Court Opinion

ID: 4592194
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:07:24.096816+00
Date Added: 2024-06-11T07:50:49.372661
License: Public Domain

BISHOP TRUST COMPANY, LIMITED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bishop Trust Co. v. CommissionerDocket Nos. 81625, 87102.United States Board of Tax Appeals36 B.T.A. 1173; 1937 BTA LEXIS 617; December 21, 1937, Promulgated 1937 BTA LEXIS 617">*617  1.  An affiliated group held to include a corporation all the shares of which are directly owned by another, notwithstanding that the shares were acquired when the subsidiary was in financial difficulty, its liabilities exceeded the value of its assets, and a plan of liquidation was in contemplation, and that it had losses after such acquisition which offset gains of the parent and served to reduce consolidated taxable income.  2.  Contributions by a corporation to a community bureau of government research are not deductible as business expenses without a showing of business benefits reasonably expected to result directly from the contribution.  Urban E. Wild, Esq., Milton Cades, Esq., and E. R. Cameron, C.P.A., for the petitioner.  Arthur H. Fast, Esq., and Henry L. Young, Esq., for the respondent.  STERNHAGEN 36 B.T.A. 1173">*1173  The Commissioner determined deficiencies of $35,588.66, $15,290.39, and $16,888.38 in the petitioner's income taxes for 1931, 1932, and 1933, respectively.  Petitioner assails the ruling that a corporation of which it owned all the stock was not within the affiliated group, and further assails the disallowance of a deduction1937 BTA LEXIS 617">*618  of contributions made each year to the Hawaii Bureau of Governmental Research.  Other issues were settled by stipulation.  FINDINGS OF FACT.  Petitioner, an Hawaiian corporation with principal office at Honolulu, Territory of Hawaii, was organized in 1906, and has been since engaged in a trust and agency business in Hawaii.  At various times it has acquired and held the stock of other corporations engaged in 36 B.T.A. 1173">*1174  a similar business.  During 1931, 1932, and 1933, affiliated with it were the Guardian Trust Co., Ltd., the Pacific Trust Co., Ltd., the Bishop Insurance Agency, Ltd., the First National Building Co., Ltd., the Honolulu Bond & Mortgage Co., Ltd., the Honolulu Holding Co., Ltd., and from July 18, 1932, the Hawaiian Properties, Ltd.  For the said years, petitioner, as the parent corporation, filed consolidated income tax returns for itself, the above affiliates, and also the Henry Waterhouse Trust Co., Ltd., the Kaimuki Land Co., Ltd., and P.E.R. Strauch. Ltd.  1.  The Henry Waterhouse Trust Co., Ltd., (herein called the Waterhouse Co.) was an Hawaiian corporation organized in 1902.  It was engaged in a trust and agency business in Hawaii until its merger into1937 BTA LEXIS 617">*619  petitioner on December 30, 1933, and from February 14, 1931, until the merger it was the owner of all the capital stock of the Kaimuki Land Co., Ltd., and of P.E.R. Strauch, Ltd., Hawaiian corporations.  In 1925 petitioner's manager proposed to the secretary of the Waterhouse Co. that the Waterhouse shareholders, who were few in number, sell all of their stock to petitioner.  No sale resulted from these negotiations because the parties could not agree upon a price, but the secretary informally promised the manager that if such a sale should be later contemplated, petitioner would be given the first opportunity to buy.  At the end of November 1930 such purchase was again suggested by petitioner's manager to the president of the Waterhouse Co., but without success.  In the middle of the previous October, the Waterhouse Co. had increased its capital stock from $200,000 to $400,000, consisting of 4,000 shares of a par value of $100 each.  The new shares were all taken by the old shareholders, who paid for them in cash at par.  In November the effects of the general business depression began to be felt in Hawaii, and as the Waterhouse assets consisted of real estate and mortgages, its1937 BTA LEXIS 617">*620  secretary became apprehensive that if many calls should be made on its demand accounts the company's financial condition would not be sufficiently liquid to meet its requirements of cash.  He discussed the situation with the treasurer and auditor, and then advised petitioner's manager that a sale of the stock might be arranged, suggesting a price of $100 each, or more, for the shares.  Petitioner thereupon made an investigation of the Waterhouse Co.'s condition.  On its books, the value of its assets appeared as $4,820,090.92, total liabilities, exclusive of capital and surplus, appeared as $4,149,437.06, and its capital and surplus appeared as $769,567.94 (of which $98,914.08 was later written off, as will hereinafter appear).  It was estimated that $3,739,287.77 could be realized on the assets.  