*1243 1. Consolidated invested capital determined.
2. Petitioner held not entitled to any deduction for obsolescence of a Boss burning system and steam drying equipment which had been used in connection with the plant and clay lands purchased by the petitioner, but were in the process of being dismantled at the time the purchase was made.
*794 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the year 1920 in the amount of $35,430.17, not all of which is in controversy. The respondent determined that the consolidated net income of the two petitioners was $108,693.83, the Columbus Brick & Tile Company having an income of $111,411.83 and the Gamble & Stockton Company a net loss of $2,718. The deficiency letter was addressed to both corporations, the entire deficiency being asserted against the Columbus Brick & Tile Company. The petitioner is filed in the name of both corporations.
There are three errors alleged: (1) That the respondent failed to include in consolidated invested capital, for 1920, $210,000*1244 for capital stock issued by the Columbus Brick & Tile Company for a brick and tile manufacturing plant, clay lands, etc., and $90,000 for capital stock issued by the same company for promissory notes; (2) that the respondent failed to allow as a deduction from gross income the amount of $6,131.97, the cost of a Boss burning system, and $26,545.58, the cost of a steam drying plant, both of which were discarded by the Columbus Brick & Tile Company in that year; and (3) if the foregoing claims are not allowed, then the respondent erred in failing to determine the excess-profits tax under the provisions of sections 327 and 328.
On motion the hearing was limited to the issues other than special assessment as defined by Rule 62(a) of the Board's rules of practice.
This proceeding was heard with that of Telfair Stockton, Docket No. 42708.
*795 FINDINGS OF FACT.
The Gamble & Stockton Company was incorporated under the laws of the State of Florida on July 28, 1910, for the purpose of manufacturing, dealing in, and selling clay products, principally brick and tile. The Columbus Brick & Tile Company was incorporated under the laws of the State of Florida on January 5, 1920, also*1245 for the purpose of manufacturing, dealing in and selling clay products.
In 1916 and on through the taxable year 1920, Telfair Stockton and Robert Gamble, both residents of Jacksonville, Florida, each owned 999 shares of the stock of the Gamble & Stockton Company, the remaining two shares being owned by C. W. Dixon.
On November 5, 1919, the Gamble & Stockton Company acquired the plant and clay lands of the Shepherd Brothers Company at Columbus, Georgia. This property was acquired at a cost of $210,000, $100,000 of which was paid in cash and the Gamble & Stockton Company gave its note due in three years and bearing 7 per cent interest, secured by a mortgage, for the remaining amount.
It was intended at the time of the purchase to form a new corporation to operate this property and an application for a charter was filed in Florida in November, 1919. The charter was granted to the Columbus Brick & Tile Company on January 5, 1920, with authorized capital of $500,000, divided into 5,000 shares having a par value of $100 per share.
The plant was in operation at the time of the purchase by Gamble & Stockton Company and was continued in operation. On and after January 1, 1920, it*1246 was operated under the name Columbus Brick & Tile Company and books and a bank account in the same name were opened on that date.
On March 2, 1920, this plant was conveyed by proper corporate action and deed to the two individuals, Stockton and Gamble, for $210,000, and was paid for by them by a joint note due in 5 years and bearing interest at 4 per cent. The Stockton & Gamble Company remained liable for the payment to Shepherd Brothers of its note of $110,000.
On this same date, March 2, 1920, Stockton and Gamble, by appropriate deed, transferred the entire brick and tile plant to the Columbus Brick & Tile Company for $210,000 of its par value of capital stock, 1,050 shares being issued to each of the individuals. Also, on the same date, $200,000 par value of stock of the Columbus Company was issued to Stockton and Gamble in equal parts, in exchange for stock of the Dennison Interlocking Tile Company of the par value of $200,000, which had been purchased by them in 1916 for $51,000 cash. The remaining $90,000 par value of authorized *796 stock of the Columbus Company was issued on the same day to Stockton, Gamble, and Dixon for their promissory notes, bearing interest*1247 of 4 per cent, due in one year, in the amounts of $42,500, $42,500, and $5,000 respectively. The issuance of stock in the above amounts for the property and notes was authorized by proper corporate action on March 2, 1920.
