*2661 In 1914 the Union Land Co. and the Kinzel Lumber Co. issued to their stockholders pro rata noninterest-bearing debenture bonds becoming due and payable in 1934. These bonds, together with a small amount of cash, were issued in cancellation of certain accounts payable representing amounts due the stockholders. Held that the debenture bonds thus issued represented borrowed capital.
*3 In this proceeding the petitioners seek a redetermination of the income and profits taxes for the calendar year 1919, for which the Commissioner has determined a deficiency of $81,265.70. The petitioners allege error on the part of the Commissioner (a) in excluding the Mount Emily Timber Co. from the affiliated group composed of the several petitioners; (b) in reducing the invested capital of the consolidated group by $3,010,000, representing noninterest-bearing debenture notes of the Union Land Co. and the Kinzel Lumber Co. outstanding during 1919; (c) in using the amount of $86,831.06 as the 1918 tax liability in computing the deduction from invested capital*2662 for the year in question.
In the original petition Mount Emily Timber Co. was named as one of the affiliated companies, but on motion and for cause shown the name of the Mount Emily Timber Co. as an appellant was stricken from the proceedings.
*3 FINDINGS OF FACT.
The petitioners are corporations organized under the laws of the State of Wisconsin. The Mount Emily Timber Co. was organized under the laws of the State of Oregon. The principal offices of the petitioners are at Merrill, Wis. The facts were stipulated in substantially the following form.
In 1920, and within the time fixed by the statute, petitioners, Union Land Co., A. H. Stange Co., Kinzel Lumber Co., and E. W. Ellis Lumber Co., together with the Mount Emily Timber Co., filed with the collector of internal revenue at Milwaukee, Wis., their consolidated corporation income and profits-tax return for the calendar year 1919, showing an income and profits-tax liability of $41,108.75.
Later and before the prosecution of this appeal, petitioners filed with the collector their amended income-tax return for 1919 wherein they disclosed an additional tax liability of $95.43.
In the deficiency letter involved*2663 in this appeal respondent ruled that the Mount Emily Timber Co. was not affiliated with the petitioner companies for 1919, and that, therefore, that company (Mount Emily Timber Co.) should be excluded from the 1919 consolidated return. The additional tax liability asserted in the notice of deficiency herein is based upon the exclusion of the income and invested capital of the Mount Emily Timber Co. from the consolidated income and invested capital of the petitioner companies. The taxable net income of the Mount Emily Timber Co. for 1919 was $2,200.83 and its invested capital was $1,124,645.56, which amounts should be added to the consolidated net income and consolidated invested capital, respectively, it being conceded that the Mount Emily Timber Co. should be included in the affiliated group for 1919.
On March 24, 1914, A. H. Stange, then principal owner of the stock of the A. H. Stange Co., a corporation organized under the laws of Wisconsin and having its principal place of business in Merrill, Wis., organized the corporation, Union Land Co., under the laws of Wisconsin.
Similarly, on May 29, 1914, said A. H. Stange organized the corporation, Kinzel Lumber Co., under the*2664 laws of Wisconsin.
On May 29, 1914, the capital stock of the A. H. Stange Co., consisting of 2,500 shares of the par value of $100 each, was reapportioned among A. H. Stange and his children in such a manner as to give to said A. H. Stange and each of his sons and daughters (and/or daughters-in-law and sons-in-law) one-seventh of such total of 2,500 shares. The ownership of the capital stock of the A. H. *4 Stange Co. prior and subsequent to the reapportionment was and is as follows:
| Stockholders in A. H. Strange Co. | |||
| Relationship | Before May 29, 1914 | After May 29, 1914 | |
| A. H. Stange | Father | 1,780 | 358 |
| C. H. Stange | Son | 120 | 357 |
| Aug. J. Stange | do | 120 | 357 |
| Chas H. Kinzel | Son-in-law | 120 | 178 |
| Mrs. C. H. Kinzel | Daughter | 179 | |
| E. W. Ellis | Son-in-law | 120 | 178 |
| Mrs. E. W. Ellis | Daughter | 179 | |
| Fred W. King | Son-in-law | 10 | 10 |
| Mrs. F. W. King | Daughter | 110 | 347 |
| Mrs. R. M. Rogers | do | 120 | 357 |
| Total | 2,500 | 2,500 |
Upon the reapportionment of the capital stock of the A. H. Stange Co. the stockholders of that company subscribed for the capital stock of the Union Land Co. and the Kinzel Lumber Co. in the same proportions as they*2665 then owned stock in the A. H. Stange Co. The stock of the Kinzel Lumber Co. was issued on June 1, 1914, and the stock of the Union Land Co. was issued on June 2, 1914, in the following amounts: By the Union Land Co., stock having a total par value of $245,000; and by the Kinzel Lumber Co., stock having a total par value of $105,000. All of the certificates of stock so issued by both the Union Land Co. and the Kinzel Lumber Co. to the stockholders of both corporations contained a provision that such stock could not be sold without first being offered for sale at par to the corporations respectively issuing same.
