1930 BTA LEXIS 1861">*1861 1. The 50 per cent stock interest of D.E. and A. M. Hewitt in the Elk Creek Lumber Co. was not owned or controlled, during the period January 1 to November 12, 1920, by the same interests which owned or controlled the other 50 per cent stock interest in that company and all, or substantially all, of the stock of the petitioner. Accordingly, the petitioner and the Elk Creek Lumber Co. were not affiliated for the period mentioned.
2. Special assessment denied.
21 B.T.A. 354">*354 This proceeding is for the redetermination of a deficiency in income and excess-profits taxes for the calendar year 1920, in the amount of $31,330.18. By amended petition, it is alleged that the respondent has erroneously denied the petitioner the right to file a consolidated return with the Elk Creek Lumber Co. for the entire year 1920, although such a return was permitted for the period November 12 to December 31, 1920. Alternatively to its claim of affiliation for the entire year, the petitioner alleges that the respondent has erroneously denied its application for special assessment1930 BTA LEXIS 1861">*1862 under the provisions of sections 327 and 328 of the Revenue Act of 1918. As relates to the issue of special assessment, the hearing has been limited by order dated April 7, 1930, in accordance with the provisions of Rule 62(a) and (b) of the Board's rules of practice.
21 B.T.A. 354">*355 FINDINGS OF FACT.
Petitioner is a West Virginia corporation, with its principal place of business at Huntington. It was organized in 1905, and during 1920 it was engaged in the manufacture and sale of hardwood lumber, operating a band mill, dry kilns, and a planing mill at Omar, Logan County, W. Va.
In 1919, D. E. Hewitt, A. M. Hewitt, his son, and one Campbell, father-in-law of the younger Hewitt, owned, or were interested in a corporation or corporations which owned, a tract of timber in Logan County near Elk and Huff Creeks. The three men named attempted to interest E. K. Mahan in the purchase of the timber tract mentioned. Mahan was president and general manager of the petitioner. As a result of negotiations between the Hewitts and Campbell and Mahan, it was agreed to organize a corporation which would purchase the said timber.
In accordance with the agreement above mentioned, D. E. and1930 BTA LEXIS 1861">*1863 A. M. Hewitt, E. K. Mahan, Fred C. Prichard, and F. M. Livezey, as incorporators, organized a West Virginia corporation known as the Elk Creek Lumber Co., hereafter referred to as the Elk Creek Co.
The authorized capital stock of the Elk Creek Co. was $500,000, divided into 2,000 shares of preferred stock with a par value of $100 per share, a total of $200,000, and 3,000 shares of common stock of the total par value of $300,000. D.E. and A. M. Hewitt, hereafter termed the Hewitt group, purchased one-half of the preferred stock and Prichard, Martin and Mahan, hereafter termed the Mahan group, purchased the other one-half, each group paying the par value of the preferred stock acquired. The common stock was divided equally between the two groups as "bonus" stock. The Elk Creek Co. then acquired the timber tract mentioned above.
Prior to organization of the Elk Creek Co. the Hewitt and Mahan groups had agreed that management of the company's operations was to be left to the Mahan group, which comprised the same persons who managed the petitioner. The Hewitt group assured Mahan that he and his associates could later acquire the Hewitt group's stock at cost, plus interest for1930 BTA LEXIS 1861">*1864 the time it carried its investment in the business.
