West Huntsville Cotton Mills Co. v. Commissioner

*1216 These are proceedings for the redetermination of deficiencies in income and profits taxes as follows:

Docket No. 18741, for the fiscal year ended August 31, 1918, in the amount of $10,725.16, which represents the rejected portion of a claim for abatement;

Docket No. 18743, for the fiscal year ended August 31, 1918, in the amount of $1,933.18, which represents the rejected portion of a claim for abatement; and

Docket No. 17843, for the period from May 20, 1919, to August 31, 1919, and for the fiscal year ended August 31, 1920, in the amounts to $204.55 and $1,130.51, respectively.

*1217 The proceedings were consolidated for hearing and decision, and all issues were settled by stipulation of the parties, except the issue involving affiliation of the petitioners, and except that upon redetermination of the deficiencies in accordance with our opinion herein, if the petitioners so*1992 desire, further proceedings will be had under Rule 62(c).

FINDINGS OF FACT.

The petitioner, West Huntsville Cotton Mills Company, is an Alabama corporation with its principal place of business at Huntsville. It was organized in 1892, with an authorized capital stock of $50,000, divided into 500 shares of the par value of $100 each. During the taxable years, this corporation was engaged in the business of manufacturing cotton yarn.

The petitioner, Huntsville Warehouse Company, is an Alabama corporation with its principal office at Huntsville. It was organized in 1895, with an authorized capital stock of $25,000 divided into 500 shares of the par value of $50 each.

The cotton mills company was organized primarily for the purpose of manufacturing cotton yarn. No warehouse was provided for the storage of cotton at the time of its organization. Later, the directors decided that it was advisable to incorporate a separate company to operate a warehouse, and accordingly the warehouse company, one of the petitioners herein, was organized for the purpose of providing a storage house for cotton to be manufactured in the mills, and also to provide a medium for the purchase of*1993 cotton and to operate a cotton gin for the ultimate benefit of the mills. The warehouse company also operated a fertilizer and feed business. From the date of organization of the warehouse company down to and through the taxable years, the same individuals comprised the directors and officers of the two corporations.

The warehouse company built its warehouse on the block adjoining that occupied by the cotton mills. Shortly thereafter, a cotton gin, connected with the mills and the warehouse, was built. A small fertilizer and feed industry, operated by the warehouse company, was established in a separate location about three blocks away. All operations of both companies were controlled by one manager through a single office. T. W. Pratt was secretary and treasurer of both corporations from 1899 to 1928, in which latter year he died. He was actively in charge of the affairs of both companies throughout said period.

The plants of the cotton mills company and of the warehouse company were physically connected by a track running from the *1218 mills to the warehouse, so that cotton could be moved directly from the warehouse into the mills. After the cotton gin was built, *1994 an overhead flume was constructed from the gin condenser to the warehouse bin so that the cotton after ginning could be passed through the flume by air process directly into the mills.

The issued and outstanding stock of the cotton mills company was owned and held during the taxable years as follows:

The issued and outstanding stock of the warehouse company was owned and held during the taxable years as follows:

The petitioner, West Huntsville Cotton Mills Company, during the fiscal year ended August 31, 1918, paid to T. W. Pratt, its president and secretary, the sum of $6,525.86 as salary for said year, and is entitled to deduct said amount from its gross income for said year.

*1219 The petitioner, Huntsville Warehouse Company, is entitled to deduct from gross income for the fiscal year ended August 31, 1919, the sum of $3,600 paid to T. W. Pratt, its president and treasurer, as salary for said year.

OPINION.

TRAMMELL: The issues relating to salary deductions have been settled by stipulation of the parties, in accordance with which we have found that the petitioner, West Huntsville Cotton Mills Company, is entitled to deduct from its gross income for the fiscal year ended August 31, 1918, the amount of $6,525.86 on account of salary paid in said year to T. W. Pratt, its president and secretary. The allowance of said amount is in lieu of a deduction of $15,000 claimed by the petitioner and $3,600 allowed by the respondent.

As stipulated by the parties, we have found that the petitioner, Huntsville Warehouse Company, is entitled to deduct from*1996 gross income for the fiscal year ended August 31, 1919, the amount of $3,600 on account of salary paid in said year to T. W. Pratt, its president and treasurer, which is the amount allowed by the respondent. No other deductions for salary are claimed by or allowable to either petitioner, and the deficiencies will be recomputed accordingly.

