*2297 1. The respondent treated the petitioner as the parent company instead of its affiliated company, the Emandess Holding Co., and he computed the net income of the two companies on the basis of a fiscal year ended July 31, 1921, instead of a calendar year basis ended December 31 of that year. Held, petitioner having failed to show that the basis employed by the respondent was incorrect because it does not clearly reflect the true net income or that the method which it contends for will more nearly reflect its net income, the action of the respondent is approved.
2. The March 1, 1913, value of certain tenement buildings owned by the petitioner's affiliated company determined.
3. The rate of depreciation determined by the respondent and applied to the properties aforesaid approved because of the failure of the petitioner to overcome the prima facie correctness of the respondent's findings.
4. Deficiencies were asserted against and collected from the petitioner for the years 1917 and 1919, which were later, but not until after the period of limitations had barred the right of recovery, found by the respondent to have been excessive. The respondent reduced petitioner's*2298 invested capital by the amount of the outlawed portion of the overpayment in tax. Held, the petitioner's invested capital should not be increased by the amount of the said outlawed portion of the overpayment in tax.
5. The petitioner having offered no evidence with respect to value of its leasehold at the date of acquisition, respondent's action in failing to allow a value for invested capital purposes is approved.
6. For failure to prove the existence of a leasehold upon premises occupied by the petitioner extending over a period of years upon which a March 1, 1913, value might be predicated, the action of the respondent in failing to allow exhaustion thereon in the taxable year is approved.
7. For failure to adduce satisfactory evidence of the March 1, 1913, value of the so-called Handley lease the respondent's failure to allow said value or exhaustion thereon is approved.
8. No evidence having been offered with respect to the depreciation upon improvements erected by the petitioner upon leasehold property, the respondent's failure to allow a deduction therefor in the taxable year is approved.
*443 This proceeding is for the redetermination of a deficiency of $17,730.43 asserted for the fiscal year ended July 31, 1921. The errors alleged to have been committed by the respondent are:
(1) His treatment of the petitioner as the parent company instead of Emandess Holding Co., and in determining the consolidated net income of said affiliated companies on the basis of a fiscal year ended July 31, 1921, instead of a calendar year basis ended December 31, 1921;
(2) In computing depreciation on buildings owned by the said affiliated company on the cost instead of the March 1, 1913, value thereof and in allowing a rate of only 2 per cent instead of 3 per cent, thereby increasing the consolidated net income by $8,182.68;
(3) In reducing invested capital by an additional tax of $9,386.30 for 1917;
(4) In his failure to increase invested capital by the refund of taxes paid for 1917 in excess of $4,868.13 allowed as an overassessment for 1917;
(5) In increasing invested capital by only $208.10, overpayment in tax allowed to said affiliated company for 1919, and in not adding thereto*2300 $5,302.75 overassessment and overpayment for the same year;
(6) His failure to allow a March 1, 1913, value of $150,000, and a $250,000 value at the date of acquisition for invested capital purposes of a certain leasehold on the East River front of New York, and in his failure to allow $18,750 exhaustion on said March 1, 1913, value;
(7) His failure to allow a March 1, 1913, value of $6,000 of a certain other leasehold upon adjacent property and to allow exhaustion thereon as a deduction; and
*444 (8) His failure to allow an addition to invested capital of $35,000, cost of improvements erected by the petitioners on said leasehold property, and in his failure to allow as a deduction $1,005, representing 3 per cent depreciation on the March 1, 1913, value of said improvements.
FINDINGS OF FACT.
The petitioner is a domestic corporation organized in 1905 under the laws of the State of New York with capital stock of $24,000, and its principal place of business is in New York City, where it is engaged in trading in brick, lime, cement, fire brick, flue lining, terra cotta, partition blocks, plaster boards, and all kinds of building material. Its capital stock is owned*2301 equally by four stockholders.
