*1561 1. STATUTE OF LIMITATIONS. Consolidated returns filed for 1918 and 1919 held to meet the statutory requirements as to filing returns. Assessment for 1918 was timely made on March 15, 1924, but the deficiency notice was not mailed until after the statutory period, as extended by a waiver, had expired and it is held that collection is barred. Assessment for 1919 was made more than five years after the return was filed and it is held that collection is barred.
2. AFFILIATION. Petitioners held not affiliated with the New England Company.
3. DEDUCTION. Parent company loaned money to a wholly owned subsidiary to finance construction for petitioners. The subsidiary included in bills to petitioners amounts to cover the interest it was required to pay the parent on the borrowed funds. Held, amounts so paid by petitioners may not be deducted as interest.
4. INCOME. Parent company guaranteed the dividends on the preferred stock of one of petitioners, and in fulfillment of that guaranty paid certain sums to the petitioner. Held, such payments were not income to the petitioner.
*196 These proceedings, duly consolidated, are brought for the redetermination of income and profits taxes determined by the respondent as follows:
(Table omitted)
For all the years, except as to 1918 in Docket No. 18591, all three petitioners allege that they were affiliated with the New England Company and that the respondent erred in not computing the tax on the basis of consolidated returns and assessing against that company any tax found due.
The deficiencies proposed for 1918 and 1919 are claimed to be barred from assessment and/or collection by the statute of limitations. The same error originally asserted as to 1920 was waived by petitioners.
An error alleged in Docket Nos. 18591 and 18593 involving reduction of invested cpaital and surplus on account of depreciation has been waived.
In Docket No. 18591 it is alleged that respondent erred in not allowing deductions for interest paid in 1919 and 1920. In Docket *197 No. 18593 petitioner alleges that it is entitled to deductions for interest accrued in 1919 and 1920.
In Docket No. *1563 18592 it is alleged that respondent erroneously included in income for 1919 and 1920 amounts paid to petitioner by the parent, New England Company, on account of the latter's guaranty of dividends on petitioner's preferred stock.
In Docket No. 29106 respondent in his answer concedes error in reducing invested capital for 1921 on account of dividends paid in the amount of $207,840.
FINDINGS OF FACT.
Facts Relating to the Issue of Affiliation.
The New England Company, hereinafter sometimes called the parent company, was a Massachusetts voluntary association, formed to act as a holding company for a group of subsidiary companies, including petitioners, which were engaged in manufacturing, distributing and selling hydroelectric and steam power. During the taxable years there were four principal operating subsidiaries or groups as follows: (1) New England Power Company, a Massachusetts corporation; (2) Connecticut River Power Company, incorporated in both New Hampshire and Vermont; (3) Bellows Falls Power Company, a Massachusetts corporation; and (4) Rhode Island Transmission Company. (The last named company is not involved in these proceedings.) The above named companies*1564 operated in Vermont, New Hampshire, Massachusetts, Rhode Island, and Connecticut. They were separately incorporated because of the requirements by the several States that public utilities be operated by domestic corporations. Most of the construction work for the above companies was done by the Power Construction Company, a wholly owned subsidiary of the parent.
Throughout the taxable years petitioner, New England Power Company, hereinafter called the Power Company, had outstanding two classes of stock, common and preferred. The preferred stock was widely scattered; it had equal voting rights with the common; it was entitled to cumulative preferential dividends of 6 per cent and no more, and on liquidation or dissolution, to $100 a share and accumulated and unpaid dividends and no more before any payment on the common stock; it was not participating or convertible.