A statement of the stockholders of the petitioner and the Elk Creek Co. during the year 1920 follows:
| Petitioner | Elk Creek Co. | |||
| Stockholder | Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1919 | Dec. 31, 1920 |
| C. T. Anderson | 27 | 27 | 20 | |
| C. H. Baisden | 37 | 105 | ||
| H. S. Black | 50 | 50 | 37 | |
| W. A. Darrah | 28 | 28 | 20 | |
| T. W. Elswick | 30 | 30 | 22 | |
| A. M. Hewitt | 750 | |||
| D. E. Hewitt | 750 | |||
| B. L. Kidd | 19 | 38 | 105 | |
| F. M. Livezey | 1 | 1 | ||
| E. K. Mahan | 1,059 | 1,020 | 1,399 | 2,014 |
| P. M. Martin | 17 | 17 | 13 | |
| W. B. Martin | 91 | 130 | 97 | |
| A. H. McQueen | 23 | 23 | 17 | |
| L. W. Olson | 36 | |||
| R. C. Pahl | 101 | 101 | 76 | |
| F. C. Prichard | 353 | 353 | 70 | 350 |
| Jos. Schmitz | 23 | 23 | 17 | |
| J. B. Smith | 15 | |||
| C. H. Tomlinson | 70 | 70 | 52 | |
| G. R. Wallace | 23 | 23 | 17 | |
| A. L. Wilkinson | 30 | 11 | 8 | |
| D. M. Wilkinson | 1 | |||
| G. M. Williams | 14 | 14 | 10 | |
| R. H. Williams | 5 | 5 | 15 | 19 |
| Total | 2,000 | 2,000 | 3,000 | 3,000 |
21 B.T.A. 354">*356 Transfers of petitioner's stock during the year 1920 were as follows:
| 1920 | Transfers | Number | Number of |
| of shares | shares | ||
| Jan. 29 | L. W. Olson | 36 | |
| to Nell W. Olson | 36 | ||
| Mar. 29 | A. L. Wilkinson | 19 | |
| to B. L. Kidd | 19 | ||
| Do | Nell W. Olson | 36 | |
| Dorothy W. Wilkinson | 1 | ||
| to C. H. Baisden | 37 | ||
| Apr. 12 | E. K. Mahan | 39 | |
| to W. B. Martin | 39 |
1930 BTA LEXIS 1861">*1865 Transfers of stock of the Elk Creek Co. during the year 1920 were as follows:
| 1920 | Transfers | Number of | Number of |
| shares | shares | ||
| Jan. 11 | J. B. Smith | 15 | |
| to F. C. Prichard | 15 | ||
| Nov. 13 | D. E. Hewitt | 750 | |
| A. M. Hewitt | 750 | ||
| to E. K. Mahan | 1,500 | ||
| Do | E. K. Mahan | 735 | |
| to C. T. Anderson | 20 | ||
| C. H. Basiden | 30 | ||
| H. S. Black | 37 | ||
| W. A. Darrah | 20 | ||
| T. W. Elswick | 22 | ||
| B. L. Kidd | 30 | ||
| P. M. Martin | 13 | ||
| W. B. Martin | 97 | ||
| A. H. McQueen | 17 | ||
| R. C. Pahl | 76 | ||
| F. C. Prichard | 265 | ||
| J. Schmitz | 17 | ||
| C. H. Tomlinson | 52 | ||
| G. R. Wallace | 17 | ||
| A. L. Wilkinson | 8 | ||
| Grace M. Williams | 10 | ||
| R. H. Williams | 4 | ||
| Dec. 17 | E. K. Mahan | 150 | |
| to C. H. Baisden | 75 | ||
| B. L. Kidd | 75 |
21 B.T.A. 354">*357 The funds acquired by the Elk Creek Co. through its sale of preferred stock were not sufficient, after purchase of the timber, to build and equip the company's mills. The petitioner and members of the Mahan group, individually, endorsed paper upon which the Elk Creek Co. borrowed funds to complete its equipment and commence operations. The total of loans secured as described was more than $220,000.
