*1304 1. The respondent's allowances for depreciation sustained in the absence of proof that the amounts are unreasonable.
2. Certain amounts paid to petitioner in 1921 and 1922 by two of its subsidiaries held to be distributions of profits.
3. A consolidated net loss sustained in 1921 may not be deducted in its entirety from consolidated net income of the same corporations in 1922, but must be apportioned in accordance with Swift & Co. v. United States, 38 Fed.(2d) 365.
4. Held that for 1922 an agreement existed for the assumption by petitioner of the tax liability of the affiliated group, and that in the absence of an agreement among the corporations for 1923, the deficiency should be apportioned on the basis of the net income properly assignable to each.
*465 This proceeding involves the redetermination of deficiencies of $22,234.57 and $11,662.66 in income taxes for 1922 and 1923, respectively. The issues are (a) whether additional depreciation on*1305 machinery is allowable; (b) whether, for the purpose of determining 1922 income and the amount of the 1921 net loss that may be carried over, certain payments required to be made by the subsidiaries to the parent should be treated ad dividends or ordinary and necessary expenses; and (c) whether the deficiencies were properly allocated to petitioner, and, if so, whether it should receive credit for taxes paid by two of its subsidiaries for 1923. In an amended answer, respondent alleges that only a part of the net loss of the American Electrical Works for 1921 may properly be carried forward to 1922 and that such part is approximately $21,068.01, instead of $41,870.55, the amount allowed, and asks for an increased deficiency for 1922.
FINDINGS OF FACT.
The petitioner, a Delaware corporation, and its subsidiaries, the Washburn Wire Company of Rhode Island, Washburn Wire Company of New York, Phillipsdale Realty Corporation, Martex Corporation and American Electrical Works, filed consolidated returns for 1921, 1922 and 1923.
Prior to 1912 the American Electrical Works did not claim depreciation on its machinery. For 1912 and 1913 it claimed depreciation on its machinery at the*1306 rate of 5 per cent per annum, and at 10 per cent per annum for 1915 to 1923, inclusive, based upon a January 1, 1912, cost of $652,245.21. For 1914 it claimed depreciation in the amount of $45,749.86.
For 1921, 1922 and 1923 the respondent allowed the American Electrical Works depreciation on its machinery in the respective amounts of $61,218.04, $27,158.51 and $24,849.40.
In his computation of the deficiencies for 1922 and 1923 the respondent denied the American Electrical Works any deduction for depreciation on machinery acquired prior to January 1, 1912, on the ground that on the basis of a useful life of ten years, as claimed, the period of usefulness expired not later than 1921.
*466 For the year 1921 respondent determined that petitioner had net income of $1,443,954.22 and that the subsidiaries had net losses in the aggregate amount of $1,485,824.78. For the year 1922 he determined that petitioner and the American Electrical Works had net income of $575,559.66 and $132,033.42, respectively, and that the Rhode Island corporation, New York corporation and the Phillipsdale and Martex corporations had net losses of $24,762, $246,740.41, $16,797.37 and $1,303.65, *1307 respectively. From the resulting consolidated net income of $417,989.65, he deducted the consolidated net loss of $41,870.56 determined for 1921.
