1931 BTA LEXIS 2158">*2158 1. The entire stock of a corporation was issued for cash and patents, in varying amounts and at various times from 1920 to 1918, under an agreement that, for each share issued for cash at par, one and one-tenth shares should be issued for the patents. The March 1, 1913, value of the patents is determined upon the basis of what a purchaser, after examination of the patents and with knowledge of then existing facts as to the amount of stock sold for cash at par and the amount of gross sales of the patented article, would probably have paid for the patents.
2. An increase in income of a subsidiary corporation by the amount of interest paid to it by its parent, is disapproved upon a finding that the amount was included in the items making up the income of the subsidiary reported in the consolidated return.
3. A deficiency against a subsidiary in the same amount as the total consolidated tax liability, the unassessed portion of which had previously been determined as a deficiency against the parent, is held to be a duplication which should be eliminated in the redetermination.
4. Respondent in effect determined that there were agreements
4. Respondent in effect determined1931 BTA LEXIS 2158">*2159 that there were agreements for assessment against the parent of the consolidated tax liability for three taxable years and introduced an information return of the subsidiary filed for one of the years stating that none of the tax was to be assessed against it. Officers of the corporations testified that no agreement had been filed for any of the taxable years and they knew of no agreement. Held, that the evidence justified the inference that there was an agreement for the taxable years.
22 B.T.A. 182">*183 These proceedings were consolidated for hearing. The respondent determined deficiencies in income and profits taxes for 1921, and income taxes for 1922 and 1923, as follows:
| Taxpayer | Docket No. | Year | Deficiency |
| Bermont Oil Co | 15543 | 1921 | $3,567.60 |
| Do | 27893 | 1922 | 4,636.99 |
| Do | 32463 | 1923 | 3,614.06 |
| O'Malley-Beare Valve Co | 36734 | 1923 | 18,538.26 |
The issues raised by the original petitions are: (1) the value as of March 1, 1913, of four patents acquired by the O'Malley-Beare Valve Company prior to that date for stock, for1931 BTA LEXIS 2158">*2160 the purpose of the allowance of deductions for exhaustion for 1921, 1922, and 1923.
(2) Whether the consolidated net income of the Bermont Oil Company and the O'.malley-Beare Valve Company for 1922 was improperly increased by the addition to the net income of the latter of $7,310.57, which was paid to the O'Malley-Beare Valve Company by the Bermont Oil Company as interest on daily balances and which, it is contended, was included in the accounts of the O'Malley-Beare Valve Company and in the consolidated gross income reported in the return.
(3) Whether the respondent erred in disallowing a deduction for depletion for 1922 in the amount of $922.77. No evidence was introduced in support of this issue.
At the hearing the petitioner attacked the assessment to the parent company of deficiencies for 1921, 1922, and 1923, in respect of the income of the subsidiary.
FINDINGS OF FACT.
The Bermont Oil Company, hereinafter referred to as the Oil Company, is a Delaware corporation with its principal business office at Bristow, Okla. During 1921, 1922, and 1923, the O'Malley-Beare Valve Company was a Delaware corporation, and was engaged in business with its principal business1931 BTA LEXIS 2158">*2161 office at Chicago, Ill. Its name was subsequently changed to Multiplate Valve Company, but it is the same corporation and exists under the same charter.