Interest was paid on the joint note of Stockton and Gamble held by the Gamble & Stockton Company on December 31, 1920, and April 30, 1921. Payment of the note was made on the latter date by the transfer to the Gamble & Stockton Company of the 2,100 shares of stock of the Columbus Company which had been issued to Stockton and Gamble on March 2, 1920. Stockton and Gamble were men of considerable means, financially responsible, and their note was good.
The notes of Stockton, Gamble, and Dixon, payable to the Columbus Company for $42,500, $42,500 and $5,000, respectively, were bona fide paid in and were worth their face value. Interest on the notes was paid on December 31, 1920. The notes were paid in 1921 by applying credits for unpaid salaries due the makers and, in the case of the notes of Gamble and Stockton, also by the acceptance from each of $38,700 par value of stock of the Gamble & Stockton Company.
The mortgage note of $110,000 given by the Gamble*1248 & Stockton Company to Shepherd Brothers Company was paid by the Columbus Brick & Tile Company when it came due out of the earnings of the latter corporation from the operation of the plant. In consideration of this payment, the Gamble & Stockton Company, on or about December 23, 1923, issued 1,000 shares,$100 par value each, of a new issue of its stock to the Columbus Brick & Tile Company.
About March 2, 1920, an appraisal was made of the clay lands and plant of the Shepherd Brothers Company and a valuation of $600,000 was fixed. This $600,000 valuation was allocated on the books as follows:
| For plant property | $172,651.97 |
| Terminals | 12,000.00 |
| Farm lands | 15,000.00 |
| Clay lands | 400,000.00 |
| Advances for operating charges | 348.03 |
The opening entries of the Columbus Brick & Tile Company show a paid-in capital of $500,000, and $390,000 surplus. This surplus represents the difference between the $600,000 valuation and the $210,000 capital stock issued for the plant.
Included in the amount of $172,651.97 representing plant property was an amount of $6,131.97 representing the cost of a Boss *797 burning system, and $30,000 representing the cost of a steam*1249 drier and boiler equipment, both of which were costly to operate. Some time after the acquisition of the plant, but prior to March 2, 1920, it was decided, upon the advice of the superintendent, to install newer systems which would enable the plant to be operated more economically. About the first of February the superintendent began the dismantling of the Boss burner. Due to the fact that the plant was continued in operation, it was necessary to change one kiln at a time and the installation of the new system was completed on April 1. A contract for the replacement of the steam drying plant was entered into on January 17, 1920. The replacement was started in January and finished in the latter part of August. The Columbus Company charged off on its books as obsolescence for the year 1920 the amount of $6,131.97 and $27,803.08, the latter amount representing the cost of the steam drying equipment less salvage. The respondent refused to allow the deduction of this amount as obsolescence, but increased the depreciation claimed by restoring these amounts and allowing a rate of 5 per cent, amounting to an additional allowance of $1,696.75.
For 1920 the Columbus Company and the*1250 Gamble & Stockton Company filed consolidated returns. In determining the consolidated invested capital, the respondent allowed $200,000 as invested capital for the Gamble & Stockton Company, which was the full amount of its capital stock, and for the Columbus Company allowed $51,000, representing the actual cost to Gamble and Stockton of the Dennison stock less necessary adjustments for inadmissibles.
The stock of the Gamble & Stockton Company for the entire year 1920, and of the Columbus Brick & Tile Company from March 2, 1920, the date of issue, throughout the balance of the year, was held as follows:
| Stockholder | Gamble & | Columbus |
| Stockton Co. | Brick & Tile Co. | |
| Telfair Stockton | 999 | 2,475 |
| Robert Gamble | 999 | 2,475 |
| C. W. Dixon | 2 | 50 |
| Total | 2,000 | 5,000 |
OPINION.
MATTHEWS: The respondent has not determined a deficiency against the Gamble & Stockton Company for 1920, and the proceeding, is so far as it purports to be on behalf of that company, is, therefore, dismissed.
