*253 Decisions will be entered for the petitioners.
Petitioners are wholly owned subsidiaries of a parent corporation organized in 1915. During the taxable year 1938 and for many years prior thereto petitioners operated under separate contracts with the parent to act as the parent's agent in managing, operating, and selling the products from the plants turned over to them by the parent for that purpose. Under these contracts the subsidiaries agreed to credit monthly to the parent all profits accruing from the operation of such plants over and above an amount equal to 6 per cent on their outstanding capital stock, which in the case of each subsidiary was a very nominal amount. The parent agreed to furnish all the necessary working capital and to provide such executive management as might be necessary for the proper conduct of the businesses. Petitioners were operated as branches or divisions of the parent corporation. Held, the income earned under each of these contracts in excess of the 6 per cent of the outstanding capital stock of each subsidiary, respectively, belonged to and was the income of the parent corporation as principal, and was not, therefore, taxable to petitioners. *254 Southern Pac. Co. v. Lowe, 247 U.S. 330, followed. Interstate Transit Lines v. Commissioner, 319 U.S. 590, distinguished.
*594 These proceedings, consolidated for hearing, involve deficiencies in income tax and declared value excess profits tax for the taxable year ended December 31, 1938, in amounts as follows:
| Docket | Declared | ||
| Petitioner | No. | Income tax | value excess |
| profits tax | |||
| National Carbide Corporation | 5822 | $ 122,285.56 | $ 101,019.08 |
| Air Reduction Sales Co | 5823 | 439,347.98 | 364,076.24 |
| Pure Carbonic, Inc | 5824 | 21,663.71 | 17,860.53 |
*255 The deficiencies in Docket Nos. 5822 and 5823 are due to adjustments to net income as follows:
| Docket No. | Docket No. | ||
| 5822 | 5823 | ||
| Net income as disclosed by return | $ 300.00 | $ 750.00 | |
| Unallowable deductions and additional income: | |||
| (a) Additional income | 881,244.30 | 3,314,141.10 | |
| Total | 881,544.30 | 3,314,891.10 | |
| Nontaxable income and additional deductions: | |||
| (b) Capital stock tax | 4.00 | 8.00 | |
| (c) Expenses of Air Reduction Co | 39,214.78 | 279,914.57 | |
| Net income adjusted | 842,325.52 | 3,034,968.53 |
*595 In Docket No. 5822 the respondent, in a statement attached to the deficiency notice, explained adjustments (a) and (c) as follows:
(a) and (c) All of your capital stock is owned by Air Reduction Company, Inc., and, on your return, all of your net income in excess of $ 300.00 was deducted and allocated to the parent company on the theory that you were an agent for said company. It is held that as a corporate entity, operating as such, you are taxable on your separate income. Such expenses as were paid or accrued by Air Reduction Company, Inc., attributable to your operations have been allocated to you under section 45 of the Revenue Act of 1938.
In Docket*256 No. 5823 the respondent made an identical explanation of adjustments (a) and (c), except that he mentioned therein $ 750 instead of $ 300.
The deficiencies in Docket No. 5824 are due to adjustments to net income as follows:
| Net income as disclosed by return | $ 300.00 | |
| Unallowable deductions and additional income: | ||
| (a) Additional income | 157,595.25 | |
| (b) Amortization of contract rights | 23,137.02 | |
| (c) Legal fees | 46,291.50 | |
| Total | 227,323.77 | |
| Nontaxable income and additional deductions: | ||
| (d) Capital stock tax | 4.00 | |
| (e) Expenses of Air Reduction Co. | 77,982.18 | |
| Net income adjusted | 149,337.59 |
In Docket No. 5824 the respondent, in a statement attached to the deficiency notice, explained adjustments (a) and (e) in the same manner as he explained adjustments (a) and (c) in Docket No. 5822. He also explained adjustments (b) and (c), respectively, as follows:
(b) This adjustment corresponds with that made in the amended return filed by you and is detailed in the copy of the report furnished you.
(c) The payment of $ 35,000.00 plus legal fees of $ 11,291.50 or a total of $ 46,291.50 in connection with the acquisition of 100 shares of capital stock of Braunstein Bros. *257 Carbonic Sales Corporation constitutes a capital expenditure not deductible from income.
Petitioners, by appropriate assignments of error, contest all of the above mentioned adjustments in all three dockets except the three small capital stock tax adjustments.
FINDINGS OF FACT.
Each of the three petitioners is a Delaware corporation, with its principal office at 60 East 42d Street, New York City. The return of each petitioner for the taxable year ended December 31, 1938, was filed with the collector for the third district of New York.
All of the capital stock of each petitioner is, and during the taxable *596 year and prior thereto was, owned by the Airco Reduction Co., a New York corporation. This latter corporation is sometimes referred to herein as Airco. Petitioners are sometimes referred to herein respectively as Carbide, Sales, and Carbonic. Airco also owned all of the capital stock of Wilson Welder & Metals Co., sometimes referred to herein as Welder. These five corporations are sometimes referred to herein as all the companies.
In 1938 Airco was engaged in four major fields of business activity and employed the agency companies in each field as follows:
Air Reduction*258 Sales Co. -- The manufacture and sale of gaseous constituents of air, principally oxygen and nitrogen, but also the rare gases, argon, neon, zenon, krypton, and helium; acetylene produced by the action of water on calcium carbide and used together with oxygen in the oxyacetylene gas welding and cutting processes; hydrogen produced by the electrolysis of water and used in annealing and welding metals; tools and apparatus for the utilization of these gases; and containers for the transportation of acetylene gas.
National Carbide Corporation. -- The manufacture and sale of calcium carbide obtained by fusing limestone and coke in an electric furnace, and used by Airco to supply its own requirements for making acetylene gas and, in part, for sale to customers for the manufacture of acetylene.
Pure Carbonic, Inc. -- The manufacture and sale of carbon dioxide in gaseous and liquid form (carbonic acid gas) and in solid form (dry ice), and apparatus for their utilization and transportation. In liquid and gaseous form carbon dioxide is used primarily in the carbonation of beverages and in solid form as dry ice for refrigeration.
Wilson Welder & Metals Co. (not a petitioner*259 herein). -- The manufacture, assembly, and sale of electric arc welding machines, welding rods, equipment, and supplies.