At January 1 of each of the several years here listed the Power Company's outstanding stock, and the ownership therein of the parent and related companies and mutual stockholders, were as follows:
| 1919 | 1920 | 1921 | 1922 | 1923 | 1924 | |
| Capital stock outstanding | ||||||
| Preferred shares | 37,968 | 37,992 | 40,992 | 53,492 | 53,492 | 65,918 |
| Common shares | 38,000 | 38,000 | 38,000 | 38,000 | 38,000 | 80,000 |
| Total outstanding | 75,968 | 75,992 | 78,992 | 91,492 | 91,492 | 145,918 |
| Ownership | ||||||
| Preferred stock: | ||||||
| By New England Company (parent) | 57 | 172 | 644 | 293 | 172 | 9,147 |
| By Power Construction Company | 2,023 | 550 | 200 | |||
| By stockholders of parent company | 4,224 | 5,243 | 6,419 | 7,230 | 7,409 | 8,379 |
| By preferred stockholders of Connecticut River Power Co | 95 | 80 | 80 | 180 | 245 | 298 |
| Common stock, by parent company | 38,000 | 38,000 | 38,000 | 38,000 | 38,000 | 80,000 |
| Total shares of stock owned by parent company, its stockholders, Power Construction Company, and preferred stockholders of Connecticut River Power Company | 44,399 | 43,495 | 45,693 | 45,903 | 45,826 | 97,824 |
| Percentage of stock so owned | 58.44 | 57.24 | 57.85 | 50.17 | 50.09 | 67.04 |
| Percentage owned outright by parent company | 50.10 | 50.23 | 48.92 | 41.85 | 41.72 | 61.09 |
*1565 *198 The Connecticut River Power Company, hereinafter called the Connecticut Company, had both common and preferred stock outstanding. The preferred stock was widely scattered. It had equal voting rights with the common stock, share for share, was entitled to cumulative preferential dividends of 6 per cent a year and no more and, on liquidation or dissolution, to $100 a share and accumulated and unpaid dividends and no more before any payments to the common stock, but was not participating nor convertible.
The amount of outstanding stock at January 1 of each year and the ownership therein of the parent company, its stockholders and stockholders of the Power Company were as follows:
| 1919 | 1920 | 1921 | 1922 | 1923 | 1924 | |
| Capital stock outstanding | ||||||
| Preferred shares | 7,140 | 7,140 | 7,140 | 7,140 | 7,140 | 12,000 |
| Common shares | 15,000 | 15,000 | 15,000 | 15,000 | 15,000 | 32,000 |
| Total outstanding | 22,140 | 22,140 | 22,140 | 22,140 | 22,140 | 44,000 |
| Ownership | ||||||
| Preferred stock: | ||||||
| By New England Company (parent) | 2,106 | 1,031 | 206 | 4,860 | ||
| By stockholders of parent company | 2,077 | 2,189 | 2,417 | 2,539 | 2,353 | 2,271 |
| By preferred stockholders of New England Power Company | 192 | 150 | 140 | 208 | 253 | 313 |
| Common stock, by parent company | 15,000 | 15,000 | 15,000 | 15,000 | 32,000 | 32,000 |
| Total shares of stock owned by parent company and its stockholders and preferred stockholders of New England Power Company | 19,375 | 18,370 | 17,763 | 17,747 | 34,606 | 39,444 |
| Percentage of stock so owned | 87.51 | 82.97 | 80.23 | 80.16 | 88.42 | 89.65 |
| Percentage of stock owned outright by parent company | 77.26 | 72.41 | 68.27 | 67.75 | 81.76 | 83.77 |
*1566 During the years involved, from 60 per cent to 70 per cent of the preferred stock of the Connecticut Company voted at meetings of the stockholders by sending in proxies to the management. Other preferred stockholders from time to time attended meetings of the stockholders in person and voted with the management.
*199 All directors of the Connecticut Company throughout this period were in fact selected and elected by the parent company.
Preferred stockholders of the Connecticut Company have never objected to any action taken by that company.
The preferred dividends of the Connecticut Company have always been paid. The number of preferred stockholders of that company has ranged from 319 to 456.
The Bellows Falls Power Company, hereinafter called the Falls Company, during the years 1919 to 1923, inclusive, owned 100 per cent of the stock of the Fall Mountain Electric Company, Bellows Falls Electric Company and Bellows Falls Canal Company. It is agreed that these companies are affiliated with the petitioner, Falls Company.
Throughout the years 1919 to 1922, inclusive, the New England Company (the parent company) owned 1,275 out of 1,500 shares, or 85 per cent*1567 of the common stock of the Falls Company. The remaining 15 per cent, or 225 shares, of the common stock was held as follows:
| Shares | |
| Bessemer Investment Company | 202 |
| Henry Phipps | 15 |
| George E.Gordon | 8 |
| Total | 225 |
Throughout the same period the Falls Company had outstanding preferred stock varying from $200,000 to $650,000 par value ( $100 a share), which was limited to preferential dividends of 5 per cent a year and no more and of which the parent company owned from 75 per cent to 95 per cent. This preferred stock was callable, in the discretion of the directors, at $105 per share. It had no voting rights except in matters relating to increasing the bonded indebtedness or the preferred stock of the company.
The 15 per cent minority common stockholders did not in fact vote their stock during this period as no stockholders' meetings, annual or special, were held from March 22, 1916, to March 19, 1928.
