*3003 1. Held that the cost of assets to corporations, and not the cost to an individual who later owned a majority of the stock in such corporations, is the basis for calculating depreciation.
2. Value of assets at date of acquisition by the corporation determined.
3. A note paid in for capital stock held to be worth its face value and includable in invested capital.
4. Premiums paid by corporations upon policies of insurance, covering the life of their majority stockholders taken out to obtain and secure loans to the corporations, held not deductible from gross income.
5. Upon the evidence, held that the corporations were affiliated during the years 1920 and 1921.
*281 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1920 and 1921, in the respective amounts of $1,647.95 and $520.49.
Numerous assignments of error were set forth in the petition but at the hearing the petitioner abandoned all of them except:
(1) The holding of the respondent that the corporations*3004 were affiliated during the years in controversy;
(2) The exclusion from invested capital of a note in the amount of $10,971.30 given to the Hewett Grain & Provision Co. of Manistique in payment for stock;
*282 (3) The holding of the respondent that the cost of certain property to C. G. Hewett was the basis to be used for depreciation and not the amount at which entered on the books of the corporations when they acquired such property at April 1, 1920; and
(4) The holding of respondent that premiums paid by the corporations on Hewett's life insurance policies were not deductible from gross income.
The second, third and fourth assignments of error apply only to the year 1920.
FINDINGS OF FACT.
Prior to April 1, 1920, Clyde G. Hewett was engaged in the grain and provision business as a sole trader in each of the cities of Escanaba, Ishpeming, Iron River, Manistique and Sault Ste. Marie, Mich., and had warehouses and stocks of goods in each of these cities.
On April 1, 1920, five corporations were organized under the laws of the State of Michigan, and each bore the name of "Hewett Grain & Provision Co.," of "Escanaba," of "Ishpeming," of "Manistique," of "Iron*3005 River," and of "the Soo."
The petitioner, in this proceeding, is the Hewett Grain & Provision Co. of Escanaba, the name of which has, however, been changed to "Hewett Grocery Company of Escanaba."
The authorized capital stock of the petitioner is $50,000, of which $40,000 was issued at organization to Clyde G. Hewett for $1,500 cash and all the stock of merchandise consisting of hay, flour, grain, butter, eggs, cheese, poultry, seeds, sugar, provisions, and other merchandise, together with a warehouse and the lease to the land on which located, all office furniture and fixtures, horses, wagons and harness, trucks and automobiles, all book accounts and bills and accounts receivable, fire and life insurance, and the good will of the business formerly owned by Clyde G. Hewett, all of the stated total value of $38,500. Clyde G. Hewett retained 299 shares of stock and caused 100 shares to be issued to his wife, Isabel F. Hewett, and one share to Joseph R. Charlebois.
The real property at Escanaba was entered on the corporation's books at $11,300. For depreciation purposes the respondent reduced the value by $7,252.74.
The authorized capital stock of the Hewett Grain & Provision*3006 Co. of the Soo was $30,000, all of which was issued at organization to Clyde G. Hewett for $600 cash and the merchandise on hand, the lease of a warehouse and office building, also the warehouse and parcel of land then occupied by the Hewett Company at Dafter, Mich., office furniture and fixtures, etc., and the good will of the business, all of the stated valuation of $29,400. Hewett caused 100 *283 shares of stock to be issued to his wife, Isabel F. Hewett and one share to Joseph R. Charlebois. The real property included in the assets was a one-story hay warehouse about 50 by 120 feet in size, and included about five acres of ground. It was acquired by Hewett about 1914. It was set up on the books of the corporation at a value of $4,600, which was its fair market value at April 1, 1920. For depreciation purposes the respondent reduced the value by $3,267.41.
The Hewett Grain & Provision Co. of Manistique issued the full amount of its authorized capital stock, $30,000, to Hewett for $140 cash and all the merchandise, bills and accounts receivable, good will, etc., of Hewett's business, office furniture and fixtures, etc., a warehouse and a lease on the premises occupied*3007 by such warehouse, all of the stated valuation of $29,860. Hewett caused 100 shares of stock to be issued to his wife, Isabel F. Hewett, and one share to Joseph R. Charlebois.
The Manistique real property was a frame structure which included a large cooler. This property was acquired by Hewett in about 1918. The structure was one-story high and about 40 by 35 or 40 feet in size. The cooler contained therein was insulated and occupied about four-fifths of the building. It had formerly belonged to a brewery and had been used for storage of beer. The corporation used the cooler for the storage of canned goods. This property was set up on the books of the corporation at $2,500 and stock was issued for it in that amount. This was its fair market value. The respondent reduced the value for depreciation purposes by $2,031.12.