Carbide on page 1 of its return (Form 1120A) for the taxable year reported $ 300 as its gross and net income, respectively, with the notation "See Schedule 'Q' attached." This schedule, among other things, stated:
NATIONAL CARBIDE CORPORATION
THE FOLLOWING IS A STATEMENT OF AGENCY OPERATIONS OF NATIONAL CARBIDE CORPORATION
FOR THE YEAR ENDED DECEMBER 31, 1938
National Carbide Corporation, whose entire outstanding capital stock (nominal in amount) is owned by Air Reduction Company, Incorporated, operates exclusively under an agency agreement in the conduct of the business and the holding of certain assets as nominee of Air Reduction Company, Incorporated. This agreement was originated on or about the date of incorporation. For this service the nominee receives $ 300.00 per annum, representing 6% on its outstanding capital stock. Accordingly, the results of this agency operation are included in the tax return of Air Reduction Company, Incorporated. A copy of the operating *597 agreement aforementioned was filed with the U. S. Treasury Department Internal*260 Revenue Service as a part of the Federal Income and Excess-Profits Tax return for the year ended December 31, 1934.
| Gross Income | |
| [Here Carbide itemizes several items of gross income, | |
| totaling $ 1,430,523.76.] | |
| Total Income | $ 1,430,523.76 |
| Deductions | |
| [Here Carbide itemizes several items of deductions such as | |
| compensation of officers, rent, repairs, bad debts, taxes, | |
| depreciation, selling expense, distribution expense, | |
| administration expense, etc., totaling $ 548,979.46.] | |
| Total Deductions | 548,979.46 |
| Book and Taxable Net Income before estimated Federal | |
| income tax | 881,544.30 |
| Estimated Federal income tax | 167,455.92 |
| Net income after estimated Federal income tax | 714,088.38 |
| Amount transferred to Air Reduction Company, Incorporated in | |
| accordance with agency agreement above | 713,788.38 |
| Net amount retained per agreement | $ 300.00 |
Sales on page 1 of its return (Form 1120A) for the taxable year reported $ 750 as its gross and net income, respectively, with the notation "See Schedule 'Q' attached." This schedule follows the same pattern as the one filed by Carbide and, after itemizing the gross income and deductions, concludes as follows:
| Taxable net income | $ 3,314,891.10 |
| Amount necessary to reconcile with book income | 18,535.10 |
| Net book income before estimated Federal income tax | 3,333,426.20 |
| Estimated Federal income tax | 631,339.84 |
| Net book income after estimated Federal income tax | 2,702,086.36 |
| Amount transferred to Air Reduction Company, Incorporated in | |
| accordance with agreement above | 2,701,336.36 |
| Net amount retained per agreement | $ 750.00 |
*261 Carbonic on page 1 of its return (Form 1120A) for the taxable year reported $ 300 as its gross and net income, respectively, with the notation "See Schedule 'Q' attached." This schedule follows the same pattern as the ones filed by Carbide and Sales and, after itemizing the gross income and deductions, concludes as follows:
| Taxable net income | $ 157,895.25 |
| Amount necessary to reconcile with book income | 91,131.23 |
| Net income per books before estimated Federal income tax | 249,026.48 |
| Estimated Federal income tax | 30,039.43 |
| Net income per books after estimated Federal income tax | 218,987.05 |
| Amount transferred to Air Reduction Company, Incorporated | |
| in accordance with agency agreement above | $ 218,687.05 |
| Net amount retained per agreement | $ 300.00 |
*598 The three above mentioned schedules were also attached to the return (Form 1120) filed by Airco for the calendar year 1938. Attached to the return filed by Airco was also a schedule relating to the operations of Welder, which followed the same pattern as the three above mentioned schedules and which, after itemizing the gross income and deductions, concluded as follows (amounts in parentheses are in red ink):
| Taxable net income (Loss) | ($ 88,432.07) |
| Amount necessary to reconcile with book income | ( 1,908.67) |
| Net income per books (Loss) | ( 90,340.74) |
| Amount transferred to Air Reduction Company, Incorporated in | |
| accordance with agreement above | ( 90,940.74) |
| Net amount retained per agreement | $ 600.00 |
*262 Airco on page 1 of its return for the calendar year 1938 reported a gross income of $ 15,153,603.71, deductions of $ 10,942,640.43, a net income of $ 4,210,963.28, an income tax due of $ 639,397.91, and an excess profits tax due of "None." It later filed an amended return for this year in which it reduced the deductions by an amount of $ 23,137.02 (see adjustment (b) in statement attached to deficiency notice sent to Carbonic), thereby increasing the net income by a like amount and showing an additional income tax due of $ 3,817.61.
Airco was incorporated on November 26, 1915; Sales on June 27, 1916; Carbide on July 28, 1922; and Carbonic on September 23, 1929.
In 1938 Airco had outstanding 2,579,855 1/5 shares of capital stock; Carbide, 50 shares of $ 100 par value; Sales, 125 shares of $ 100 par value; Carbonic, 50 shares of $ 100 par value; and Welder, 100 shares of no par value. Not any of these corporations had any funded debt.
The above mentioned returns filed for the calendar year 1938 required the particular taxpayer to state the "Value of capital stock as declared in your capital stock tax return for the year ended June 30, 1938 * * *." Airco reported this value to be $ *263 72,981,000; Carbide reported $ 3,999; Sales reported $ 7,999; and Carbonic reported $ 3,999. (10 per cent of these reported values was in excess of the net income as reported by petitioners and Airco on page 1 of their respective returns; hence, no excess profits tax was reported as due. See secs. 601 and 602 of the Revenue Act of 1938.)
Airco was organized primarily for the purpose of producing oxygen from the air for use with acetylene in the oxyacetylene process. In producing oxygen the air is liquified under pressure and then at different *599 sub-zero temperatures nitrogen as well as oxygen is distilled and also such rare gases as argon, neon, zeon, krypton, and helium. These rare gases comprise less than 1 per cent of the total of air. Disregarding the rare gases, oxygen comprises about one-fifth of the atmosphere and nitrogen about four-fifths. The rare gases are used principally in fluorescent lighting.
From the time Airco was organized in 1915 through 1919, it organized or acquired 15 subsidiary companies for the manufacture and distribution of gases. These plants were spread throughout the several states. Airco paid the bills for the organization of those companies*264 which it organized, and paid cash or issued stock for the companies that were acquired. In the companies that were organized Airco paid in the capital and took the stock.
When Sales was organized in 1916, Airco initiated a policy in connection with that company and the 15 subsidiaries. That policy was the signing of an agency agreement early in 1917 between Airco and Sales and a similar agreement between each new company organized or acquired and Sales. The said agency agreement between Airco and Sales was made on March 1, 1917, and among other things provided as follows:
That for good and valuable considerations each to the other given and received, the parties hereto hereby agree as follows:
First: Airco hereby employs Sales as its agent to manage and operate, during the term of this contract, all plants for the production of oxygen, acetylene and other gases and for the manufacture of apparatus and containers for the utilization and transportation of such gases, which it or its subsidiary or controlled companies now own or control, or which it or they may hereafter build or acquire; and likewise employs Sales as its agent to market and sell, during the term of this contract, *265 the output of all such plants.