On May 18, 1905, prior to the incorporation of the petitioner, Wm. H. Schmohl, Wm. H. Schmohl, Jr., Charles E. Murtha, Jr., and Graham Murtha, as individuals, leased a plot of ground from Morris Littmann between 108th and 109th Streets, in the City of New York, which occupied a block front on Marginal Street, the lease expiring by its terms May 1, 1915. This plot contained approximately 16,000 square feet, for which the lessees promised to pay in quarterly installments, a yearly rental of $2,500, plus taxes and water rates. The lease required the lessees to erect and complete improvements on the premises at an actual cost of not less than $4,000, and it provided that the lessees "will not assign this lease, nor let nor underlet the whole or any part of the said premises, without the written consent of the party of the first part under penalty of forfeiture and damages." Marginal Street paralleled the East River, thereby affording water transportation to concerns located on the river front. Prior to its being leased the premises had been used as a dumping ground. The petitioner cleared the property of debris, and erected an office building, sheds, *2302 and a garage thereon, at a total cost to it of approximately $25,000, and it thereafter occupied the premises, and paid the rent therefor, although no assignment of the lease was ever made by the individual lessees to the corporation.
In 1908 or 1909 the petitioner was negotiating for a lease on vacant property adjacent to the property which it already occupied. Prior to consummating this lease the matter of a renewal of the Littmann lease, hereinbefore discussed, was taken up with Littmann by William H. Schmohl and his son, and they were assured by Littmann that they could lease the premises for an additional ten years at the same rental upon the expiration of the then existing lease. Upon the strength of that assurance, the petitioner, on January 11, 1909, leased from Richard Handley, a plot of ground approximately 100 feet by 100 feet, which adjoined the petitioner's *445 premises along 109th Street, for a period of 21 years and 2 months from March 1, 1909, at an annual rental of $1,200, plus taxes and water rates. This lease gave the petitioner a total frontage on 109th Street of about 168 feet. The additional ground was used for storage of building materials. The*2303 materials were delivered by cargo boats at the petitioner's pier, from which they were carried by hand truck, wheelbarrow or flat car across the street to petitioner's place of business. This method of handling building materials saved the petitioner considerable money annually in truck and drayage costs.
Notwithstanding the Littmann lease of May 18, 1905, expired by its terms on May 1, 1915, the petitioner continued to occupy the premises pursuant to the oral assurance obtained prior to leasing the Handley property.
Between 1905 and 1913 the character of the neighborhood where petitioner located was entirely changed. Petitioner removed the dump heap, the street was repaved, the bulkhead was repaired and many improvements were made, so that property in that vicinity became more desirable.
During the period subsequent to its organization and prior to 1908, the petitioner had furnished building materials for various construction jobs, and when the bills were not paid it filed mechanics liens, instituted foreclosure proceedings, and bought in a number of tenement houses. In 1908 the Emandess Holding Co., a New York corporation, was organized with capital stock of $2,000 to*2304 hold and operate the properties so acquired, and thereafter the following properties were transferred to the said Emandess Co., the buildings upon which on March 1, 1913, had an aggregate fair market value of $500,000.
| March 1, 1913. value | |
| 295-9 Rivington Street | $95,000 |
| 231-33 West 67th Street | 60,000 |
| 417-21 East 68th Street | 90,000 |
| 26 East 105th Street | 50,000 |
| 64-66 East 97th Street | 60,000 |
| 233-37 East 124th Street | 90,000 |
| 508 West 135th Street | 55,000 |
| 500,000 |
The buildings were all six-story brick tenement houses, some or all of which contained stores and when acquired were practically new, as they had been constructed during the period 1905 to 1908, inclusive. The buildings had been erected in accordance with the rules and regulations of the building department of New York City, and several of them had been constructed under the tenement house law requiring fireproof walls. The foundations were of brick and stone *446 and the roofs were plastic slate or composition. The buildings were occupied by tenants of various types and nationalities.
Subsequent to 1913 the Emandess Holding Co. acquired eight 6-story tenement houses, similar in*2305 structure to the above-mentioned properties on 99th Street at Second Avenue.
During 1921, and for years prior thereto, the petitioner and the Emandess Holding Co. were affiliated, the basis of affiliation being that all the stock of both companies was owned by the same stockholders. Each company kept its books of account on the accrual basis, but the petitioner's books were kept on the basis of a fiscal year ended July 31, while the Emandess Holding Co. kept its books on a calendar year basis. For the years prior to 1921 the companies had reported their income on a calendar year basis.
The petitioner and its affiliated company reported a consolidated net income for 1921 of $80,320.59, and consolidated invested capital of $365,902.21. The deductions taken from gross income included an item of $22,850.51 for depreciation on the Emandess Co. properties, based on a rate of 2 per cent. The balance sheet of the Emandess Holding Co. on December 31, 1920, showed real estate at cost of $1,142,525.58.