All directors of the Falls Company throughout this period were in fact selected and elected by the parent company, the owner of 85 per cent of the common stock of the Falls Company.
The 15 per cent minority common stockholders have never objected to any*1568 action taken by that company. All of this minority common stock was acquired by the parent company on January 1, 1923, making 100 per cent ownership of all common stock. There is no affiliation issue concerning this company for 1923.
The Bessemer Investment Company, listed above as one of the minority stockholders in the Falls Company, was controlled by the *200 Phipps family, which upon organization of the Falls Company had advanced the funds used by the latter to buy certain water rights. The 15 per cent stock was issued at that time as a bonus, and it was agreed when the stock was issued that it would be turned back to the company at some future time at a price to be agreed upon. George E. Gordon was financial secretary to Henry Phipps and treasurer of the Bessemer Investment Company.
The officers and directors of the several companies during the years involved were as follows:
| New England Company (parent) | ||
| Office | 1919-1920 | 1921-1923 |
| President | G. S. Smith | G. S. Smith. |
| Vice president | M. G. Chace | M. G. Chace. |
| Vice president | G. B. Baker | G. B. Baker |
| Treasurer | W. W. Brooks | W. W. Brooks. |
| Secretary | R. Y. FitzGerald | R. Y. FitzGerald. |
| Trustee | C. L. Ayling | C. L. Ayling. |
| Do | G. B. Baker | G. B. Baker. |
| Do | M. G. Chace | M. G. Chace. |
| Do | H. I. Harriman | H. I. Harriman. |
| Do | Philip Young | Philip Young. |
| Do | G. S. Smith. |
| New England Power Co. | |||
| Office | 1919 | 1920 | 1921-1923 |
| President | H. I. Harriman | H. I. Harriman | H. I. Harriman |
| Vice president | George S. Smith | George S. Smith | George S. Smith |
| Treasurer | W. W. Brooks | W. W. Brooks | W. W. Brooks |
| Clerk | R. Y. FitzGerald | R. Y. FitzGerald | R. Y. FitzGerald |
| Member of executive | C. L. Ayling | C. L. Ayling | C. L. Ayling |
| committee | |||
| Do | G. B. Baker | G. B. Baker | G. B. Baker |
| Do | M. G. Chace | M. G. Chace | M. G. Chace |
| Do | H. I. Harriman | H. I. Harriman | H. I. Harriman |
| Do | Philip Young | Philip Young | Philip Young |
| Director | C. L. Ayling | C. L. Ayling | C. L. Ayling |
| Do | R. L. Bacon | R. L. Bacon | |
| Do | G. B. Baker | G. B. Baker | G. B. Baker |
| Do | M. G. Chace | M. G. Chace | M. G. Chace |
| Do | H. I. Harriman | H. I. Harriman | H. I. Harriman |
| Do | John S. Phipps | John S. Phipps | John S. Phipps |
| Do | Philip Stockton | Philip Stockton | Philip Stockton |
| Do | George S. Smith | George S. Smith | George S. Smith |
| Do | E. V. R. Thayer | ||
| Do | Philip Young | Philip Young | Philip Young |
| D0 | S. C. Moore | S. C. Moore | S. C. Moore |
| Do | A. E. Pope | A. E. Pope | |
| Do | R. Y. FitzGerald |
| The Connecticut River Power Company | ||
| Office | 1919-1922 | 1923 |
| President | C. A. Harris | C. A. Harris. |
| Vice president | John N. Harvey | Philip Young. |
| Secretary | H. E. Whitney | H. E. Whitney. |
| Clerk | E. J. Temple | E. J. Temple. |
| Treasurer | W. W. Brooks | W. W. Brooks. |
| Director | C. A. Harris | C. A. Harris. |
| Do | J. N. Harvey | J. N. Harvey. |
| Do | H. E. Whitney | H. E. Whitney. |
| Do | E. J. Temple | E. J. Temple. |
| Do | W. W. Brooks | W. W. Brooks. |
| Do | Philip Young. |
| Bellows Falls Power Company | |
| Office | 1919-1923 |
| President | G. B. Baker. |
| Vice president | M. G. Chace. |
| Treasurer | W. W. Brooks. |
| Assistant treasurer | P. H. Hadley. |
| Secretary | |
| Clerk | R. Y. FitzGerald. |
| Director | H. I. Harriman. |
| Do | M. G. Chace. |
| Do | Geo. B. Baker. |
| Do | W. W. Brooks. |
| Do | Philip Young. |
*201 The parent company and its several subsidiaries, including the petitioners herein, comprised what is known as the New England Company system. The Falls Company plant was on the Connecticut River at a point where there was no control of the flow of the river, and the power produced varied with the flow. Farther south on the same river was located the plant of the Connecticut Company. The flow of water at that point was not fully controlled, but some degree of regulation was obtained by the use of flash boards. The Power Company was on the Deerfield River in which the flow of water was controlled by means of a reservoir. In periods of low water the power produced at the hydroelectric plants was supplemented with power produced by steam plants, some of which were owned by outside interests, the power from them being supplied under contract.