Second: This contract, and the said employment of Sales hereunder, shall continue until December 31st, 1917; and thereafter shall continue from year to year subject to the right of either party to terminate the same at any time by giving thirty days previous written notice to the other of its intention so to do.
Third: Airco agrees (1) to give Sales the use of all cylinders, containers, motor trucks, equipment, and shipping facilities, which it now owns or may hereafter acquire; (2) to supply such working capital as Sales may need; (3) to provide such executive management (but not accounting, bookkeeping and clerical service), and office accommodation and facilities, as may be necessary for the proper conduct of Sales business; and (4) to procure for Sales such contracts with Airco's subsidiary or controlled companies as will enable Sales to exercise in each case the agency hereby created, and as will in each case constitute Sales the agent of such subsidiary or controlled company.
Fourth: Sales agrees (1) to manage and operate efficiently and carefully all of said plants; (2) to maintain the same in first class condition, charging necessary repairs *266 and replacements to operating expense and setting aside and charging to operating expense proper reserves for depreciation and for wear and tear not immediately replaceable by repairs; (3) to distribute, market and sell, the product manufactured in said plants as efficiently as possible, realizing, to the best of its ability, the largest obtainable gross receipts therefrom; (4) to pay all expenses *600 of such operation, maintenance and selling, and to discharge all expenses or liabilities incurred therein or thereby and to collect all accounts receivable or other proceeds resulting therefrom; (5) to credit monthly on its books to Airco all profits accruing to it from the operation of its entire business over and above an amount equal to six per cent. (6%) per annum on its outstanding capital stock, which said amount it is hereby authorized to deduct and retain, and it hereby agrees to accept as full compensation for its services hereunder; and (6) to pay over to Airco upon demand any profits becoming due and credited to Airco as aforesaid.
After Sales had been organized the physical assets of the 15 subsidiaries were, at the direction of Airco, turned over to Sales. About 7 *267 of the 15 subsidiaries were dissolved during the period 1923 to 1935 and about May 1936 the remainder of the 15 subsidiaries were dissolved. These dissolutions were made upon Airco's instructions.
During the period 1922 to 1936, Airco purchased the business and assets of 26 other companies and paid either stock or cash or both stock and cash for such assets. These assets were turned over to Sales in order to enable it to function under its agency agreement of 1917.
Airco in order to make its own acetylene had to have calcium carbide, so in 1920 it acquired an interest in the National Carbide Corporation of Virginia. About April 1921 it secured control of that company. This company had been operating two plants of its own, one at Ivanhoe, Virginia, and one at Keokuk, Iowa. Calcium carbide is made by fusing coke and limestone in an electric furnace, and it is turned into acetylene by the action of water on the calcium carbide.
On July 28, 1922, National Carbide Corporation of Virginia organized under the laws of Delaware, as a wholly owned subsidiary, the National Carbide Sales Corporation.
On August 25, 1922, an agreement was made between National Carbide Corporation of Virginia, *268 therein called the Company, and National Carbide Sales Corporation, therein called Sales. (Not to be confused with petitioner Sales. As will appear later, National Carbide Sales Corporation is petitioner Carbide, the name National Carbide Sales Corporation having been changed to National Carbide Corporation on August 1, 1936.) The agreement states that the parties agree as follows:
First: The Company hereby employs Sales as its selling agent to market and sell during the term of this contract, the output of all the plants of the Company.
Second: The Company agrees (1) to give Sales the use of all cylinders, containers, motor trucks, equipment and shipping facilities, which it now owns or may hereafter acquire; and (2) to supply such working capital as Sales may need, and (3) to substitute Sales for itself in such contracts as it may heretofore have made with customers for the sale or distribution of its products.
Third: Sales agrees (1) to distribute, market and sell the product manufactured in said plants as efficiently as possible, realizing, to the best of its ability, the largest obtainable gross receipts therefrom; (2) to collect all accounts receivable *601 or other proceeds*269 resulting therefrom; (3) to credit monthly on its books to the Company all the proceeds from the sale and distribution of the product of such plants over and above the actual overhead and running expenses of its organization and an amount equal to six per cent (6%) per annum on its outstanding capital stock, which amounts it is hereby authorized to deduct and retain, and it hereby agrees to accept the same as full compensation for its services hereunder; and (4) to pay over to the Company upon demand any proceeds becoming due and credited to the Company as aforesaid.
Fourth: This contract and the said employment of sales hereunder shall continue until August 1st, 1923, and thereafter shall continue from year to year subject to the right of either party to terminate the same at any time by giving thirty (30) days previous written notice to the other of is intention so to do.
On July 31, 1936, Airco caused National Carbide Corporation of Virginia to be liquidated and dissolved. It caused all the assets of that company (with certain exceptions hereinafter mentioned) to be transferred to National Carbide Sales Corporation, subject to all the liabilities of National Carbide Corporation*270 of Virginia, except liabilities for Federal taxes as appearing on its balance sheet as of the close of business July 31, 1936. The excepted assets were license agreements, patents and applications for patents, drawings and formulae, retirement and pension funds, cash, securities, notes and accounts receivable, and books and records. These excepted assets were by bill of sale transferred to Airco, subject however to the liabilities of National Carbide Corporation of Virginia for the Federal taxes above mentioned, which liabilities Airco assumed.
On August 1, 1936, the name of National Carbide Sales Corporation was duly changed to National Carbide Corporation.
On August 1, 1936, an agreement was made between Airco and Carbide, which, after referring to the above mentioned agreement dated August 25, 1922, recites that the National Carbide Corporation of Virginia has been liquidated "and in pursuance thereof all of its rights and obligations" under said agreement have passed to Airco as its sole stockholder; and that the parties hereto desire to extend the scope of the employment of Carbide under said agreement to provide that Carbide "shall manage and operate said plants in addition*271 to marketing and selling the output thereof * * *." After these recitations the agreement states that the parties agree as follows (in this agreement Airco was referred to as Company and Carbide was referred to as Sales, which again should not be confused with petitioner Sales):
First: This Agreement shall be supplementary to the aforesaid Agreement dated August 25, 1922.
Second: The Company hereby employs Sales as its agent, during the term of this contract, to manage and operate its plants.
Third: Sales agrees (1) to manage and operate efficiently and carefully said plants; (2) to maintain the same in first class condition, charging necessary repairs and replacements to operating expense and setting aside and charging *602 to operating expense proper reserves for depreciation and for wear and tear not immediately replaceable by repairs; (3) to pay all expenses of such operation and maintenance and to discharge all expenses or liabilities incurred therein or thereby and to collect all accounts receivable or other proceeds resulting therefrom; (4) to credit monthly on its books to the Company all profits accruing to it from the operation of its entire business, over and above*272 an amount equal to six per cent (6%) per annum on its outstanding capital stock, which said amount it is hereby authorized to deduct and retain, and it hereby agrees to accept as full compensation for its services hereunder; and (5) to pay over to the Company upon demand any profits becoming due and credited to the Company as aforesaid.