The O'Malley-Beare Valve Company, hereinafter referred to as the Valve Company, was organized in 1910 as a corporation to succeed a partnership composed of Thomas O'Malley, Edward O'Malley, and one Beare. The authorized capital was $900,000, consisting 22 B.T.A. 182">*184 of 90,000 shares of the par value of $10 each. Four hundred and ninety-five thousand dollars par value of the stock was issued at various times to the partners for four United States patents, Nos. 978,927, 978,928, 978,929, and 978,930, which were issued by the Patent Office on December 20, 1910, in the name of the Valve Company; and $405,000 was issued at various times for cash at par. From 1910 to March 1, 1913, $40,930 of stock was issued for cash at par. The remainder of the $405,000 issued for cash at par was issued as follows: $15,000 in 1916; $85,000 in 1917; and $264,070 in 1918. The Valve Company issued the $495,000 of stock for the patents at various times and in varying amounts, the first being issued in 1910 and the last in August, 1918. The stock was1931 BTA LEXIS 2158">*2162 issued under a provision of the by-laws of 1910 that there should be issued to the original partnership, for every share of stock issued or sold, a like share of stock at par, and also an additional amount of 10 per cent, until the amount of $495,000 should be issued for the patents, and that "should the corporation go into liquidation, or cease to do business for any reason, or be sold, or its assets transferred or assigned, or before the full amount of said $450,000 had been issued, there shall immediately be issued to said O'Malley Company [the partnership] as it may direct, certificates of stock for said balance."
In 1917, the Valve Company set up on its books an account "Capital stock due for patents," $290,477. By August, 1918, the entire authorized capital stock of $900,000 had been issued and it remained outstanding throughout the years 1921, 1922, and 1923.
The patents in question cover the construction of improved valves with a series of removable plates which are easily and inexpensively replaced when their contact surfaces become worn without replacing the entire valve body. These patented valves can be manufactured at lower cost and sold at higher price than ordinary1931 BTA LEXIS 2158">*2163 valves. When installed, they can be more cheaply and more conveniently maintained and have a longer life.
The Valve Company was engaged entirely in the manufacture and sale of these patented valves. It granted no licenses. It has had no infringements or litigation. Its gross sales, as shown by its records, were as follows:
| 1911 | $1,673.43 |
| 1912 | 1,647.11 |
| 1913 | 35,276.68 |
| 1914 | 54,697.25 |
| 1915 | 62,021.60 |
| 1916 | 152,403.32 |
| 1917 | 223,555.95 |
| 1918 | $561,218.79 |
| 1919 | 493,456.63 |
| 1920 | 744,030.46 |
| 1921 | 221,538.37 |
| 1922 | 303,317.55 |
| 1923 | 488,190.35 |
In 1916, one Jones, who at that time was connected with the Bermont Oil Company, invested $15,000 in the Valve Company and 22 B.T.A. 182">*185 thereafter transferred his interest to the Oil Company. In 1918, the Oil Company acquired a substantial interest in the Valve Company.
The fair market price or value of the four patents on March 1, 1913, was $20,000.
The Oil Company filed consolidated returns for 1921, 1922, and 1923, on behalf of itself and its then subsidiary, the Valve Company, which included the net income of the Valve Company, and the tax liability was determined on the basis of such returns. The returns1931 BTA LEXIS 2158">*2164 were prepared by the Oil Company from profit and loss statements furnished by the Valve Company.
In the consolidated return for 1922 there was included in the consolidated gross income an item of interest on bank deposits, notes, mortgages and corporation bonds, amounting to $117,924.46, which was itemized in a schedule attached to the return as follows:
| Bermont Oil Co. | O'Malley-Beare Valve Co. | Consolidated | |
| Daily balances | $58,593.10 | $8,497.01 | $67,090.11 |
| Notes receivable | 47,423.65 | 13.50 | 47,437.15 |
| Accounts receivable | 854.78 | 832.42 | 1,687.20 |
| Industrial bonds | 1,710.00 | 1,710.00 | |
| 108,581.53 | 9,342.93 | 117,924.46 |
The net income of the Valve Company for 1922, as shown in the return, and in the profit and loss account on its ledger, was $24,323.92. It included interest received in the amount of $9,342.93. The Valve Company deposited money with the Oil Company and the latter paid interest on the daily balances. The item of $9,342.93 consisted of interest received from the Oil Company on daily balances, $7,310.57; interest on daily bank balances, $1,186.44; interest on notes receivable, $13.50; and interest on accounts receivable, $832.43.