*1571 At Millbury, near Worcester, Massachusetts, the parent company maintained a central distributing plant, at which records of the flow of the river were kept. A dispatcher was stationed at the plant and he apportioned the power load to the petitioners on the basis of the flow. The hydroelectric plants were used as far as possible and any deficiency in their production was made up by the use of the most efficient of the steam plants. The purpose of this arrangement was to operate the several plants of petitioners and other subsidiaries of the parent as a unit as nearly as possible. The expense of maintaining the Millbury distributing plant was prorated to the several operating companies on the basis of the amount of business of each. In apportioning the power loads to the several plants of petitioners, the dispatcher made no distinction because of the separate corporate entities, his instruction being to make the apportionment in such a way as to operate the plants in the most efficient manner. This arrangement resulted in a lower aggregate investment for petitioners than would have been required if each company had had to maintain plant and equipment sufficiently large to meet*1572 its own peak loads.
*202 The auditor employed by the parent company rendered to each petitioner monthly bills for power transferred from others as above described. In the bills so rendered the kilowatt hour rate was fixed by the general manager of the several companies. At the end of each year a survey of the year's operations was made and corrected billings were made up, in which the rate was fixed in such a manner that no operating company should show a loss.
The several operating companies were under the direction of a general manager employed by the parent company and responsible to its trustees. It was his duty to see that efficient and proper use was made of all available sources of power. His salary was paid by the parent company, which in turn apportioned it to the operating companies except the Falls Company, which was a small unit, and no direct charge was made to it for the general manager's services.
All of the books of the parent and the several subsidiaries were kept at the parent's offices by a staff employed by the parent under the direction of its general auditor.
Decisions as to any construction work for the operating companies were made by*1573 the trustees of the parent upon recommendation of the general manager. Most of the construction work was performed by a wholly owned subsidiary of the parent, the Power Construction Company, which also acted as purchasing agent for the operating companies. Funds for construction work were advanced by the parent to the Power Construction Company at regular interest rates.
The general policies of the companies comprising the system were determined by the trustees of the parent company.
Various expense items, in addition to those above mentioned, including salaries of bookkeeping staff, dues to National Electric Light Association, and costs of welfare and safety work, were paid by the parent and then arbitrarily prorated and charged to the several subsidiaries without regard to the amount for which each company was actually responsible.
Facts relating to the Issue of Statute of Limitations.
1918 (Docket No. 18591).
On June 16, 1919, the parent company filed a consolidated income and profits-tax return for the year 1918, which showed separately the items of gross income, deductions, and invested capital of the Connecticut Company for that year.
On March 6, 1924, petitioner, *1574 the Connecticut Company, executed a waiver extending for one year "after the expiration of the statutory period of limitation" the time for assessment and collection of 1918 taxes. This waiver was filed with the respondent and signed by him *203 or in his behalf. On March 15, 1924, the respondent made a jeopardy assessment against petitioner for the year 1918 in the amount of $175,183.43. Notice and demand were received by petitioner on August 11, 1924, and on August 16, 1924, it filed a claim for abatement of the assessment. In October, 1925, respondent issued a certificate of overassessment against the assessment made in March, 1924, in which he stated the correct tax liability to be $30,884.15 and found an overassessment of $144,299.28. Against the tax liability found in the amount of $30,884.15, respondent credited overassessments for prior years in the amount of $3,601.67, and the Connecticut Company on November 4, 1925, paid $17,232.84 and filed claim for abatement of the balance, amounting to $10,049.64. With the abatement claim petitioner filed a proper surety bond.
By letter dated May 22, 1926, respondent advised the Connecticut Company that its correct tax*1575 liability for 1918 had been determined to be $29,736.04, and that by reason of the previous assessment in March, 1924, of which $30,884.15 had not been abated, there was an overassessment of $1,148.11. Upon this letter the company based its petition for redetermination.