In connection with this transaction, Hewett also gave the corporation for stock his note for $10,971.30, bearing interest at 7 per cent. The note has not been paid but is still held by the corporation. At the time the note was made, Hewett owned stocks valued at about $3,000, a home of the value of about $10,000, stock in the five corporations valued*3008 at about $150,000, three elevators in Wisconsin and Minnesota worth about $30,000, and automobiles of a value of about $4,000. At that time he owed very little money. The books of the Manistique Company were set up as follows as of April 1, 1920:
| Assets | Amount |
| Cash | $257.30 |
| Accounts receivable | 13,026.34 |
| Inventory | 20,197.63 |
| Bills receivable | 10,971.30 |
| Prepaid expense | 328.28 |
| Truck and auto | 1,275.00 |
| Office fixtures | 692,83 |
| Buildings | 2,500.00 |
| H. G. & P. Ishpeming | 11,645.38 |
| 60,894.06 | |
| Liabilities | Amount |
| Accrued interest | $430.00 |
| Bills payable | 22,450.00 |
| Commissions payable | 137.19 |
| Accounts payable | 7,876.87 |
| Capital stock | 30,000.00 |
| 60,894.06 |
*284 The Hewett Grain & Provision Co. of Iron River issued the full amount of its authorized capital stock, $30,000, to Hewett for $1,300 cash and all merchandise, good will, accounts receivable, office furniture and fixtures, etc., together with a warehouse, all of the stated valuation of $28,700. Hewett caused 100 shares of stock to be issued to his wife, Isabel F. Hewett, and one share to Joseph R. Charlebois.
The real property at Iron River was a frame building with a basement and was acquired*3009 by Hewett about 1913. The building was 40 by 120 feet, was one story high and was built of durable wood. This property was entered on the books of the corporation at $10,700, which was its fair market value as of April 1, 1920, and stock in that amount was issued therefor. The valuation of $10,700 includes a furnace which the corporation installed at a cost of about $1,000. The corporation has a lease on the land. For purposes of depreciation the respondent reduced the book value of the property by $6,291.42.
The Hewett Grain & Provision Co. of Ishpeming issued the full amount of its authorized capital stock, $40,000, to Hewett for $750 cash and all merchandise, office furniture and fixtures, good will, accounts receivable, etc., together with a three-story stone warehouse, all of the stated valuation of $39,250. Hewett retained 299 shares of stock and caused to be issued to his wife, Isabel F. Hewett, 100 shares and one share to Joseph R. Charlebois. The building had been acquired by Hewett about 1915. It was placed on the books of the corporation at a value of $36,886.78 as of April 1, 1920. For depreciation purposes the respondent reduced this value by $22,185.28, which*3010 was its fair market value. The building was used for wholesaling groceries. It was formerly used for sale of hay, feed and grain. After the corporation acquired it, new elevator bins, new structures and new floors were put in at a cost of about $4,000. This amount is included in the value placed upon the corporation's books. About $250,000 worth of business was done yearly by the company at Ishpeming, the net profit being about 1 per cent. The building is of red stone and has wood floors, concrete structures in basement, large timber structures above, slate roof and hot water heat. It was built in 1893.
Ishpeming is a town of about 8,000 population. There is another town of about 7,000 population three miles away. When this property was acquired in 1915, Ishpeming had a population of about 5,000 or 6,000. In 1920 this property was returned for local tax purposes at a value of $36,886.78.
In the case of each corporation the value of the property as set up on the books was used for the valuation for local tax purposes.