It was then suggested that the Waterhouse Co. raise sufficient funds to assure its liquidity.  The Waterhouse Co.36 B.T.A. 1173">*1175  was conducting business as usual, but was encountering some financial difficulties; economic conditions were not clear, and after the investigation petitioner's executives wished to look further into the matter before acting.  After February 1, 1931, petitioner1937 BTA LEXIS 617">*621  advised the Waterhouse shareholders that it would not pay cash for their shares, but that it would guarantee the company's existing obligations if the Waterhouse Co. would procure responsible parties to promise to lend it $400,000 on its notes bearing 4 percent annual interest.  Eight corporations and individuals promised loans aggregating the required amount.  They were moved to make these loans either by long personal interest in the Waterhouse Co. or through an interest in avoiding the serious effect upon Hawaii's general financial condition of a collapse of the Waterhouse Co.  Petitioner further insisted that two of the shareholders who were indebted to the Waterhouse Co. for $733,914.08, as shown by its books, pay $535,000 in cash and convey certain properties to it for a credit of $100,000, and that the remaining $98,914.08 be written off.  All the prescribed conditions were met, and on February 13, 1931, petitioner was advised that all the shares were available.  On Saturday, February 14, petitioner's president made the following statement to its board of directors, as recorded on the minutes: This is a special meeting called to consider a proposition to take over the Henry1937 BTA LEXIS 617">*622  Waterhouse Trust Co., Ltd.  At first it was a proposition to purchase the stock of that company, somewhat as we purchased the stock of the Pacific Trust Co., but as a result of investigation, it changed largely to a salvage proposition.  The plan now is for our Company to acquire all the stock of the Waterhouse Trust Co. without cost; for Mr. and Mrs. R. W. Shingle and Mr. A. N. Campbell, in settlement of their indebtedness to the Company, to pay into it $535,000.00 and to convey to its order their respective 18% and 10% undivided interests in certain land, fish ponds and fishery at Kalihi, the same to be sold for $87,000.00 and the proceeds, with $13,000.00 additional contributed by the Bishop Trust Co., to make up an even $100,000.00, to be paid into the Waterhouse Trust Co., making in all $635,000.00 thus paid in.  In addition, a number of corporations and individuals are to contribute various sums aggregating $400,000.00, thus making altogether $1,035,000.00 of cash to be paid into the Waterhouse Trust Co.  The Bishop Trust Co. is to pay such amount, if any, as may be required in addition to enable the Waterhouse Trust Company to meet its liabilities, but it is hoped that no1937 BTA LEXIS 617">*623  such contribution will be required.  That, however, remains to be seen.  The Bishop Trust Co. is to take over, without other cost, the business of the Waterhouse Trust Co., other than the assets and liabilities, and to operate such business at its own expense and for its own benefit.  This will include the trusts, executorships, agencies, insurance, safe deposit business, etc., with the necessary furniture, equipment and supplies therefor.  It is hoped also that the Bishop Trust Co., will profit through making new contacts.  The stock and bond and real estate departments will probably be discontinued.  36 B.T.A. 1173">*1176  The assets and liabilities of the Waterhouse Trust Co. are to be gradually liquidated by applying the assets to the liabilities, together with the expenses of liquidation, including $1,000.00 a month to be paid to the Bishop Trust Co. for supervision.  In final settlement, if there is an excess of assets over liabilities, it is to be applied, first, to the reimbursement of the amount, if any, that may be contributed by the Bishop Trust Co. in addition to the $1,035,000.00, and, secondly, pro rata to the contributors of the $400,000.00 with simple interest at 4%, and, 1937 BTA LEXIS 617">*624  thirdly, the balance, if any, to go to the Bishop Trust Co.There are three objects: First, to prevent the failure of such a company as the Waterhouse Trust Co., with the consequent general disastrous effects; secondly, to prevent loss on the part of many who have entrusted their money to the Company for investment and who can ill afford the loss; and, thirdly, to enable the Bishop Trust Co. to acquire new business.  These three objects naturally appeal with different degrees of force to different groups of contributors.  The management recommends that the Bishop Trust Co., join in the plan.  The plan, as outlined, was approved by the board of directors and consummated.  The Waterhouse shareholders transferred their 4,000 shares of stock to petitioner, and on February 16 a new board of directors and new officers were elected, most of whom were petitioner's officers.  