Swayne Lumber Co. v. Commissioner

*335 This proceeding was brought for the redetermination of a deficiency in income and profits taxes for the year 1920, amounting to $10,439.31.

The petitioner alleges as error the refusal of the respondent to include in statutory invested capital the entire capital stock of the Truckee Lumber Company, an affiliated company, "or at least the excess of assets acquired over the liabilities assumed."

At the hearing the petitioner specifically limited the issue to the question whether or not the respondent erred in failing to include in the consolidated invested capital of the petitioner and its subsidiaries the approximate sum of $175,000, being the amount by which an unpaid loan made by Southern Pacific Company to Butte and Plumas Railway Company and Truckee Lumber Company was reduced by a compromise settlement.

FINDINGS OF FACT.

The petitioner is a corporation, with its principal place of business in San Francisco, California. On the 6th day of December, 1916, the petitioner entered into an agreement with the West Side Lumber Company and the*1542 Truckee Lumber Company, by which the petitioner for a valuable consideration acquired from the West Side Lumber Company all of the 10,000 shares of the capital stock of the Truckee Lumber Company. The last named company owned all of the capital stock of the Butte and Plumas Railway Company. The agreement of December 6, 1916, recited, among other things, that the Truckee Lumber Company was the owner of timber lands and a lumber manufacturing plant situated in Butte and Plumas Counties in the State of California, and that the Butte and Plumas Railway Company connected the Truckee Company's sawmill at Orrville with the latter company's timber lands and timber situated in Butte County. The agreement also recited that there were outstanding *336 bonds issued by the Truckee Lumber Company in the principal sum of $299,000 and bearing interest at the rate of 6 per cent per annum. It was also recited that the Truckee Lumber Company was indebted to the Southern Pacific Company upon nine promissory notes, aggregating the principal sum of $400,000, exclusive of interest, which notes had been executed and delivered to the Southern Pacific Company by the Truckee Company and the Butte*1543 and Plumas Railway Company, and that the Truckee Company was further indebted to the Southern Pacific Company in the sum of $40,000 on account of cars purchased by the Truckee Company from the Southern Pacific Company. As part consideration for its acquisition of the capital stock of the Truckee Company the petitioner assumed and undertook "jointly and severally with the Truckee Company to pay, satisfy and discharge" within five years from the date of the agreement the bonded indebtedness of the Truckee Company, amounting to $299,000. The agreement contained the following paragraphs, among others:

3. The Swayne Company also agrees to assume and, jointly and severally with the Truckee Company, to pay, satisfy and discharge the indebtedness of said Truckee Company to the Southern Pacific Company amounting to the sum of $420,000, as hereinabove mentioned, provided that, by and with the consent or approval of the West Side Company and Truckee Company, arrangements may be made, within thirty days from this date, with the consent of the Southern Pacific Company, to take care of said indebtedness in some satisfactory manner; otherwise this agreement shall be null and void.

4. At*1544 the expiration of five years from the date hereof, or from and after the time when said bonded indebtedness of the Truckee Company shall have been satisfied and discharged, if the same shall be so satisfied and discharged prior to the expiration of said period of five years from this date, the Swayne Company shall become liable to pay to the West Side Company, or its assigns, at the times hereinafter provided, the sum of Two Dollars and Fifty Cents ($2.50) per thousand feet, as and when the timber may be cut from the lands now owned by the Truckee Company, including the lands described in said mortgage, until such payments so made shall amount in the aggregate to the sum of Seven Hundred and Fifty Thousand Dollars ($750,000.), or until all of the merchantable lumber, as hereinafter defined, shall have been cut from said lands, if at such latter time all of the payments called for by this contract to be made to the West Side Company shall have been made but shall not have aggregated said sum of $750,000.