1919 (Docket Nos. 18591, 18592, 18593).
On March 12, 1920, the parent company filed a consolidated income and profits-tax return for the year 1919, which return showed separately the items of gross income, deductions, and invested capital of the petitioners herein. On September 15, 1925, the respondent entered jeopardy assessments against petitioners as follows: Power Company, $32,959.73; Connecticut Company, $12,791.01; Falls Company, $1,245.16. On October 7, 1925, petitioners filed claims for abatement of the entire assessments, and in each case filed a surety bond conditioned upon payment of the amount determined to be due by the respondent or by this Board.
The respondent rejected the claims in abatement and advised petitioners thereof and of additional amounts to be assessed as follows:
| Petitioner | Date of letter | Claim rejected | Additional to be assessed |
| Connecticut Co | May 22, 1926 | $12,791.01 | $22,514.71 |
| Power Co | May 24, 1926 | 32,959.73 | 36,338.90 |
| Falls Co | May 22, 1926 | 1,245.16 | 2,184.84 |
*1576 The petitions for redetermination are based on those letters.
Facts Relating to Claimed Interest Deductions.
As hereinbefore stated, construction work for the operating subsidiaries was performed by another subsidiary, the Power Construction *204 Company, in which the parent owned all the stock. The practice was for the parent to advance funds to the Power Construction Company, from which the latter made disbursements for wages, materials, and supplies for carrying on the construction work. Interest was charged by the parent company on the money so advanced, and the Power Construction Company, in order to meet such interest charges, made a charge therefor as a part of the cost of work billed to the operating company for which the construction work was performed. The operating companies paid for the construction work either out of bank borrowings or from proceeds of sale of bonds or preferred stock.
During 1919 and 1920 the petitioner, New England Power Company, charged on its books as capital expenditures the sums, respectively, of $48,213.29 and $25,474.25 interest, these amounts being interest charged by the parent company on sums advanced to the Power Construction*1577 Company. The amounts so charged were neither claimed as deductions in returns of the Power Company (petitioner) nor allowed as deductions by respondent.
Similarly, the Connecticut River Power Company charged on its books for 1919 and 1920 the respective sums of $3,650.91 and $36,835.71, which items are of the same character as those described in the two preceding paragraphs, and which were neither claimed nor allowed as deductions.
Facts Relating to Guaranty of Dividends.
The parent company in the years 1919 and 1920 paid the Falls Company the sums of $17,461.82 and $21,832.50, respectively, such payments in each year being on account of the parent company's guaranty of preferred dividends of the Falls Company, as hereinafter described. The amounts so paid were not included by the Falls Company in income, but were added to that company's net income by respondent in his notice of deficiency.
By an instrument executed May 1, 1915, which was a supplement to prior instruments that need not be described in detail here, the parent company bound itself to pay to the Old Colony Trust Company semiannually an amount which, added to the available income of the Falls Company, *1578 would be sufficient to pay an annual dividend of $5 on the preferred stock of the Falls Company. In practice the sums necessary to make up the annual dividend were paid directly to the Falls Company rather than to the Old Colony Trust Company. The Falls Company was not a party to any of the agreements.
OPINION.
ARUNDELL: At the outset we must consider the suggestion of lack of jurisdiction in the Connecticut River Power Company case, Docket *205 No. 18591, in so far as the year 1918 is concerned. The original return, a consolidated return, showed no tax due from this company separately. On March 15, 1924, the respondent, after refusing to allow affiliation, assessed against this petitioner $175,183.43. Abatement claim was filed, which was allowed for $144,299.28 and rejected to the extent of $30,884.15. This latter amount was satisfied to the extent of $20,834.51, partly by credit and partly by payment, and against the balance of $10,049.64 petitioner filed a claim in abatement. Correct tax liability was finally determined by respondent to be $29,736.04, and, by reason of the unabated portion of the March, 1924, assessment in the amount of $30,884.15, respondent*1579 found an apparent overassessment of $1,148.11. The net result of this is that the respondent is asserting a claim for taxes for the year 1918 in the amount of $8,901.53. In other words, he is asserting a deficiency and not finding an overassessment as alleged. The determination was made in the letter of May 22, 1926, and we have jurisdiction. Section 283(e), Revenue Act of 1926.
Statute of Limitations.
This issue is raised with respect to the year 1918 in Docket No. 18591, and as to 1919 in Docket Nos. 18591, 18592 and 18593.
