in like proportion certificates for a total of 1,000 shares of its second preferred stock. The old corporation was to transfer and convey all of its assets, property, and business to the new corporation when organized and the new corporation was to assume all of the debts and liabilities of the old corporation. Pursuant to the above agreement the petitioner was organized under the laws of the State of Delaware on November 1, 1923, and the other provisions of the contract were carried out and executed by November 14, 1923. At that time, and as provided in the contract, 1,000 shares of the 1,255 shares of second preferred stock of the new corporation were issued to the stockholders of Sprague Canning Machinery Co. in proportion to their respective holdings of stock in the old corporation. The remaining shares of second preferred*1218 stock were issued to certain of the creditors of the old corporation in part payment of their claims. Of the 1,000 shares of first preferred stock issued by the petitioner, 470 shares were issued to creditors. The remainder of the first preferred stock, with the exception of 20 shares, was never issued. To take care of the remaining indebtedness of the old corporation notes were issued by the new corporation to the creditors, such notes in some cases being endorsed by Sells personally. From the date of its organization on November 1, 1923, to September 30, 1924, inclusive, the petitioner earned a net income, exclusive of deductions for losses sustained by the Sprague Canning Machinery Co., of $49,918.72. For its fiscal year ended September 30, The petitioner and the Sprague Canning Machinery Co. filed a consolidated income tax return for the fiscal year beginning October 1, 1923, and ending September 30, 1924, which showed a net loss of $47,641.86. This return included the operations of the petitioner from the date of its organization on November 1, 1923, to September 30, 1924, and that of the Sprague Canning Machinery Co. for the entire fiscal year. In arriving at such*1219 net loss of $47,641.86, a deduction from gross income was claimed in the amount of $75,843.15 representing *1168 the net loss of the Sprague Canning Machinery Co. for its fiscal year ended September 30, 1922. The petitioner and the Sprague Canning Machinery Co. filed a consolidated return for the fiscal year ended September 30, 1925. It was stated thereon that the "subsidiary [Sprague Canning Machinery Co.] had no income and no expense." In such return there was claimed as a deduction from gross income the net loss of Sprague Canning Machinery Co. for its fiscal year ended September 30, 1923, in the amount of $96,551.25. In the determination of deficiencies for the fiscal period November 1, 1923, to September 30, 1924, and for the fiscal year ended September 30, 1925, the respondent disallowed the deduction from gross income of the net losses of the Sprague Canning Machinery Co. for its fiscal years ended September 30, 1922, and September 30, 1923, in the amounts of $75,843.15 and $96,551.25, respectively; he also disallowed the deduction from gross income of the fiscal period November 1, 1923, to September 30, 1924, of one twelfth of the net loss of the Sprague Canning*1220 Machinery Co. sustained during the fiscal year ended September 30, 1924. Such disallowance was based upon the theory that the petitioner and the Sprague Canning Machinery Co. were affiliated for only 11 of the 12 months of the fiscal year ended September 30, 1924, and accordingly that one twelfth of the net loss of the Sprague Canning Machinery Co. for its fiscal year fell without the affiliation period and hence was not a legal deduction from gross income. Docket No. 42434 involves a deficiency for the fiscal period March 1 to September 30, 1926. The Peerless Husker Co. was a New York corporation. It was not affiliated with the petitioner prior to the period for which the deficiency was determined. For the period October 1, 1925, to February 28, 1926, the Peerless Husker Co. sustained a net loss in the amount of $45,468.31. On March 8, 1926, that corporation, "in consideration of the sum of ten dollars ( $10) to it paid and for other good and valuable considerations," sold to the petitioner all of its assets of every description and thereafter the business of the Peerless Husker Co. was carried on by the petitioner. For the period March 1 to September 30, 1926, the petitioner*1221 filed a consolidated return with the Peerless Husker Co., in which it deducted from its income the net loss of the Peerless Husker Co., sustained for the period October 1, 1925, to February 28, 1926, in the consolidated return with the Peerless Husker Co., in which it deducted from its income the net loss of the Peerless Husker Co., sustained for the period October 1, 1925, to February 28, 1926, in the amount of $45,468.31. The deduction of such net loss has been disallowed by the respondent in the determination of the deficiency of $7,745.85 for the period March 1 to September 30, 1926. For the fiscal period beginning March 1 and ending September 30, 1926, the petitioner paid to the Secretary of State for the State of *1169 Illinois $300 which it claimed upon its return as a legal deduction from gross income. The respondent disallowed the deduction in the determination of the deficiency for such fiscal period. OPINION. SMITH: In these proceedings the petitioner claims the right to bring forward and deduct from its gross incomes net losses sustained by the Sprague Canning Machinery Co. for the prior years. *1222 This claim is predicated upon the theory that the business conducted by the petitioner is the same as that which was conducted by the Sprague Canning Machinery Co. and that there was in effect a merger of the two corporations. The petitioner relies especially upon the decision of the court in . Since the hearing of these proceedings, the Supreme Court has decided the very question involved herein in . That decision is adverse to the petitioner's contentions. Accordingly the claims of the petitioner upon that point are not sustained. 