The books of account of the A. H. Stange Co. show that as of December 31, 1913, that company had a total book surplus of $1,807,227.93, and in 1914 suffered an operating loss of $91,718.64. It continued to engage in business throughout the calendar year 1914 and for several years thereafter and on February 27, 1915, filed a non-taxable income-tax return showing said operating loss of $91,718.64 for the calendar year 1914. On January 19, 1914, it paid a cash dividend of $25,000. On June 10, 1914, it transferred to the Union Land Co. cash in the amount of $60,000 and property*2666 having a book value of $1,059,667.15, a total of $1,119,667.15. On the same date, June 10, 1914, it also transferred to the Kinzel Lumber Co. cash and notes receivable in the amount of $300,000, and one piece of real estate not carried upon the books of the A. H. Stange Co., but having a value of $5,000.
The books of account of the A. H. Stange Co., after the above described operations and distributions, show that as at December 31, 1914, it had a total remaining book surplus of $270,842.14.
The transfers of cash and other assets by the A. H. Stange Co. to the Union Land Co. and to the Kinzel Lumber Co., respectively, as *5 described were made pursuant to a resolution adopted by the directors of said A. H. Stange Co. at a special meeting held June 1, 1914. The minutes of the meeting were as follows:
MERRILL, WISCONSIN, June 1, 1914.
Special meeting of the Directors of A. H. Stange Company held at the company's office at 2 o'clock P.M. on the above date, at the call of the President, all members being present.
To carry in to execution the plan for a long time under consideration to discontinue A. H. Stange Co., holdings of cut-over and timbered lands as well*2667 as its logging operations, it was moved, seconded and unanimously carried -
1. That the following accounts as they will appear on the books of this company as of June 10, 1914, be closed, to wit:
Pine Lands
Lincoln County Lands
General Log Equipment
Camp Pellegrin
Camp No. 2
2. That the values, set up opposite the said accounts as they will appear on June 10, 1914, together with the sum of $60,000 in cash, be charged against surplus account.
3. That the officers of this company be and they are hereby authorized to give by proper deeds of conveyance to UNION LAND CO. (a corporation of Merrill, Wisc., composed exclusively of the stockholders of A. H. STANGE CO., the respective interests of the stockholders in UNION LAND COMPANY being equal to their present prorata holdings in A. H. STANGE CO.) all real estate and personal property represented by the above named accounts together with the sum of $60,000 in cash.
4. That on June 10, 1914 the sum of $300,000 be charged against surplus account and cash or its equivalent be given to KINZEL LBR. CO., a corporation of Merrill, Wisconsin (comprised of the stockholders of A. H. STANGE CO., the interest of the stockholders*2668 in both corporations being pro-ratably equal.)
On June 10, 1914, the property, having a book value of $1,059,667.15, transferred to the Union Land Co. as explained above, was appraised and entered on the books of the Union Land Co. at a value of $3,431,382.61. The property so transferred and valued consisted chiefly of timber and timber lands which had been acquired by the A. H. Strange Co. between the date of its organization in 1895 and the date of said transfer, June 10, 1914.
Subsequent to the valuation of the timber and timberland property and the entry of the value of $3,431,382.61 upon its books June 10, 1914, and prior to September 9, 1921, the Union Land Co. submitted to the Bureau of Internal Revenue a questionnaire relating to the value of the timber and timberlands as of June 10, 1914, in which questionnaire it was alleged that the fair market value as of June 10, 1914, of the property was not less than $4,512,137.95. Upon consideration of the information contained in the questionnaire, engineers of the Bureau of Internal Revenue, under date of September 9, 1921, approved a value of $4,189,968.81.
*6 Upon the basis of these various valuations of the timber*2669 and timberlands, the fair market value as of June 10, 1914, of the total amount of cash and property transferred by the A. H. Stange Co. to the Union Land Co. would be as follows:
| Value set up on the books of the Union Land Co., June 10, 1914 | $3,491,382.61 |
| Value claimed in questionnaire | 4,572,137.95 |
| Value approved by engineers of the Bureau of Internal Revenue, | 4,189,968.81 |
| Sept. 9, 1921 |
The property transferred by the A. H. Stange Co. to the Kinzel Lumber Co. on June 10, 1914, consisted of $300,000 in cash and notes receivable and one piece of real estate having a fair market value of $5,000 (which real estate was not carried upon the books of account of the A. H. Stange Co.), making a total value of property transferred $305,000.
These conveyances were made on June 10, 1914, by the A. H. Stange Co. directly to the Union Land Co. and the Kinzel Lumber Co., and without any intermediate transfer of any of the assets being made to or through any of the stockholders.
No consideration in money or money's worth passed from any of the sons, daughters, or sons-in-law to A. H. Stange for the transfer of stock above described.