Fourth: The provisions contained in subsections (4) and (5) of the foregoing paragraph numbered Third of this Agreement shall be in lieu of subsections (3) and (4) of paragraph numbered Third of the said Agreement dated August 25, 1922, which required Sales to credit to the Company certain proceeds from its selling operations as therein provided, and in all other respects the terms of the said Agreement dated August 25, 1922 shall remain in full force and effect and binding upon the parties hereto.
In 1921 Airco entered the field of manufacturing and distributing carbon dioxide. Carbon dioxide comes in gaseous, liquid, and solid forms. In the gaseous and liquid forms it is commonly known as carbonic acid gas or carbonic gas and in solid form it is known as dry ice. The primary use of carbonic gas is in the carbonation of beverages for human consumption.
*273 In manufacturing carbon dioxide drawn steel cylinders are also used. The carbon dioxide cylinder is practically the same as an oxygen cylinder, but not the same as an acetylene cylinder. A so-called 220-foot oxygen cylinder weighs empty about 130 pounds and when filled contains about 220 cubic feet of compressed oxygen weighing about 18 pounds. The value of the cylinder itself is about $ 15 or $ 16, and the maximum value of the contents is about $ 2. Airco maintained a large distribution department and a large fleet of trucks.
The initial step which Airco took on entering the carbon dioxide field was the acquisition in 1921 of a controlling interest in a concern known as the Compressed Carbonic Co. which operated in Baltimore. About 1929 this company either merged or consolidated with Pure Carbonic Co. of Illinois and Pure Carbonic Co. of California to form Pure Carbonic Co. of America. About a month later, namely, on September 23, 1929, Pure Carbonic Co. of America organized as its 100 per cent owned subsidiary the petitioner referred to herein as Carbonic.
On October 1, 1929, an agreement was made between Pure Carbonic Co. of America, therein called Pure, and Carbonic, therein*274 called Sales (not to be confused with petitioner Sales or the corporations involved in the above mentioned agreements dated August 25, 1922, and August 1, 1936). The agreement, among other things, provided as follows:
*603 That for good and valuable consideration each to the other given and received the parties hereto hereby agree as follows:
First: Pure hereby employs Sales as its agent to manage and operate, during the term of this contract, all plants for the production of carbonic acid gas and any and all other gases in gaseous, liquid and solid form, and all by-products thereof, and for the manufacture of apparatus and containers for the utilization and transportation of such gases, which it or its subsidiary or controlled companies now own or control, or which it or they may hereafter build or acquire; and likewise employes Sales as its agent to market and sell, during the term of this contract, the output of all such plants.
Second: This contract, and the said employment of Sales hereunder, shall continue until October 1st 1950; and thereafter shall continue from year to year subject to the right of either party to terminate the same at any time by giving thirty days *275 previous written notice to the other of its intention so to do.
Third: Pure agrees (1) to give Sales the use of all cylinders, containers, motor trucks, equipment, and shipping facilities, which it now owns or may hereafter acquire; (2) to supply such working capital as Sales may need; (3) to provide such executive management (but not accounting, bookkeeping and clerical service), and office accommodation and facilities, as may be necessary for the proper conduct of Sales business; and (4) to procure for Sales such contracts with Pure's subsidiary or controlled companies as will enable Sales to exercise in each case the agency hereby created, and as will in each case constitute Sales the agent of such subsidiary or controlled company.
Fourth: Sales agrees (1) to manage and operate efficiently and carefully all of said plants; (2) to maintain the same in first class condition, charging necessary repairs and replacements to operating expense and setting aside and charging to operating expense proper reserves for depreciation and for wear and tear not immediately replaceable by repairs; (3) to distribute, market and sell, the product manufactured in said plants as efficiently as possible, *276 realizing, to the best of its ability, the largest obtainable gross receipts therefrom; (4) to pay all expenses of such operation, maintenance and selling, and to discharge all expenses or liabilities incurred therein or thereby and to collect all accounts receivable or other proceeds resulting therefrom; (5) to credit monthly on its books to Pure all profits accruing to it from the operation of its entire business over and above an amount equal to six percent (6%) per annum on its outstanding capital stock, which said amount it is hereby authorized to deduct and retain, and it hereby agrees to accept as full compensation for its services hereunder; and (6) to pay over to Pure under demand any profits becoming due and credited to Pure as aforesaid.
This Agreement shall be binding upon and inure to the benefit of the respective successors and assigns of the parties hereto.
Thereafter, Pure Carbonic Co. of America acquired the businesses and assets of three or four other companies. In these acquisitions Airco put up the necessary consideration, and caused the acquired assets to be transferred to Carbonic. On April 6, 1934, Pure Carbonic Co. of America purchased the business and assets*277 of American Dry Ice Corporation, and caused the property of that company to be transferred to Dry Ice, Inc., a Delaware corporation organized in 1934 as a wholly owned subsidiary of Pure Carbonic Co. of America. Subsequently, Airco acquired the entire capital stock of Pure Carbonic Co. of America and dissolved that company on July 30, 1936. *604 Upon this dissolution Airco acquired all of the capital stock of Dry Ice, Inc., and all of the capital stock of Carbonic, including the rights of Pure Carbonic Co. of America under the above mentioned agreement dated October 1, 1929, and directed that all the physical assets of Pure Carbonic Co. of America be transferred to Carbonic.
On July 31, 1936, Airco caused the assets of Dry Ice, Inc. (the corporation that was organized in 1934), to be transferred in part to itself and in part to Dry Ice, Inc. (a Delaware corporation organized in 1936) whereupon the 1934 corporation was dissolved. On September 30, 1937, Airco caused the assets of the 1936 corporation (Dry Ice, Inc.) to be transferred in part to itself and in part to Carbonic, whereupon the 1936 corporation was dissolved.
On May 18, 1938, Airco entered into an agreement with *278 Alabama Carbon Dioxide Ice, Inc., whereby the latter was to transfer to Carbonic all of its assets except furniture, fixtures, cash, and accounts receivable. A bill of sale was executed to that effect on March 24, 1938.
On or about January 1, 1931, Airco acquired an interest in Welder. This company was engaged in electric welding as distinguished from gas flame welding. Sometime in 1934, Airco acquired all the outstanding capital stock of that company and about June 1936 it caused the capital stock of that company to be reduced by some $ 300,000 to $ 10,000 and also caused the number of shares to be reduced from 10,000 to 100 shares through a partial liquidation. The assets so distributed in partial liquidation went to Airco.
