*1925 1. DEDUCTIONS - EXPENSES. - Payments made by petitioners, a realty holding company and a realty operating company, for advertising a mercantile house which was their principal tenant, largely indebted to them, and the maintaining of whose business in its present location was principal factor in maintaining a high rental scale on other property they controlled in the immediate vicinity, held to be reasonable and necessary business expenses deductible from gross income in the years in which made.
2. AFFILIATION. - On the facts, petitioners are held to have been affiliated with the Plymouth Clothing House in the calendar year 1924 and the three companies having filed a consolidated return for that year, the tax liability of petitioners should be determined on that basis.
3. Id. - Petitioners for the calendar years 1925 and 1926 filed separate returns and it is held that income for those years should be determined on such basis.
*119 These proceedings, consolidated for hearing, seek redetermination of deficiencies*1926 determined by respondent for years and in amounts as follows:
| Petitioner | Docket No. | Year | Deficiency |
| Hennepin Holding Company | 33323 | 1923 | $796.08 |
| Do | 33323 | 1924 | 182.83 |
| Do | 33323 | 1925 | 1,078.43 |
| Do | 37397 | 1926 | 1,095.72 |
| Burton Company | 37392 | 1924 | 2,341.20 |
| Do | 37392 | 1925 | 8.58 |
| Do | 37396 | 1926 | 3,527.79 |
At the hearing the Hennepin Holding Company abandoned its contention as to the deficiency of $796.08 for the year 1923. The remaining errors assigned are (1) respondent's failure to allow to the Hennepin Holding Company deductions for 1924 of $25,000 and for 1926 of $3,000 and to the Burton Company deductions for 1924 of $35,000 and for 1926 of $21,500, representing the cost of advertising, alleged to be regular and necessary business expenses, and (2) failure to compute the tax liability of petitioners for the calendar years 1924, 1925, and 1926 upon the basis of affiliation with the Plymouth Clothing House.
*120 FINDINGS OF FACT.
The Plymouth Clothing House is a Minnesota corporation and since 1882 has been engaged in the retail clothing business at Minneapolis. The petitioners, the Hennepin Holding Company and the Burton Company, *1927 are New Jersey corporations, the first organized in 1909 and the second in 1917, for the purpose of holding title to certain leases.
In 1909 the lease held by the Plymouth Clothing House to the property it then occupied would soon expire, and its stockholders and directors, who were members of the Burton family, determined to seek a new location and negotiated an arrangement with one Andrus, owning a site at the intersection of Hennepin Avenue and Sixth Street, under which that party agreed to erect a large office building, the basement and ground floor to be adapted for occupancy by the Plymouth Clothing House. The plans called for a building larger than any of this kind previously erected in Minneapolis.
At this time the location of Hennepin Avenue and Sixth Street was not in the regular retail district of the city, and it was the purpose of the Burton interests to create a retail district at this point, and before divulging their plans, they secured 99-year leases to all of the properties across the street and extending on Hennepin Avenue from Sixth to Seventh Streets and one property on Seventh Street immediately in the rear of the leased property at the corner of Hennepin*1928 Avenue and Seventh Street.
The Burton interest then organized the petitioner, the Hennepin Holding Company; the leases of all of the properties, including a 20-year lease upon the building to be erected by Andrus, being taken in the name of that corporation.
The building on the Andrus property, known as the Plymouth Building, was erected and was occupied by the Plymouth Clothing House, the Hennepin Holding Company holding title to all of the leased properties and operating them until October, 1917, when the Burton interests organized the petitioner, the Burton Company, purely as a holding company, with the plan that the Hennepin Holding Company act merely as an operator of the properties. Following this, four of the six leases held by the Hennepin Holding Company were transferred to the Burton Company. The lease to the Plymouth Building was retained and the lease to one other property was transferred to the Plymouth Clothing House. The operation of all of the properties was still carried on by the Hennepin Holding Company.