This leaves for decision here the single issue whether or not the petitioner corporations were affiliated during the taxable years within the meaning of section 240(b) of the Revenue Act of 1918, which provides that:

(b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated * * * (2) if substantially all of the stock of two or more corporations is owned or controlled by the same interests.

The respondent determined that the corporations were affiliated during the first taxable year, that is, the fiscal year ended August 31, 1918, and computed the deficiency for said year on the basis of a consolidated return. The respondent determined that the corporations were not affiliated during the fiscal years ended August 31, 1919, and 1920, and computed the deficiencies for those years on the basis of*1997 separate returns.

The petitioners allege that either they were not affiliated during any of the taxable years or were affiliated during all of the taxable years, and contend that if the respondent was correct in forcing consolidation for 1918, which resulted in an increased tax liability, then, since there was no change in stock ownership or control during the two remaining taxable years, they are entitled as a matter of right to such benefits as result from having their tax liability computed for those years on a consolidated basis also.

*1220 The issue being raised as to the correctness of the respondent's determination respecting affiliation in 1918, we may not merely examine the record to determine whether or not there was any change in stock ownership or control in the subsequent years. The action of the Commissioner in requiring affiliation for 1918 is presumed to be correct, but affiliation for 1919 and 1920 can not be established by estoppel of the Commissioner on account of his action in a prior year. The precise question presented here is whether or not "substantially all of the stock" of the two corporations was "owned or controlled by the same interests" *1998 during all of the taxable years.

In many respects, the evidence adduced is unsatisfactory in so far as it bears on the issue above stated. The stock record books of the two corporations were offered in evidence. They were in a confused state and from them it is difficult to determine the facts as to stock ownership during the respective years, but a statement of the stock ownership of each corporation was made up from the books. These statements, the parties stipulated, correctly set forth the ownership of the stock in the taxable years as disclosed by the stock books. From these statements, we have set forth in our findings of fact the names of the stockholders of each company, the number of shares shown to have been owned by each during each of the taxable years, and the percentages of the outstanding stock so standing in the names of such persons.

In addition, the petitioners offered the testimony of the witness Stanley on the question of stock ownership. This witness became connected with the corporations in 1899, and has been with them continuously to the present time. Originally he was the bookkeeper, and later office manager, for both companies. He testified that*1999 the stock books disclosed the true ownership of the stock of the petitioners during the taxable years "absolutely," but also testified contrary to the books and the stipulated statements as to their contents. A portion of his testimony is as follows:

Q. Now, I will ask you whether shortly after this [beginning of the first taxable year] Mr. Pratt acquired the shares of Messrs. Coons, Winright and Fenhagen too?

A. No, he acquired, as I understand it, he acquired the shares of most of these long before this.

A. That is what I am wondering too. He must have had Winright's long before this.

It appears that the witness was testifying from a memorandum apparently inconsistent with the books which had been made up by some undisclosed person, and that he, the witness, had no personal knowledge on the subject. The witness stated that he had "never had charge of the certificate books," and was not familiar with the *1221 contents of those records. We do not think that this witness' testimony, which is contrary to the book records and statements taken therefrom, is entitled to weight, since he had no personal knowledge*2000 of the facts.

The stock book of the cotton mills company shows that certain certificates were canceled, the dates of cancellation not being shown, and that the stock was not thereafter reissued. Other certificates are shown merely to have been canceled and the dates of cancellation not shown. However, the record does not establish that the stock book of either company is in any wise incorrect, but only incomplete in the particulars mentioned. In finding the facts, we have accepted these records as establishing the ownership of the stock of the petitioners during the taxable years, in so far as definitely shown. We can not assume that stock shown by the certificate book to have been canceled was canceled subsequent to the taxable years, nor can we assume or find that canceled stock was reissued, or that any assignments were made, in the absence of some evidence. On the question of the relationship of the parties the witness was asked a question which purported to set forth certain relationships between the parties, but it does not appear that the witness answered the question or even intended to affirm the statement.