The various stockholdings in the five companies during 1920 and 1921 were as follows:
| HEWETT GRAIN & PROVISION CO. OF ESCANABA | ||
| (Now Hewett Grocery Co. of Escanaba) | ||
| Years 1920 and 1921 | ||
| Name of stockholders | Amount of stock | Percentage of stock |
| Shares | ||
| C. G. Hewett, president | 330 | 76.6 |
| I. F. Hewett (wife) | 100 | 23.2 |
| J. R. Charlebois | 1 | .2 |
| Total | 431 | 100 |
| HEWETT GRAIN & PROVISION CO. OF MANISTIQUE | ||
| (Now Hewett Grocery Co. of Manistique) | ||
| Year 1920 | ||
| C. G. Hewett | 169 | 56 1/3 |
| I. F. Hewett | 100 | 33 1/3 |
| J. R. Charlebois | 1 | 1/3 |
| A. H. Stuht | 30 | 10 |
| Total | 300 | 100 |
| Year 1921 | ||
| C. G. Hewett | 169 | 56 1/3 |
| I. F. Hewett | 100 | 33 1/3 |
| J. R. Charlebois | 1 | 1/3 |
| Walter Lippold | 30 | 10 |
| Total | 300 | 100 |
| HEWETT GRAIN & PROVISION CO. OF THE SOO | ||
| Year 1920 | ||
| C. G. Hewett | 169 | 56 1/3 |
| I. F. Hewett | 100 | 33 1/3 |
| J. R. Charlebois | 1 | 1/3 |
| Klaus Wicklund | 15 | 5 |
| Herbert Ryan | 15 | 5 |
| Total | 300 | 100 |
| Year 1921 | ||
| C. G. Hewett | 169 | 56 1/3 |
| I. F. Hewett | 100 | 33 1/3 |
| J. R. Charlebois | 1 | 1/3 |
| A. M. Chalmers | 30 | 10 |
| Total | 300 | 100 |
| HEWETT GRAIN & PROVISION CO. OF IRON RIVER | ||
| (Now Hewett Grocery Co. of Iton River) | ||
| Years 1920 and 1921 | ||
| C. G. Hewett | 184 | 61 1/3 |
| I. F. Hewett | 100 | 33 1/3 |
| J. R. Charlebois | 1 | 1/3 |
| A. J. Johnson | 15 | 5 |
| Total | 300 | 100 |
| HEWETT GRAIN & PROVISION CO. OF ISHPEMING | ||
| (Now Hewett Grocery Co. of Ishpeming) | ||
| Years 1920 and 1921 | ||
| C. G. Hewett | 219 | 54 3/4 |
| I. F. Hewett | 100 | 25 |
| J. R. Charlebois | 1 | 1/4 |
| D. B. Bilkey | 80 | 20 |
| Total | 400 | 100 |
*286 *3012 The above named parties were identified with the five corporations as follows:
J. R. Charlebois, manager of Escanaba Co.Klaus Wicklund, manager of the Soo Co.
Herbert Ryan, asst. mgr. of the Soo Co.
A. H. Stuht, manager of Manistique Co.Walter Lippold, manager of Manistique Co. in 1921.
D. B. Bilkey, manager of Ishpeming Co.A. J. Johnson, manager of Iron River Co.This stock was sold to these men by Hewett. Some paid in full and some paid under a working arrangement, giving Hewett notes.
When notes were given in payment for stock an agreement was entered into with each purchaser whereby it was provided that the stock should be returned to Hewett at any time he might desire, or whenever the purchaser severed his connection with the corporations. By the terms of the agreement, the stock was to be left with Hewett as security for payment of the notes. Hewett had such agreements with Bilkey at Ishpeming and Stuht at Manistique, Lippold at Manistique. Chalmers, Ryan and Wicklund paid for their stock. Chalmers, Ryan and Wicklund then left the company and they returned the stock to Hewett and received the money they had paid, in accordance with a previous*3013 agreement.
It was necessary for the corporations to take out bank loans and the banks, before they would loan money, required Hewett to take out life insurance. Some of these policies were made payable to Hewett's wife and some were made payable to Hewett's estate. The premiums were paid by the corporations, and the policies were and are used in the banks as collateral to corporate loans. After April 1, 1920, the corporation borrowed about $90,000, the notes for which bore Hewett's personal indorsement. There is still outstanding $50,000 of this indebtedness but the interest has been paid.
OPINION.
SIEFKIN: The petition alleges numerous errors on the part of the respondent but at the hearing some of these were abandoned and the questions remaining to be decided as to the year 1920 are whether the respondent erred in:
*287 (1) Holding that the cost to Clyde G. Hewett of certain property which was later turned over to the corporations was the basis to be used for depreciation, and not the amount at which such property was entered upon the books of the corporations when they acquired such property at April 1, 1920;
(2) Excluding from invested capital a note in*3014 the amount of $10,971.30, given to the Hewett Grain & Provision Co. of Manistique in payment for stock;
(3) Holding that premiums paid by the corporations on Hewett's life insurance policies were not deductible from gross income; and
(4) Holding that the corporations were affiliated during the years in controversy.
The last question to be decided applies to both 1920 and 1921.
(1) At the time the corporations were organized, April 1, 1920, Hewett turned over to them certain real properties which he had theretofore owned, in exchange for capital stock. Some of the property was entered on the books of the corporations at higher figures than the amounts which Hewett had paid for it. The values at which the property was set up on the books of the corporations, the date at which Hewett acquired the property, and the reductions of values thereof for invested capital purposes by the respondent are set forth below:
| Place located | Value on books | Date acquired by Hewett | Reduction by respondent |
| Escanaba | $11,300.00 | $7,252.74 | |
| Ishpeming | 36,886.78 | About 1915 | 22,185.28 |
| Manistique | 2,500.00 | About 1918 | 2,031.12 |
| Sault Ste. Marie | 4,600.00 | About 1914 | 3,267.41 |
| Iron River | 10,700.00 | About 1915 | 6,291.42 |
*3015 Capital stock was issued for the real property in the amount of the value of such property as set up on the books of the corporations. The respondent has held that the proper basis for computing depreciation on this property is the cost of such property to Hewett. Section 214(a)(8) of the Revenue Act of 1918 provides:
SEC. 214. (a) That in computing net income there shall be allowed as deductions:
* * *
(8) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. * * *.