During1930 BTA LEXIS 1861">*1866 the year 1920, petitioner made advancements to the Elk Creek Co. in amounts as follows:
| Year | Amount |
| 1919 | |
| Dec. 31 | $2,300 |
| 1920 | |
| Jan. 15 | 1,100 |
| Jan. 17 | 2,500 |
| Jan. 20 | 1,000 |
| Jan. 22 | 1,000 |
| Mar. 13 | 1,800 |
| Mar. 30 | 17,000 |
| 1920 | |
| June 30 | $3,000 |
| July 12 | 4,500 |
| Aug. 11 | 5,500 |
| 39,700 | |
| Nov. 12, notes assumed | 27,000 |
| Nov. 15, notes assumed | 84,000 |
| 150,700 |
The directors of petitioner during 1920, were E. K. Mahan, F. C. Prichard, W. B. Martin, P. M. Martin and R. C. Pahl. The directors of the Elk Creek Co. were, for the period January 1 to November 12, 1920, E. K. Mahan, F. C. Prichard, W. B. Martin, and D.E. and A. M. Hewitt. The Hewitts were not directors of the Elk Creek Co. for the period November 13 to December 31, 1920.
The Mahan group directed the operations of the Elk Creek Co. E. K. Mahan was general manager of petitioner and the Elk Creek Co. Logging and manufacturing superintendents of either company were sometimes used to direct the operations of the other. The sales, cost accounting and collections of the Elk Creek Co. were conducted through the petitioner's offices.
The stock of the Elk Creek Co. held during the period January 1 to1930 BTA LEXIS 1861">*1867 November 12, 1920, by E. K. Mahan, F. C. Prichard, F. M. Livezey, J. B. Smith, and R. H. Williams, aggregating 1,500 shares, was held by these persons for the benefit of all the petition's stockholders. Smith and Williams were employees of Prichard. Livezey held one share to qualify as aw director, actual ownership of his stock being in Mahan.
The common stock of the Elk Creek Co. was, during 1920, the only stock of that company having voting rights.
On November 12, 1920, E. K. Mahan purchased the entire stock interests of D.E. and A. M. Hewitt in the Elk Creek Co., consisting of 1,000 shares of preferred and 1,500 shares of common stock. Mahan made this purchase on behalf of all the stockholders of petitioner, 21 B.T.A. 354">*358 and on November 13, 1920, some of it was transferred to each such stockholder.
Petitioner and the Elk Creek Co. filed an affiliated return for the entire year 1920, upon the basis of which income and excess-profits taxes were shown due, and were paid, in the amount of $15,310.89.
Petitioner's invested capital and net income for the years 1914 to 1919, inclusive, and for two periods during 1920, are shown as follows:
| Year | Invested | Net income. |
| Capital. | ||
| 1914 | $235,228.18 | $13,153.87 |
| 1915 | 223,382.05 | 15,987.60 |
| 1916 | 214,369.65 | 42,013.15 |
| 1917 | 248,565.32 | 53,338.45 |
| 1918 | $264,501.25 | $47,808.82 |
| 1919 | 321,736.79 | 81,530.44 |
| 1920 (a) Jan. 1 to Nov. 12 | 294,768.01 | 130,685.45 |
| (b) Nov. 12 to Dec. 31 | 84,980.72 | 14,592.13 |
1930 BTA LEXIS 1861">*1868 The invested capital shown above for the period November 12 to December 31, 1920, is the consolidated invested capital of petitioner and the Elk Creek Co.
In some manner not detailed by the record, petitioner took over the business of the Elk Creek Co. as of January 1, 1922. The consolidated net income of petitioner and the Elk Creek Co. for the year 1921, and the net income of petitioner for the years 1922 to 1925, inclusive, are shown as follows:
| Year | Net income |
| 1921 (consolidated) (loss) | $ (60,777.82) |
| 1922 | 20,729.85 |
| 1923 | 8,684.71 |
| 1924 (loss) | (29,075.35) |
| 1925 | 12,862.21 |
The net income indicated for 1925 is that shown before the application of the 1924 loss against income for the year 1925.