2. In the determination of the deficiencies for the fiscal period November 1, 1923, to September 30, 1924, the respondent allowed the deduction from gross income of the petitioner of $19,741.75 representing eleven twelfths of the operating loss of the Sprague Canning Machinery Co. for its fiscal year. The respondent now contends that inasmuch as the Sprague Canning Machinery Co. was inactive after November 14, 1923, its loss for the fiscal year ended September 30, 1924, was likewise its loss for the*1223 period October 1 to November 14, 1923, inclusive, and that since the loss of $21,536.45 was sustained during a period of 45 days of operation, the petitioner is entitled to deduct from its own gross income only fourteen forty-fifths of $21,536.45, or $6,700.23, since only 14 days of the period fell within the period of affiliation. The respondent therefore contends that he was in error in allowing the deduction of the difference between $6,700.23 and $19,741.75 and has moved to increase the deficiency for the period in question by adding back to net income the excess loss deduction in the amount of $13,041.52. The petitioner, on the other hand, contends that it is entitled to the deduction of the entire operating loss of $21,536.45. We think it clear from the evidence that the petitioner was affiliated with the Sprague Canning Machinery Co. from November 1, 1923, to September 30, 1924. Even though the Sprague Canning Machinery Co. was not an operating company after November 14, 1923, it continued in existence, the petitioner owning 3,995 shares out of a total of 4,000 shares during such period. It was obligated to make a return for its entire fiscal year. It made such a return*1224 together *1170 with the petitioner and such return showed a net loss for the period of $21,536.45. Only one consolidated return for the entire year was required to be filed. ; ; ; ; ; . Such consolidated return must of necessity comprehend the operations of both companies for the entire return period. The respondent's motion for an increase in deficiency for the fiscal period November 1, 1923, to September 30, 1924, is denied. The petitioner's contention that it is entitled to offset its net income by the operating loss of the Sprague Canning Machinery Co. in the amount of $21,536.45 is sustained. 3. The contention of the petitioner that it is entitled to deduct from the gross income for the period March 1 to September 30, 1926, the net loss of the Peerless Husker Co. for the period October 1, 1925, to February 28, 1926, is*1225 not sustained, upon the authority of 4. In Docket No. 42434 the petitioner alleges that the respondent erred in disallowing the deduction from gross income for the period March 1 to September 30, 1926, $300 "paid the Secretary of the State of Illinois for authority to sell 25,000 shares of Class A stock of Sprague-Sells Corporation under the Illinois Securities Act." The petition alleges as a fact that "in computing the consolidated net income of Sprague-Sells Corporation and Peerless Husker Co., Inc., for the period begun March 1, 1926, and ended September 30, 1926, there was deducted $300 paid to the Secretary of State of Illinois for authority to sell 25,000 shares of Class A stock of Sprague-Sells Corporation under the Illinois Securities Act." The allegation of error and the allegation of fact were both denied in the original answer and the amended answer filed by the respondent. At the hearing of this proceeding counsel for the respondent stated: There is also a minor issue in one of these appeals, which is, can the taxpayer deduct from its net taxable income an amount paid to the Secretary of the State of Illinois*1226 in connection with what I might term an adjustment of its capitalization behind the issue of the capital stock. For the purpose of simplifying this question, I have admitted, and do now admit of record, that they paid that sum to the Secretary of State, and that the sum was $300.00. Now, why they paid it, I do not admit, except that I do admit that they paid the $300.00 to the Secretary of State during the taxable period at issue in connection with the issuance of corporation stock. The petitioner contends that the $300 is a legal deduction from gross income, upon the authority of . The amount was a legal deduction from gross income if it was paid as a tax, as was the case in We can *1171 not determine, however, from the evidence of record upon this point, all of which is set out above, whether the $300 was paid as a tax or for what it was paid. For lack of proof the action of the respondent in disallowing the deduction of the $300 in question is sustained. Reviewed by the Board. Judgment will be entered under Rule 50.