On August 1, 1936, an agreement was made between Airco and Welder similar in its provisions to the above mentioned agreements dated March 1, 1917, August 25, 1922, August 1, 1936, and October 1, 1929.
In 1938 Airco and its 4 subsidiaries were, therefore, engaged in 4 fields of operation. The first field was centered around the oxyacetylene process and the business was carried on by Sales. The second field was the calcium carbide business. This consisted*279 of the operation of the plants at Ivanhoe and Keokuk and was carried on by Carbide. The third field was the manufacturing and distribution of carbon dioxide in both the liquid and the solid form. The business in this field was carried on by Carbonic. The fourth field was the manufacture and distribution of apparatus and equipment and was carried on by Welder. The products manufactured by these corporations are sometimes familiarly referred to as Airco products. They have 159 plants scattered throughout the United States. The general offices of Airco and its 4 subsidiaries are located in the Lincoln Building at 60 East 42d Street, New York City.
Each operating or agency contract has remained in force and unchanged in its terms from its inception down to the present time. *605 After Airco entered into each agreement the initial working capital of the subsidiary was supplied by Airco and, as time went on, each subsidiary built up additional working capital through its operations, which was not withdrawn by Airco, but was left in the subsidiary's bank accounts to maintain minimum working balances based upon the operational requirements of each field of operation.
Title to *280 all gas cylinders, one of the most essential and most valuable assets, was retained by Airco and cylinders were allocated to the various agency companies as required.
The petitioners and Welder acquired assets in addition to those transferred to them directly by Airco or transferred by third parties to them at Airco's direction. They acquired such additional assets upon specific authorization and appropriation by the Airco board of directors, either by payment of cash from working capital directly supplied by Airco, or by payment of cash resulting from the operations of each company under its agency agreement and credited to Airco but not withdrawn by Airco.
There were credited to the accounts payable by the agency companies to Airco, and debited to the accounts receivable by Airco from each agency company, the amount of working capital furnished by Airco, the value of all assets held by the agency companies, and the net proceeds from the operations of these companies under their respective agreements in excess of the nominal amounts of 6 per cent on their capital stock. No interest ran on any of these accounts.
Where Airco acquired a plant by issuance of its stock, the stock was*281 given an exchange rate or value in the contract for the purchase of the property and the agreed value of the stock issued to purchase the property was used as the amount of the credit to the accounts payable to Airco on the subsidiary's books and as the amount of the debit to the accounts receivable from the subsidiary on the parent's books. Thus, all assets held and used by the petitioners in 1938 were furnished by Airco, which paid for them with its own cash or by exchange of its own stock.
Airco and its four subsidiaries had 28 officers during the year 1938. The salary of each officer was originally paid out of the funds of Airco. C. E. Adams was chairman of the board of directors of all the companies and "Chairman of Company" of Airco and Sales. He was the chief executive officer of Airco and Sales. A. R. Ludow was vice chairman and director of Airco and Sales, president and director of Carbonic, and director of Welder. C. S. Munson was director of Carbonic and Welder, and president and director of the other three. T. B. Hasler was president and director of Welder. M. W. Randall was vice president of Airco, Sales, and Welder and vice-president and director of Carbonic *282 for a part of the year. H. Van Fleet was *606 vice president and operating manager of Airco and Sales, and director of Sales, Carbonic, and Welder. C. D'W. Gibson was "vice president in charge of sales" of Airco and Sales. W. C. Keeley was vice president of Airco and Sales, and director of Carbide and Welder. F. J. Metzger was "vice president in charge of development and research" of Airco and Sales. W. W. Ogier, Jr., was executive vice president and director of Carbonic for a part of the year. He died December 28, 1938. R. J. Rowen and T. W. Gibson were vice presidents of Carbonic. G. C. Cusack was "vice president in charge of sales" of Carbonic for a part of the year. E. C. Ackerman was vice president of Carbide. R. B. Davidson was secretary of all the companies, and director of Sales and Carbonic. R. W. Ryder was treasurer of all the companies. E. C. Turner and L. A. Hull were assistant vice presidents of Airco and Sales. G. E. Hawkins and R. A. Sossong were assistant vice presidents of Airco and Sales, and vice presidents of Carbonic. T. G. Harrison, E. R. Humann, and A. J. Thoma were assistant secretaries of all the companies. E. R. Holmes, F. J. McCulloch, *283 J. E. Bowman, and F. B. Adams, Jr., were assistant treasurers of all the companies. A. Anderson was assistant treasurer of Welder. With one or two minor exceptions each of the above mentioned 28 officers had offices in the general offices of Airco and its 4 subsidiaries.
The officers of Airco administered and managed the business of the three petitioners and Wilson Welder & Metals Co. in accordance with the policies determined by the Airco board of directors in 1938 and prior years through the substantial identity of Airco's officers with those of each agency company.
The business of Airco and its four agency companies was divided into six main branches, directed by five vice presidents and one assistant vice president of Airco. These six branches were corporate, operations, sales, financial, distribution, and research.
Randall was in charge of the "corporate" branch. He had under his supervision C. R. Spence, Davidson, Ogier (part of the year), and Cusack (part of the year). Spence was in charge of the business relations bureau for all the companies. Davidson had under his supervision Harrison, Humann, and Thoma. Harrison had charge of the legal work and contracts for all *284 the companies. Humann had charge of Federal taxes and general audits for all the companies. Thoma had charge of insurance and state and local taxes for all the companies. Practically all the insurance of the group was taken out in the name of Airco and collected by Airco when occasion for collection on a loss occurred. Ogier and Cusack had charge of 18 district sales offices for Carbonic. Some of these district offices were under a separate manager and others were under a joint manager for Carbonic and Sales. The district offices at Seattle, Washington, Portland, *607 Oregon, and New Orleans were under a joint manager. The employees there served both Carbonic and Sales.
