Smith Paper Co. v. Commissioner

SMITH PAPER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. EXPORT LEAF TOBACCO COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. T. C. WILLIAMS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Smith Paper Co. v. Commissioner Docket Nos. 61394-61396. United States Board of Tax Appeals 31 B.T.A. 28; 1934 BTA LEXIS 1175; August 8, 1934, Promulgated *1175 1. CLOSING AGREEMENTS - REVENUE ACT OF 1928, SECTION 606. - The execution of such agreements, December 5, 1930, closing the tax liabilities of members of an affiliation, continuing through 1926, 1927, and 1928, for 1927 upon a consolidated basis, neither constitutes the permission, under section 142(b), Revenue Act of 1928, necessary to change the basis of return of the affiliation for 1928, where the return for that year was filed June 15, 1929, nor bars respondent from establishing the proper basis of return for 1927 in a proceeding involving an income tax deficiency for 1928. 2. AFFILIATION - CONSOLIDATED RETURNS - REVENUE ACT 1928, SECTION 142(a). - The term "return", as used therein, necessary to base a similar form of return for the succeeding year, means proper return. 3. Id. - RIGHT OF ELECTION. - Where the same parent corporation in an affiliation continues throughout 1926, 1927, and 1928, no new right of election of basis for income tax return results to the affiliation in 1927 or 1928 from the addition thereto of one corporation in the former, and two in the latter year. Huntington Beach, Inc.,30 B.T.A. 731, followed. H. H. Shelton,*1176 Esq., and H. M. Robertson, Esq., for the petitioners. Allin H. Pierce, Esq., and Irving M. Toller, Esq., for the respondent. LEECH *29 Respondent has determined deficiencies in income tax for the year 1928, against petitioners, as follows: Name Docket No. Deficiency Smith Paper Co 61,394 $18,400.22 Export Leaf Tobacco Co 61,395 95,287.33 T. C. Williams Co 61,396 3,658.14 The petitioners request redetermination of the deficiencies in these consolidated proceedings. The only error assigned as a basis therefor is the action of respondent in refusing to compute the income tax of petitioners, together with the Brown & Williamson Corporation, and the Brown & Williamson Tobacco Sales Corporation, for 1928, upon a consolidated basis. FINDINGS OF FACT. The three petitioners, together with the Brown & Williamson Tobacco Corporation, a Delaware corporation, and the Brown & Williamson Tobacco Sales Corporation, a Delaware corporation, comprise a related group of corporations. The British-American Tobacco Co., Ltd., hereinafter called British-American, is a British corporation organized on September 29, 1902, with*1177 its principal place of business in London, England. Its business was that of manufacturing and exporting cigarettes and tobacco. The Export Leaf Tobacco Co., of New Jersey, hereinafter called Export of New Jersey, was a New Jersey corporation organized on July 2, 1912. Its principal office was in New York City, and its business was that of a dealer and commission merchant in leaf tobacco with its affiliated companies throughout the world. In connection with its operations in the United States, it maintained plants at about 15 points therein. The property used by it in such business had a value of approximately $14,500,000. Its employees numbered 1,548, to whom salaries and wages were paid in the sum of approximately $1,603,000 in 1927. Its gross business was at the *30 rate of about $32,000,000 a year. Its authorized capital stock was $5,000,000, divided into 50,000 shares of the par value of $100 each. During the year 1926, and to November 30, 1927, these shares were owned and held as follows: Name Shares held Percentage British-American Tobacco Co., Ltd 49,500 99% R. C. Harrison [300] 3/5 of 1% E. G. Curran [200] 2/5 of 1% As of December 1, 1927, all*1178 of the business and assets of this New Jersey corporation were transferred to a Delaware corporation of the same name and capital, in structure and amount, one of the petitioners herein, in exchange for all the stock of the latter corporation, which was distributed immediately, share for share, to the stockholders of the former, and the assumption of all the liabilities of the New Jersey corporation by the Delaware corporation. The Delaware company was organized for this purpose. The officers and principal place of business of the Delaware corporation, hereinafter called Export of Delaware, were the same as those of the New Jersey corporation of the same name. This reorganization was accomplished without bookkeeping entries or a change in organization, although new books were opened thereafter by the new company. As soon as the transfer was effected, the New Jersey corporation was dissolved. Following the transfer, the Delaware corporation regarded and designated itself as the successor of the New Jersey corporation. The two companies were substantially identical except for the state of incorporation. From December 1, 1927, to the end of 1928, the stock of the Delaware corporation*1179 was held exactly as that of its predecessor, the New Jersey corporation, during 1926 and until November 30, 1927, indicated above. The T. C. Williams Co., herein called Williams, one of the petitioners, was a Virginia corporation organized on April 13, 1889. Its principal office was at Richmond, Virginia, though all of its books were kept at the New York City address of the Export Co., from which address most of its business was conducted. This business was that of an exporter of plug tobacco to New Zealand, Australia, and South Africa. A large portion of its products was sold to British-American. It possessed trade names and brands