A committee of three members, representing and appointed by the lenders, was created to assist in an advisory capacity, with no power of control, and was at times consulted.  The Waterhouse Co. continued to do business, first at its old offices and later at offices in the Bishop Trust Co. Building.  By identical1937 BTA LEXIS 617">*625  letters to all the lenders of the $400,000 loan, the Waterhouse Co., over its officers' signatures and the approving signatures of petitioner's officers, outlined the future plan, as follows: * * * 5.  The Bishop Trust Co., Ltd., will take over, own and operate at its own expense and for its own benefit, in its own name or in the name of the Henry Waterhouse Trust Co., Ltd., the business * * * other than the assets subject to the liabilities (referred to in paragraph 6) of the Henry Waterhouse Trust Co., Ltd.  Any of the business, so taken over by the Bishop Trust Co., Ltd., may by it be discontinued, sold or merged with its other business.  6.  The assets and liabilities of the Henry Waterhouse Trust Co., Ltd., will gradually be liquidated by applying the assets or their proceeds and the income therefrom to (a) the expenses involved in such liquidation * * *; (b) $1,000.00 per month to the Bishop Trust Co., Ltd., for overhead or supervision; (c) interest payable; (d) indebtedness; and (e) other liabilities, if any.  The assets shall be deemed to include cash on hand, bank deposits, notes and accounts receivable, stocks and bonds, stock exchange seat, and furniture, equipment1937 BTA LEXIS 617">*626  and supplies (except as otherwise provided in paragraph 5) owned by the Henry Waterhouse Trust Co., Ltd., at the close of business on February 14, 1931, and the sums since paid or to be paid in as set forth in paragraphs 2, 3 and 4 [relating to the Shingle and Campbell debt settlement; the $400,000 loan and petitioner's guaranty of obligations]; the liabilities shall be deemed to include all liabilities of the Company as of that date, and liabilities subsequently incurred 36 B.T.A. 1173">*1177  in connection with the liquidation; the expenses of operation shall be deemed to include, besides other items, the cost of investigation by accountants preliminary to the reorganization, the cost of an audit of the Company's affairs and of the set-up of the accounting system at the outset by accountants, a proper pro rata of salaries of officers and employees of the Bishop Trust Co., Ltd., transferred temporarily for the reorganization, rehabilitation and readjustment of the affairs of the Henry Waterhouse Trust Co., Ltd., at the outset and a proper pro rata of the salaries of officers and employees of the Henry Waterhouse Trust Co., Ltd., so long as their services are rendered in part in connection1937 BTA LEXIS 617">*627  with the liquidation and in part in connection with the business taken over by the Bishop Trust Co., Ltd.  * * * 7.  In final settlement, the excess, if any, of the assets as defined in paragraph 6 or their proceeds and the income therefrom over the payments specified in paragraph 6 is to be applied, so far as it will go, in following order of priority: First, to reimbursing the Bishop Trust Co., Ltd., for such amount, if any, without interest as may be contributed by it under paragraph 4 above; secondly, to paying pro rata, principal and interest, the notes mentioned in paragraph 3, and, thirdly, the balance, if any, of such excess to be paid to the Bishop Trust Co., Ltd.8.  The Henry Waterhouse Trust Co., Ltd., may from time to time borrow money (from the Bishop Trust Co., Ltd., and/or others) to meet its requirements in connection with the liquidation and repay the same with interest.  * * * As recorded on petitioner's minutes of May 29, 1931, the vice president, manager, and a director of the Waterhouse Co. stated to petitioner's board of directors that the operation of the Waterhouse business was causing a monthly loss "as it is in the nature of a receivership." He added1937 BTA LEXIS 617">*628  the belief that "the bulk of the work in straightening out the affairs of the Company will be accomplished within a year or two." At a meeting of June 26, 1931, he advised the board that: * * * he had made a recommendation to the Bishop Trust Company of a transfer of all of the work of the Waterhouse Trust Company directly to the Bishop Trust Company, with the exception of the collection agency end of the business.  At the same time he stated his belief that petitioner would suffer no loss if business should again become normal, and suggested that by filing a consolidated income tax return, including the Waterhouse losses, petitioner could effect a substantial saving in taxes.  Petitioner did in fact take over some of the Waterhouse business, but the Waterhouse Co. continued to do some business until it, the Guardian Trust Co., Ltd., and the Pacific Trust Co., Ltd., were formally merged into petitioner on December 30, 1933.  