The consolidated return for 1921 was prepared and filed upon a calendar year basis. Upon audit of that return the respondent changed the basis of reporting income from the calendar*2306 year basis to a fiscal year ended July 31, 1921. He determined the consolidated net income to be $101,091.76 and consolidated invested capital to be $202,032.86. In computing the net income of the Emandess Holding Co. for the calendar year 1921 the revenue agent, whose action was approved by the respondent, allocated $733,391.36 of the real property value to buildings and allowed depreciation of $14,667.83, based on a rate of 2 per cent. The remainder of the amount originally claimed, or $8,182.68, was disallowed because it represented depreciation taken on land value. This adjustment of the depreciation deduction resulted in the determination of net income for the Emandess Holding Co. for the calendar year 1921 of $14,959.83. Under date of April 28, 1926, respondent notified petitioner of a deficiency of $17,730.43 for the fiscal year ended July 31, 1921.
Thereafter, under date of May 19, 1927, respondent issued to petitioner certificate of overassessment No. 1,022,120, showing the petitioner's correct tax liability for the period January 1 to July 31, 1917, to be $4,888.13, that there had been assessments against the petitioner for that period of $17,888.16, but that there*2307 had been allowed $10,078.14, disclosing an overassessment of $2,921.89. Respondent allowed $2,099.12 thereof but refused to allow $822.77 of *447 the overassessment because no claim for refund had been filed so as to remove the bar imposed by the statute of limitations.
Certificate of overassessment No. 1,022,199 was issued to petitioner and the Emandess Holding Co. with respect to their 1919 taxes. This certificate shows that there had previously been assessed for 1919, $5,302.75; that no tax was due for that year; that there had been an overassessment of $5,302.75 for 1919; that $3,694.90 had been abated; and that $1,607.85 of the overassessment was barred by reason of the statute of limitations.
In changing the basis for reporting income of the Emandess Holding Co. the respondent took five-twelfths of $14,512.27, which he determined was the net loss for 1920, and seven-twelfths of the 1921 net income. By this computation he found the net income of the Emandess Co. for the fiscal year ended July 31, 1921, to be $2,679.78.
Respondent computed the net income of Murtha & Schmohl Co. for the fiscal year 1921 to be $98,411.98. He eliminated as a deduction the amount*2308 of $36,235.40, representing Federal income and profits taxes which had been paid during the fiscal year.
In computing consolidated invested capital the respondent reduced petitioner's invested capital by $9,368.30, representing an additional tax for the period January 1 to July 31, 1917. Respondent increased petitioner's invested capital for 1921 by $208.10, representing overpayment of 1919 taxes. Respondent refuses to include in invested capital the $822.77 overpayment for 1917 and the $1,607.85 overpayment for 1919 because these overpayments were barred by the statute of limitations.
OPINION.
MORRIS: The first issue raised by the parties is with respect to the respondent's treatment of the petitioner as the parent company instead of its affiliated company, the Emandess Holding Co., and in computing the net income of the affiliated companies on the basis of a fiscal year ended July 31, 1921, instead of a calendar year basis ended December 31 of that year.
It appears from the record that both of these companies kept their books of account on the accrual basis and that the petitioner's books were on a fiscal year basis, while those of its affiliated company were on a calendar*2309 year basis. Therefore, what the petitioner contends for is that the respondent was in error in adopting the fiscal year basis, instead of the calendar year basis.
Section 232 of the Revenue Act of 1921 provides that the net income of a corporation "shall be computed on the same basis as is provided in subdivision (b) of section 212 or in section 226." Subdivision (b) of section 212 of that Act provides that "The net income shall be computed upon the basis of the taxpayer's annual accounting *448 period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income."