Money borrowed by petitioner during the year 1920, is shown as follows:
Prior to date of affiliation as determined by respondent:
| 1920 | Debit | Credit | Balance |
| Jan. 1 | $29,500.00 | ||
| Jan. 2 | $6,250.00 | 23,250.00 | |
| Apr. 1 | 6,250.00 | 17,000.00 | |
| Apr. 20 | $7,000.00 | 24,000.00 | |
| Apr. 20 | 1,000.00 | 23,000.00 | |
| May 3 | 1,000.00 | 22,000.00 | |
| May 5 | 1,000.00 | 21,000.00 | |
| May 10 | 2,500.00 | 18,500.00 | |
| June 4 | 1,000.00 | 17,500.00 | |
| July 1 | 6,250.00 | 11,250.00 | |
| July 3 | $1,000.00 | $10,250.00 | |
| July 10 | 2,000.00 | 8,250.00 | |
| July 24 | $2,500.00 | 10,750.00 | |
| July 24 | 2,500.00 | 13,250.00 | |
| July 24 | 2,500.00 | 15,750.00 | |
| Aug. 4 | 1,000.00 | 14,750.00 | |
| Sept. 14 | 1,000.00 | 13,750.00 | |
| Oct. 2 | 6,250.00 | 7,500.00 | |
| Nov. 5 | 25,000.00 | 32,500.00 |
1930 BTA LEXIS 1861">*1869 Subsequent to date of affiliation as determined by respondent:
| Nov. 13 | $70,000.00 | $102,500.00 | |
| Nov. 15 | 84,000.00 | 186,500.00 | |
| Nov. 23 | $30,000.00 | $216,500.00 | |
| Dec. 18 | 20,000.00 | 236,500.00 |
21 B.T.A. 354">*359 A certificate of inventory attached to the consolidated return filed by petitioner and the Elk Creek Co. for the year 1920 indicated that the inventory was taken at "cost or market," whichever was lower. The petitioner now contends that its inventory was taken upon the basis of the average cost of timber cut and manufactured, with the result that the value of all manufactured timber was indicated to be the same regardless of species or grade, although the selling price would vary with these factors.
During 1920 high labor charges, freight rates, and costs of kiln drying caused many purchasers to buy only the best grades of lumber, upon the theory that it would be most economical to use good lumber because it would last longer. Due to this the petitioner sold during that year a considerably greater percentage of high priced lumber than was usual, with the result that its closing inventory contained a great amount of the poorer grades of lumber, 1930 BTA LEXIS 1861">*1870 which, under the average cost inventory system, reflected an improper value of the inventory. The petitioner terms this an "over-realization" of income.
The petitioner's records indicate the amount of each species and grade of lumber shipped during the year 1920 and the amount of each species and grade on hand at the beginning and end of that year. They also indicate the amount by which the proportion of high priced lumber shipped in the taxable year exceeded the usual proportions of such shipments in relation to shipments of the poorer grades. As indicated on the consolidated return, the inventories of manufactured lumber were, at January 1, 1920, $61,799.05, and at December 31, 1920, $181,662.89.
The business and operations of the petitioner are fairly comparable to the business and operations of the following named concerns, all of whom are engaged in hardwood lumbering operations at the places indicated:
Raine Lumber Co., Cloverlick, W. Va.
Guyan Lumber Co., Herndon, W. Va.
C. L. Ritter Lumber Co., Huntington, W. Va.Norwood Lumber Co., Forney, N.C.
OPINION.
LOVE: The petitioner contends that it was affiliated with the Elk Creek Co. for the entire year1930 BTA LEXIS 1861">*1871 1920, or, alternatively, that it is entitled to special assessment under the provisions of section 328 of the Revenue Act of 1918.
The provision of section 240 of the Revenue Act of 1918, upon which rests the petitioner's claim for affiliation, is as follows:
(b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated * * * (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.
21 B.T.A. 354">*360 The respondent has determined that the two corporations mentioned were affiliated for the period November 13 to December 31, 1920, inclusive. The petitioner urges us to determine that such affiliation existed for the entire year 1920.