Van Fleet was in charge of the "operations" branch. He had under his supervision Turner and Sossong and 5 department heads, namely, J. H. Allen, D. M. Hasbrauck, W. E. Mock, J. J. Crowe, and J. L. Anderson. Allen acted as assistant to Van Fleet and was given special assignments. Hasbrauck was the manager of an apparatus-manufacturing plant for Sales and Carbonic and the head of a general stores department for all the companies. There were about 26 district stores established throughout the United States*285 where Airco products were warehoused and held for distribution to customers. Mock was the chief inspector at the above mentioned apparatus-manufacturing plant. Crowe was in charge of the department that conducted research and development (except engineering research) of methods and processes employed in the application of oxygen and acetylene to welding and cutting. Here occurred the development of the first models of torches, acetylene regulators, and, in general, all the manual as distinguished from machine tools and appliances used with the gases manufactured by Sales, Carbonic, and Welder. Anderson was in charge of the engineering research department. This department handled that part of the research and development that was carried on by machinery as distinguished from manual methods. It maintained a research laboratory at Jersey City and performed research services for Sales, Carbonic, and Welder. Turner had under his supervision J. E. Fricker, who was the chief engineer for all of the companies. As chief engineer Fricker had charge of the design of buildings and their construction, the design of mass concrete and its construction, and the mechanical design and installation*286 of plant equipment. Sossong had under his supervision 3 plant managers, C. G. Andrew, H. W. Hill, and C. A. Wallin. Andrew was general superintendent of those gas plants manufacturing oxygen, hydrogen, nitrogen, carbon dioxide (both liquid and solid), and the rare gases. There were at least 8 such plants scattered through the United States that were used jointly by Sales and Carbonic. Hill was general superintendent of the acetylene plants for Sales. During 1938 about 48 per cent of the calcium carbide produced by Carbide was transferred to Sales for use in these acetylene plants. Wallin was manager of a cylinder manufacturing plant for Sales. After the cylinders were manufactured the ownership thereof was transferred to Airco.
C. D'W. Gibson was in charge of the "sales" branch. He had charge of the sales made by all of the companies except Carbonic. The sales made by Carbonic were under the general supervision of Randall, as previously stated. Gibson had 3 assistants. He also had under his supervision 5 department managers and 25 district offices, with *608 each headed up by a district manager. The 5 department managers were E. F. Pettigrew, H. L. Rogers, C. B. Armstrong, *287 H. W. Reade, and G. Van Alstyne. Pettigrew managed the gas sales; Rogers the applied engineering; Armstrong the railroad sales; and Reade the apparatus sales. Van Alstyne was the advertising manager for all the companies. This department published notices of dividends to Airco stockholders, intercompany bulletins, a general "Airco" catalogue, special bulletins, and technical pamphlets, and arranged exhibits at various public expositions covering all the Airco products.
Keeley was in charge of the "financial" branch. He had under his supervision Ryder and Hull. J. Bonapart was auditor for all the companies and was responsible directly to Keeley. Ryder as treasurer for all the companies had under his supervision Holmes, H. M. Daggett, McCulloch, Bowman, W. Winters, Jr., F. B. Adams, Jr., W. A. Bower, and D. Allen, and also the New York office service for all the companies. Holmes had charge of the pay roll section for all the companies. Daggett was purchasing agent for all the companies. Emergency expenditures not in excess of $ 50 could be made without authorization. Expenditures between $ 50 and $ 500 were made on construction, maintenance, and betterments orders, or construction*288 production orders, on an appropriation basis, requiring the approval of an executive officer of Airco, but not the approval of the board of directors or the chairman. Any expenditure over $ 500 had to be requested by the head of the department requiring the expenditure, and it went before the Airco board of directors and was approved or disapproved at their pleasure.
Materials purchased for one subsidiary were often transferred to another subsidiary. Where this was done, the transfer was reflected on the accounting records at cost through intercompany accounts, without the passage of any cash. Likewise, products produced by one subsidiary were sometimes transferred to another subsidiary for its use or for sale to outsiders. When such transfers were made, they were also reflected on the accounting records at cost, through intercompany accounts payable and accounts receivable, without the passage of any cash between the companies.
McCulloch had charge of the cash section for all companies. The cash was accumulated in the districts and transmitted to local accounts, of which there were about 150, exclusive of the petty cash accounts. Each subsidiary had several separate bank accounts*289 at plant and district office locations. McCulloch was empowered to draw on any of these accounts indiscriminately wherever cash was available over operating requirements. C. E. Adams, F. B. Adams, Jr., Ryder, and Holmes could also sign checks, drafts, and orders for all the companies; Ludlow could sign for Airco, Sales and Carbonic; Munson could sign *609 for Airco, Sales and Carbide; Randall could sign for Airco, Sales, and Welder; Keeley and Hull could sign for Airco and Sales; Ackerman could sign for Carbide; Hasler and Anderson could sign for Welder; and Ogier, Rowen, and T. W. Gibson could sign for Carbonic. Two signatures were necessary in each case. The district offices made daily reports of cash received and petty cash paid out and bank deposits and from this was made up the combined daily cash report for Airco and twice each month this consolidated cash report was submitted to the board of directors of Airco. All of this was under the cash section.
Bowman's particular work was in auditing the accounts receivable, petty cash, and stores of the field and district office accounts. Winters was credit manager for all the companies. He had complete responsibility for*290 authorization of credit in the district offices and in the New York office. He delegated this authority through his credit clerks in the field, who reported to him twice each month, showing the delinquent balances for all accounts of about 60,000 customers.
F. B. Adams, Jr., was in charge of the pension policy section for all the companies and was also given special assignments. There were two pension plans for Airco and its four subsidiaries. The first plan covered services rendered by all employees of all the companies prior to May 1, 1935. The second plan covered services rendered by all employees of all the companies after May 1, 1935. The first plan provided for retirement income out of a trust fund established and entirely supported by Airco by contributions to a fund on deposit with Bankers Trust Co. The second plan was maintained by the joint contribution of Airco and the individual employee. Airco contributed approximately 60 per cent and the individual employee approximately 40 per cent, and their joint contribution was used to purchase a group annuity contract with the Aetna Life Insurance Co.
Bower was field office manager for Sales and Carbonic and dealt principally*291 with personnel questions.
Allen was manager of cylinder records for Airco, Sales, and Carbonic. Title to all gas cylinders was retained by Airco. Cylinders were allocated between Sales and Carbonic as required. In 1938 Airco had approximately 850,000 cylinders in service, of which 600,000 were in service for Sales and 250,000 for Carbonic. Hull had under his supervision Ackerman, R. F. K. Tothill, and Hasler.
Ackerman looked after a certain type of sales by Carbide, such as mine lamp and house lighting, which did not fit into the standard Airco products. He also handled special types of direct mail advertising to that kind of trade, and also handled direct carload shipments.
Tothill was the operating manager of the two carbide plants at Keokuk and Ivanhoe for Carbide. Hasler, as president of Welder, *610 had charge of an assembly plant and looked after certain special sales to jobbers.
The general accounting department of the financial branch under Bonapart was located in the general offices at New York. Separate books were kept for each subsidiary. Uniform methods of accounting were employed for all the companies and the accounts were kept strictly in accordance with*292 the operating or agency agreements. Each subsidiary credited to Airco, as an account payable, the amount of working capital furnished the subsidiary by Airco, and also the net proceeds from its operations in excess of 6 per cent on its capital stock. Airco recorded such amounts on its books as accounts receivable due from the subsidiaries. No interest ran on any of these accounts. Intercompany accounts were cleared monthly through the parent's books on consolidation of the accounts of the subsidiaries.
