*1439 A corporation with an established taxable year ending July 31 became affiliated on January 5, 1927, with the petitioner, a new corporation then formed, which established a calendar year as its taxable year. The old corporation filed a separate return for the fiscal year ended July 31, 1927, and in September, 1927, requested and received permission for a change in its accounting period in order that it might file a return for the five-month period ended December 31, 1927, and place itself on a calendar year basis. No return was filed by the old corporation for the five-month period ended December 31, 1927, but instead a return was filed in March, 1928, in the names of both corporations which included the income of the petitioner for the entire year ended December 31, 1927, and that of the old corporation for the five-month period ended December 31, 1927. Held, that the tax liability of the two corporations may not be determined upon the basis of a consolidated return for the year ended December 31, 1927.
*1032 This proceeding involves a deficiency in income tax as determined by the Commissioner for 1927 in the amount of $5,700.86 and has for its only issue the question whether the petitioner and/or Holed-Tite Packing, Inc., an affiliated company, exercised an option which precludes the determination of the tax liability of the two corporations for 1927 on a consolidated basis.
FINDINGS OF FACT.
The petitioner is a Delaware corporation which was incorporated on January 5, 1927. It was organized to acquire property, consisting *1033 of certain license agreements, from Holed-Tite Packing, Inc., a Delaware corporation which was organized in 1922.
From the date of incorporation of the petitioner on January 5, 1927, to the end of the calendar year 1927 at least 95 per cent of the voting stock of the two above mentioned corporations was owned by the same interests.
The petitioner established a calendar year for its taxable year as the basis upon which to report its income for Federal tax purposes and Holed-Title Packing, Inc., had established a fiscal year ending July 31 as its taxable year as the basis upon which to report its income for*1441 Federal tax purposes.
Prior to the incorporation of the petitioner, Holed-Tite Packing, Inc., was engaged in the business of manufacturing pulp devices for packing, especially for mailing, and also of developing inventions in packing devices. Some years prior to the incorporation of the petitioner it had developed a device for packing eggs for safe transportation which has come into general use in this country. This device had been turned over to Mapes Consolidated Manufacturing Company for sale in the United States on a royalty basis. Holed-Tite Packing, Inc., was also at that time working on other devices, some of which have since been developed. Under the royalty agreement with the Mapes Company it was obtaining substantial royalties amounting to about $100,000 a year. In connection with the running of this business and the development of its patents, the expenses of Holed-Tite Packing, Inc., were very large. In its Federal income-tax returns, which were filed on the basis of a fiscal year ending July 31, the expenses of the company were deducted from the income received as royalties, which was its only source of income. Its returns filed in this way were accepted and*1442 passed by the Government, with the result that it paid tax on its net income, consisting of the royalties less expenses.
Prior to 1927 Holed-Tite Packing, Inc., had entered into an agreement with the International Paper Company by which it was understood that after a period of experiment a new company would be formed on a joint profit-sharing basis, which, however, was not to be entitled to the royalties under the license agreement with the Mapes Company. In order, therefore, to segregate the revenue to be received from the Mapes Company, the petitioner was incorporated under the name of Patent Royalties Corporation, to denote that it was formed for the purpose of receiving the royalties from the Mapes Company.
Before incorporating the petitioner the board of directors of Holed-Tite Packing, Inc., inquired of counsel as to the effect of a separation into two companies from an income-tax standpoint, as it was desired to continue the practice of having the expenses of the *1034 company paid out of its only source of income, the revenue from the royalties. Upon thus consulting counsel they were informed that a consolidated return could be made that would in effect accomplish*1443 that result. They also asked. A. H. Berger, who had been in their employ for several years as their accountant and served in connection with the preparation of their tax reports, whether the incorporation of the petitioner would have any effect in connection with the income taxes of Holed-Tite Packing, Inc., and whether the deductions of the one company could be offset against the income of the other. He advised them that they could be so offset, and that to that end a consolidated return should be filed.
