*2299 1. Where the actual cost of certain depreciable assets is not established, the determination of the respondent as to the basis for depreciation must be approved.
2. Petitioner reduced 1923 net income by a net loss sustained in 1922 giving it a balance subject to tax of less than $25,000, and it claimed the $2,000 exemption allowed by section 236(b) of the Revenue Act of 1921. Held that in computing a taxpayer's net income a net loss is to be regarded as a credit rather than as a deduction.
*390 The above proceedings were consolidated for hearing and determination since the companies involved constitute an affiliated group.
In Docket No. 29025, the deficiency letter, addressed to Alderman, Fairchild Co. notifies petitioner of an overassessment of $123.26 for 1924, and a deficiency of $275.50 for 1925. The petitioner alleges that respondent's determination is based upon the following errors:
(a) Failure of respondent to allow additional depreciation for Alderman, Fairchild Co. for the year 1924, amounting to $3,568.02; and
(b) *2300 Failure of respondent to allow additional depreciation for 1925, amounting to $3,090.30.
In Docket No. 38464, the deficiency letter, addressed to Alderman, Fairchild Co., notifies petitioner of a deficiency for 1923 of $250. The errors alleged in the petition are:
(a) Failure of respondent to allow additional depreciation to Alderman, Fairchild Co. for 1923, based upon the fair value of the assets of the Orchard Building Co. purchased by Alderman, Fairchild Co., and
(b) Failure of respondent to allow statutory exemption of $2,000.
In Docket No. 36518, the petitioner, Commercial Paper Box Co., was notified of a deficiency of $270.75 for 1925. In Docket No. 36519, the petitioner, Riverside Paper Box Co., was notified of a deficiency of $162.90 for 1925. The deficiencies in Docket Nos. *391 36518 and 36519 are based upon an allocation of the deficiencies among the companies composing the affiliated group.
At the hearing respondent's motion to dismiss the proceeding with respect to the year 1924 was granted because no deficiency has been determined by respondent against any of the petitioners for that year.
FINDINGS OF FACT.
The petitioners are corporations*2301 organized under the laws of the State of New York, with their principal office at 367 Orchard Street, Rochester, N.Y. The petitioners are engaged in the business of paper box manufacturing.
The business of the Alderman, Fairchild Co. was organized and started in 1900. In 1913 this company moved into the premises located at 367 Orchard Street, paying as rent therefor $12,000 per annum, and being furnished with coal necessary for heat and power purposes. The building was completely equipped as a factory building with heat and power plants, electric wiring, and other necessary equipment. The building and equipment was owned by the Orchard Building Co., all the capital stock of which was owned by J. K. Hunt.
By 1919 the Alderman, Fairchild Co. was paying $18,000 a year rent and furnished its own coal, carried insurance on the building and paid all maintenance charges. In the fall of 1919 the Alderman, Fairchild Co. decided to purchase the assets of the Orchard Building Co. so as to acquire the premises that it occupied.
On December 31, 1919, the Alderman, Fairchild Co. was capitalized at $25,000 and its 250 shares of capital stock were owned, 85 shares by Alderman, 85 shares*2302 by Fairchild and 80 shares by J. K. Hunt, who had acquired his stock in or about 1902 for $6,200. At one time H. B. Neuen held 42 shares of common stock for which he had paid $4,200, but in 1918 this stock was purchased for $25,000.
Prior to the acquisition of the assets of the Orchard Building Co. the capitalization of the Alderman, Fairchild Co. was increased. After the increase and after the acquisition of the assets of the Old Orchard Co., Alderman had 800 shares of common, Fairchild 800 shares of common, and Hunt 440 shares. At no time did Hunt have a controlling interest in the Alderman, Fairchild Co. and the negotiations between Hunt and that company were at arm's length, and entirely as a business proposition.
In January, 1920, the assets of the Orchard Building Co. were acquired from Hunt in exchange for 500 shares of Alderman, Fairchild Co.'s preferred stock and 120 shares of its common, and the assumption by the company of a $50,000 mortgage. Later, Hunt received 320 additional shares of common stock. By this transaction *392 the Alderman, Fairchild Co. acquired a building having 60,000 square feet of floor space, approximately 1 1/4 acres of land, and*2303 the equipment in the building, consisting of boilers, generators, sprinkler systems, office furniture, heating plants, etc. The only sales of stock occurring about this time were of preferred, a block of 100 shares being sold during 1920 for $100 per share.
The estimated value of the building, equipment and ground was $250,000, which was allocated, $35,000 for land, $35,000 for the equipment, and $180,000 for the building. During 1920 the Alderman, Fairchild Co. built an addition to the original building, the construction being done by the same contractor who had built the original building. The addition was of the same type and character of structure but had only 30,000 square feet of floor space and cost approximately $91,700. This cost did not include any expenditures for equipment.