The 1918 return was filed by the parent company on June 16, 1919. As that return showed for the several companies separately the data necessary for the computation of the tax of each, it was sufficient to put the statute of limitations in operation. Continental Oil Co.,23 B.T.A. 311">23 B.T.A. 311, and cases therein cited. The statutory period for assessment and collection, as extended by the waiver filed, expired June 16, 1925. Consequently the assessment of March 15, 1924, was timely, but under *1580 Russell v. United States,278 U.S. 181">278 U.S. 181, collection was barred when the deficiency notice of May 22, 1926, was sent, unless, as contended by respondent, the period was extended by reason of the filing of claim in abatement and bond. We have repeatedly held that the filing of an abatement claim or a bond does not extend the statutory period. Wirt Franklin,8 B.T.A. 977">8 B.T.A. 977; Gulf States Steel Co.,12 B.T.A. 1244">12 B.T.A. 1244; J. B. Dortch,19 B.T.A. 159">19 B.T.A. 159. Respondent's contention is that collection is not barred, because section 279(a) of the Revenue Act of 1924 provides that upon the filing of an abatement "claim and bond the collection * * * shall be stayed pending the final disposition of the claim." That provision, however, relates only to assessments made under section 274(d) of the same act; that is, assessments made after the enactment of the statute, which was on June 2, 1924. Assessments made prior to that date fall within the rule of the Russell case, *206 supra, which in this case requires us to hold that collection was barred at the time the deficiency notice was mailed. Whether collection can be enforced*1581 by suit on the bond (see United States v. Barth Co.,279 U.S. 370">279 U.S. 370) need not be decided in this proceeding.
The 1919 consolidated return, setting forth separately the items of gross income, deductions, and invested capital for each of the petitioners, was filed on March 12, 1920. No waivers are shown to have been filed, and the statute of limitations therefore barred assessment and collection on March 12, 1925. As the assessments herein were not made until September 15, 1925, they were too late, and as the notices of deficiency were not sent until in May, 1926, they were likewise outside the statutory period.
Counsel for respondent concedes that if the consolidated return filed meets the requirements set out in F. A. Hall Co.,3 B.T.A. 1172">3 B.T.A. 1172, the contention of petitioners herein would appear to be correct. We hold that the return filed meets the statutory requirements and that assessment and collection are barred.
Affiliation Issue.
(a) New England Power Company. - Reference to the table set out in the findings of fact shows that the parent owned all the outstanding common stock of this petitioner and only a small amount of*1582 its preferred stock. Some of the preferred stock of petitioner was owned by the parent's stockholders, some by one of its subsidiaries, and some by the stockholders of another subsidiary. It is argued that if the preferred stock is to be taken into consideration in determining the extent of ownership or control, these holdings should be added to the parent's direct ownership. Granting for the moment that such addition is proper, the sum total of these holdings would range from a low of 50.09 per cent to a high of 67.04 per cent of the total outstanding stock. Obviously these percentages standing alone are not sufficient to sustain the claim for affiliation.
But petitioner's principal argument is that the preferred stock should be disregarded in affiliation cases and it cites a number of cases, some of which at first glance would seem to give support to the contention made. Temtor Corn & Fruit Products Co.,299 Fed. 326 (affd. sub nom. Schlafly v. United States, 4 Fed.(2d) 195), is a case in which one company owned all the common stock of another, and the latter's preferred stock was held by some 3,000 stock holders. *1583 The preferred stock was entitled to vote only in the event that dividends were passed for a stated period. The courts disregarded the preferred stock and held the two corporations affiliated. In view of the restricted voting power of the preferred stock in that case, we think the decisions are of little weight in the *207 matter before us. In Shillito Realty Co.,8 B.T.A. 665">8 B.T.A. 665; affd., 39 Fed.(2d) 830, the parent owned all the common and 50 per cent of the preferred stock of the subsidiary. The preferred had full voting rights. The holders of 67.16 per cent of the parent's stock, who for the most part were officers, directors, or employees of the parent, or their relatives, owned 15.516 per cent of the preferred stock of the subsidiary. On these facts we allowed affiliation, saying that "Only an inconsiderable amount [of the preferred stock] was in the hands of persons who properly may be regarded as outside interests." It thus appears that the preferred stock with voting rights was taken into consideration in determining the extent of ownership or control. In *1584 Atlantic City Electric Co.,15 B.T.A. 1084">15 B.T.A. 1084, the parent owned all the common stock of the subsidiaries. The subsidiaries had outstanding voting preferred stock which in the case of one was less than 23 per cent, and as to the other less than 30 per cent of the total outstanding stock. In holding the companies affiliated we said, "The holder of the preferred stock resembled a creditor