On December 31, 1919, total outstanding common stock of the petitioner in the amount of 2,000 shares was held by nineteen persons. Three of these persons, namely, E. K. Mahan, F. C. Prichard, and R. H. Williams, holding 1,417 shares (70.85 per cent) of the petitioner's stock, also held (in their own names and through Livezey and Smith) 1,500 shares (50 per cent) of the common stock of the Elk Creek Co. The evidence indicates that this 50 per cent interest in1930 BTA LEXIS 1861">*1872 the Elk Creek Co. was held by the persons mentioned for the benefit of all the stockholders of the petitioner. The petitioner's witnesses have so testified and the respondent did not challenge or controvert them. Upon this basis the owners of 100 per cent of the petitioner's common stock owned or controlled 50 per cent of the common stock of the Elk Creek Co. There were no substantial changes in the stock ownerships recited during the period January 1 to November 12, 1920.
The remaining 50 per cent of common stock of the Elk Creek Co. was held by D.E. and A. M. Hewitt, who held no stock of the petitioner.
The petitioner concedes that the "control" prescribed by statute refers to control of the voting stock. . It contends that the same interests which owned or controlled all, or substantially all, of its stock, and which owned 50 per cent of the stock of the Elk Creek Co., also controlled the 50 per cent interest of the Hewitts in the Elk Creek Co., and, therefore, that such "interests" owned or controlled all, or substantially all, of the stock of the two companies.
To establish such control the petitioner relies upon several1930 BTA LEXIS 1861">*1873 factors. First, is the promise given Mahan by the Hewitts, that Mahan and his associates could buy the Hewitts' stock upon payment of its cost plus interest for the time that they carried their investment in the business. Other alleged evidences of control of the Hewitt's stock are the agreement by which the Mahan group managed the business of the Elk Creek Co., the fact that three of the five directors were members of the Mahan group, the loans and endorsements extended by the petitioner, and the fact that petitioner handled the sales, cost accounting, and collections of the Elk Creek Co.
We are not persuaded, however, that any or all of the factors above mentioned warrant our finding that the 50 per cent stock interest of the Hewitts was controlled by the same interests which owned or controlled the other 50 per cent of the stock of the Elk Creek Co. 21 B.T.A. 354">*361 The Board has had occasion in similar proceedings to consider the effect of each of the factors relied upon by the petitioner as evidence of asserted control of the minority stockholdings. The principal reliance of the petitioner is upon the Hewitts' agreement to sell their stock as detailed in our findings. Referring1930 BTA LEXIS 1861">*1874 to this agreement, which was not in writing, petitioner's counsel stated:
* * * There was an understanding between Mr. Mahan and Mr. Hewitt, - I say while not legally enforceable, yet there was an understanding * * * and at any time during the year that those interested in the Peytona Lumber Company wanted to acquire that outstanding stock that they might do so.
On brief, counsel refers to this agreement as an "option."
In , the Board considered the effect of an option to buy stock, saying:
* * * A contract to buy which is binding on the seller does not itself give the buyer a control of the stock. * * * Until the contract had been executed and the stock bought, the control remained in the owner.
We held to the same effect in , and in .
The courts and the Board have frequently held that management or control of the business is not the control required by statute. In 1930 BTA LEXIS 1861">*1875 , the court said:
The management of the business of the corporation is not the control required by the statute. It refers to stock control. The fact that the minority is acquiescent and permits the majority to manage the business does not prove actual control over the minority interests. * * * The control of the stock owned by the same interests refers to beneficial interest.
We said in , that "control of the stock means more than control of the management." See also ; ;; ; ; , and long list of cases there cited.
In , we said:
The record does show that Heller Brothers Co. controlled the board of directors and consequently they were in1930 BTA LEXIS 1861">*1876 a position to control the activities of the Tool Company, so long as there was no interference with the rights of the minority stockholder. But this is far from a control of his stock and stock control is the test laid down by the statute.
The fact that one corporation managed the affairs of another and loaned it money from time to time does not alone warrant affiliation. .
21 B.T.A. 354">*362 And in , we said:
It must be admitted that the Howes Brothers dominated the company, directed its policies, and managed its business, but the test of the statute makes no mention of these factors in laying down the rule governing affiliation.