The West Side Lumber Company agreed to assume and pay all the debts and obligations of the Truckee Company appearing in the latter's books at the date of the agreement other than*1545 its bonded indebtedness and its indebtedness to the Southern Pacific Company. Paragraph 15 of the agreement is, in part, as follows:

The Truckee Company shall mortgage and pledge all of its property, real and personal, including all of the stock of the Butte and Plumas Railway Company, as security for its own obligations and the obligations of the Swayne Company herein provided for, to the West Side Company. The Swayne Company shall also pledge to the West Side Company all of the stock of the *337 Truckee Company, as security for the obligations of the Swayne Company hereunder, but said shares of stock shall stand on the books of the Truckee Company in the name of the Swayne Company, and the Swayne Company shall have the right to vote all of said stock at all meetings, * * *

After the execution of the agreement of December 6, 1916, and in accordance with the provisions of paragraph 3 thereof, hereinbefore quoted, the petitioner entered into negotiations with the Southern Pacific Company for the purpose of effecting a satisfactory arrangement to take care of the indebtedness of the Truckee Company and the Butte and Plumas Railway Company, amounting approximately to the*1546 sum of $420,000 with accrued interest. On April 27, 1917, the petitioner, the Butte and Plumas Railway Company and the Southern Pacific Company duly executed an agreement in writing in settlement of the indebtedness referred to. In March, 1917, however, the petitioner, through its officers, had entered upon and taken possession of the properties owned by the Truckee Lumber Company and the Butte and Plumas Railway Company. At the dates of the agreements of December 6, 1916, and April 27, 1917, respectively, the property of the Butte and Plumas Railway Company had not been used for six or seven years and was in bad condition. The settlement agreement of April 27, 1917, contained the following recitals, among other things:

The Butte and Plumas Railway Company and the Truckee Lumber Company jointly executed nine promissory notes, payable to Southern Pacific Company aggregating the principal sum of $400,000.00, each of said notes bearing interest upon said principal sum at the rate of 4% per annum from the date specified therein. The notes were delivered to the Southern Pacific Company pursuant to the terms of a certain agreement between the Truckee Lumber Company and the Southern*1547 Pacific Company dated June 15, 1910, and secured by a mortgage dated June 8th, 1910, executed by the Butte and Plumas Railway Company to the Southern Pacific Company which mortgage was recorded in the County Recorder's office of the County of Butte on July 7, 1910 in Book 58 Page 466 of Mortgages. No part of either the principal or interest of said nine promissory notes, or any of them, have been paid, except the first year's interest upon the notes dated respectively June 15, 1910, July 13, 1910, August 11, 1910, September 16, 1910, October 16, 1910, November 18, 1910, and the interest due during the first six months upon the notes dated December 17, 1910, January 18, 1911 and February 18, 1911; the principal sum of each and all of said promissory notes, together with the remainder of the interest thereon, as provided in said notes, is now due and owing to the Southern Pacific Company and unpaid. On September 1, 1911 the Truckee Lumber Company executed a promissory note payable to the Southern Pacific Company in the sum of $21,210.00, said note bearing interest upon said principal sum at the rate of 6% per annum from March 1, 1911, on each installment. On January 31, 1912 $1,000.00*1548 was paid upon the principal sum of said note; there is now due and owing on said note $20,210.00 together with interest on $21,210.00 from March 1, 1911 to January 31, 1912 and interest on $20,210.00 from January 31, 1912.

*338 In the contract of April 27, 1917, the petitioner and the Butte and Plumas Railway Company agreed to execute and deliver to the Southern Pacific Company their promissory note for $250,000, bearing interest at the rate of 5 per cent per annum and payable, together with interest on deferred payments, as follows: $15,000 in the month of December of each of the years 1918, 1919 and 1920 and $27,500 each year thereafter until the whole principal sum should be fully paid. It was further agreed that as security for the payment of the note the Butte and Plumas Railway Company would execute and deliver a mortgage in favor of the Southern Pacific Company, creating a first lien on all property of the mortgagor then owned or thereafter acquired. The Southern Pacific Company, on its part, agreed that upon delivery of the note and mortgage it would satisfy and discharge the mortgage dated June 8, 1910, referred to in the recitals of the agreement of April 27, 1917, hereinbefore*1549 quoted, and would cancel the Truckee Company's note dated September 1, 1911, which was in the amount of $21,210.