of the corporation more than he resembled a common stock holder." We did not, however, disregard the preferred stock in reaching our conclusion. Had we done so, our holding would have been based purely on the 100 per cent common stock ownership by the parent, which, of course, in the absence of preferred stock would have been sufficient to allow affiliation. That we gave consideration to the preferred stock is shown in the opinion (p. 1089), where we listed as factors taken in consideration, "stock ownership, limitations surrounding the ownership of preferred stock, and the complete business dominance of petitioners by the parent company." In *1585 J. A. Folger & Co. et al.,23 B.T.A. 210">23 B.T.A. 210, interests outside a closely related group owned voting preferred stock amounting to not in excess of 30 per cent of the total common and preferred. We held that by reason of the domination exercised over the minority stock, there was "control" over it within the meaning of the statute. The latest decision on the question in Commissioner v. Howes Bros. Hide Co.,284 U.S. 583">284 U.S. 583, which reversed the Circuit Court of Appeals for the First Circuit (49 Fed.(2d) 878), which had reversed the Board in the same case, 17 B.T.A. 129">17 B.T.A. 129. In that case five brothers owned all the common stock of one company which sought affiliation with another in which the brothers likewise owned all the common stock and all of the second preferred stock, but in which there was a large outside holding of first preferred stock. All of the preferred stock had voting rights. The holders of the first preferred stock almost without exception were absent from stockholders' meetings and such *208 stock of this class as was represented was voted by proxies given to two of the Howes brothers. In denying affiliation*1586 we held that:
It is true that at all times the five Howes brothers owned and controlled 50 per cent of the voting stock, but the evidence fails to show that they ever had a beneficial interest in any substantial amount of first preferred stock. It must be admitted that the Howes brothers dominated the company, directed its policies, and managed its business, but the test of the statute makes no mention of these factors in laying down the rule governing affiliation. The statute provides that substantially all the stock must be owned or controlled by the same interests, and "substantially all" can not be construed to mean a bare majority.
Counsel would have us hold that, since the common stock holders had it within their power to call the first preferred for redemption at any time, they effectually controlled this class of stock within the meaning of section 240(b) of the 1918 Act. It is undoubtedly true that the first preferred stockholders held their stock subject to call after proper notice, but it is just as true that this power was never exercised, and that the first preferred stockholders exercised their voting rights at every stockholders' meeting. The power or ability*1587 to control is not the control required by the statute, and it can not be said from the evidence before us that the first preferred stockholders were locking in any of the elements of ownership of their stock."
The Howes Bros. case we think goes far towards dispelling any doubt that may have existed previous to the Supreme Court's decision as to whether preferred stock having voting rights should be included in the total stock outstanding for the purpose of determining whether there is ownership or control of "substantially all of the stock." In our opinion such stock must be included.
Applying this conclusion to the present situation, it is plain that the parent did not own or control sufficient stock of the New England Power Company - 50.09 to 67.04 per cent - to constitute substantially all, and it must be held that the two were not affiliated.
(b) Connecticut River Power Company. - The parent Company owned all the common stock and some of the preferred. Counting in both the common and preferred, as we held above must be done, the parent's ownership varied from 67.75 per cent to 83.77 per cent. Petitioner contends these percentages should be augmented by the holdings*1588 of the stockholders of the parent and the stockholders of the New England Power Company. In our opinion this may not be done. No control by the parent over such stock is shown. The fact that the parent dominated the business policies and operations of the subsidiaries is not sufficient to establish control over the stock held by others. Under the decision in Handy & Harman v. Burnet,284 U.S. 136">284 U.S. 136, the control required by the statute is legally enforceable control, and that exercised through economic domination is insufficient.
In the present case the question is thus narrowed to whether the percentages set out above, representing the parent company's direct ownership, constitute "substantially all" the stock of the Connecticut *209 River Power Company. In the light of the decided cases we are of the opinion that they do not, and that affiliation must be denied. Handy & Harman v. Burnet, Supra (in which the owners of 93.71 per cent of the parent owned or controlled 81.27 per cent of the subsidiary); *1589 United States v. Cleveland P. & E.R. Co., 42 Fed.(2d) 413 (77 to 84 per cent ownership); Denunzio Fruit Co.,16 B.T.A. 1326">16 B.T.A. 1326; affd., 49 Fed.(2d) 41 (80 1/3 per cent ownership and control of additional 3 per cent).