Upon the formation of the petitioner it was decided to place the petitioner on the calendar year basis and to file consolidated returns on such calendar year basis. Accordingly petitioner established a calendar year as its taxable year upon which to compute its income under the Federal revenue laws. Berger, the accountant, was instructed to prepare consolidated returns so that the same method as theretofore followed of charging the expenses of the business against the royalties could be continued.
The last return of Holed-Tite Packing, Inc., prior to incorporation of the petitioner, was filed for the fiscal year ending July 31, 1926. Since the petitioner established a*1444 calendar year as its taxable year and since it was desired that the consolidated returns for the two companies should be filed on a calendar year basis, the accountant was under the impression that it would be necessary to file a return for the Holed-Tite Packing, Inc., for a period less than a year and that permission to file for such period should be secured from the Commissioner. In order to carry out what he considered the proper procedure for placing the two corporations on a basis for filing their consolidated return, on September 20, 1927, the accountant had Holed-Tite Packing, Inc., file a separate return for the fiscal year ending July 31, 1927, and on or about the same date, he filed an application for a change in accounting period on the part of Holed-Tite Packing, Inc. The following reasons were given as to why the change was desired:
The Patent Royalties Corp., incorporated January 1927, took over royalty contracts held by Holed-Tite Packing Inc., the stockholders of the Holed-Tite Packing Inc., receiving one share of Patent Royalty stock for every ten shares of Holed-Tite Stock held. Inasmuch as the companies are affiliated it is desired to file consolidated reports*1445 at the end of the first calendar year of the new Company.
In order to do so, permission is requested for the Holed-Tite Packing Inc., to file for the period August 1, 1927, to December 31, 1927, at which time the affairs of the two companies will be filed in a consolidated report.
Shortly thereafter, the permission requested was granted in a letter which read in part as follows:
*1035 Permission is hereby granted the Holed-Tite Packing Company to change its accounting period and taxable year from a fiscal year ending July 31 to a calendar year ending December 31. In order to effect the change as granted a return will be required for the period from August 1, 1927 to December 31, 1927, on or before March 15, 1928. * * *
On March 15, 1928, a return was filed which purported to be a consolidated return and which included the income of the petitioner for the calendar year 1927 and the income of Holed-Tite Packing, Inc., for the period August 1, 1927, to December 31, 1927. The aforementioned return and the return of Holed-Tite Packing, Inc., for the period August 1, 1926, to July 31, 1927, were considered at the same time by the internal revenue agent in charge in New*1446 York City and on July 12, 1929, reports were rendered in which it was recommended that income of Holed-Tite Packing, Inc., for the last seven months of the fiscal year ended July 31, 1927, be included in the other return which was considered on a consolidated basis for the calendar year 1927. After protest by the corporations on points not here material, the internal revenue agent in charge issued a revised report on October 30, 1929, in which the same allocation of income was followed. When the aforementioned reports were considered by the income tax unit in Washington, D.C., the entire income of the two corporations was considered on a consolidated basis for the calendar year 1927, but instead of determining the tax liability on the basis of one consolidated return, it was held as follows:
You are advised that during the period August 1, 1926 to December 31, 1926 your corporation was not affiliated within the purview of Section 240 of the Revenue Act of 1926 with any corporation and a separate return should have been filed covering that period and that for the periods January 1, 1927 to July 31, 1927 and August 1, 1927 to December 31, 1927 the Holed Tite Packing, Incorporated*1447 and the Patent Royalties Corporation were affiliated and should have filed consolidated returns.
The segregation of the income for the fiscal year ended July 31, 1927 into two periods is based upon the affiliation rulings and is not brought about by the permission to change the accounting periods which does not permit a calendar year computation for 1927.
After protest by the petitioner, a deficiency of $3,476.25, as determined on the foregoing basis, was assessed by the Commissioner and paid by the petitioner.