of its own under which its products were sold. It had authorized and outstanding capital stock of $10,000, divided into 100 shares of the par value of $100 each, all of which, during the calendar years 1926 to 1928, inclusive, was owned by British-American. At December 21, 1927, it had assets in the amount of $372,443.17, of which approximately $340,000 was cash. It manufactured nothing for itself, and *31 had neither selling organization nor employees, its books being kept for it by British-American. For the calendar year 1926, its separate*1180 income tax return showed gross income of $169,716.05, and net income of $24,311.06; for the calendar year 1927, gross income of $155,108.84 and net income of $25,547.06, and for 1928, as shown on the consolidated return for that year, its net income was $30,484.46. The Brown & Williamson Tobacco Corporation, hereinafter called Brown & Williamson, was organized on March 16, 1927, under the laws of the State of Delaware. Its principal office and place of business was in Winston-Salem, North Carolina. The business of the company was that of manufacturing tobacco products. It had authorized and outstanding capital stock of $4,400,000, consisting of $4,000,000 preferred stock, divided into 40,000 shares of the par value of $100 each, and 400,000 shares of common stock without par value, upon which $1 a share had been paid. From the time of incorporation to and including December 31, 1928, 95 percent or more of its capital stock was owned by British-American. This company owned property costing in excess of $4,500,000, employed an average of 1,450 persons, had a monthly pay roll in excess of $100,000, and did an annual gross business of approximately $4,500,000 a year. The Brown*1181 & Williamson Tobacco Sales Corporation, hereinafter called Brown & Williamson Sales, was organized on June 5, 1928, under the laws of the State of Delaware, with its principal office at Louisville, Kentucky. Its business was that of selling the tobacco products manufactured by Brown & Williamson on the Pacific coast of the United States. It had authorized and issued capital stock of $25,000, all of which from the date of its incorporation to and including December 31, 1928, was owned by Brown & Williamson. The Smith Paper Co., hereinafter called Smith, one of the petitioners herein, was a Massachusetts corporation organized on July 30, 1917, with its principal office at Lee, Massachusetts. Its business was that of manufacturing cigarette papers and other kinds of tissue paper. It sold a large portion of its products to its affiliated companies and British-American. It had authorized and outstanding capital stock of $1,227,100, consisting of 10,000 shares of preferred stock of the par value of $100 per share, and 22,710 shares of common stock of the par value of $10 per share. This company employed 300 persons, had an annual pay roll in excess of $550,000, and did a gross business*1182 from October 8 to December 31, 1928, in excess of $600,000. Its net income for the period from October 8 to December 31, 1928, was $144,900.46. During the years 1926 and 1927, and from January 1 to October 8, 1928, Export of New Jersey or Export of Delaware, owned and *32 held 93.3 percent of its stock. From the last mentioned date to the end of 1928, Export of Delaware owned and held 95 percent thereof. The foregoing corporations were affiliated, within the purview of sections 240 of the Revenue Act of 1926 and 142 of the Revenue Act of 1928, as follows: Affiliated Name of corporation [1928] 1. T. C. Williams Co Yes Yes Yes 2. Export Leaf Tobacco Co. (New Jersey) (dissolved November 30, 1927) Yes Yes 3. Export Leaf Tobacco Co. (Delaware) (incorporated October 31, 1927) Yes Yes 4. Brown & Williamson Tobacco Corporation (incorporated March 16, 1927) Yes Yes 5. Brown & Williamson Tobacco Sales Corporation (incorporated June 5, 1928) Yes 6. Smith Paper Co. (acquired October 8, 1928) Yes For the year 1926, Export of New Jersey and Williams, one of the petitioners herein, filed*1183 separate returns of their income for the entire calendar year. For the year 1927 Export of New Jersey and Brown & Williamson filed a consolidated return of their incomes for the period January 1 to November 30, 1927, inclusive. Export of Delaware and Brown & Williamson filed a consolidated return of their incomes for the period December 1 to December 31, 1927, inclusive. These returns were filed tentatively on March 15, and finally on June 15, 1928. Williams filed a separate income tax return of its income for the entire year 1927. On or about June 15, 1928, British-American filed, with the proper collector of internal revenue, affiliation schedules on the regular Treasury Department form, disclosing the stock ownership by British-American in the domestic corporations, including the then five affiliated corporations, mentioned heretofore, as well as all changes in stock ownership and all facts relating to the affiliation of such corporations during the period January 1 to December 31, 1927. Export Co. of Delaware, Brown & Williamson Tobacco, Brown & Williamson, Smith, and Williams filed a tentative consolidated return of their incomes for 1928 on March 13, and a final similar*1184 return on June 15, 1928. Under date of December 5, 1930, Export of Delaware, as successor to Export of New Jersey, executed, with the Commissioner of Internal Revenue, an agreement as to final determination of tax liability, pursuant to section 606 of the Revenue Act of 1928, closing the income tax liability of Export of New Jersey for the period January 1 to March 15, 1927, which was approved by the Secretary of the Treasury. Also, under date of December 5, 