The books of the Old Orchard Co. show that the following amounts were paid by that company in or about 1913 for the assets that it turned over to Alderman, Fairchild Co. in 1920:
| Factory building | $79,523.78 |
| Electric wiring | 4,500.01 |
| Power plant | 7,232.02 |
| Heating plant | 10,748.21 |
| Garage building | 6,195.61 |
| Land | 13,359.60 |
| Fagan property - land | 6,091.52 |
| 127,650.75 |
*2304 About the time these assets were purchased the American Appraisal Co. made an appraisal of them for the Alderman, Fairchild Co.
In computing 1920 income the respondent added the following amounts to the depreciable assets of the Alderman, Fairchild Co.:
| Factory building | $92,748.05 |
| Building equipment (electric wiring) | 2,653.58 |
| Power and heating equipment | 16,889.79 |
| Total | 112,291.42 |
Additional depreciation was allowed by the respondent on this amount for 1920, but for 1923 and 1925 respondent refused to allow depreciation on these amounts and avers that the allowance for 1920 was erroneous.
The net income reported by Alderman, Fairchild Co. for 1923 amounted to $33,795.91. Respondent determined that for 1922 the company had sustained a net loss of $12,199.97, which he applied against the net income for 1923 under section 204 of the Revenue Act of 1921. Based on this computation respondent determined that *393 the balance of petitioner's net income subject to tax was $21,595.94 and refused to allow the company the statutory exemption of $2,000 because net income exceeded $25,000.
OPINION.
MORRIS: The first question presented is whether respondent*2305 erred in reducing Alderman, Fairchild Co.'s depreciable assets for 1923 and 1925 in the following amounts:
| Factory buildings | $92,748.05 |
| Building equipment (electric wiring) | 2,653.58 |
| Power and heating equipment | 16,889.79 |
In computing Alderman, Fairchild Co.'s net income for 1920 the respondent included these amounts in that company's depreciable assets and allowed depreciation thereon, but for 1923 and for 1925 the respondent has refused to allow any depreciation on the above amounts and avers that the allowance in 1920 was erroneous.
The issue thus presented is the cost to the petitioner of the depreciable assets that it acquired in 1920. At that time the building, and presumably the equipment, was seven years old and petitioner gave in exchange therefor 500 shares of its preferred stock and 120 shares of common stock and assumed a mortgage of $50,000. The evidence is not entirely clear as to how many shares of common stock were given in part payment for these depreciable assets, the testimony being that 120 shares of common represented the full purchase price as to common stock, while other testimony was to the effect that later 320 additional shares of*2306 common were issued in part payment for these assets.
The value of the preferred stock was established by the sale of a block of 100 shares in 1920 at $100 per share but the value of the common stock, which represents a portion of the cost or purchase price paid by Alderman, Fairchild Co., has not been proved. One sale of 42 shares of common stock in 1918 for $25,000 is shown by the record but it appears that since 1918 the capitalization of the Alderman, Fairchild Co. had been increased to an undisclosed amount and it is impossible to determine from this one sale that the common stock in 1920 was worth anything like the sale price in 1918. No evidence was offered to prove the book value, nor was opinion evidence offered to establish the value of the common stock at the time it was issued for these assets. We are faced, therefore, with a situation that makes it impossible for us to determine the cost of the depreciable assets to the Alderman, Fairchild Co.
The petitioner offered evidence to prove that in 1920 a factory building of the same type and structure as the original building was erected at a cost of approximately $91,700, which building had only *394 one-half*2307 the floor space of the original structure. While this testimony indicates that the cost of reproduction new in 1920 of a building of the same size, type, character and structure as the original building would have been $183,400, this evidence is by no means conclusive as to the value of building that has been in use for seven years. Nor do we feel that the rental paid is decisive of the question of cost of these assets to the petitioner. In view of all the facts, it is our opinion that respondent's determination should be sustained because we are unable to determine the cost of these assets to the petitioner, Alderman, Fairchild Co.
The petitioners contend that the burden of proof with respect to the disallowance of depreciation on these amounts in 1923 and 1925 is on the respondent since his answer avers that the allowance of depreciation on these amounts in 1920 was erroneous. We do not construe the statement in the answer as an affirmative allegation by the respondent which must be supported by evidence adduced on his part. It seems rather that this statement is the basis or reason that guided respondent in refusing to allow depreciation on these amounts in 1923 and 1925.
*2308 The second issue is whether petitioner, Alderman, Fairchild Co., is entitled to the statutory exemption of $2,000 for the year 1923 allowed by section 236(b) of the Revenue Act of 1921. It appears that the Alderman, Fairchild Co. reported net income for 1923 in the amount of $33,795.91, but that since the company sustained a net loss for 1922 of $12,199.97, its net income subject to tax in 1923 was only $21,595.94. Since this balance is less than $25,000, petitioner argues that it is entitled to the $2,000 credit. This question has been before the Board in a number of proceedings and it has been decided that in ascertaining the right of a corporation to this credit a net loss deductible under section 204 of the Revenue Act of 1921 is to be regarded as a credit rather than as a deduction in determining a taxpayer's net income. , and cases therein cited.
Judgment will be entered for the respondent.