*2001 Affiliation is a question of fact and a statutory status, the determination of which depends upon the evidence in each case, and must be determined separately for each year. , and authorities there cited.

In , we discussed at length the question of what constitutes "control" of corporate stocks and what constitutes "the same interests" within the meaning of the taxing statute. There we reviewed many of the court decisions on the subject and referred to our own prior decisions. And, in the light of the facts disclosed by the evidence before us in the present proceedings, a discussion in detail of these points is not deemed necessary here.

The record shows that during the fiscal years ended August 31, 1918, and August 31, 1919, C. D. Fenhagen owned 125 shares or 42.38 per cent of the total outstanding stock of the cotton mills company, and did not own any stock in the warehouse company. During the fiscal year ended August 31, 1920, Fenhagen owned 75 shares or 30.47 per cent of the outstanding stock of the cotton mills company, and no stock in the warehouse company.

*2002 During the fiscal years ended in 1918 and 1919, Gordon M. Buck owned 125 shares or 25 per cent of the stock of the warehouse company, and did not own any stock in the cotton mills company. During the fiscal year 1920, Buck owned no stock in either company. *1222 During all three fiscal years, J. Coons and R. A. Pratt each owned 25 shares or a total of 10 per cent of the warehouse company's stock, but owned no stock in the cotton mills company. Thus, during 1918 and 1919, 35 per cent of the warehouse company stock was owned by persons who held no stock in the other company. During those same years, 42.38 per cent of the cotton mills company's stock was owned by a person who held no stock in the warehouse company. And it is not shown that the stock standing in the names of these persons was "controlled" in any manner by anyone else.

Most of the remaining stockholders did not own the same percentage of stock in each company. For example, in 1918, T. W. Pratt owned 13.56 in one corporation and 31.6 in the other. Emma Pierce owned 18.65 in the one and 8.4 in the other. The record fails to show the relation of these persons to each other and does not disclose any facts*2003 from which we can determine whether or not they constituted "the same interests." But, if it be true that all of the holders of stock in both companies together constituted "the same interests," yet they owned and/or controlled in the years 1918 and 1919 only 65 per cent of the outstanding stock of the one company and 57.62 per cent of the stock of the other. Under no theory approved by the courts or accepted in our prior decisions could it be said that these facts establish that "substantially all" of the stock of these two corporations was "owned or controlled by the same interests" in 1918 or 1919.

During the fiscal year ended in 1920, the percentages of stock owned by holders common to both companies was somewhat higher, amounting to approximately 69.53 in one company and 90 in the other. However, in the absence of any facts from which we can determine what persons constituted "the same interests," we can not say that the respondent erred in holding that the petitioners were not affiliated in said year. We can not say that the above percentages of stock ownership constitute ownership of substantially all the stock in both corporations, nor does the evidence establish control*2004 of minority stock not owned.

We hold, therefore, that the petitioners were not affiliated within the meaning of the statute during any of the taxable years involved.

In reaching this conclusion, we have carefully considered the opinion of the Court in , and we think the instant case on the facts is clearly distinguishable therefrom.

In the Pelican case Behre and his family owned more than 95 per cent of the ice company's stock and they owned or controlled directly or indirectly through their holdings in the ice company, 90 per cent of the cold storage company's stock, if the stock held by Edenborn *1223 be not considered. The Court found that Edenborn held his stock as security for the amount he had advanced upon the purchase price of certain land, and that he could not sell his stock to an outsider without the consent of Behre and his family.

No such situation is presented in the case at bar. As pointed out above, if we regard all the holders of stock in both companies here as constituting "the same interests," they owned or controlled in 1918 and 1919 only 65 per cent of the stock in one*2005 company and 57.62 per cent in the other. In 1920, the holders common to both companies held 90 per cent of the stock in the one and 69.53 in the other. We can not conclude, therefore, as did the Court in the Pelican case, that "substantially all" of the stock in these two corporations was held during the taxable years by "the same interests."

The petitioners having raised the issue that the respondent failed to use proper comparatives in determining the profits tax under the provisions of section 328 of the Revenue Act of 1918, and all other issues having been disposed of herein, unless the parties agree upon the correct amount of the deficiencies recomputed in accordance with this opinion,

Further proceedings will be had under Rule 62(c).