1930, there were executed and approved similar closing agreements covering the *33 income tax liabilities of Export of New Jersey and Brown & Williamson for the period March 16 to November 30, 1927, inclusive; and of Export of Delaware and Brown & Williamson for the period December 1 to December 31, 1927. All these agreements were executed upon the bases of consolidated returns for the respective periods covered. British-American was the parent corporation through 1926, 1927, and 1928, but the two Export companies were the principal reporting companies during their respective lives, in the consolidated returns filed for 1928 and the two periods constituting 1927. No specific request was made of the Commissioner*1185 of Internal Revenue by the petitioners, or any of their affiliated corporations, for permission to change the basis of filing their income tax returns for 1927 or 1928, nor was such permission specifically granted by the Commissioner. The respondent determined that the filing of separate returns for the year 1926 by Export of New Jersey and Williams constituted an election to file returns on a separate basis, in accordance with section 240(a) of the Revenue Act of 1926; and that, inasmuch as permission had not been granted to change from the separate basis to the consolidated basis of filing returns, the corporations, affiliated in 1927 and 1928, should have filed separate returns for those years. He computed the tax liabilities of the petitioners for the year 1928 on the basis of separate returns, and determined the contested deficiency against each. OPINION. LEECH: The sole issue here is whether the petitioners, together with Brown & Williamson and Brown & Williamson Sales, are entitled to have their income taxes for the calendar year 1928 computed on a consolidated basis. The applicable statutory provisions are practically identical sections, 240(a) of the Revenue Act*1186 of 1926, 1 and 142(a) of the Revenue Act of 1928. 2 *1187 *34 Since Export of New Jersey and Williams were affiliated throughout 1926, under the provisions of section 240(d) of the Revenue Act of 1926, Regulations 69, article 632, each had the privilege to elect whether to file its income tax return for that year upon a separate or a consolidated basis. Each filed upon and therefore elected the separate basis of return. This election was binding upon both for every return made thereafter for any taxable period, under either of the cited statutory provisions, during that affiliation unless permission to change such basis was had from the Commissioner. ; certiorari denied, ; ; affd., ; ; ; ; ; *1188 . The same affiliation continued until November 30, 1927, except for the addition of Brown & Williamson on March 16 of that year. But such addition, we have held, does not result in a new right of basis election, at least where the same parent existed, as here, ; Cf. , reversing . In the first cited case, after carefully reconsidering the question, this Board respectfully refused to follow the decision of the Third Circuit Court of Appeals in , and reiterated its earlier decision. Regulations 74, article 731, 3 promulgated under the Revenue Act of 1928, construes the "return" for 1927, authorizing the same basis of return for 1928, to mean a proper return. This construction does not change that approved under the cited and pertinent sections of the preceding revenue act. *1189 ;. The filing of consolidated returns is a right existing only by grant of Congress upon certain conditions set out in the revenue acts, following that of 1918, extending it. Cf. section 141, Act of 1934, abolishing such returns except by railroad companies. Likewise is its complement - the right to change basis of return. *35 If the word as here used means anything other than proper return, this right, granted, by the cited provision, solely upon permission of the Commissioner of Internal Revenue, would*1190 not be a right, the existence of which depended wholly upon the law creating it, but where affiliation was present, as here, it would be an absolute and unconditional right, the exercise of which nothing but the pleasure of the taxpayer would control. Such construction would nullify the purpose of the act and render it meaningless - a result repugnant to the well established canons of statutory construction. ; . The mere filing of a consolidated return did not establish the necessary permission to so file. ;; Since no permission to change the 1926 basis of return was secured from the Commissioner of Internal Revenue, it follows that the consolidated return of Export of New Jersey and Brown & Williamson, for the period January 1 to November 30, 1927, had no other legal effect for tax-computing purposes than that of separate returns and, a fortiori, were not the returns contemplated by the cited*1191 provision necessary to base consolidated returns for the succeeding taxable period. ;;; ; The same reasoning and precedents apply with equal force to the status of the affiliation existing from December 1 to December 31, 1927, and the consolidated returns filed by Export of Delaware and Brown & Williamson for that period. Although unnecessary to these conclusions, it is observed that, under the cited statutory provisions, the rule is well recognized which prevents a consolidated return by an affiliation where one of the affiliates has filed a separate return for the same taxable period, as Williams did here for 1927, Southern Power Co. (now ; affd., ; certiorari denied, ; ; *1192 ;. True, this rule has been held not to include a case where such separate return was filed by a nonactive corporation without income (), but we think it doubtful on reasoning and authority