Court Opinion

ID: 4612669
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:51:39.84212+00
Date Added: 2024-06-11T07:54:28.879466
License: Public Domain

HUGHES TOOL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hughes Tool Co. v. CommissionerDocket No. 90002.United States Board of Tax Appeals40 B.T.A. 963; 1939 BTA LEXIS 771; November 28, 1939, Promulgated *771  1.  The portions of a year prior and subsequent to affiliation constitute one taxable year and a net loss sustained by an affiliate prior to affiliation, adjusted by the consolidated income for that portion of the year in which a consolidated return is made, is deductible from consolidated net income of the succeeding year, under article 41(c) of Regulations 75.  2.  Under article 41(c) the deduction is limited to the cost or aggregate basis of the stock and a claim received as a dividend from one subsidiary against another and later canceled and remitted as a contribution to capital, in the absence of evidence of its value, does not serve to increase the cost or aggregate basis of the stock acquired in effecting the affiliation.  3.  Article 41(c) is a valid exercise of authority conferred on the Commissioner by section 141 of the Revenue Act of 1928.  J. L. Lockett, Esq., for the petitioner.  R. P. Hertzog, Esq., for the respondent.  ARNOLD *963  This case involves a deficiency in income tax asserted by the Commissioner for the year 1930 in the amount of $104,743.36.  The question presented for our determination is petitioner's*772  right to deduct from 1930 consolidated income, without limitation, a net loss sustained by the Caddo Co. from January 1 to December 12, 1929, inclusive, a period prior to its affiliation with petitioner, without adjustment for income realized by the affiliated group from December 13 to 31, 1929, inclusive.  *964  In its consolidated return for 1930 petitioner claimed a statutory net loss deduction of $801,790.88, all of which was disallowed by the Commissioner.  By agreement of the parties this amount was reduced to $728,415.87.  Two other specifications of error were assigned, one of which petitioner abandoned, and as to the other the parties have agreed that the Commissioner erred in his computation representing salaries and compensation paid to officers and employees during the year 1930, to the extent of $105,255.09.  This will be adjusted under Rule 50, pursuant to the stipulation of the parties on that issue.  The principal facts on the issue presented were stipulated.  FINDINGS OF FACT.  Petitioner is a Delaware corporation having its principal office in Houston, Texas.  During the calendar years 1929 and 1930 and until November 12, 1936, it conducted its business*773  under the corporate name of "Hughes Industries Company, Ltd." On November 12, 1936, its corporate name was changed to "Hughes Tool Company," under which name it has since been carrying on its business.  Prior to its change of name a corporation known as "Hughes Tool Company," now out of existence, was a wholly owned subsidiary of the Hughes Industries Co., Ltd.  Preliminary discussions leading up to the corporate action set forth in the stipulation of facts were held by the officers of the companies involved in the affiliated group, and action was informally agreed upon in 1929.  The stipulated facts are as follows: On October 31, 1929, Petitioner (then under the name Hughes Industries Company, Ltd.) acquired through a nontaxable exchange with Howard Hughes, twenty-five (25) shares of capital stock of The Caddo Company, Inc., which company had a total of 100 shares authorized and outstanding capital stock of par value $100.00 per share.  Said 25 shares of stock had been acquired by Howard Hughes under his father's will and before transfer to Petitioner, were held on a basis of no value.  On Petitioner's books said shares were set up at a value of $2,500.00.  On December 13, 1929, Petitioner*774  (then under name of Hughes Industries Company, Ltd.) acquired at a cost of $5,000.00 fifty (50) shares of capital stock of The Caddo Company, Inc.  The remaining 25 shares of stock of The Caddo Company, Inc. was from December 13, 1929 to December 19, 1929 (both dates inclusive) owned by Hughes Tool Company (not Petitioner, but a Company now out of existence, but then a wholly owned subsidiary of Petitioner).  On December 20, 1929, said Hughes Tool Company (not Petitioner but its aforementioned subsidiary) transferred to Petitioner said 25 shares of stock of The Caddo Company, Inc., through the medium of a dividend declared *965  December 12, 1929, payable December 20, 1929.  Said shares were on Petitioner's books, assigned a nominal cost of $50.00.  On and immediately prior to December 23, 1929, said Hughes Tool Company (not Petitioner but its above mentioned subsidiary) had on its books an account against The Caddo Company, Inc., in the aggregate amount of $2,500,000.00, (plus interest thereon to December , 1929, $79,881.94, aggregating $2,579,881.94) representing cash advances theretofore, from time to time, made by said Hughes Tool Company; on December 12, 1929, said Hughes*775  Tool Company (not Petitioner) declared a dividend (separate from dividend of same date above mentioned) in the aggregate sum of $3,000,000.00, payable December 20, 1929; payment of said dividend to the extent of $2,579,881.94, was made to Petitioner (then owner of all stock of said Hughes Tool Company) by transfer of said account of $2,579,881.94, owing to Hughes Tool Company by The Caddo Company, Inc.  