These three corporations were adjudged affiliated by respondent for the years 1918 to 1923, inclusive, and their tax liabilities determined on the basis*1929 of consolidated returns. The operation of all *121 three during the entire period of their existence was conducted as though a single enterprise, intercompany loans being freely made whenever needed, and the credit of one being pledged as needed for the benefit of the other. The directors and officers of the companies were members of the Burton family. The holdings of stock in these companies during the taxable years were as follows:
| Shares held | |||
| Stockholders | Hennepin | Burton Co. | Plymouth Clothing |
| Holding | House | ||
| Co. | |||
| Hazen J. Burton | 284 | 621 | |
| Ward C. Burton | 3 | 70 | 2,097 |
| Hazel Burton | 1 | 10 | |
| Alice Burton | 1 | 10 | 66 |
| Ariel Burton Pomeroy | 10 | ||
| Subtotal; shares held by Burton family | 289 | 100 | 2,784 |
| H. H. Picking | 1 | ||
| Various employees | 16 | ||
| H. L. Tucker, shares fully owned by | |||
| purchase for cash | 66 | ||
| Subtotal | 290 | 100 | 2,866 |
| H. L. Tucker, shares issued under | |||
| agreement | 134 | ||
| Total voting stock | 290 | 100 | 3,000 |
Prior to 1899, the Plymouth Clothing House had secured the services of one H. L. Tucker, then in business with Jordan Marsh & Company of Boston. Thereafter his service with the Plymouth Clothing House continued*1930 unbroken until he resigned in 1926. Tucker was a man of experience and very active in the business, having the management of certain departments, and responsive to his wish for an opportunity to acquire an interest in the business, a stock certificate was issued in his name for 134 shares of the common stock, which was immediately endorsed by him for transfer and returned to the corporation with his note for $13,400 with interest at 6 per cent and thereafter the note and stock were held by the corporation until canceled in 1926. No written agreement was entered into, but there was a clear oral understanding that the note and interest were only to be paid out of future dividends, if and when declared. Tucker voted the stock whenever he was present at stockholders' meetings. The interest on the note was accrued by the corporation upon its books and included in income. No dividends were ever declared or paid and the note and interest were carried without credit of any kind until 1926, when the stock certificate was canceled and the note returned to Tucker. In addition to the 134 shares referred to, 66 shares were purchased for cash by Tucker and when he resigned in 1926 these shares*1931 were taken over from him by H. J. Burton at par for cash.
*122 The Plymouth Clothing House for many years enjoyed a fine business, and its move in 1910 to the Plymouth Building contributed largely to the development of that vicinity. However, after reaching a peak in 1920 its sales began steadily to decline, and by 1923 it was realized that the decrease was assuming proportions which involved the safety of the enterprise. The question of liquidating the Plymouth Clothing House was debated and it was realized that in such case these two petitioners would be left with the lease of the Plymouth Building which would expire in 1929, and that it would be very difficult to secure a tenant for the few remaining years, and that this could probably be done only on the making of extensive repairs and remodeling of the premises, the cost of which could not be recovered in the short time before the termination of the lease.
After consideration of the conditions faced by petitioners it was finally agreed that they would expend certain amounts for advertising the business of the Plymouth Clothing House in an endeavor to rehabilitate its sales, and make it possible for it to continue*1932 in business. Other tenants of the petitioner's properties were showing declines in their businesses and were asking for reductions in their rents and it was decided that the dissolution or failure of the Clothing House would seriously affect the interests of the petitioners in all of their properties.
Petitioners' directors thereupon duly authorized advertising expenditures for the Plymouth Clothing House. The deductions claimed in the returns as representing expenditures made by these petitioners for this purpose, and the disallowances thereof by respondent in determining the deficiencies here in question, were as follows:
| Deductions claimed | Disallowances | |||||
| 1924 | 1925 | 1926 | 1924 | 1925 | 1926 | |
| Hennepin Holding Co | $25,000.00 | $3,000.00 | $25,000.00 | $3,000.00 | ||
| Burton Co | 35,000.00 | 21,500.00 | 35,000.00 | 21,500.00 | ||
| Plymouth Clothing | ||||||
| House | 22,747.15 | $66,427.01 | 44,003.26 | |||
| Total advertising | ||||||
| expense | 82,747.15 | 66,427.01 | 68,503.26 |
A consolidated return for these three corporations was filed for 1924, but each corporation filed a separate return for 1925 and 1926. The respondent has determined the several tax liabilities of*1933 petitioners upon a separate or unaffiliated basis for all three of those years.