to so treat the result of the 1927 return of Williams, an active corporation having a comparatively small but nevertheless substantial income. *36 The unavoidable result of these conclusions, under section 142(a) of the Revenue Act of 1928, supra, is that the respondent was right in refusing to compute the income taxes of petitioners and their affiliates for 1928 upon a consolidated basis, as returned, unless, as argued by petitioners, (1) a new right of election of basis resulted to the affiliation from the addition in that year of Brown & Williamson Sales on June 5, or Smith on October 8, British-American remaining throughout the year the parent corporation; or (2) the execution of agreements under section 606 of the Revenue Act of 1928 4 constituted retroactive permission by the Commissioner to change the basis of*1193 return for 1927 so as to make the return filed the proper return necessary to base the consolidated return made for 1928, or by reason of such agreements themselves the respondent is barred now from raising the question of propriety of the returns made for 1927. *1194 The anser to petitioners' first position is necessarily in the negative, based upon the same reasons and authorities as those upon which our conclusions as to the status of the affiliation and the returns therefor for 1927 were based. Petitioners' second contention is without merit also. It must be remembered we are considering here the question of the existence of a statutory conditional right. Cf. , and petitioners, to enjoy its advantages, must bring themselves clearly within the specified conditions precedent to its grant. . Since the filing of the consolidated returns for 1927 on June 15, 1928, without the permission of the Commissioner, had the effect only of separate returns, at that date, obviously, under section 142(a) of the Revenue Act of 1928, supra, the only legal method of computing the tax liabilities to which those returns were directed was upon a separate basis for each member of the affiliation. The obligations, *37 thus definitely fixed by statute, could not thereafter be changed by any action of the Commissioner. *1195 ; ;. Cf. . The execution of the several agreements under section 606 of the Revenue Act of 1928, supra, occurred a year and a half after the consolidated return involved herein was filed. Cf. , reversing . These agreements, authorized only, as in the present case, by the Commissioner, with the approval of the Secretary of the Treasury, are localized and limited in their operations by the statute, through which, alone, they are possible, to tax liabilities for definite periods covered therein. Neither the cited statutory provision permitted nor the instruments executed thereunder here included any agreement binding either party thereto to recognize any element necessary to the computation of a tax liability for 1928, and thus permit the perpetuation of a palpable error. The present agreements closed certain tax liabilities for periods within 1927 and nothing*1196 else. The method used in computing the amounts of those liabilities for that year, whether proper or otherwise, could not and did not conclude the respondent in his computation of these disputed tax liabilities for 1928. ; ; ; . The contested deficiencies are approved. Judgment will be entered for the respondent. Footnotes 1. 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. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is granted by the Commissioner. ↩ 2. SEC. 142. (a) Consolidated returns permitted.↩ - Corporations which are affiliated within the meaning of this section may, for the taxable year 1928, 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. If return for the taxable year 1927 was made upon either of such bases, return for the taxable year 1928 shall be upon the same basis unless permission to change the basis is granted by the Commissioner. 3. Consolidated returns of affiliated corporations for 1928. - Affiliated corporations as defined in section 142(c) may for the taxable year 1928 make separate returns or make a consolidated return in which will be reported the consolidated net income of the affiliated corporations, except that if a return for the taxable year 1927 was properly made↩ upon either of these bases, the return for the taxable year 1928 must be made upon the same basis unless permission to change is granted by the Commissioner. * * * 4. SEC. 606. CLOSING AGREEMENTS. (a) Authorization. - The Commissioner (or any officer or employee of the Bureau of Internal Revenue, including the field service, authorized in writing by the Commissioner) is authorized to enter into an agreement in writing with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal-revenue tax for any taxable period ending prior to the date of the agreement. (b) Finality of agreements. - If such agreement is approved by the Secretary, or the Undersecretary, within such time as may be stated in such agreement, or later agreed to, such agreement shall be final and conclusive, and, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact - (1) the case shall not be reopened as to the matters agreed upon or the agreement modified, by any officer, employee, or agent of the United States, and (2) in any suit, action, or proceeding, such agreement, or any determination, assessment, collection, payment, abatement, refund, or credit made in accordance therewith, shall not be annulled, modified, set aside, or disregarded. (c) Section 1106(b) of the Revenue Act of 1926 is repealed, effective on the expiration of 30 days after the enactment of this Act, but such repeal shall not affect any agreement made before such repeal takes effect. ↩