1931 BTA LEXIS 2158">*2165 On May 2, 1927, the Oil Company filed its petition attacking the deficiency determined against it for 1922, alleging error in the disallowance of part of a claimed deduction for depletion, in computing the net income of the Oil Company, and in the disallowance of any deduction for depreciation of patents and the addition of the aforementioned interest item of $7,310.57, in computing the net income of the Valve Company. Thereafter, under date of December 31, 1927, the respondent sent to the Valve Company a notice of deficiency for the same year (1922) in the amount of $7,562.73. The notice merely stated the year and the amount of the deficiency, and the Valve Company was not informed, either by said notice or by any subsequent communication, of the adjustments on which the deficiency was based. On March 30, 1928, the Valve Company received from the collector 22 B.T.A. 182">*186 a notice and demand for the tax, plus interest of $2,109.65 to March 21, 1928, and it paid the tax and interest in 1928 and 1929.
For the year 1923 the respondent determined the consolidated net income and computed the tax thereon as follows:
| Consolidated net income | |
| Net income - O'Malley-Bear Valve Co | $183,829.33 |
| Net loss - Bermont Oil Co | 35,523.22 |
| Consolidated net income | 148,306.11 |
| Computation of tax | |
| Consolidated net income | $148,306.11 |
| Tax at 12 1/2% | 18,538.26 |
| Tax previously assessed | 14,924.20 |
| Deficiency | 3,614.06 |
1931 BTA LEXIS 2158">*2166 Under date of September 27, 1927, the respondent sent a notice of the above deficiency to the Oil Company. The consolidated net income reported in the return was $119,393.56. The return included a net income of the Valve Company of $183,819.33, without deduction for depreciation of the patents, and a net income, after allowance of $28,852.66 for depreciation of patents, of $154.966.78. The net income of the Valve Company of $183,819.33 is in accordance with its records, and the difference between that amount and the net income determined by the respondent ($183,829.33) results from the restoration to income of a donation of $10. The tax liability shown in the consolidated return was $14,924.20 and that amount was paid by the Valve Company.
For the same year, 1923, the respondent determined a deficiency against the Valve Company of $18,538.26, and sent a notice thereof to that company. No explanation of the adjustments on which the asserted deficiency was based was given in the statement accompanying the notice, and the Valve Company received no other statement showing the basis of the determination.
The Valve Company filed for the years 1920 and 1921, Form 1122, "Information1931 BTA LEXIS 2158">*2167 Return of Subsidiary or Affiliated Corporation," in which it was stated that none of the income and profits taxes for the taxable period was to be assessed against the subsidiary. The return for 1920 also contained the statement, "Tax will be paid by Parent Company."
OPINION.
STERNHAGEN: (1) The petitioners are entitled, under section 234(a)(7), Revenue Act of 1921, to deductions in 1921, 1922, and 1923, of a reasonable allowance for the exhaustion of the four patents 22 B.T.A. 182">*187 owned on March 1, 1913, and the basis of such deduction is their fair market price or value on that date. The petitioners claim a value of $495,000 which they measure by the par value of the stock issued for the patents at various times up to 1918. The respondent has denied any value on March 1, 1913. The question is, whether petitioners have proved any value; and if so, how much.
The findings of fact fairly set forth the principal evidence of such value; - the description of the patents, their economic and commercial significance, the method required to finance their exploitation and the extent of its success measured by stock sold before March 1, 1913, and the gross sales. There is no evidence1931 BTA LEXIS 2158">*2168 of costs or other expenditures and no other figures or facts from which earnings or profits, if any, present or prospective, can be computed or inferred. There is no allocation of the 1913 sales to the periods before and after March 1. There is no fact or other explanation of the sudden jump in sales in 1913 or, as we have said, whether it was profitable, and no evidence as to whether an increase in these sales was reasonably in prospect on March 1, 1913. As has been frequently held, it is not the actual subsequent facts which are important in determining value on the basic date, but only the reasonable prospects of the future which could be seen on that date. A possible purchaser of these patents on March 1, 1913, could only examine the patents, the gross sales of 1911 and 1912, and an unknown portion of the sales of 1913 and the amount of cash that had been paid for stock, $40,930, under the terms of the by-laws that 10 per cent more would be issued for the patents than for cash. He would have no knowledge of what the cash capital had been used for or whether it had been spent. With this evidence before us, and the burden of proof on the petitioner, we can not evaluate the1931 BTA LEXIS 2158">*2169 patents on March 1, 1913, at a higher figure than such a reasonable purchaser would probably have paid. With such limited facts before him, he would perhaps be unwilling to buy; but we can not entertain that idea, because the law assumes that there is a price at which theparties will meet, and this is the figure to be fixed.