Therefore, whether the basis adopted by the petitioner in filing its consolidated return is correct or whether the respondent was justified in changing the basis from a calendar year to a fiscal year depends, in our opinion, upon which of the two bases will "clearly reflect*2310 the income," for the period in controversy. The respondent saw fit to change the basis adopted by petitioner, apparently because it did not in his opinion clearly reflect the true net income and in so far as we are concerned his determination is prima facie correct and so being the burden is upon the petitioner to establish the contrary. The petitioner has neither shown that the basis employed by the respondent was incorrect because it does not clearly reflect the true net income of the consolidated group, nor that the method which it contends for will more nearly reflect its net income. Indeed, the evidence adduced by the petitioner, if it establishes anything at all in that respect, it is that the basis adopted by the respondent should be approved. We have before us the balance sheets and income and expense statements for the year ended December 31, 1921, from which we may easily conclude that the consolidated return should conform to the petitioner's basis rather than that of its affiliated company. The affiliated company's balance sheet carries among its assets certain tenement properties to which we have referred in our findings of fact hereinbefore, and its liabilities consist*2311 merely of mortgages and amounts of that company's obligations to the various stockholders and Murtha and Schmohl, its parent. The balance sheet of the petitioner, on the other hand, consists of accounts receivable, bills receivable, equipment, investments, automobile stock and inventories on hand in the 14th Street yard and in the 109th Street yard. Therefore, since the accounts of the petitioner appear to be decidedly more complicated than those of its affiliated company, and its income more difficult to determine because of the necessity for computing inventories, it is reasonable to assume, in the absence of evidence to the contrary, that the less complicated method should yield to the more complicated and be adopted by the consolidated group in computing its net income for the purpose of income tax. The respondent's determination with respect to this issue, must, therefore, be approved.
With respect to the valuation of buildings owned by the Emandess Holding Co., certain improvements erected by the petitioner on *449 leasehold property and the valuation of two leaseholds owned or alleged to have been owned by the petitioner in 1913, we have the testimony of Herman*2312 W. Sternburgh and Morris Rosenthal, two real estate operators, and that of William H. Schmohl, Jr. Because of Rosenthal's obvious lack of familiarity with the properties in controversy in 1913 and because of his absolute refusal to submit to proper and complete cross-examination by the respondent's counsel, his testimony is of little if any value and must be disregarded. On cross-examination when he was asked why he had at first testified that one of the leaseholds was worth $30,000 and later that it was worth $50,000, said that it was because he did not know that it had water front rights. How an expert, knowing all of the important elements entering into the value of properties about which he testifies can possibly overlook the most valuable element attaching to this property, is beyond our comprehension. He testified that he had never personally bought leases of similar property in that neighborhood in 1913 and did not recall whether his employees had or not. The respondent's counsel attempted to cross-examine the witness with respect to all properties testified to on direct examination and when asked for further details about the Rivington Street property he said "I don't*2313 want to repeat all this stuff. If I am going to have to do this, I will have to vamoose. I don't want to be made any fool out of here," and he thereupon refused flatly to answer the question propounded. Other questions were asked of the witness and he again either refused or replied that he had answered once before. Persistent efforts of counsel for the respondent to draw further answers from the witness met with further refusal. The respondent's counsel, tiring of this situation, asked the witness if he intended to persist in his refusals and the witness replied, "According to what questions you ask me." In order to learn the basis for the values used by the witness he was asked the condition of the premises in question in 1913 and the witness replied that he did not know. Throughout the taking of testimony the witness either made use of memoranda or his memory was prodded by counsel for the petitioner. He was asked, upon cross-examination, if he was able to place values on the various properties, concerning which he had testified, without reference to memoranda and he replied that he would have to look at the paper. The witness had said that he had appraised properties and*2314 had testified in court with respect to said appraisals but when counsel for the respondent asked him in what courts he had so testified, the witness replied, "Oh, that is years ago, I don't recall; a long time ago." From these brief but pertinent comments with respect to witness Rosenthal, it must be perfectly obvious that his testimony should be disregarded.
*450 Considering the fact that the tenement buildings owned by the affiliated company were acquired at or about the time of the so-called panic of 1907 and the fact that they were acquired through foreclosure proceedings, and doubtless at a much lower cost than had they been purchased in the open market during the succeeding and more prosperous years between 1907 and 1913, and the testimony of witnesses Sternburgh and Schmohl, we are of the opinion, and have so found as a fact, that the aggregate value thereof on March 1, 1913, was $500,000.
We are not satisfied from the evidence, however, that the 2 per cent rate of depreciation used by the respondent was incorrect. Schmohl testified that some of these properties had a useful life of 30 years and others of 40 years beyond March 1, 1913, and he testified that his*2315 meaning of useful life was that the "building will be in such bad shape that you may as well rip it down as to go on and make alterations and put it back into the shape it was originally." He was asked if at the end of 30 and 40 year periods it would be necessary for the taxpayer to reconstruct the foundations and he said it would all depend upon the class of construction going on in New York City at that time, that is, possibly there will be new regulations requiring a different structure altogether. In other words, the witness anticipated what the authorities of New York might require at the end of the 30 or 40-year periods. The witness was asked to anticipate or assume that the laws would not require any change and whether under those circumstances those buildings would last longer than 30 or 40 years, and he replied that they would possibly last 50 or 60 years, but that because of their condition you could not exact the same rent for them. There is no showing that the rent that could be exacted would not be an economic return upon the investment necessitating destruction of the building; therefore, in view of this testimony we must sustain the rate used by the respondent in*2316 the computation of depreciation.