Entry on Petitioner's account books reflecting said transfer was dated December 31, 1929; entry on account books of said Hughes Tool Company (not Petitioner) was dated January 2, 1930.  Exhibit A. hereto attached is a true copy of the transcript of said account as shown on books of said Hughes Tool Company.  April 30, 1930, an entry was made on the books of Hughes Industries Company, Ltd. charging "capital stock of subsidiaries" with $2,579,881.94, a corresponding amount being credited to the account of "The Caddo Company, Inc."; the explanation in the journal of Petitioner reads as follows: "The amount of their indebtedness to the Company as of date December 31, 1929, contributed to the capital stock of The Caddo Company." On July 7, 1930, the Board of Directors of Hughes Industries, *776  Ltd. adopted a formal resolution as follows: "WHEREAS, this corporation is the owner and holder of all the subscribed and issued capital stock of The Caddo Company, Inc. a corporation organized and existing under and by virtue of the laws of the State of Louisiana; and WHEREAS, said The Caddo Company, Inc. was on January 1, 1930, indebted to this corporation in the sum of Two Million Five Hundred Seventy Nine Thousand, Eight Hundred and Eighty One Dollars and ninety four cents ($2,579,881.94), as shown by the books of this corporation; and WHEREAS, the conduct of the business of said The Caddo Company, Inc. will be facilitated by the cancellation of said indebtedness and the consequent increase of the net worth of said corporation, and it is therefore for the best interests of this corporation that action to that end be taken; NOW THEREFORE, BE IT RESOLVED; that the indebtedness of The Caddo Company, Inc. to Hughes Industries Co. Ltd. amounting to the sum of Two Million, Five Hundred Seventy Nine Thousand, Eight Hundred Eighty One Dollars and Ninety four cents ($2,579,881.94) as at January 1, 1930, be and the same is hereby forgiven, remitted and cancelled.  RESOLVED, FURTHER, *777  that the President or a Vice President and the Secretary of this corporation be and they are hereby authorized and directed, in the name and under the seal of this corporation to execute and deliver to said The Caddo Company, Inc. such instrument or instruments and to perform such other act or acts as may be necessary and/or desirable to evidence and render fully effective this resolution." For the period January 1, 1929 to December 12, 1929 (both dates inclusive) The Caddo Company, Inc. filed a separate income tax return on the basis of actual receipts and disbursemtnts; its statutory net loss for that period as shown after Respondent's audit of its return and books was $728,415.87.  *966  For the period December 13, 1929 to December 31, 1929 (both dates inclusive) a consolidated return was filed for Petitioner (then Hughes Industries Company, Ltd.) and its affiliated companies, including The Caddo Company, Inc.; in which there was taken into account loss (in the sum of $42,365.11) of The Caddo Company for the period December 13-31, 1929, but in which no effect was given to The Caddo Company's, Inc. loss for the period in 1929 to and including December 12; that consolidated*778  return, after audit by Respondent, showed a taxable income of $141,828.10 (no effect being given to loss of The Caddo Company, Inc. for the period January 1 to December 12, 1929).  Petitioner and its subsidiary companies, Hughes Tool Company (a Texas corporation), Hughes Development Company, Ltd., Hughes Tool Company of California, Ltd., and The Caddo Company, Inc. listed in the statement accompanying respondent's aforesaid deficiency notice, were during the entire year 1930 affiliates within the meaning of Section 141 of the Revenue Act of 1928, and elected to make and did make and file by and through Petitioner (then known and designated as Hughes Industries Company, Ltd.) the parent corporation of said affiliated group, a consolidated return of net income, and did agree that any income tax for the year 1930 should be assessed against and paid by said parent corporation.  Each of the subsidiary corporations above mentioned did, in respect of income for the year 1930, execute and cause to be filed in duplicate as required by Respondent, form 1122, "Authorization and Consent of Subsidiary Corporation Included in a Consolidated Income Tax Return and Return of Information." OPINION. *779  ARNOLD: Petitioner contends that it is entitled to carry forward as a deduction from 1930 consolidated income the net loss of $728,415.87 sustained by the Caddo Co., from January 1 to December 12, 1929, a period prior to affiliation, without adjustment for taxable income of $141,828.10 realized by the affiliated group from December 13 to December 31, 1929, for which period a consolidated return was filed.  It further contends that the cost or aggregate basis of its Caddo stock was increased $2,579,881.94 by a contribution to capital of the Caddo Co. made under the following circumstances: Said amount was received by petitioner as part of a $3,000,000 dividend declared December 12, payable December 20, 1929, by the Hughes Tool Co. then a wholly owned subsidiary of petitioner, in the form of a claim of said Hughes Tool Co. against the Caddo Co., transfer of the claim to petitioner being reflected by entry on petitioner's books December 31, 1929, and on the books of the Hughes Tool Co. January 2, 1930, which amount was charged by petitioner to "capital stock of subsidiaries", and credited to the account of the Caddo Co. by entry on petitioner's books on April 30, 1930, and forgiven, *780  remitted, and canceled by resolution of petitioner's board of directors on July 7, 1930.  