*1507 1. Petitioner owned 66 2/3 per cent and held a proxy for the balance of M Company's stock; it owned 71.48 per cent and held proxies for the balance of O Company's stock; it owned 75.54 per cent of S M Company's stock. Held, insufficient to authorize affiliation.
2. Petitioner held certain promissory notes. The debtor was in poor financial condition in 1923, but it did not appear that any of the notes were past due in that year or that it was then known that the debtor would not be able to pay when the notes fell due. Held, the amounts of such notes are not deductible as bad debts in 1923.
3. Interest and commissions held properly included as income for the year when they accrued, where accounts were kept on an accrual basis.
4. Amounts expended for salaries and rent allocated on petitioner's books to subsidiary companies held not deductible by petitioner as ordinary and necessary expenses.
*555 This proceeding is for the redetermination of a deficiency in income tax asserted by the respondent for the year 1923*1508 in the amount of $8,177.61. Some of the errors alleged in the petition were abandoned. Those now urged are: (1) Disallowance of affiliation with three other companies; (2) disallowance of a deduction of $95,090.66 on account of an alleged bad debt; (3) disallowance of deductions for bad debts, being monies advanced to a subsidiary company; (4) inclusion of $34,583.45 as accrued income from subsidiaries; (5) disallowance of certain items claimed as expenses.
The parties filed a stipulation of facts. Petitioner also filed a further statement of facts which respondent admitted to be true, but contended they were not relevant to the issue presented. From those two documents we make the following findings of fact.
FINDINGS OF FACT.
The petitioner is a corporation, with its principal office in New York City. It was organized in May, 1922, and during that year it acquired 1,906 shares or 42.85 per cent of the capital stock of the Southern Menhaden Corporation, hereinafter called the Menhaden Company. During 1923 petitioner acquired 1,454 additional shares, and on December 31, 1923, it owned 75.74 per cent of the outstanding stock of the Menhaden Company. In addition four of*1509 petitioner's stockholders, who were also directors, owned stock of the Menhaden Company as follows:
| Shares of petitioner's stock | Shares of Menhaden Co. stock | |||
| Stockholder | Jan. 1 | Dec. 31 | Jan. 1 | Dec. 31 |
| W. C. Peyton | 3,500 | 3,500 | 1 | 1 |
| Eugene du Pont | 2,550 | 2,550 | 350 | 350 |
| W. A. Larner | 400 | 400 | 1 | 1 |
| T. W. Keithley | 200 | 200 | 55 | 1 |
Petitioner's outstanding common stock throughout the year 1923 amounted to 10,000 shares. Of the 3,500 shares held by W. C. Peyton 2,500 were held in trust with Eugene du Pont.
There were 4,448 shares of the Menhaden Company stock outstanding throughout the year 1923.
*556 In April, 1923, the McIntosh-Morello Orchards Company, Inc., hereinafter called the Orchard Company, was organized. Its total outstanding voting stock on December 31, 1923, amounted to 1,893.20 shares, of which 1,353.35 shares, or 71.48 per cent, were owned by the petitioner. Petitioner also held as collateral 409.97 shares standing in the name of F. D. Waugh, and by agreement petitioner was entitled to take ownership of said stock upon default of said F. D. Waugh in payment of his indebtedness.
In 1922 petitioner acquired*1510 all of the outstanding capital stock, 250 shares, of Charles J. Maxwell & Company, hereinafter called the Maxwell Company. On May 14, 1923, petitioner sold 83 1/3 shares to Howard V. Sutherland, manager of the Maxwell Company's business. It was agreed that if the business were sold it would be sold as an entirety and Sutherland's stock sold with that of petitioner; and that if Sutherland left the employ of the Maxwell Company, petitioner would have first call upon his stock. On December 31, 1923, petitioner owned 66 2/3 per cent and Sutherland owned 33 1/3 per cent of the outstanding common stock of the Maxwell Company. In March, 1929, Sutherland left the company and returned the 83 1/3 shares of stock to petitioner, who then canceled and returned to Sutherland his promissory note for $3,500 which he had given in payment for the stock in 1923.