Allegation of error numbered three herein was conceded by respondent's counsel at the hearing of this proceeding, except that the amount should be $9,368.30 instead of $9,386.30. He also admitted the error set forth in allegation of error numbered five, but only to the extent of $3,694.90.
The respondent refused to include $822.77 and $1,607.85, overassessments for 1917 and 1919, in the petitioner's invested capital for the period in controversy, on the ground that said overassessments are barred by the statute of limitations. In (affd. U.S.C.C.A., 3d Cir., Aug. 29, 1929), and , we held that invested capital of those petitioners should not be reduced by amounts of deficiencies *451 for prior years which were barred by the statute of limitations. Although those opinions do not specifically state the reason for the conclusion reached it must be apparent. There the taxpayer's invested capital had not been impaired, but was as though no deficiency had ever been asserted by the respondent. In the instant case the deficiencies in tax*2317 were in fact asserted and collected and were later, but not until after the period of limitations had expired on the right to recover, found by the respondent to have been excessive. Invested capital of the petitioner was consequently reduced by the amounts of the outlawed portion of the overpayment which has not and can not be recovered. We are, therefore, of the opinion that the petitioner's invested capital should not be increased by said amounts.
No evidence having been offered by the petitioner with respect to the value of its leasehold at the date of its acquisition, the respondent's failure to allow a value for invested capital purposes is approved.
The sixth allegation of error herein is with respect to the value of a certain leasehold on East River property in the City of New York occupied by the petitioner. Said lease was entered into in May, 1905, prior to the organization of the petitioner, between the lessor, on the one hand, and the four organizers and stockholders of the company, on the other hand, as individuals.
Even assuming that the petitioner was the owner of the leasehold in question or at least had an exhaustible property right therein on March 1, 1913, a*2318 question we do not decide, although no assignment of the lease was ever made by the individual lessees to the corporation, we are of the opinion that the contention of the petitioner can not be sustained for the reason that the evidence does not convince us that there was a lease on the premises upon which an exhaustible value could be predicated beyond the life of the original lease which expired on May 1, 1915, prior to the taxable year in controversy. Of course the petitioner contends that it occupied the premises under an oral lease after May 1, 1915, for an additional period of 10 years, but the testimony in support of this contention falls far short of establishing that fact. It is shown by the record, and we have found as a fact, that in 1908 or 1909 the petitioner was negotiating for a lease on vacant property adjoining the property covered by this leasehold and that prior to consummating said lease the matter of a renewal of the lease upon the premises already occupied was taken up with the lessor, by William H. Schmohl and his son, at which time they were assured that they could lease the premises for an additional period of 10 years at the same rental upon the expiration*2319 of the then existing lease. Although the testimony is clear that they were so assured, there is no satisfactory showing that any oral agreement was ever *452 entered into upon the expiration of the lease which expired in May, 1915. We can not assume that because the petitioner continued in possession after May, 1915, that it had an enforceable lease upon the premises for an additional period of 10 years. Having so determined, it is unnecessary for us to go into the question of value of said leasehold, and we, therefore, sustain the findings of the respondent in this particular.
The seventh allegation of error herein is with respect to the respondent's failure to allow a March 1, 1913, value upon the so-called Handley lease entered into in 1909. Schmohl's uncorroborated testimony was that that lease had a value on March 1, 1913, of $6,000, based upon the fact, as he said, that the petitioner paid $1,200 rental, whereas he thought it was reasonably worth $1,800 per annum. There is no satisfactory showing that the property was in fact worth $1,800 a year instead of the stipulated rental of $1,200, and since the value testified to by that witness is unsupported by sufficient*2320 detail disclosing the basis upon which the value is predicated, and since the value itself is uncorroborated by further testimony, we must sustain he respondent's findings with respect thereto.
In view of the fact that the petitioner's counsel expressly waived allegation of error numbered eight herein, in so far as it pertained to invested capital, and no evidence having been offered with respect to exhaustion contended for therein, the findings of the respondent must be sustained in that particular.
Reviewed by the Board.
Judgment will be entered under Rule 50.