Respondent contends that the cost or aggregate basis of the Caddo Co. stock is $5,000 and can not be increased by the remission or cancellation *967  of the claim against the Caddo Co., as a contribution to capital stock of the Caddo Co.; that article 41(c) of Regulations 75 limits the allowable deduction to the cost or aggregate basis of the Caddo stock in the hands of petitioner and, since the consolidated net income for that portion of 1929 covered by the consolidated return was in excess of $5,000, there is no statutory net loss carryover deductible from 1930 consolidated income.  Petitioner assails Commissioner's construction and the validity of the regulation and contends that the regulation exceeds the authority conferred on the Commissioner by section 141(b) of the Revenue Act of 1928.  Section 117(a) of the Revenue Act of 1928 defines net loss as the excess of the deductions allowed by this title over the gross income, with certain exceptions not here material.  Section 117(b) provides that, if for any taxable year it appears upon the production of evidence satisfactory*781  to the Commissioner that a taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year and, if such net loss is in excess of such net income, the excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year under regulations prescribed by the Commissioner.  Section 141(a) of the same act gives affiliated corporations the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year in lieu of separate returns.  Such privilege is upon the condition that all corporations which have been members of the affiliated group at any time during the taxable year for which the return is made shall consent to all the regulations under subsection (b) prescribed prior to the making of such return, and the making of a consolidated return shall be considered as such consent.  In the case of a corporation which is a member of the affiliated group for a fractional part of the year the consolidated return shall include the income of such corporation for such part of the year as it is a member of the affiliated group.  *782  Section 141(b) of the act empowers the Commissioner, with the approval of the Secretary, to prescribe such regulations as he may deem necessary in order that the tax liability of an affiliated group making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be determined, computed, assessed, collected, and adjusted in such manner as clearly to reflect the income and to prevent avoidance of tax liability.  Section 141(c) provides that where a consolidated return is made the tax shall be determined, computed, assessed, collected, and adjusted in accordance with the regulations under subsection (b) prescribed prior to the date on which such return is made.  *968  Pursuant to section 141(b) the respondent, with the approval of the Secretary, promulgated article 41(c) of Regulations 75, which was in effect prior to the time the consolidated return covering the latter part of 1929 was filed.  The regulation is as follows: (c) Net Loss Sustained by Separate Corporation Prior to Consolidated Return Period.A net loss sustained by a corporation prior to the date upon which its income is included in the consolidated*783  return of an affiliated group (including any net loss sustained prior to the taxable year 1929) shall be allowed as a deduction in computing the consolidated net income of such group in the same manner, to the same extent, and upon the same conditions as if the consolidated net income were the income of such corporation; but in no case in which the affiliated status is created after January 1, 1929, will any such net loss be allowed as a deduction in excess of the cost or the aggregate basis of the stock of such corporation owned by the members of the group.  (d) Taxable Year.Any period of less than 12 months for which either a separate return or a consolidated return is filed, under the provisions of article 13, shall be considered as a taxable year.  Under the authority of ; ; ; and , that portion of the year for which a separate return is made and that portion of the year for which a consolidated*784  return is made are to be considered as one taxable year, notwithstanding article 41(d) of Regulations 75 to the contrary.  The authorities cited do not sustain petitioner's contention that the entire net loss sustained by Caddo, Inc., for the period in 1929 prior to affiliation should be carried over as a deduction from 1930 consolidated income unaffected by the consolidated income realized during the affiliated period in 1929.  Under section 117(b) the net loss carry-over allowable as a deduction from consolidated income of the succeeding year is the net loss sustained for the taxable year, not for a portion of the taxable year.  Prior to the enactment of the Revenue Act of 1928 a consolidated group had no right to carry over a net loss sustained by one of the affiliates prior to the affiliation as a deduction against income of an affiliated group.  