From the time the petitioner acquired its stock of the above companies those four corporations, with some others in which petitioner was a stockowner, had a centralized management. They were operated together, occupied the same offices, and all were directed by the same executive heads. Petitioner financed the needs of the other three*1511 companies during 1923.
For the year 1922 separate income-tax returns were filed by petitioner, the Maxwell Company, and the Menhaden Company. For 1923 these three companies filed a consolidated return, including also the Orchard Company and other companies. Petitioner did not file a consolidated return for 1922 because it was not organized until May, and did not acquire any of the stock or securities of the said companies until about June 29, 1922.
At the stockholders' meeting of the Menhaden Company held in May, 1923, of the total outstanding stock of 4,448 shares, 3,623 shares were represented and voted. W. C. Peyton, petitioner's president, held and voted proxies for 3,565 shares, 3,360 of which were owned by petitioner. The remaining 58 shares at the meeting were voted by their owners, all of whom were directors and officers of petitioner.
At the stockholders' meeting of the Orchard Company held in 1923, petitioner, by proxy and as owner, voted 100 per cent of the stock represented.
*557 At the stockholders' meeting of the Maxwell Company held May 14, 1923, petitioner held the proxy of Howard V. Sutherland and voted all the outstanding stock.
The Menhaden*1512 Company was engaged in fishing for menhaden and converting the fish into fertilizer and fish oil. In poor fishing seasons large losses are often sustained in that industry, but through a series of years the industry is a profitable one as a rule.
On April 4, 1923, the petitioner purchased from Frank L. Connable the following securities:
| $131,333.33 bonds of Menhaden Co. for | $65,666.67 |
| 1,388 shares stock of Menhaden Co. for | 1.00 |
| $117,762.22 notes Menhaden Co. for | 95,256.33 |
| 521 shares pfd. stock Stoker Co. for | 39,075.00 |
| 4,001 shares com. stock Stoker Co. for | 1.00 |
| Total | 200,000.00 |
For the above securities Frank L. Connable received preferred stock of the petitioner and a note of petitioner, as follows:
| Preferred stock of the value | $150.00 |
| Note for | 50,000 |
| Total | 200,000 |
The Menhaden Company sustained a loss of $244,963.08 in 1923.
On December 31, 1923, the said notes of the Menhaden Company amounting to the principal sum of $117,762.22 were charged to profit and loss in the amount of $95,090.66 which amount was claimed as a deduction in the 1923 return. (The difference between $95,256.33 and $95,090.66 is accounted for by the adjustment*1513 made on the books of petitioner.)
There were outstanding on December 31, 1923, $436,000 of first mortgage 6 per cent bonds of the Menhaden Company, of which $384,000 or 88.07 per cent was owned by petitioner. The bonds constituted a first lien on all property and assets of the Menhaden Company.
The plant of the Menhaden Company has not been operated since December 31, 1924. Ever since that date petitioner has endeavored to liquidate the Menhaden Company and to sell its plant.
Petitioner made loans to the Menhaden Company aggregating $22,666.67 during 1922 and $37,833.33 during 1923. No part of the amounts so loaned was repaid during 1922 or 1923, nor has petitioner received any payment on account of the notes purchased from Frank L. Connable. Subsequent to 1923 petitioner increased its stockholdings in the Menhaden Company and owned 95 per cent of the stock in 1927 and 99.8 per cent in 1929.
*558 The books of the petitioner were kept upon the accrual basis during 1923 and subsequently. Items representing charges against various subsidiary companies were entered on petitioner's books and were included by respondent as income to the petitioner for the taxable year. *1514 These items constituted credits and obligations due to petitioner for interest and financial commissions and were incurred during 1923 as follows: by the Cardiff Green Marble Company, $4,423.60; by the Menhaden Company, $3,594.48; by the Orchard Company, $3,416.65; and by the Delvatex Petroleum Corporation, $23,148.72 - total, $34,583.45. Petitioner did not in fact receive any part of the above amounts in 1923, nor has it since been able to collect any part thereof. These credits to "revenue" were made on the books in the belief that petitioner was entitled to file a consolidated return, in which event the credits would be eliminated by corresponding entries to "expense" on the books of the subsidiaries.