In May, 1916, the Washburn Wire Company, a Maine, and the then parent, corporation, sold and assigned to the Washburn Wire Company, Inc., a New York corporation and one of petitioner's subsidiaries, (a) the right to use the name "Washburn Wire Company, Inc.," (b) the right to use such part of the good will of the Maine corporation as attached to the business built up by the seller through its branch office and plant in New York, New York, together with trade-marks and trade names, and certain real estate in New York, New York; (d) certain of its machinery, tools, apparatus and supplies located in New York State on June 1, 1916; (e) all merchandise, including raw materials and supplies on hand in the New York factory on June 1, 1916; office furniture, equipment and supplies in the New York branch, and cash on hand in the New York office and on deposit at a certain bank; (f) all existing contracts for the sale and purchase of goods made for the benefit of the New York branch, and all other tangible property of the seller located in the*1308 State of New York. The Maine corporation also agreed to purchase for and sell to the buyer, at prices to be fixed by mutual agreement, material required by the latter in the manufacture of its products; and to advance to the New York corporation from time to time as working capital sums not to exceed $100,000, at any one time, and the latter agreed to assume and pay all probable debts of the former appearing on its books June 1, 1916. The New York corporation further agreed to deliver to the Maine corporation all of its capital stock and $1,500,000 face value of its 6 per cent debenture bonds, and:
* * * to account for and pay over to the MAINE CORPORATION, as a royalty for the exercise of the rights herein conveyed, twenty per cent. (20%) of the gross incoem derived from the business of the NEW YORK CORPORATION each fiscal year, such gross income to be computed by adding the total inventory at the beginning of the year to the total net purchases and subtracting the sum so derived from the sum of total net sales and total inventory at the end of the year. The inventory in each case shall include machinery, equipment, plant, real estate, fixtures, merchandise, (finished, unfinished*1309 and in process), raw material and all other tangible property.
*467 The purpose of this agreement was to enable the Maine corporation to obtain the larger part of the earnings of the New York corporation without having the latter go through the formality of declaring dividends.
On the organization in 1917 of petitioner, the Maine corporation assigned its rights under the contract to petitioner.
In 1919 the petitioner and the Washburn Wire Company of Rhode Island entered into a similar contract respecting the business and assets of the former in Rhode Island, the amount payable to the petitioner being 12 1/2 per cent of gross income.
In 1921, 1922 and 1923 there were paid to petitioner under the contracts the following amounts:
| Year | Rhode Island corporation | New York corporation |
| 1921 | $88,799.67 | $243,557.44 |
| 1922 | 127,574.87 | 360,854.92 |
| 1923 | 169,795.63 | 549,220.87 |
These sums were returned as income by petitioner and claimed as deductions by the paying corporations.
The payments made under the contracts were in fact dividends and not ordinary and necessary expenses of the subsidiaries.
The consolidated returns of petitioner for 1922*1310 and 1923 were accompanied by information returns, Form 1122, executed by each of its subsidiaries. In the information returns filed for 1922 each of the subsidiaries stated that none of the tax for that year should be assessed against it. The tax of $24,780.32 shown to be due under the consolidated return filed for 1922 was assessed against and paid by petitioner in quarterly installments in 1923. There was no written agreement concerning the assessment of the 1922 taxes other than the Forms 1122 filed.
For 1923 the respondent determined that the petitioner, Washburn Wire Company of New York and American Electrical Works each had net income and that the other subsidiaries of petitioner sustained losses. The deficiency in tax under the consolidated return was determined against petitioner, and a notice thereof was mailed to it in October, 1926. In 1928 notices were sent to the Washburn Wire Company of New York and the American Electrical Works proposing deficiencies in tax liability of $1,775.94 and $8,295.73, respectively, for 1923. The amount of tax allocated to the subsidiary corporations was based upon the net income properly assignable to each. The subsidiary corporations*1311 paid the taxes shown to be due in the deficiency notices. No reduction has been made in the *468 tax determined against petitioner for 1923 on account of the payments made by the subsidiary corporations. The Forms 1122 filed for 1923 were not placed in evidence, and there is no evidence of any agreement between the several companies concerning the assessment of taxes for 1923.
OPINION.
ARUNDELL: Petitioner's claim for additional depreciation allowances is confined to machinery of the American Electrical Works on hand January 1, 1912. As to this item petitioner contends that, having taken but 76 per cent of the cost thereof prior to 1921 - 5 per cent in each of the years 1912 and 1913, 6 per cent in 1914, and 10 per cent each year thereafter to and including 1920 - it is entitled to a rate of 10 per cent in 1921 and 1922 and the remaining 4 per cent in 1923, based upon cost of $652,245.21 at January 1, 1912. The respondent allowed depreciation at the rate of 10 per cent for half of 1921 and declined to make further allowances, on the ground that the useful life of the assets expired not later than 1921.