*798 The first issue involves the computation of invested capital.
Petitioner contends that it is entitled to include in invested capital $210,000 as the value of the*1251 Shepherd plant paid in for stock in that amount, and $90,000 as the value of the notes of Gamble, Stockton, and Dixon paid in for stock in the same amount.
The respondent, in his deficiency notice, does not give any reason for the exclusion of the value of plaint and the value of the notes from invested capital, but counsel for respondent in his brief argues that aside from the $51,000 paid by Stockton and Gamble for the Dennison stock, which they turned in to the Columbus Brick & Tile Company for stock, the rest of the transaction was merely a paper one, with the result that the Gamble & Stockton Company owned stock of the Columbus Company in exchange for assets, and, since the two corporations were affiliated, this amounted to a purchase of its own capital stock, resulting in no change in invested capital.
We can not agree with respondent's view of the transaction.
Subdivision (a) of section 240 of the Revenue Act of 1918 requires corporations which are affiliated to make a consolidated return of net income and invested capital for income-tax and excess-profits-tax purposes. Subdivision (b) of that section provides that:
For the purpose of this section two or more domestic*1252 corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.
All the stock of the Gamble & Stockton Company and of the Columbus Brick and Tile Company was owned by the same persons in 1920, and both corporations were controlled by the individuals, Telfair Stockton and Robert Gamble, who owned in equal amounts substantially all the stock. The corporations were affiliated, therefore, within the meaning of the second class of affiliations enumerated in section 240(b). The question to be decided is the correct amount of the consolidated invested capital.
In American Bond & Mortgage Co.,15 B.T.A. 264">15 B.T.A. 264, we said:
We have repeatedly held that consolidated invested capital should be determined by computing separately the statutory invested capital of each corporation, as defined by section 326, and then eliminating from the combined statutory invested capital of the affiliated group, so determined the amount*1253 of any duplications which may appear. * * *
In Middlesex Ice Co. et al.,9 B.T.A. 156">9 B.T.A. 156, we had before us a question involving the determination of consolidated invested capital, and in the course of our opinion, we said:
"Each member of the affiliated group enters the consolidation with its invested capital as defined by section 326 of the Revenue Acts of 1918 and 1921. From this preliminary exhibit there is then eliminated such items or amounts as are shown to be duplications either of investment or of earned surplus and undivided *799 profits. The law does not specifically provide for, and we are unable to find, that it in any sense contemplates any reduction or elimination of actual assets not appearing as duplications."
Section 326 provides as follows:
SEC. 326. (a) That as used in this title the term "invested capital" for any year means (except as provided in subdivisions (b) and (c) of this section):
(1) Actual cash bona fide paid in for stock or shares;
(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock*1254 or shares specifically issued therefor, * * *
* * *
(c) There shall be deducted from invested capital as above defined a percentage thereof equal to the percentage which the amount of inadmissible assets is of the amount of admissible and inadmissible assets held during the taxable year.
In computing the invested capital of the Columbus Company under section 326, supra, we must determine how much can be included on account of the notes and the plant paid in for stock. Petitioner admits that the Dennison stock can only be included at $51,000 under the provisions of section 331. We have found, upon a consideration of the evidence, that the notes were worth their face value at the time paid in and that they were bona fide paid in. The makers were responsible and solvent, and bankers with whom the individuals and corporations did business and obtained credit testified that the notes were worth face value. Interest was paid on the notes when due. They should be included in invested capital at their face value. Harding Glass Co.,15 B.T.A. 621">15 B.T.A. 621.
There is no doubt that the plant was worth at least $210,000 when paid in for capital stock. This was the amount*1255 paid for it by the prior owners and by the Gamble & Stockton Company in an arm's length transaction only a few months before, and the evidence substantiates such a valuation. It should be included in invested capital at $210,000.