On July 1, 1914, the Union Land*2670 Co. issued to its stockholders noninterest-bearing debenture notes, which notes were issued by the company to its stockholders in proportion to their stockholdings, in the aggregate amount of $3,185,000; and on the same day the Kinzel Lumber Co. likewise issued to its stockholders, also in proportion to their stockholdings, debenture notes in the amount of $140,000. The following is a specimen copy of the debenture notes, all of which contained identical provisions except for the face amounts thereof:
TWENTY YEAR NON-INTEREST BEARING DEBENTURE NOTE OF UNION LAND COMPANY.
$15,000.
Series C.
No.
Union Land Company, a corporation, of Merrill, Wisc., for value received, promises to pay to the bearer or registered holder thereof, on or before twenty years from date hereof, the sum of FIFTEEN THOUSAND DOLLARS ($15,000.) without interest, at the Company's office in the City of Merrill, Wisconsin. This note is one of 510 Notes in three series - Series A numbered from 1 to 210, both inclusive, Series B numbered from 211 to 410, inclusive, and Series C numbered from 411 to 510, both inclusive, all of like tenor, issued in denominations of $2,500, $5,000, $7,500, $10,000 and $15,000*2671 the aggregate of which is limited to $3,185,000. The issue can only be retired in payments of $35,000 or multiples thereof of any of said series and only in the numerical order of any of said series.
This note, with all other outstanding notes of Series A, B, and C, shall be a first lien, on all of the assets of Union Land Company, which corporation agrees with the bearer or registered holder hereof that it will not mortgage its real or personal property while this note or any other notes of this issue *7 remains outstanding and unpaid. This note may be registered in the name of the holder on the books of the company. Otherwise, shall pay by delivery and without endorsement.
In witness whereof Union Land Company has caused this note to be signed by its President and by its Treasurer, and its corporate seal to be hereto affixed this First day of July, 1914.
UNION LAND COMPANY,
By A. H. STANGE,
President.
By F. W. KING,
Treasurer.
At the time of the issuance of the above described debenture notes, the Union Land Co. had assets of a total book value of $3,491,382.61 as indicated above. Against the book value of $3,491,382.61 there was outstanding*2672 capital stock in the sum of $245,000 and accounts payable in the amount of $3,234,000. These accounts payable represented the aggregate of the amounts shown by the books of account as due to the several stockholders. Against these stockholders' accounts, totaling $3,234,000, the Union Land Co. issued the above described debentures in the total face value of $3,185,000, leaving a balance of $49,000, which was duly paid to the stockholders. The Union Land Co. had no net earnings during the period March 24, 1914, to July 1, 1914.
On June 11, 1914, the Kinzel Lumber Co. had assets of a total book value of $315,000, against which there were outstanding capital stock in the sum of $105,000 and accounts payable in the amount of $210,000. These accounts payable represented the aggregate of the amounts shown by the books of account as due to each stockholders. On said date of June 11, 1914, the company distributed to its stockholders, in proportion to their stockholdings, the sum of $70,000, leaving a balance of $140,000, for which amount the debentures described above were subsequently issued to the stockholders in the proportion of their stockholdings. The Kinzel Lumber Co. had no*2673 net earnings during the period May 29, 1914, to July 1, 1914.
In determining the income and profits-tax liability of the affiliated group for 1919, respondent eliminated from the consolidated invested capital the amount of $3,010,000, being the amount of the debentures outstanding at the beginning of the year.
OPINION.
VAN FOSSAN: The issue relating to the affiliation of the Mount Emily Timber Co. has been settled by the stipulation of the parties that the Mount Emily Timber Co. was affiliated with the petitioners during the year 1919 and that, therefore, the net income and invested capital of the Mount Emily Timber Co. should be included in the consolidated net income and consolidated invested capital of the petitioner companies.
*8 The third issue was withdrawn by the petitioners at the hearing.
There remains for determination only the question as to whether or not the debenture bonds issued by the Union Land Co. and the Kinzel Lumber Co. outstanding during 1919, and amounting to $3,010,000, represented borrowed capital.
This identical question and the same parties were before the Board for one of the previous years in *2674 . The effect of the holding in that case was that the evidence did not overcome the presumption that the securities in question represented borrowed capital.
The petitioners claim that the above decision of the Board is not controlling for the reason that in that appeal the Board did not have before it all of the material facts which are set forth in the stipulation in the present case. They further assert that the questions of law raised in the present appeal were not considered or decided by the Board in its previous decision.
Careful consideration of the stipulated facts in this case leads us to the same conclusion announced in the previous case. Counsel's attempt to differentiate the two proceedings is not convincing nor are the cases cited found to be controlling. To adopt petitioners' interpretation of the transaction would require a strained and unreasonable construction.
We are of the opinion that the debenture bonds, amounting to $3,010,000, outstanding in 1919, represented borrowed capital of the petitioners and that the action of the respondent in eliminating this amount from consolidated*2675 invested capital was proper.
Judgment will be entered under Rule 50.