The basis for calculation of depreciation is the cost of the property to the taxpayer. See , and .
*288 No question is raised as to the cost of the assets to Hewett or as to the rates of depreciation used by the respondent.
Hewett, who was familiar with real estate values at April 1, 1920, testified that the values of the properties at Manistique, Sault Ste. Marie, Ishpeming and Iron River, at the time acquired by the corporations, were truly reflected by the values carried upon the corporate books. The evidence*3016 disclosed that these values were used for local tax purposes. We hold that these were the fair market values of the properties as of April 1, 1920, and that depreciation should be calculated upon those values. The respondent erred in holding that depreciation should be based upon the costs of properties to Hewett. The holding of the respondent with regard to the Escanaba property will not be disturbed, since no evidence was adduced by the petitioner as to the April 1, 1920, value of such property.
(2) The Hewett Grain & Provision Co. of Manistique on April 1, 1920, turned over to Hewett the full amount of its authorized capital stock, par value, $30,000, for all merchandise, bills and accounts receivable, good will, etc., office furniture and fixtures, etc., a warehouse and a lease on the premises occupied by the warehouse, all of the agreed valuation of $29,860, Hewett's note for $10,971.30 and $140 in cash. The note was excluded by the respondent, from the invested capital of the corporation for 1920.
The note has not been paid, but Hewett testified that it would be paid. The evidence disclosed that at the time Hewett gave the note to the Manistique Company he was worth*3017 approximately $197,000. We believe that the note was bona fide paid in for stock of the Manistique Co., and find that it was worth its face value. It is, therefore, includable in invested capital at that value, under section 326(a)(2) of the Revenue Act of 1918. See .
(3) It was necessary for the corporations to borrow money to carry on their business and before the banks would loan them money, they required Hewett to take out insurance on his life. Some of the policies were made payable to his wife and some to his estate The premiums were paid by the corporations and the policies were used in the banks as collateral to the corporate loans. The respondent disallowed such payment as deductions from gross income.
Section 215 of the Revenue Act of 1918 provides:
That in computing net income no deduction shall in any case be allowed in respect of -
* * *
(d) Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy.
*3018 *289 In a similar case, , we stated:
The insurance involved here was upon the life of petitioner's president and in our opinion the petitioner was indirectly a beneficiary during the time the policies were being used as collateral to its loan. It was because of this assignment and pledge to the bank that petitioner was enabled to obtain credit and funds for the operation of its business, which it sorely needed. The respondent did not err in refusing the deductions claimed for the years in question.
See also .
In the instant proceeding we must affirm the holding of the respondent.
(4) The evidence discloses that in 1920 and 1921 Hewett owned 76.6 per cent of stock of the Escanaba Company and that his wife owned 23.2 per cent in 1920 and 1921.
In 1920 and 1921 Hewett owned 56 1/3 per cent of stock of the Manistique corporation and his wife owned 33 1/2 per cent.
In 1920 and 1921, Hewett owned 56 1/3 per cent of stock in the corporation at Sault Ste. Marie, and his wife owned 33 1/3 per cent.
In 1920 and 1921, Hewett owned 61 1/3 per cent of the stock of*3019 the Iron River corporation and his wife owned 33 1/3 per cent.
In 1920 and 1921, Hewett owned 54 3/4 per cent of the stock in the Ishpeming Company and his wife owned 25 per cent.
Section 240(b) of the Revenue Act of 1918 and section 240(c) of the Revenue Act of 1921 provide:
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.
All of the stock was issued to Hewett at the organization of the corporations and he caused some of the stock to be transferred to others. Hewett sold stock to the managers and assistant managers of the various corporations. Four of them paid for this stock in full and two purchased under a working arrangement and gave Hewett notes. Under this arrangement Hewett had the right to have the stock returned to him whenever the purchaser severed his connections with the corporations, or whenever Hewitt desired, upon his returning the*3020 amounts paid by the purchaser. The stock was left with Hewett as security for payment of the notes. Three of those who paid in full for their stock, left the corporation and returned the stock to Hewett in accordance with a previous agreement. No evidence was introduced as to the other person who paid *290 in full, but we assume that he purchased under some similar agreement with Hewett.
We conclude that Hewett and his wife constituted the same interest that controlled substantially all the stock of the various corporations here involved. We hold that the corporations were affiliated during the years 1920 and 1921.
Reviewed by the Board.
Judgment will be entered under Rule 50.