The settlement agreement of April 27, 1917, was carried out according to its terms.

In the income and profits-tax return for the year 1920 filed by the petitioner, the consolidated invested capital of the petitioner and its affiliates, the Truckee Lumber Company and the Butte and Plumas Railway Company, is stated as $1,499,962.35. In the deficiency notice which was dated July 11, 1927, reference was made to "Bureau letter dated January 22, 1927," and that letter was admitted in evidence at the hearing of this proceeding for the sole purpose of showing "how the Commissioner arrived at the deficiency." In Bureau letter dated January 22, 1927, which relates to the taxable years 1919 to 1922, inclusive, it is stated that "revenue agent's report dated February 1, 1926, has been made the basis of this examination." The statutory invested capital of the petitioner and affiliates for the year 1920 was computed in the Bureau letter as follows:

*1550 OPINION.

VAN FOSSAN: The petitioner contends that there should be included in consolidated invested capital for the year 1920 the amount by which the indebtedness of the Truckee Lumber Company and the Butte and Plumas Railway Company to the Southern Pacific Company *339 was reduced as a result of the contract between the petitioner, the Butte and Plumas Railway Company and the Southern Pacific Company. The petitioner refers to the amount of the reduction as $275,000 and states in its brief that this sum was necessarily entered as surplus on the books of account of the Truckee Company and the Butte and Plumas Railway Company and therefore must be considered as additional invested capital. No proof of such an entry was offered. The figure quoted is evidently in error - the difference between the loan and interest and the settlement figure being approximately $175,000.

Under the provisions of section 326 of the Revenue Act of 1918, which are applicable to this proceeding, "invested capital" means cash or property at its actual cash value, bona fide paid in for stock or shares, and also certain paid-in or earned surplus, not including surplus and undivided profits earned*1551 during the taxable year. The respondent computed the consolidated invested capital for the taxable years in the sum of $499,962.43, as stated in Bureau letter dated January 22, 1927. This amount is practically identical with the face value of petitioner's outstanding capital stock at the end of the year 1919, as shown in its income and profits-tax return for 1920, plus its prorated cash receipts from additional capital stock sold during 1919.

With the exception of the tax return and the Bureau letters, very little evidence of the facts revealed by the accounts of the several companies was offered by petitioner. A tax return showing certain figures is not proof of the correctness or even the existence of records. None of the books of account of either of three corporations, the operations of which are involved in this proceeding, were introduced in evidence. No witness testified as to the contents of such books. There is no evidence from which we can determine whether prior to January 1, 1920, the petitioner and its affiliated corporations had an earned surplus or an operating deficit. It can not be determined as a fact whether the amount of the reduction in indebtedness hereinbefore*1552 referred to had ever been entered in the books of account as surplus, nor can it be determined whether, if such amount was so entered, it had been diminished or altogether extinguished by a deficit in the operating account. Moreover, since it appears affirmatively in the evidence that at the date of the acquisition by petitioner of the capital stock of the Truckee Lumber Company the property of the Butte and Plumas Railway Company had not been used for several years and was in bad condition, it is fairly inferable that between December, 1916, the year of petitioner's acquisition of the capital stock of the Truckee Lumber Company and the end of 1919 there had been operating losses of a considerable amount.

The fact that petitioner filed a tax return indicating certain invested capital provies little or nothing with respect to the issue *340 before us. Respondent has allowed certain invested capital. The burden was on petitioner to prove the error, if any, in this allowance. It must submit all facts necessary to enable us to reach a conclusion on the issue joined. This it has failed to do, although attention was specifically directed to that fact at the hearing and, on*1553 suggestion of the respondent after petitioner had concluded its case, opportunity was afforded to adduce additional evidence. Proof of essential facts can not be left to speculation and conjecture. Being unable to determine, because of insufficient evidence, whether or not the amount of petitioner's consolidated invested capital was in excess of the amount computed by the respondent, we hold against petitioner.

Judgment will be entered for the respondent.