Petitioner's theory may be sound, but it is not supported by*1312 facts. The evidence does not show the time of acquisition, the March 1, 1913, value of the machinery acquired before that date, the useful life, or the machinery on hand in the taxable years. Such evidence as the record contains on this question is very unsatisfactory. The witness on this issue testified that some of the machinery in respect of which depreciation is now claimed might have been in use as long as ten years prior to January 1, 1912. As to such machinery, its ten-year life, which petitioner says is a proper average, was exhausted long before the taxable years. The witness further testified that the policy of the company was to record discards of machinery "valued in the thousands." Shortly thereafter he was asked whether the policy was to record "large discards of, say, roughly, $1,000," and in answer to this he said, "I could not definitely state what the policy would have been in those years." There is no evidence at all of the quantity of machinery discarded prior to the taxable years, and so even if the so-called cost at January 1, 1912, could be accepted as a starting point, we are still without a basis for computing depreciation in the taxable years. The witness*1313 above referred to is assistant treasurer and comptroller of petitioner; he has been connected with petitioner or its predecessors since 1900; and since 1915 the records of the American Electrical Works have been made under his direction. In this situation it seems to us that a more satisfactory account of the machinery on which depreciation is claimed might easily have been produced. On the record made we do not feel warranted in disturbing the respondent's determination as to depreciation on the American Electrical Works machinery.
*469 In an amended answer respondent concedes that his allowance for depreciation on tenement houses of the American Electrical Works should be increased $1,398.65 for each of the years 1922 and 1923. Except for these adjustments, the respondent's determination of depreciation will not be disturbed.
In addition to the depreciation allowances, the consolidated net loss in 1921 and net income in 1922 is affected by the proper disposition to be made of the payments made to petitioner in each of those years by the New York and Rhode Island corporations out of gross income under the 1916 and 1919 contracts.
*1314 The consolidated returns filed by the affiliated group for 1921 and 1922 treat these items as income of petitioner and deductions of the paying corporations. The respondent made no alterations in the returns in respect to the manner in which petitioner treated the payments. The petitioner is now contending that the items are not business expenses of the New York and Rhode Island corporations, but dividends, and, as such, should be disallowed as deductions to the paying corporations and deducted from the gross income of petitioner under the provisions of section 234(a)(6) of the taxing act. The respondent, on the other hand, asks that we affirm his action in not disturbing the items as returned, on the ground that they represent payments of royalty, and, as such, business expenses in accordance with .
We are not aware of the designation given the payments in the returns or how respondent labeled them in his computation of the tax liability. The conclusion of respondent that they should be characterized as royalty payments is not discussed in his brief, he apparently having accepted it as a fact in view of the manner in which*1315 the amounts were termed in the agreements. From the showing made here it is evident that the sums were in reality distributions of profits.
Under the agreements there was an outright sale of the sellers' assets in the respective states, including the right to use the corporate name, trade-marks, trade names, and good will built up in the states, for all of the capital stock of the buyers, and in the case of the New York corporation, all of its 6 per cent bonds in the amount of $1,500,000. Each buyer also agreed to pay to the sellers for the exercise of the rights conveyed sums termed royalties and based upon a percentage of gross income computed in a specified manner. All of the property, tangible and intangible, was unconditionally conveyed. Manifestly, the purpose of the agreements was to transfer the business of the sellers in the respective states in exchange for all of the stock of the buyers. The only rights acquired not actually transferred were agreements on the part of the sellers to *470 make advances to the buyers from time to time for use as working capital.
The petitioner was in control of the transactions at all times. Everything points to the fact*1316 that the New York and Rhode Island corporations were organized by the parent for the express purpose of taking over the business being conducted in such states, and the evidence is that the directors of petitioner fixed the amount to be paid by the New York corporation. Thus it appears that the agreements did not result from negotiations conducted at arm's length, but were dictated altogether by the parent corporation.
