Court Opinion

ID: 4595193
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:14:32.434003+00
Date Added: 2024-06-11T07:51:23.800695
License: Public Domain

FARMERS & MERCHANTS BANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Farmers & Merchants Bank v. CommissionerDocket No. 35009.United States Board of Tax Appeals21 B.T.A. 1383; 1931 BTA LEXIS 2195; January 28, 1931, Promulgated 1931 BTA LEXIS 2195">*2195  1.  From the evidence, held that the petitioner and an association operated under the name of the Stockholders Investment Fund should be treated as separate taxable entities and the loss of the Stockholders Investment Fund is not the loss of petitioner.  2.  Inasmuch as the Stockholders Investment Fund transacted no business in 1925 and was not required to file a return for that year as an association doing business as a corporation, the statutory net loss of the consolidated group for 1924 is not a proper deduction from gross income of the petitioner for the year 1925.  3.  Held that the respondent was in error in refusing to allow the petitioner to deduct from gross income for the year 1925 its own statutory net loss for the year 1924.  George W. Roberts, Esq., for the petitioner.  T. M. Mather, Esq., for the respondent.  BLACK 21 B.T.A. 1383">*1383  In this proceeding the petitioner seeks a redetermination of its income tax liability for the calendar year 1925, for which year the respondent has determined a deficiency in the amount of $1,864.68.  The petitioner alleges that the respondent erred in treating the Stockholders Investment Fund as a1931 BTA LEXIS 2195">*2196  separate taxable association and in refusing to treat its losses as the losses of petitioner and/or if the Stockholders Investment Fund was a separate taxable association, the respondent erred in refusing to allow petitioner to bring forward the consolidated statutory net loss of the affiliated group for 1924 and use it as a deduction in computing petitioner's net income for 1925; and as an alternative petitioner urges that the respondent erred in refusing to allow as a deduction from gross income in 1925 the statutory net loss sustained by the petitioner in 1924.  FINDINGS OF FACT.  The petitioner is a banking corporation duly organized under the laws of the State of Washington, with its office in Walla Walla, in that State.  In 1915 the petitioner declared a cash dividend of $65,000, which was paid to the Stockholders Investment Fund, an association, which was created at that time by an agreement entered into by all the stockholders of the petitioner, the pertinent parts of which agreement read as follows: That there be created a Stockholders Investment Fund by the Board of Directors of said bank, on the 12th day of January 1915, and placed in the 21 B.T.A. 1383">*1384  name of the Cashier1931 BTA LEXIS 2195">*2197  of said bank, as trustee, and his successor, by the declaration of a dividend of $65,000, to be held for the stockholders of said bank in proportion to their holdings of stock.  That thereafter on the second Tuesday of January of each year (after paying the regular dividends, which the Directors may declare each year) the said Directors may, at their option, declare an additional dividend from the earnings of said bank and add the same to the above established fund until the amount of said fund shall reach the sum of $200,000.  That the trustees of said fund shall be the executive committee of the bank, and their successors in office, and their execution of this agreement shall constitute their acceptance of this trust.  That the trust hereby created shall continue for a period of ten years from the 12th day of January 1915, unless sooner terminated by the unanimous consent of the stockholders of said bank interested in said fund, and on said termination such fund and all additions or accretions thereto shall be distributed to the stockholders interested in said fund as their respective interests may appear: Provided, however, it shall be the duty of said trustees to notify all1931 BTA LEXIS 2195">*2198  parties interested in said fund six months before the expiration of this agreement, of the condition of said fund, the necessity of its maintenance, or otherwise, and ascertain if it is desired by those interested in said fund that the time of this agreement shall be further extended.  The said fund shall, at all times, be inseparably appurtenant to the shares of stock of said bank, and the interest of such stockholders therein shall, at all times, be inseparably appurtenant to the shares of stock in said bank owned by the stockholders.  The sale and assignment of stock in said bank shall be deemed to transfer a pro rata share of interest in said fund to the purchaser or assignee of the stock sold or assigned, whose interest in said fund so acquired shall, in all things, be subject to the terms of this agreement, to the same effect and in the same manner as though such purchaser or assignee of said stock were a party to this agreement.  Any sale or agreement to sell, or attempt to sell any interest in such fund, except by sale of stock in said bank, to which it is appurtenant, shall be void.  The Stockholders Investment Fund was paid additional funds out of stockholders' dividends, 1931 BTA LEXIS 2195">*2199  amounting to $20,000 and $15,000, on January 11, 1918, and January 31, 1919, respectively, thus raising its capital from $65,000 to $100,000.  From the time of its creation the Stockholders Investment Fund was under the control of the executive committee of the petitioner.  Its books of record consisted of a general ledger, a liability ledger, and a check record.  No meetings of the Stockholders Investment Fund were held and no officers elected.  The Stockholders Investment Fund was operated profitably from 1915 and paid dividends to its shareholders until the early part of 1923.  On January 27, 1923, the petitioner received the following letter from a State bank examiner: Gentlemen: Below is given a list of objectionable assets found in your bank on this date.  