Hawkins was in charge of the "distribution" branch. He had under his supervision S. B. Stouffer, E. C. McClintic, T. P. Keevins, and H. B. Welsh. Stouffer was assistant distribution manager for all the companies. He handled the distribution of all products from plants and warehouses to customers. McClintic was traffic manager for Carbonic. He handled mainly the dry ice, steel tubes, and all the traffic handled in leased cars or standing in warehouses. Keevins was traffic manager for all the companies except Carbonic. Welsh was the truck supervisor for all the companies.
Metzger was in charge of the "research" branch. He had under his supervision W. Wilkinson, a research *293 engineer; W. G. Fogg, the chief chemist; E. R. Balcar, in charge of rare gas research; and C. C. Van Nuys, the chief physicist. All these men performed services for all the companies. This branch carried on extended research in connection with the production of synthetic alcohol in 1938 and in the improvements of the Airco products. It increased the purity of oxygen from about 98 per cent to 99.5 per cent. It also developed the processes for getting all the rare gases that all the companies can market.
The board of directors of Airco met 22 times during 1938, which was twice each month except January and July. The board of directors of Sales met 5 times during 1938; Carbide, once; Carbonic, twice; and Welder, twice. Airco had 16 directors during 1938; Sales, 5; Carbide, 3; Carbonic, 7; and Welder, 7. C. E. Adams and Munson were directors in all the companies. Ludlow was a director in all the companies except Carbide.
During the year 1938 Airco also owned an interest in three other corporations, which operated under the names of Magnolia Airco Gas Products Co., Crystal Pure Carbonic, Inc., of Texas, and Commercial Acetylene Supply Co. These three companies operated as separate*294 companies and not as branches or divisions of Airco. They returned *611 their respective incomes separately and are not involved in these proceedings. Some of the profits of these three companies were declared as dividends to Airco and their accumulated profits appeared as surplus on their balance sheets, rather than as accounts payable to Airco, as in the case of petitioners herein.
The method by which Airco conducted its business through corporate agencies was consistently adhered to and all details of the relationship between Airco and each of its corporate agencies or divisions were always fully disclosed to the Government and the Commissioner.
Petitioners were the corporate agents of Airco and were operated as incorporated branches or divisions of Airco. The income from the operations of petitioners which is in excess of 6 per cent of petitioners' outstanding capital stock belonged to and was the income and property of Airco as principal.
OPINION.
The issue which we have to decide in this proceeding is whether, as the respondent has determined, the income from the operations of the three petitioners belonged not to Airco, the parent, but to the petitioners, and was taxable*295 to them; or whether, as the three petitioners contend, the income from the operations of the petitioners in 1938, exclusive of the small amounts paid to petitioners under the contracts, belonged and was taxable to Airco, the parent company, both because the petitioners were in fact incorporated departments, divisions, or branches of Airco's business and because the petitioners operated pursuant to express contract with Airco.
Wilson Welder & Metals Co. was another subsidiary of Airco, which operated in the same manner as the petitioners, but it is not a party to these proceedings. Concededly, there was a loss from its operations in 1938 and the Commissioner has not determined any deficiency against it.
In our findings of fact we have endeavored to give a full and complete picture of the method of operations of petitioners as agents or branches or divisions of Airco. Therefore, in our discussion of the issue which we have to decide we shall endeavor not to unnecessarily repeat these facts.
It requires scant citation of authorities to establish the principle that normally corporations are separate juristic persons and are to be so treated for tax purposes. See .*296 Likewise, mere ownership by one corporation of all of the stock of a subsidiary does not of itself merge the two corporations or create the relationship of principal and agent between them. There are exceptions, however, particularly where the *612 subsidiary is so much a part of the parent in its operations that it amounts to no more than a mere department or agency.
It is the contention of petitioners that their manner of organization and their method of operation during the taxable year and for many years prior thereto bring them within the latter classification, and that their entire net income, outside of the nominal amounts retained by each of them under the terms of their respective contracts with the parent corporation, Airco, belonged to Airco and should have been returned for taxation by that corporation, and that it was so returned by the parent corporation and taxes were paid thereon. In support of their contention petitioners rely principally upon ; ; and .*297
Respondent, on his part, contends that the foregoing authorities are not applicable and that each of the petitioners is taxable on its own net income, regardless of any contract or agreement or method of operation which petitioners may have followed. Among the authorities cited by respondent to sustain his determination are ;; ; and ; affirmed per curiam, .
We have carefully examined the authorities cited by petitioners and respondent and have studied them in the light of the facts present in the instant case, and we think that the facts which we have here bring petitioners within the ambit of the cases relied upon by them rather than those relied upon by respondent.
The Supreme Court, in , held that the distributions which were in *298 issue in that proceeding were not dividends, for the reason that the Central Pacific and Southern Pacific were in substance identical because of the complete ownership and control which the latter possessed over the former as stockholder and in other respects. The Court said in part:
* * * While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control. * * *
We think the foregoing words of the Supreme Court are aptly descriptive of the relationship which existed between petitioners and their parent, Airco, in the instant case. We summarize as follows some of the facts which have brought us to this conclusion: The capital stock of each petitioner is nominal in amount and is all owned by Airco. The members of the board of directors of each petitioner are elected *613 by Airco and, with one exception, they are all senior executive officers of Airco. The chairman of the board of directors of Airco was also chairman of the board of directors of each petitioner. The president of Airco was also a *299 director of Airco and of each petitioner. The Airco board held regular meetings and exercised complete domination and control over the business of Airco and each of the petitioners. The board of directors of the petitioners held an organization meeting each year and thereafter only met when called upon by Airco to formalize action taken by the Airco board. The chairman, vice chairman, and president of Airco were in charge of the administration and management of the activities of each petitioner and carried out the policies and directives with respect to each petitioner as promulgated by the Airco board. One main office was maintained for Airco and the petitioners in the Lincoln Building, New York City, and, with two minor exceptions, the offices of all the executive officers of Airco and the petitioners were located there. All assets held by each petitioner were furnished to it by Airco, which paid for them with its own cash or stock. Airco supplied all the working capital of each petitioner. The business of the parent and the petitioners was conducted as one business unit, divided into six branches: corporate, operations, sales, financial, distribution, and research. Each *300 of the six main branches was directed by a senior officer of Airco. The subdivisions of each of the six branches were also directed and managed by officers of Airco. All employees in each of the six branches performed their duties for Airco and each petitioner, whenever and wherever their services could be utilized in connection with the operations of any of the petitioners. All expenditures for Airco and each petitioner of more than $ 500 required specific approval of the Airco board of directors and its chairman. Advertising was conducted under one advertising manager, and through this medium Airco represented to its stockholders and the general public that the petitioners were divisions of the parent company. All purchases for each petitioner from persons outside the affiliated group, except emergency purchases up to $ 50, were made only upon orders issued by the general purchasing agent of Airco. Products produced by or materials purchased for one agency company were often transferred to another agency company. Where this was done the transfer was reflected on the intercompany accounts at cost, without the passage of any cash. There were no intercompany profits. All bank*301 accounts maintained in the name of each petitioner were treated by Airco as its own and were drawn upon indiscriminately by it when money was needed by any company. There was substantial identity of officers authorized to sign checks on the bank accounts of Airco and on the bank accounts of each petitioner. All credits and collections were in charge of the Airco credit manager. Airco maintained pension systems *614 for all employees of all companies. Accounting was done for all companies by one general accounting office under the general auditor of Airco and accounting procedure was uniform. The proceeds realized from each petitioner's activities did not come to Airco as the result of any independent action by the agency company, such as declaration of dividends. A written operating agreement was entered into between Airco and each petitioner, under which the petitioner agreed to conduct a branch of the Airco business for a purely nominal fee. In each agreement the agency company agreed to credit, and did credit, monthly on its books to Airco all profits from its operations above the nominal amount of its compensation. The accounts between Airco and each petitioner were*302 kept strictly in accordance with each operating agreement.