OPINION.
TRUSSELL: In respect to the first issue, we are convinced by the proof that the expenditures by petitioners for advertising the Plymouth *123 Clothing House were reasonable and justified as in the individual interests of these two petitioners. The Plymouth Clothing House was largely indebted to them and its ability to ultimately pay such indebtedness was jeopardized by its continuing decrease in business. It was also the most valuable tenant which they had in their leased properties and its failure would have necessitated the securing of another tenant, which could only be done upon the expenditure of very large sums for remodeling, and this would be out of the question as the lease of the Plymouth Building had only a few years to run, and this expenditure could not have been recovered through the rents for that short period. In addition to this, the failure of this enterprise would have seriously affected the values of the other properties of petitioners in the immediate vicinity. The action of respondent in disallowing the deductions in question as made by petitioners in their*1934 returns for 1924 and 1926 is disapproved.
In respect to the second issue it appears that all three of these corporations filed separate returns for 1925 and 1926, this action being taken subsequent to the enactment of the Revenue Act of 1926. For prior years they had filed consolidated returns. The action taken in 1925 and 1926 was voluntary and an exercise of the option provided by section 240 of the act in question. We hold that the determination by respondent of income for those years on the basis of such individual returns was proper. ; ; ; .
As to 1924 a different condition exists. For that year the three corporations filed a consolidated return and the sole question is whether or not they were in fact affiliated. Section 240(c)(2) of the Revenue Act of 1924 provides:
For the purpose of this section two or more domestic corporations shall be deemed to be affiliated * * * (2) if at least 95 per centum of the voting stock of two or more*1935 corporations is owned by the same interests. * * *
The record shows that in such years all of the stock of these two petitioners, with the exception of one share in the Hennepin Holding Company, was owned by Hazen J. Burton, his wife, son and two daughters. We think it unquestionable that these two petitioners were affiliated through ownership by the "same intersts." With respect to the Plymouth Clothing House, it is shown that of its 3,000 shares, 2,784 were owned by H. J. Burton, his wife and son, and that the stockholdings of the son were received by him from his father, encumbered with annuities in favor of the latter and of the recipient's mother and two sisters. The ownership of this stock is, in our opinion, in the "same interests" owning the stock of the two petitioners. Of the balance of 216 shares it is shown that 134 shares *124 stood on the stock book in the name of one H. L. Tucker, then and for many years prior to that time a valued employee of the corporation, and after careful consideration of the peculiar circumstances shown by the record in respect of the issue of this stock, it is our conclusion that it does not constitute a stock ownership by a separate*1936 interest in contemplation of section 240(c)(2) above quoted. It is true that this stock stood on the books in the name of Tucker, but it remained in possession of the corporation, and its issue appears to have been an incident in the carrying out of an arrangement whereby this old employee was to be permitted to acquire a stock interest from future earnings of the corporation which it was anticipated would result from his employment by it and his efforts in its behalf. This anticipation as to earnings did not bear fruit, the corporation producing no profit for distribution, and consequently no equity was acquired by Tucker on this stock, and after some years the agreement was canceled and the stock turned back into the treasury of the corporation. Cf. ; ; .
The basis of affiliation and the allowance of consolidation of income for tax purposes is actual unity of interest and in few of the cases considered by us has there existed the unity of control and operation here shown and in few such unity of interest. The prosperity of each*1937 concern was in large measure dependent upon the continued prosperous operation of the other two. The failure of one did not mean merely the probable loss by the Burton interests of their investment therein, but the probable loss of a large part of the investments in all three.
We hold that the two petitioners and the Plymouth Clothing House were affiliated in 1924, and the tax liability of petitioners should be computed on the basis of the consolidated return as filed for that year.
Reviewed by the Board.
Judgment will be entered pursuant to Rule 50.
MURDOCK dissents.