Considering the arguments advanced by the petitioner, singly and collectively, we find nothing in the record to indicate that the stock held by the Hewitts was controlled by the interests whom the petitioner contends controlled it. So far as we are advised the Hewitts were free to vote their stock as they saw fit, and presumably they did so. The fact that they worked harmoniously with Mahan and his associates does not establish that the1930 BTA LEXIS 1861">*1877 latter had control of their stock. . We approve the respondent's determination denying affiliation to the petitioner and the Elk Creek Co. for the period January 1 to November 12, 1920.
Alternatively, the petitioner seeks special assessment under the provisions of section 328 of the Revenue Act of 1918. Under the provisions of section 327 of the same act, a taxpayer is not entitled to have its profits tax computed under section 328 until it has established by competent evidence that there exist abnormal conditions affecting its capital or income for the taxable year involved. ; . So far as is material herein the said section 327 provides:
SEC. 327. That in the following cases the tax shall be determined as provided in section 328:
* * *
(d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional1930 BTA LEXIS 1861">*1878 hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, * * *
The petitioner's brief states that:
* * * It is entitled to the benefit of special assessment because of abnormality of income during the calendar year 1920 and that such abnormality normality is apparent from a comparison of its income for that year with previous and succeeding years and because of the conditions prevailing in the lumber market during that year such as brought about the purchase of a larger percentage of higher grades of lumber than in other years. Without the benefit of special assessment petitioner's excess profits tax for the period from January 1, 1920, to November 12, 1920, will be 26.9% of its net income for such period.
21 B.T.A. 354">*363 Consideration of the above-quoted statement of its claim reveals that the petitioner is relying1930 BTA LEXIS 1861">*1879 upon two points; namely, its asserted "over-realization" of income due to the sale of an unusually large proportion of high-priced lumber with the consequent accumulation of the poorer grades, which, nevertheless, were included in its closing inventory at the average cost of all grades, and, second, that a comparison of its income for prior and succeeding years indicates that its profits in the taxable years were abnormally high. The second point is a resultant of the first.
The petitioner's records, according to the testimony of its president, would reveal in detail the amount of each species and grade of lumber on hand at the beginning and end of the taxable year, together with the amount of each shipped during that year. They would also reveal the extent by which shipments of high priced lumber during the taxable year exceeded the usual proportion of such shipments in relation to shipments of the poorer grades of lumber. But no such detail has been offered us. We are asked to accept conclusions of the witness upon the factual issue and this we will not do. If an abnormality resulted from the conditions alleged by the petitioner, clearly it is susceptible of definite proof. 1930 BTA LEXIS 1861">*1880 We have no such proof and we find no merit in this claim.
Nor can we afford the petitioner relief because its net income during the taxable year exceeded that of prior and succeeding taxable years. The petitioner offers no proof that its prosperity during the taxable year resulted from an abnormality. There is nothing to indicate that the petitioner's capital was other than normal for the business in which it engaged. The mere fact that a corporation earns large profits in an especially favorable year does not create an abnormality in its income such as to entitle it to special assessment. ; ; ; and . And the fact that the taxpayer considers its tax too high is not sufficient to warrant special assessment. .
As a further ground for special assessment the petition alleges use of a large amount of borrowed capital in the petitioner's business. This point requires very little discussion. 1930 BTA LEXIS 1861">*1881 The use of borrowed capital in large or small amounts can justify special assessment only when its use creates an abnormality. We have no evidence of such a result. As we said in :
It may well be that the use of as much money as was borrowed by the petitioner * * * was the usual, normal and ordinary course of business dealings by corporations engaged in the same or similar enterprises.
21 B.T.A. 354">*364 See also , and .
We hold that the petitioner has failed to establish an abnormality affecting its capital or income for the period January 1 to November 12, 1920, or for the year 1920, and, consequently, we approve the respondent's denial of special assessment for each of such periods.
Judgment will be entered for the respondent.