(c) Bellows Falls Power Company. - In this company the parent owned 85 per cent of the common and from 75 to 95 per cent of the preferred stock. The voting rights of the preferred were limited to matters relating to increasing bonded indebtedness and preferred stock. The parties appear to be agreed that in view of the limited voting rights of the preferred stock it should not be included in determining the parent's ownership or control. No such control as contemplated by the statute is shown to have existed over the 15 per cent owned by the so-called "Phipps interests." This leaves the affiliation claim resting on the parent's ownership of 85 per cent, which in our opinion is insufficient. United States v. Cleveland P. & E. R. Co., supra; S. N. & C. Russell Mfg. Co.,16 B.T.A. 501">16 B.T.A. 501.
We are accordingly of the opinion that none of the petitioners were affiliated, within the meaning of the*1590 statute, with the New England Company, and the respondent's denial of affiliation is sustained.
Claimed Interest Deductions.
For the years 1919 and 1920 the New England Power Company and the Connecticut River Power Company entered on their books as capital items certain amounts which they now seek to deduct as interest, claiming that such amounts are interest on funds used for construction of new plant facilities.
Interest as such is properly deductible in the year of accrual or payment, as the case may be (sec. 234(a)(2), Revenue Act of 1918), and it is not a proper capital item. Westerfield v. Rafferty, 4 Fed.(2d) 590; Spring Valley Water Co.,5 B.T.A. 660">5 B.T.A. 660. See also Arthur C. Fraser,6 B.T.A. 346">6 B.T.A. 346; affd., 25 Fed.(2d) 653. But in this case it does not appear that petitioners ever became liable for or paid any interest. The only evidence on this point is contained in the testimony of the individual who is treasurer of the parent company, and who during the taxable years was either auditor or general auditor of the parent and all the subsidiaries. He testified that construction jobs for the operating companies*1591 were financed by the loan of funds by the parent to the Power Construction Company, which funds were used by the Construction Company to pay wages and purchase materials and supplies in connection with the construction work. The *210 construction company made charges to the work representing the interest, and such charges became a part of the cost of the work, which was billed by the construction company to the operating company for which the work was performed. It does not appear that the operating companies, petitioners here, ever borrowed any funds from the parent for construction purposes. The loans were made to the construction company and it put itself in position to pay the interest by increasing the cost of the work in an amount sufficient to cover the interest it was required to pay. We see no difference between the situation here and the ordinary case where a contractor borrows funds to prosecute a construction job and figures in the interest he will be required to pay in the sale price he fixes for the completed job. In such a case, while the purchaser reimburses the contractor for the interest, he does not pay interest as such.
Guaranty of Dividends.
*1592 Under written contracts the parent company assumed the liability to pay semiannually an amount which, added to the available income of the Bellows Falls Power Company, would be sufficient to pay an annual dividend of $5 on the preferred stock of the latter. While the parent agreed to make the payment to a designated trust company, in practice a shortcut was taken and payment was made directly to the Bellows Falls Power Company, so that it could pay its dividends in full in one payment. The amounts so paid were included by respondent in income of the Falls Company, and his action in so doing is alleged to be erroneous.
Petitioner contends that this case is not within the rule of Rensselear & S.R. Co. v. Irwin,249 Fed. 726; Old Colony Trust Co. v. Commissioner,279 U.S. 716">279 U.S. 716, and similar cases, because it was not a party to the guaranty agreements, and, further, there was no lease of property or any consideration whatever on the part of the Falls Company. In our opinion the sums received by the Falls Company from the parent do not fit within the definition of income as "gain derived from capital, from labor, or from both combined," *1593 Eisner v. Macomber,252 U.S. 189">252 U.S. 189. The payments received did not represent a return on any capital investment on its part, nor were they received for any labor or service rendered. The Falls Company was merely a conduit through which the payments passed to those entitled to them.
Respondent has long held that payments by a holding company in fulfillment to a guaranty of dividends of a subsidiary may not be deducted by the holding company in computing net income, but may be added to the cost of its stock in the subsidiary. See art. 582, *211 Reg. 45, 62, and 65; art. 282. Reg. 74. If this view of the respondent be correct, it would seem to follow necessarily that the payments when received by the subsidiary would not constitute income. Without passing on the validity of these regulations, we are of the opinion that the payments by the New England Company to the Bellows Falls Power Company were not income to the latter.
Decision will be entered under Rule 50.