These items require your special attention and must be adjusted in accordance with the requirements of this department.  Schedule A assets to be charged off with a list totaling $96,055.11.  21 B.T.A. 1383">*1385  On October 25, 1924, a similar letter was received by the petitioner ordering it to charge off assets in the amount of $54,311.46.  From the date of the receipt of the first letter from the State Banking Department, 1931 BTA LEXIS 2195">*2200  the petitioner treated the Stockholders Investment Fund as a sort of a reserve for bad debts, the capital and surplus accounts of the petitioner being insufficient to stand the charge-off, and it was considered inexpedient to assess the stockholders of the bank.  During the years 1923 and 1924 there were transferred from the petitioner to the Stockholders Investment Fund notes and accounts aggregating $149,037.07, which the bank examiner had ordered charged off.  In exchange for these notes and accounts, assets of the same book value, but having a much greater actual value, were transferred from the Stockholders Investment Fund to the petitioner.  The notes transferred were not endorsed.  The transfer consisted of changing the notes from the pouches of the petitioner to those of the Stockholders Investment Fund.  The assets remained in the possession of the executive committee of the petitioner, who continued to handle them from the petitioner's office.  On October 8, 1923, the executive committee of the petitioner passed the following resolution: The Cashier made a report on the condition of the Stockholders Investment Fund, showing the former book value of this fund as $104,452.71, 1931 BTA LEXIS 2195">*2201  actual value, loss $74,112.88.  Motion prevails that this loss be charged off, and that a resolution be recommended to the directors at the regular meeting Tuesday, reducing the capital of the Stockholders Investment Fund from $100,000 to $30,000.  As a result of the reduction of the capital of the Stockholders Investment Fund, the sale value of stock in Farmers & Merchants Bank decreased $45 per share.  The petitioner continued to use the Stockholders Investment Fund as a dumping ground for its bad paper until December, 1924, when, on December 8, $25,000 worth of assets were sold for cash to the Central Finance Co. and the proceeds of the sale were used to take up additional bad paper of the petitioner.  As a result of these transactions, by December 31, 1924, the assets of the Stockholders Investment Fund were reduced to three cents which were reflected in a deposit account with the petitioner.  The Stockholders Investment Fund transacted no business in 1925 and was formally dissolved by action of the stockholders of the petitioner at their annual meeting held January 13, 1925.  The parties hereto have stipulated the following facts: That petitioner had a statutory net loss for1931 BTA LEXIS 2195">*2202  the year 1924 of $10,855.69 and that the Stockholders Investment Fund had a statutory net loss for 1924 of $39,024.25.  That in the year 1923 the Stockholders Investment Fund deducted as a loss on account of notes purchased from the petitioner the amount of $66,384.32 and in the year 1924 21 B.T.A. 1383">*1386  there was deducted as a loss on the books of the Stockholders Investment Fund on account of notes purchased from the petitioner the amount of $35,244.21, and to this amount was added a loss of $2,799.38 on other notes and an additional loss of $4,557.60 on account of real estate purchased from the petitioner.  For all years up to and including 1922 the petitioner maintained that the Stockholders Investment Fund was a separate concern and protested the inclusion of the earnings of the fund with the petitioner.  For the year 1923 a consolidated return was filed.  The consolidation was disallowed by the respondent because permission had not been granted to change from separate to consolidated returns.  Consolidated returns were filed in 1924 under the provisions of article 632 of Regulations 65, which permitted taxpayers to make separate or consolidated returns irrespective of the basis1931 BTA LEXIS 2195">*2203  on which returns were filed prior to that year.  This return showed a consolidated net loss for 1924 of $49,880.34.  For the year 1925 petitioner filed its individual corporation income tax return showing its income and expenditures during 1925 and claiming thereon the consolidated statutory net loss for 1924 of the petitioner and the Stockholders Investment Fund.  OPINION.  BLACK: The petitioner's principal contention is that the respondent erred in treating the Stockholders Investment Fund as a separate taxable entity; that it was really a part of petitioner's business; that instead of being a separate entity it was only a department of the Farmers & Merchants Bank; and that its losses on the bad paper transferred to it by the bank were in fact the losses of the bank.  We can not accept this view.  These losses were ultimately the losses of the shareholders of the Investment Fund and merely because they happened to be the same persons as the stockholders of the bank does not make their losses the losses of the bank.  In fact the bank, as a corporate entity, was the gainer by the transactions.  It traded bad paper for good.  There can be no question, we think, that the Stockholders1931 BTA LEXIS 2195">*2204  Investment Fund was a separate taxable entity.  It had its own capital stock of $100,000, which was set up from dividends regularly declared and paid by the Farmers & Merchants Bank.  These dividends, when declared and paid by the bank, were no longer the property of the bank.  They became the property of the stockholders and the mere fact that the agreement setting up the Stockholders Investment Fund provided that ownership in its property should always be in proportion to ownership of shares in the bank did not operate to change the character of the new institution.  