Acting upon the same belief respecting a consolidated return, petitioner made other charges against subsidiaries in 1923 as follows: Marble Company, for salaries paid employees of petitioner, $4,075.57; Orchard Company, for salaries, $812.50; Marble Company, for rent, $332.50; Orchard Company, for rent, $237.50 - total, $5,458.07. Petitioner did not receive any part of said amounts in 1923, nor has it since been able to collect any part thereof. If a consolidated return is*1515 allowable, the above items will be eliminated by corresponding entries to "expense" on the books of the subsidiaries.
During 1923 the petitioner's subsidiaries suffered losses as follows: Marble Company, $15,640.81; Orchard Company, $23,505.18; Delvatex Petroleum Corporation, $68,086.61. The directorates of petitioner, the Marble Company, the Menhaden Company, the Maxwell Company, the Standard Stoker Company, and the Orchard Company were interlocking in the year 1923.
OPINION.
MARQUETTE: Except as incorporated in our findings of fact, the "Additional Statement of Facts" filed at the hearing has been disregarded as being irrelevant to the issues here presented.
The petitioner filed a consolidated income-tax return for 1923 for itself and five other companies. Affiliation was denied by the respondent and petitioner now concedes that such denial was correct in regard to the Cardiff Marble Company and the Standard Stoker Company, but insists that respondent erred in denying affiliation with the Southern Menhaden Corporation, Charles J. Maxwell & Company, and the McIntosh-Morello Orchards Company.
The Revenue Act of 1921, so far as it is here pertinent, provides:
SEC. *1516 240. (a) That corporations which are affiliated within the meaning of this section may, for any taxable year beginning on or after January 1, 1922, *559 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 granted by the Commissioner.
* * *
(c) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.
The provisions of subsection (c) have been considered by the Supreme Court in *1517 . In that case six men owned 93.71 per cent of the stock of the taxpayer and they also owned about 75 per cent of the stock of Hamilton & DeLoss, Inc., a subsidiary. Harold H. Hamilton was president of the subsidiary, and 20 per cent of its stock was issued to him. The taxpayer, through its power over Hamilton's official position and salary, and its ability to dominate both corporations, was in position effectually to influence Hamilton in respect of the voting, use or disposition of his stock, and thus, as a practical matter, to exert control. Respecting the statute in question, the court said:
The section requires control of substantially all of the stock; control of the corporation is not enough. The carrying on of a business unit by two or more corporations does not in itself constitute affiliation. The shares of Hamilton & DeLoss, Inc., owned by the six shareholders did not constitute substantially all of its stock * * *. It would require very plain language to show that Congress intended to permit consolidated returns to depend upon a basis so indefinite and uncertain as control of stock without title, beneficial*1518 ownership or legal means to enforce it. Control resting solely on acquiescence, the exigencies of business or other considerations having no binding force is not sufficient to satisfy the statute.
We think the above decision is controlling here. At the time of the stockholders' meeting in May, 1923, and for the remainder of that year, petitioner owned 66 2/3 per cent of the Maxwell Company's stock, while 33 1/3 per cent was held by a person having no connection with, or financial interest in, the petitioner. Although petitioner held and voted a proxy for that one-third interest, the evidence indicates that the control thus acquired by the petitioner rested upon the exigencies of business and hence was not the legal control of the stock required by the statute.
Respecting the Orchard Company, petitioner owned 71.48 per cent of the stock in 1923. Through proxies 100 per cent of the Orchard Company's stock was voted by petitioner. The evidence does not disclose that petitioner had any title or beneficial ownership in the *560 stock for which the proxies were given, and the proof therefore fails to establish the control required by the statute to constitute affiliation.