That was a privilege first granted by section 141(a) and it was limited to corporations making consolidated returns for the taxable year 1929 and thereafter.  Petitioner and Caddo could have filed separate returns had they so desired.  Petitioner, having elected to file a consolidated return for that portion of 1929 during affiliation*785  and for 1930, consented to the regulations prescribed and was bound thereby. ; . By *969  filing a consolidated return it consented that its income should be computed in the same manner, to the same extent, and upon the same conditions as if its income were the income of the Caddo Co.  As the two periods in 1929 constitute one taxable year and under the regulations the consolidated income is to be treated as the income of Caddo, it follows that Caddo's loss of $728,415.87 sustained from January 1 to December 12, 1929, should be reduced by $141,828.10, the amount of taxable income realized during the affiliated period of 1929, making the net loss carry-over to the subsequent year $586,587.77.  Cf. . In , we held article 41(c) of Regulations 75 a valid exercise of authority conferred upon the Commissioner by section 141 of the Revenue Act of 1928.  The particular question before the Board there was the validity of that portion of the regulation which*786  limits the allowable deduction to the cost or aggregate basis of the stock of a subsidiary of the parent where affiliation was effected subsequent to January 1, 1929.  Petitioner says that, while the taxpayer there questioned the authority of the Commissioner to promulgate the regulation, it was not pointed out to the Board in what particular the Commissioner exceeded his authority, and attempts to supply that omission.  It is argued that as the limitation in the regulation is applicable only to groups affiliated after January 1, 1929, the regulation is discriminatory in that it does not apply to all corporations and Congress did not indicate an intention to impose a limitation on some and not on all.  The purpose of the regulation in limiting the amount of the deduction to the cost or aggregate basis of the stock is to make it profitless to acquire stock or outstanding claims of a distressed, insolvent, or bankrupt corporation and gain the benefit of deductions in excess of what is paid.  ; *787 The incentive or opportunity to escape tax liability through the acquisition of claims against impaired or bankrupt corporations did not exist where affiliation was effected prior to January 1, 1929, as no right existed prior thereto to carry forward net losses of an affiliate as a deduction from consolidated income in succeeding years.  The regulation removes the incentive by limiting the amount of the deduction.  It prevents the avoidance of tax liability, which Congress clearly intended when it empowered the Commissioner to prescribe regulations to that effect by section 141(b).  The courts and this Board have condemned attempts to escape tax liability under different circumstances, , and cases there cited, and this regulation was specifically intended to *970  prevent tax avoidance in effecting affiliations.  We think the reasoning and conclusions of the Board in , are a sufficient answer to petitioner's argument and need not here be restated. We, therefore, hold that article 41(c) of Regulations 75 is a valid exercise of authority*788  conferred upon the Commissioner by section 141 of the Revenue Act of 1928.  Having concluded that the regulation is a valid exercise of authority by the Commissioner, under which whatever deduction petitioner is entitled to shall first be applied against the consolidated income realized in that portion of 1929 for which a consolidated return was filed, it becomes necessary to determine the cost or aggregate basis of petitioner's stock in the Caddo Co.  The affiliation of petitioner and the Caddo Co. was effected by the acquisition of all the capital stock of the Caddo Co., consisting of 100 shares.  Fifty shares had no cost basis in petitioner's hands, and 50 shares were acquired at a cost of $5,000.  Petitioner's contention that its forgiveness, remission, and cancellation of its claim against the Caddo Co. resulted in an increase in the cost or aggregate basis of its Caddo Co. stock to the extent of the amount of the claim, $2,579,881.94, is without merit.  The claim against the Caddo Co. was received as a dividend from its wholly owned subsidiary, the Hughes Tool Co.  It does not appear that petitioner paid anything for it nor is there any evidence in the record that the claim*789  had any value either at the time it was received or when it was canceled.  It may have been worthless, as the Caddo Co. had net losses in 1929, prior and subsequent to affiliation, of $728,415.87 and $42,365.11, respectively, and a net loss in 1930, according to the deficiency notice, of $1,555,872.40.  If the claim was worthless its forgiveness, remission, and cancellation would not in any manner be a contribution to capital nor would it increase the cost or aggregate basis of the Caddo Co. stock in petitioner's hands.  In the absence of proof of value of the claim so remitted and charged to capital of the Caddo Co., none can be assigned.  Cf. Edward Mallinckrodt, Jr;, et al., . We, therefore, hold that the cost or aggregate basis of petitioner's stock in the Caddo Co. is $5,000 and that amount is deductible from 1930 consolidated income.  Reviewed by the Board.  Decision will be entered under Rule 50.