Slim as the evidence is, we think it proves that the patents were, on March 1, 1913, not entirely worthless, as respondent has in effect held. In our opinion, the fair market price or value on that date was $20,000 and this has been included in our findings of fact. The reasonable allowance for exhaustion for the years 1921, 1922, and 1923 should be computed accordingly.
2. The issue as to the item of interest of $7,310.57 in 1922 is surrounded by confusion on both sides. The determination of the Commissioner and the accompanying explanation are ambiguous; but interpreting it as best we can, it indicates that a deduction in respect of this intercompany item was disallowed because the commissioner 22 B.T.A. 182">*188 had no evidence that the amount had been correlatively included in the income of the receiving company. As shown by the findings, the Valve Company1931 BTA LEXIS 2158">*2170 did include this item among those making up its income of $24,323.92 by including it in its interest on daily balances, - $8,497.01. The respondent was therefore in error in increasing the Valve Company's income for 1922 by this item, and the determination is in this respect reversed.
3. For 1923, the Commissioner first determined a deficiency of $3,614.06 against the Oil Company, this being the unassessed portion of the total consolidated tax liability which he determined for this year amounting to $18,538.26. While the proceeding attacking this deficiency was pending before the Board, the respondent determined a deficiency of $18,538.26 against the Valve Company and sent notice of this deficiency to that company without explanation of its computation. The Valve Company duly attacked this before the Board. It is now contended by these petitioners that this is a duplication of the same tax liability, and it is manifest that this is so. The total consolidated tax as determined by the respondent was $18,538.26. Of this, $14,924.20 had been included on the original return and paid, leaving an apparent deficiency of $3,614.06. The duplicate amount of $18,538.26 should be eliminated1931 BTA LEXIS 2158">*2171 in the redetermination.
The deficiency of $3,614.06 rests upon the disallowance of the deduction for depreciation of patents. In accordance with our decision above, the deficiency should be redetermined by the allowance of depreciation in 1923 based upon a value of $20,000, and as so adjusted the amount of the deficiency is held to have been correctly determined.
4. The petitioner contends, however, that in respect of this consolidated tax liability for all three years there has been no agreement between the affiliated corporations for the apportionment of the liability; therefore, as provided in section 240, Revenue Act of 1921, the apportionment must be made in accordance with the respective net income; and, since the deficiencies are predicated entirely upon the net income of the Valve Company, the Oil Company may not be charged with any portion of them, especially for 1923 when the Oil Company had no net income but a loss. The Commissioner, on the contrary, has in effect determined that there was an agreement for assessment against the Oil Company. He has also introduced in evidence his Form 1122, filed by the Valve Company for 1920 and 1921, stating that the tax would1931 BTA LEXIS 2158">*2172 be paid by the Oil Company as the parent and that none of it was to be assessed against the Valve Company, the subsidiary. The only evidence tending to disprove an agreement was that of one officer of the Valve 22 B.T.A. 182">*189 Company that no agreement had been filed by it with the Commissioner, and of another officer in both companies who stated that he knew of no agreement. We think, therefore, that we may infer from the evidence that there was such an agreement for the taxable years here in question as was contemplated by section 240 of the statute, and that the deficiences for these years adjusted as we have indicated may properly be determined against the Oil Company. Cf. ; .
Judgment will be entered under Rule 50.