*1519 During the taxable year petitioner owned 75.54 per cent of the Menhaden Company's capital stock. It is true that four of petitioner's stockholders and directors together owned 7.94 per cent of Menhaden Company stock, but we can not assume that such individual holdings were controlled by petitioner within the meaning of the statute. In each instance the petitioner owned less than 76 per cent of the stock of the corporation with which it claims affiliation, and no control of the other stock is shown. It has been held repeatedly that such a percentage is insufficient to constitute "substantially all." ; burnet v. ; . We conclude, therefore, that no affiliation existed with either of the three companies in question during 1923.
The petitioner also contends that it is entitled to deductions on account of bad debts with respect to certain promissory notes as follows: $95,090.66 representing the purchase price of the Menhaden Company's notes bought by petitioner from Frank L. Connable, which amount petitioner*1520 charged to profit and loss on December 31, 1923, and $60,500 representing money loaned in 1922 and 1923 by petitioner to the Menhaden Company and evidenced by that company's promissory notes.
Under section 231(a)(5) of the Revenue Act of 1921, debts may be deducted when they are ascertained to be worthless and are charged off within the taxable year. Both the ascertainment of worthlessness and the charging off must take place within the taxable year. In our opinion the evidence offered does not show that the notes, or the debts they represented, were ascertained to be worthless during 1923. The Menhaden Company may have been in poor condition financially, but the evidence does not disclose that any of the promissory notes were past due in 1923, nor that the debtor company was not able to pay the notes when they did fall due. The fact that petitioner has never received any payment on the notes is not proof that they were worthless, or ascertained to be worthless in 1923. At the close of that year there was a fair possibility that the coming fishing season would be profitable for the Menhaden Company and enable it to meet its obligations when due. Clearly, the evidence adduced*1521 does not establish that petitioner had ascertained in 1923 that the notes in question were without value. So far as concerns the notes given for loans, not only does the same reasoning apply, but apparently they were not charged off petitioner's books at all. The petitioner thus has failed to sustain the burden of establishing its right to the deductions claimed. Cf. ; *561 affd., ; .
During 1923 the petitioner entered on its books of account charges against four subsidiary companies for interest and financial commissions accrued during that year in the aggregate amount of $34,583.45. The books were kept upon the accrual basis and respondent has included the amounts as taxable income. It is now contended that the items did not constitute income but were merely bookkeeping entries made in the belief that petitioner was entitled to file a consolidated return, in which event the items credited on petitioner's books would be eliminated by corresponding entries to expenses on the books of the subsidiaries.
We are not impressed by the argument. *1522 Apparently, the items were proper ones to be charged against the companies which incurred them, and, as petitioner was on the accrual basis, the entries were of necessity made at the time of accrual. The making of proper entries to reflect the petitioner's business transactions was not dependent upon or affected by the petitioner's right to file a consolidated return. Cf. ; ; . The interest and commissions, therefore, constituted accrued income to the petitioner in 1923. When, as here, entries must be made to properly reflect business transactions, the validity and force of such entries can not be dispelled because the taxpayer believed he could offset their effect by a method which, in fact, he is not entitled to pursue. We sustain the respondent's determination upon this point.
The petitioner also charged on its books and against some of its subsidiaries amounts aggregating $5,458.07. Of this total, $4,888.07 represented salaries paid by petitioner to its own employees, while $570 represented rental charges. The subsidiaries and*1523 petitioner occupied the same general offices and petitioner's employees performed the office work necessary for the subsidiaries.
The amounts in question represented expenses paid out by the petitioner. For purposes of its own petitioner chose to carry the items on its books as charges allocated to subsidiary companies rather than as expense to itself. These charges having been made against the subsidiaries upon the books of petitioner, they either represented charges properly made against them or were fictitious entries for tax purposes. The petitioner's contention that they were mere bookkeeping entries made in the belief that they would be eliminated in a consolidated return is not entitled to much weight in the circumstances, and in our opinion these amounts should be treated as advances to the subsidiaries and, as such, represent neither income nor deductible expense to petitioner.
Decision will be entered under Rule 50.