It is true, of course, that, taken separately, some of the foregoing facts would not be sufficient in themselves to make inoperative the general rule that corporations are separate juristic persons and are to be so treated for tax purposes. We think, however, that when all these facts are viewed together they bring petitioners within the rule announced by the Supreme Court in
The Circuit Court of Appeals of the Second Circuit held, in , that the taxpayer, Munson Line, should be deemed the owner of each vessel held by and documented in the name of its wholly owned subsidiaries. In thus holding, the court, among other things, said:
* * * The situation is similar to that involved in , where the court held that there was practical identity between the Central Pacific and the Southern Pacific because of the complete *303 ownership and control which the latter corporation possessed over the former. Thus even in tax cases the separate identity of corporations may be disregarded in exceptional circumstances. See, also, ; . * * *
Respondent, in support of his determination, relies heavily upon , which affirmed , which in turn affirmed our decision in . We think that case is clearly distinguishable from the instant case on its facts. In the Interstate Transit Lines case the taxpayer (a Nebraska corporation) operated an interstate bus line between Illinois and California, and Missouri and Wyoming. Under California law as it existed prior to 1937, the petitioner, being a foreign corporation, was prohibited from doing an intrastate business in California. In order*304 to handle such local business on its buses, the taxpayer organized a California bus corporation, named Union Pacific Stages of California, and made an agreement with that corporation under which the California*615 corporation was to take over the operation of Interstate's buses at the state line and operate them in California for its benefit and under its direction, the profits to be paid to Interstate and any deficit to be borne by it. In the year 1936 the California corporation had an operating deficit of $ 28,100.66 and Interstate paid that amount to the California subsidiary and deducted it as a business expense in its own return. The Supreme Court, sustaining the decisions of the lower courts, held the deduction improper. The decision of the majority of the Court was placed squarely upon the ground that the subsidiary was engaged in a business which the parent corporation could not lawfully do; hence, that the parent corporation could not claim the deduction as an ordinary and necessary expense of its business. The majority opinion pointed out that "an income tax deduction is a matter of legislative grace and that the burden of clearly showing the right to the claimed*305 deduction is on the taxpayer." The Court then said:
This is not the case of a mere branch or division of a business conducted solely for convenience's sake under a separate corporate form. Petitioner did an interstate bus business and was a corporation foreign to California. On the other hand the business of Stages in the tax year in question was both interstate and intrastate. For petitioner to engage in intrastate business in California was, on the findings, illegal. * * *
The Court also pointed out that, even if it could be claimed that the intrastate business done by the subsidiary was legitimate business of the parent corporation, the record failed to show what part of the deficit, if any, resulted from that business as distinguished from the local business, so that no part of the deduction could be allowed.
We have no such facts in the instant case as existed in The Commissioner makes no contention that Airco and its subsidiaries operated in the manner shown in our findings of fact because it was illegal for Airco to do such business on its own account. On the contrary, the evidence affirmatively shows that*306 such was not the reason for the manner of operation by Airco and its subsidiaries. The reasons which did prompt such method of operation are fully set out in our findings of fact and need not be repeated here. Moreover, the issue in the instant case is altogether different from the issue in the Interstate case. In the Interstate case the issue was one of deduction for ordinary and necessary business expense. We have no such issue here. The issue is squarely whether the income of the subsidiaries is taxable to them because it was their income, or whether, because they were operated as branches or divisions of Airco and each under a contract which clearly disclosed the relationship, the net income of these subsidiaries was taxable to Airco.
Petitioners make no contention that if they lose on this issue they are in the alternative entitled to deduct as business expenses the *616 amounts of income which they turned over to Airco. They concede this if the issue which is raised by the pleadings is decided against them, then the deficiencies are those which have been determined by respondent. On the other hand, respondent concedes that, if the issue raised by the pleadings*307 is decided in favor of the petitioners, then there are no deficiencies.
As we have already stated, we think the law and the facts are on the side of petitioners, and, therefore, we decide in their favor.
, was not cited or relied upon by the Commissioner in his brief. However, we think it is appropriate to point out that one of the issues in that case was similar to that involved in , and we decided it in the same way as we had decided in the Interstate case. As one of the authorities for such decision, we cited the Interstate case. If the distinction which we have made above between the Interstate Transit Lines case and the instant case is sound, as we think it is, then undoubtedly the same distinction applies to
It may be argued, although not stressed in respondent's brief, that consolidated returns by affiliated corporations were denied generally by the Revenue Act of 1934, and, therefore, on that account, if no other, petitioners should not prevail*308 in this proceeding. We are not unmindful of this change in the law effected by the 1934 Act and we have no purpose to impinge upon it. However, we do not believe that this change in the law affected that narrow class of corporations which are conducting their operations in the manner such as described by the Supreme Court in The respondent himself evidently so construed the law so far as petitioners were concerned, because it was not until the taxable year 1938 that he refused to recognize Airco's right to return the income of petitioners as its own.
So far as the record shows, the income tax returns of Airco and petitioners for the years 1935, 1936, and 1937 were not disturbed, although they were filed on the same basis as in the taxable year and they were all years subsequent to 1934, when Congress amended the law so as to deny the privilege of filing consolidated returns to affiliated corporations generally. Of course, respondent is not in any way estopped to do what he has done in the instant case by any action of his in the years 1935, 1936, and 1937. Nevertheless, we think *309 that his apparent interpretation of the law in 1935, 1936, and 1937 as it affected petitioners was correct and that the rule announced by the Supreme Court in , still stands.
Decisions will be entered for the petitioners.