In our interpretation of the agreements we are aided by the testimony of J. E. Hayward, petitioner's assistant treasurer and comptroller, who took part in the discussions at the time the agreements were made and was a member of the board of directors of the Maine corporation that authorized the first contract. His uncontradicted testimony is that the purpose of inserting the so-called royalty provisions in the agreements was to obtain the larger part of the earnings of the subsidiaries without a declaration of dividends.
It does not appear that the parent corporation was performing any service for the subsidiaries to form a basis for the payments other than the purchase of material required to produce their goods, and the charges were not imposed for the use*1317 of property belonging to the parent corporation, as the assets covered by the agreements were unconditionally transferred. Certainly no corporation exercising independent action would have undertaken the obligation to pay the sums paid for the mere right to receive advances for working capital when needed and to have another act as its purchasing agent for material. The agreements, construed in the light of surrounding facts, are contrary to such a conclusion. In our opinion the payments should be regarded as distributions of profits, and accordingly eliminated as deductions from gross income of the paying corporations and excluded from the net income of the petitioner by treating them as dividends under section 234(a)(6) of the act.
For 1921 the respondent determined that each of the subsidiaries sustained a net loss, the total of the losses being $41,870.56 in excess of his determination of net income of the petitioner. For 1922 he found that the American Electrical Works and petitioner had net income and that the other subsidiary corporations had net losses. From the resulting consolidated net income of $417,989.65 he deducted the whole of the 1921 consolidated net loss. *1318 He now claims such action to be error and asks that the amount be limited to the proportion that the net losses sustained by the corporations having net income in 1922 bears to the whole net losses, in accordance with the rule announced in . *471 If the adjustments to be made in 1921 and 1922 in conformity with this opinion, including the recomputation of the consolidated net loss in 1921 by eliminating the dividend payments, result in a consolidated net loss, the same should be applied against any 1922 net income in accordance with the Swift case. ; .
The consolidated return filed for 1922 was accompanied by information returns executed by each subsidiary stating that none of the tax should be assessed against it. The consolidated return was signed by Frank C. Weidenmiller as vice president and Frank N. Phillips, as treasurer. Phillips was also president of petitioner in 1922. The returns of the Rhode Island and New York corporations were executed by the same persons in the same*1319 capacities. Of the other subsidiary corporations, only the American Electrical Works had net income and its return was signed by Phillips as president, and J. E. Hayward as treasurer. The tax of $24,780.32 shown to be due on the consolidated return was paid by the petitioner in 1923 in quarterly installments.
The respondent has found petitioner to be liable for the tax of the affiliated group for 1922, and this determination, in addition to being presumptively correct, is supported by the information returns filed by the several companies. The burden of proving the existence or nonexistence of an agreement for allocation of the tax is on the petitioner. ; . This burden it has not met. J. E. Hayward, vice president and comptroller of petitioner, testified that there was no written agreement among the companies requiring petitioner to pay all taxes. Whatever force his testimony might have in other circumstances is overcome by the information returns filed by the several companies. We accordingly hold that petitioner is liable for any deficiency in tax for 1922. Cf. *1320 ; .
For the year 1923 a different situation exists. The parties agreed that for that year the subsidiary corporations filed information returns and it appears from the statement attached to the deficiency notice that the respondent examined such returns in determining the deficiency asserted. Those returns, however, were not placed in evidence and we have no knowledge of their contents. From the respondent's conduct in sending deficiency notices both to the petitioner and to two of the subsidiaries the fair inference is that there was no agreement that petitioner was to bear the tax of all. Certainly in these circumstances there can be no presumption that respondent acted rightly in asserting the whole deficiency against the petitioner. As to the year 1923 there is nothing to contradict *472 Hayward's testimony that no written agreement existed. We are accordingly of the opinion that for 1923 the tax should be apportioned to the several companies on the basis of the net income properly assignable to each. Section 240(a), Revenue Act of 1921. Cf. *1321 .
Holding as we do that for 1923 petitioner is liable only for the portion of the deficiency which is attributable to its own net income, there is no occasion for considering the question of whether the deficiency asserted by respondent should be reduced by the deficiencies asserted against and paid by the subsidiaries based on their net income.
Decision will be entered under Rule 50.