By virtue of the $400,000 loaned and petitioner's guaranty, the Waterhouse Co. was able to meet all of its obligations.  From and after February 14, 1931, petitioner owned directly all of the stock of the Henry Waterhouse Trust Co., Ltd.  36 B.T.A. 1173">*1178 1937 BTA LEXIS 617">*629  2.  In 1932 and 1933, petitioner contributed to the Hawaii Bureau of Governmental Research $250 and $225, respectively, and the Pacific Trust Co., Ltd., contributed $150 and $75, respectively.  This bureau was organized as an Hawaiian corporation in 1928, * * * with the object and purpose of acting as a non-political, non-profit-making citizens' agency for securing the highest obtainable degree of efficiency and economy in the Territory of Hawaii, through investigating, collecting, classifying, studying and interpreting facts concerning the powers, duties, actions, limitations, methods and problems of the several departments of government, and making such information available to public officials and citizens, and promoting the development of a constructive program for the said Territory and each county, city and county and other political subdivision thereof that shall be based upon adequate knowledge and consideration of community needs thereby encouraging economy and efficiency in the conduct of public business in order that the tax payers may be assured of full return value in services rendered for taxes paid and money spent in governmental cost; * * * The bureau was organized1937 BTA LEXIS 617">*630  by representatives of local business firms, and membership was made available to any taxpayer of Hawaii upon a contribution of not less than $10 a year.  In operation the bureau offers gratuitous advice and assistance to the governor and governmental bureaus and agencies, usually at their request; it studies and devises plans designed to effect efficiency and economy in governmental administration; analyzes proposed legislation and makes recommendations thereon to the legislature; and supplies interested organizations, such as churches and chambers of commerce, and groups of citizens with information and counsel on proposed legislative measures.  It has no "political aspect." Typical of its activities are a survey and suggested revision of the administrative organization of Maui County, made in 1933, and an analysis of income tax returns, made in 1934 at the request of an advisory committee on taxation, to determine the ability to pay of various taxpayers.  The bureau is supported entirely by its members' voluntary contributions, which range from $10 to $10,000 a year.  An attempt is made to interest all the people of the Territory in it, and make it a citizens' agency.  Contributions1937 BTA LEXIS 617">*631  are made by corporations, individuals, and chambers of commerce.  Definite amounts are requested of the several members, apportioned on the basis of taxes paid, but each member is free to give what he wishes, and some contribute at intervals longer than one year or sporadically.  About 75 percent of its receipts are paid by corporations.  OPINION.  STERNHAGEN: 1.  The principal question in issue is whether the petitioner was entitled to include the Henry Waterhouse Trust Co., 36 B.T.A. 1173">*1179  Ltd., in its consolidated return under the Revenue Acts of 1928 and 1932, sec. 141.  This it was entitled to do if the Waterhouse Co. was within the affiliated group as defined in subdivision (d). 1 The petitioner included the Waterhouse Co. as a party to its consolidated return, and the Commissioner ruled against the affiliation in the following language: The question of affiliation was considered again and the revenue agent was sustained in the disallowance of the loss of the Henry Waterhouse Trust Company, Limited, for the period February 15, 1931, to December 31, 1931, as a deduction in the computation of the consolidated net income for the reason that the companies are held to be not affiliated; 1937 BTA LEXIS 617">*632  also for the further reason that the loss was sustained prior to the period February 15, 1931, to December 31, 1931.  The facts in your case show that the Henry Waterhouse Trust Company, Limited, was hopelessly insolvent at the time the stock of that corporation was turned over to you, and was held only for the purpose of liquidation; therefore, you and the Henry Waterhouse Trust Company, Limited, are held to be not affiliated during the period February 15, 1931, to December 31, 1931.  The "further reason" is now disavowed by the respondent and it is stipulated1937 BTA LEXIS 617">*633  that the loss was sustained after February 14, 1931.  The petitioner claims that on February 14, 1931, it acquired all of the Waterhouse stock in fact and in law and continued to own it thereafter until the merger at the close of 1933; that this is squarely within the language of the statute defining an affiliated group; and that it is therefore entitled to file a consolidated return covering that corporation.  