Of course the arrangement evidenced by the agreement set out in our findings of fact created a very close affiliation between 21 B.T.A. 1383">*1387  the bank and the Investment Fund, but this close affiliation did not make them one and the same taxable entity.  The bank remained a corporation and the Investment Fund became an association taxable as a corporation.  For a period of seven years the Investment Fund was operated successfully.  Dividends were paid to its shareholders and in addition a substantial surplus was accumulated.  During this period the petitioner in making its income tax returns contended that the Stockholders1931 BTA LEXIS 2195">*2205  Investment Fund should be treated as a separable taxable entity.  Early in 1923 the petitioner found itself in difficulties with the Washington State Banking Department.  It was instructed to either charge off or dispose of notes aggregating a large amount.  The charging off of this amount would have so impaired the petitioner's capital that an assessment on its stockholders would have been a necessity.  Instead of making the assessment, substantial amounts of the criticized assets were exchanged for good assets of the Stockholders Investment Fund.  This method of handling bad assets was continued until December of 1924, at which time all the assets of value of the Stockholders Investment Fund, with the exception of three cents, had been used to take over bad assets of the petitioner.  But the loss of the Stockholders Investment Fund in 1924 was not the loss of petitioner, and therefore is not such a loss as it has a right to carry forward and use as a deduction in determining its own net income for 1925.  . From the evidence it appears that the Stockholders Investment Fund was liquidated in December of 1924.  Nothing further remained1931 BTA LEXIS 2195">*2206  to be done but dispose of the balance of three cents and pass a formal resolution of dissolution, both of which acts were performed on January 13, 1925.  Under this state of facts the Stockholders Investment Fund, an association taxable as a corporation, transacted no business as a corporation in 1925 and was therefore not required to file a return in 1925 and did not do so.  Accordingly, the respondent was correct in holding that for the year 1925 the petitioner and the Stockholders Investment Fund were not entitled to file a consolidated return, and petitioner is not entitled to bring forward into 1925 the statutory net loss of the affiliation in 1924.  The remaining assignment of error is that the respondent was in error in refusing to allow the petitioner to deduct from gross income for 1925 its own statutory net losses for 1924, which have been stipulated to be $10,855.69.  Section 206(b) of the Revenue Act of 1926, applicable to the taxable year 1925, provides: If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the1931 BTA LEXIS 2195">*2207  net income of the taxpayer for the succeeding taxable year (hereinafter in this section called "second year") * * *.  Section 21 B.T.A. 1383">*1388  206 is a relief provision designed to alleviate hardship resulting from the imposition of a tax on the income received in one year in those cases where a taxpayer suffers a loss in the preceding year.  This relief is by the express terms of the statute given to "any taxpayer" who has suffered a "net loss" in the preceding year.  For the year 1924 the respondent computed the tax of the petitioner and the Stockholders Investment Fund on the consolidated basis and their consolidated net loss was $49,880.34.  Of this consolidated statutory net loss it has been stipulated that $39,024.65 represented the net loss of the Stockholders Investment Fund and $10,855.69 represents the statutory net loss of the Farmers & Merchants Bank.  Respondent has refused to allow petitioner to bring forward into 1925 the consolidated statutory net loss of $49,880.34, because the corporation and the association were not entitled to file a consolidated return, the association having ceased to do business in 1924 and having been dissolved early in 1925.  In this action we1931 BTA LEXIS 2195">*2208  think respondent has committed no error.  Respondent has likewise refused to allow petitioner to bring forward its own statutory net loss for 1924, citing as authority for such action . The respondent contends that the above cited case is authority for the proposition that a loss sustained by a corporation during a year in which it formed a part of an affiliated group may not be taken as a deduction in the succeeding year, when not a member of the affiliated group.  We do not think the case cited supports the contention of the respondent.  We agree that when the affiliation ceases the taxpayer may not bring forward as a deduction in determining its own net income for the succeeding year the consolidated statutory net loss of the affiliated group, but where the facts show, as in this case, that both members of the affiliated group had statutory net losses for the prior year and that the net loss of the taxpayer was not used in such prior year to offset income of the other members of the affiliated group, we think it would be a strained construction of section 206 of the Revenue Act of 1926 to say that petitioner would not be permitted1931 BTA LEXIS 2195">*2209  under such circumstances to bring forward its own statutory net loss for 1924, and use it as a deduction in determining net income for 1925.  In , we said: "Each individual corporation is a taxpayer and the same taxpayer, regardless of the fact that for one year it is and for another year it is not affiliated with other corporations." Accordingly, the respondent was in error when he refused to allow the petitioner to deduct its own statutory net loss of $10,855.69 for the year 1924, in computing its net income for the year 1925.  No such apportionment as 21 B.T.A. 1383">*1389  outlined in , is required in this proceeding because both members of the affiliated group in the preceding year had statutory net losses.  Reviewed by the Board.  Judgment will be entered under Rule 50.