Thus, by following the method outlined in the case of American Bond & Mortgage Co., supra, and computing separately the invested capital of these two corporations, we find that the Columbus Company has an invested capital of $351,000, before adjustment for inadmissibles, computed under the provisions of section 326. This amount is arrived at as follows:
| Stock of the Dennison Company paid in for stock | $51,000 |
| Plant of Shepherd Bros. paid in for stock | 210,000 |
| Notes of Gamble, Stockton and Dixon paid in for stock | 90,000 |
The respondent has allowed the Gamble & Stockton Company an invested capital of $200,000, representing the par value of its capital stock. This would make a consolidated invested capital of $551,000, before necessary adjustments in which there are no duplications.
*800 The fact, as shown by the evidence, that in 1921 the notes for $90,000 were paid to a large extent in stock of the Gamble*1256 & Stockton Company and the note for $210,000 held by the Gamble & Stockton Company was paid in stock of the Columbus Company, can not affect invested capital for 1920. The year 1921 is not before us and, therefore, we do not have to determine the effect on invested capital of such payments. Neither does the fact that in 1922 the Columbus Company paid out of its earnings the note for $110,000 given by the Gamble & Stockton Company to the Shepherd Brothers Company and in 1923 received stock of Gamble & Stockton Company, affect invested capital for 1920.
The invested capital of the Columbus Company should be averaged from the date of issue of its stock. At the hearing the respondent moved to amend his answer to conform to the proof in that the evidence showed that the stock of the Columbus Company was not issued until March 2, 1920, which would require that invested capital of the Columbus Company be averaged from the date of issue. See section 326(d) of the Revenue Act of 1918; Federal Development Co.,18 B.T.A. 971">18 B.T.A. 971.
The second assignment of error relates to the disallowance by the respondent of the cost, less salvage, of a Boss burner and steam drier equipment*1257 which were discarded in the early part of 1920 as obsolete in order that more up-to-date systems might be installed. At the time the plant was conveyed to the Columbus Company the process of replacing these two systems was in progress, though not completed until April and August of that year, respectively. The respondent disallowed the deduction upon the ground that it was definitely known not later than January that these systems would be discarded, and increased the depreciation claimed by the amount of $1,696.75, representing 5 per cent of the $33,935.05 disallowed. The deficiency on this point is based on the report of the revenue agent, in which the following explanation of this disallowance appears:
* * * The purchase was at a lump sum price for the brick yard as a whole, and in disallowing the deduction of $33,935.05, it of course restores that amount to the total purchase price to be allotted to such parts of the plant as did possess a value at the time of acquisition; that is, the plant as a whole was worth as much without the useless burning and drying systems (less the salvage) as it was with such useless and valueless systems.
*1258 It has been held both by the courts and by this Board that where a taxpayer purchases real estate and a building and intends at the time of such purchase to tear down a part of the building to make alternations thereon, the cost of such demolition and of the property destroyed is not deductible as a loss, but constitutes a part of the purchase price. See Liberty Baking Co. v. Heiner, 34 Fed.(2d) 513; Union Bed & Spring Co. v. Commissioner, 36 Fed.(2d) 383; and *801 Milwaukee Woven Wire Works,16 B.T.A. 75">16 B.T.A. 75. In Union Bed & Spring Co., supra, the court said: "If he [the taxpayer] intends at the time of purchase, to demolish and rebuild, then the cost of so doing must be considered as part of his capital investment."
It seems to us that the instant case present a somewhat similar situation. The corporation paid the $210,000 for the plant and clay lands, knowing that the Boss burner and steam drying plant were obsolete and were at that time in the process of being dismantled. The petitioner contends that the property was operated for the Columbus Company and in the name of the Columbus Company from*1259 the first of January, and that, since it was not until later that these two systems were scrapped, the corporation is entitled to the claimed deduction. We see no merit in this contention. Although the charter for the Columbus Company had been granted, the property in question was not conveyed to it until March 2, at which time these systems were being dismantled. We are, therefore, of the opinion that the respondent was correct in assuming that the corporation expended the total purchase price for the property as a whole, without the Boss burner and steam drying equipment." The Columbus Company is, accordingly, not entitled to any deduction for obsolescence of these two systems.
Further proceedings may be had under Rule 62(b) and (c).