The respondent does not dispute that petitioner was the record owner of the shares after February 14, 1931, but for various reasons disputes the application of the statute.  The evidence provides in detail the history and circumstances of the transactions, all of which were described by credible witnesses.  It is free from doubt, and there has been none to resolve in making the findings.  That all the Waterhouse shares were owned directly by petitioner is a fact indubitable in the record and is therefore categorically found.  If the statute means what it says, the finding decides the case.  The respondent asserts that the shares were acquired by petitioner without cost and therefore not by purchase; that in reality petitioner did not own them, but only held the formal1937 BTA LEXIS 617">*634  legal title as a means of achieving liquidation for the equitable owners, among whom were 36 B.T.A. 1173">*1180  the contributors to the $400,000 loan, who, rather than petitioner, controlled the situation; that petitioner was a sort of trustee or agent; and there is a suggestion that the whole plan was factitious and shaped artificially to enable petitioner to reduce its taxes.  The argument is hard to follow.  Most of it is beside the point.  Affiliation is purely a statutory matter, and it must be administered with a close adherence to the statutory language.  Ownership and control of the shares mean juristic and not practical or economic ownership and control, ; ; ; and are equally effective when the subsidiary corporation is being liquidated, ; 1937 BTA LEXIS 617">*635 ; or is commercially unsuccessful, ; or inactive, ; ; and when the subsidiary's shares are under pledge, ; or its properties leased for a long term, 2The evidence gives no ground for finding a trust, or an agency, or that petitioner's acquisition was not by purchase, or that its ownership was qualified or partial, or that liquidation was the sole or primary purpose of the acquisition, or that tax reduction was a motive.  Hence it is unnecessary to consider a construction of the statute to apply to such situations.  There was no acquisition of a subsidiary for the sake of its prior net losses within the condemnation of the Woolford Realty decision.  The clear implication1937 BTA LEXIS 617">*636  of that decision is that the losses of one affiliate are available to offset taxable net income of another if sustained during the period of affiliation - which is the situation here.  , is wholly inapplicable unless it is to be read as disapproving any construction of a statutory term like reorganization or affiliation which recognizes a lower tax.  That case revealed a sham, and the Court disregarded the mask and dealt with realities; but, as in , it can here be said, "The present record discloses no such situation; nothing suggests other than a bona fide business move." The Commissioner's determination denying affiliation was in error.  2.  The petitioner deducted the contributions made in 1932 and 1933 to the Hawaii Bureau of Governmental Research.  The deductions were held by the Commissioner not to be allowable, and the 36 B.T.A. 1173">*1181  petitioner argues that they are ordinary and necessary expenses of carrying on its business.  In order to succeed in this contention, the evidence must support a finding that the contributions were made to promote the petitioner's1937 BTA LEXIS 617">*637  business and that they could be reasonably expected to result directly in a business benefit.  ; ; certiorari denied, ; . Such a finding can not, however, be made from the evidence.  The question is not whether the Bureau of Governmental Research is such an organization as is exempt from tax or contributions to which by individuals are deductible as donations.  Whether it is such an organization need not, therefore be decided.  The question is whether the petitioner's contributions are made for the sake of benefits to be derived, whether such benefits may reasonably be expected to result, and, if so, whether the result is direct.  A general benefit to the community as a whole does not support the deduction.  That kind of benefit is the most that can be inferred from the present record, and the respondent's determination is therefore sustained. 1937 BTA LEXIS 617">*638 Judgment will be entered under Rule 50.Footnotes1. (d) DEFINITION OF "AFFILIATED GROUP." - As used in this section an "affiliated group" means one or more chains of corporations connected through stock ownership with a common parent corporation if - (1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations.  As used in this subsection the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. ↩2. See Law of Federal Income Taxation, Paul and Mertens, vol. 4, ch. 38, VI § 38.73 et seq.↩