On October 4, 1930, the Commissioner mailed the deficiency notice which gave rise to this proceeding and in which it was held that the tax liability of the petitioner and Holed-Tite Packing, Inc., should be determined on the basis of separate returns for the taxable year 1927. The letter explaining the action taken reads in part as follows:
You are advised that the Holed-Tite Packing, Incorporated, and the Patent Royalties Corporation were affiliated during the year 1927 within the purview of section 240 of the Revenue Act of 1926. However, the Holed-Tite Packing, *1036 incorporated filed a separate return for the fiscal year ended July 31, 1927 which was*1448 the first taxable year after it became affiliated with Patent Royalties Corporation.
* * *
Inasmuch as permission was not granted by the Commissioner to change the basis of filing returns for the year 1927 from separate to consolidated, the audit is being made on the basis of a separate return for each company.
OPINION.
SEAWELL: The contention of the Commissioner is that since Holed-Tite Packing, Inc., a corporation affiliated with the petitioner within the meaning of section 240(d) of the Revenue Act of 1926, filed a separate return for the fiscal year ended, July 31, 1927, which was within the first year of the affiliated status, such action constitutes an election to file separate returns and therefore both corporations must file separate returns for 1927 and subsequent years unless permission to change is granted by the Commissioner. On the other hand, the petitioner contends that the two corporations intended and desired to file on a consolidated basis for 1927 and that their acts must be construed as having accomplished that purpose, or at least that their acts should not be considered as an election to file their returns on a separate basis. The controlling provision*1449 of the statute is section 240(a), which reads as follows:
Corporations which are affiliated within the meaning of this section may, for any taxable year, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is grantedby the Commissioner.
We think it clear and well established that the two corporations had the right under the foregoing provision to elect the basis upon which they would file returns for 1927, that is, whether on a separate or a consolidated basis, and that if they had desired to file on the latter basis the proper course would have been for Holed-Tite Packing, Inc.To have filed a return for the remaining five months of its fiscal year in the calendar year 1926 when it was not affiliated with the petitioner and then for the two corporations to have filed a consolidated return for the calendar year 1927*1450 in which would have been included the income and deductions of both corporations for the entire year. ; certiorari denied, ; ; ; ; and . See also article 634 of Regulations 69.
*1037 It is obvious, however, that the parties did not proceed in the manner indicated above, but, on the contrary, in a manner which makes necessary the conclusion that a return on a consolidated basis may not be permitted for the year ended December 31, 1927. While it may be true, and this is conceded by the Commissioner, that what the two corporations desired and intended was that the two corporations should report their income on a consolidated basis, we can not determine tax liability on the basis of desires and intentions; we must proceed on the basis of what was actually done, and a given taxpayer must be held to the consequences of its own acts. The statute*1451 specifically provides that, "If return is made on either of such bases [that is, separate or consolidated], all returns thereafter made shall be upon the same basis unless permission to change the basis is granted by the Commissioner." And when we come to consider the returns filed by the corporations for the year in question (1927), we find that Holed-Tite Packing, Inc., filed a separate return for the fiscal year ended July 31, 1927, which was the first return filed during the period of affiliation. When one member of an affiliated group files a separate return, the remainder of the group must likewise file separate returns. , and Apartment Corporation, sjpra.It therefore follows that at least for the period from January 1, 1927, to July 31, 1927, the petitioner would not have been permitted to file a consolidated return. However, even after that date we do not find that the corporations sought permission to change from a separate to a consolidated basis for the remainder of 1927, but rather for permission for a change in the accounting period of Holed-Tite Packing, Inc., in order that that corporation might file*1452 a separate return for the five-month period ended December 31, 1927, which would place it on the same accounting-period basis as the petitioner, namely, a calendar year. The permission requested was granted, but instead of following the course of procedure for which such permission was granted, a socalled consolidated return was filed for the calendar year 1927, which included the income of the petitioner for the entire year and that of Holed-Tite Packing, Inc., for the last five months of the year. Whatever may have been the effect of the granting of permission in so far as years subsequent to 1927 are concerned, we are of the opinion that it could not be interpreted as permitting the filing of a consolidated return for 1927, and since a separate return was filed by Holed-Tite Packing, Inc., for the fiscal year ended July 31, 1927, a consolidated return of the two corporations for the calendar year ended December 31, 1927, may not be permitted.
Judgment will be entered for the respondent.