Appeal from the United States Board of Tax Appeals.
Before MANTON, SWAN, and CHASE, Circuit Judges.
In 1923, the petitioner and three other corporations, Southern Menhaden Corporation, McIntosh-Morello Orchards Company, Inc., and Charles J. Maxwell & Co., which will hereafter be referred to as Menhaden, Orchards, and Maxwell, occupied the same offices, had interlocking directorates, were operated together by the same persons, and were financed by the petitioner.
Separate returns were filed for 1922 by the petitioner, by Menhaden, and by Maxwell. The commissioner did not thereafter grant permission to file a consolidated return. Petitioner was organized in May, 1922, and first acquired stock in Menhaden on June 27, 1922. It first acquired stock in Maxwell on November 21, 1922, when it took all of its capital stock. It first acquired stock in Orchards in April, 1923, when that corporation was organized. On May 14, 1923, the petitioner sold 33 1/3 per cent. of its stock in Maxwell to the manager of that corporation under an agreement that if the corporation were sold this stock should be sold with that of the petitioner and that if the manager left the employ of Maxwell the petitioner should have the first call upon his stock.
During the latter part of 1923, and for a period so long that it is not to be taken as negligible, the petitioner owned 75.54 per cent. of the capital stock of Menhaden; 71.48 per cent. of the stock of Orchards; and 66 2/3 per cent. of the stock of Maxwell. The remaining Maxwell stock was owned by a Mr. Waugh; was held by the petitioner as collateral against a loan made to Waugh; and could have been taken by the petitioner upon the default of Waugh in payment of the loan. The petitioner could and did in 1923 have all the shares in the three other corporations, owned as above set forth, voted at meetings of the several corporations as it desired.
Menhaden was engaged in the business of catching the nonedible fish of that name and converting them into oil and fertilizer. It was a highly speculative business in which the profits in a good season were apt to be large and in a poor season the losses were likely to be large also. During 1922, Menhaden borrowed $22,666.67, and in 1923 $37,833.33, from the petitioner and gave the petitioner its promissory notes for those amounts. On April 4, 1923, the petitioner purchased of Frank L. Connable promissory notes of Menhaden of the face value of $117,762.22 for $95,256.33. In 1923, Menhaden had a poor fishing season and sustained a loss of $244,936.08. On December 31, 1923, the petitioner charged off on its books as worthless the notes it had purchased of Connable in the amount it had paid for them after making a slight adjustment which is not now material and will be disregarded. It did not charge off then the notes it held for the money it had loaned Menhaden. When it purchased the notes of Connable in April, 1923, it also bought of him 1,388 shares of Menhaden stock for $1. None of the Menhaden notes have ever been paid and they never will be.
The statutes applicable are sections 240 (a) (c) and 234 (a) (5) of the Revenue Act of 1921 (42 Stat. 254, 260):
"Sec. 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, 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."
"See. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * * (5) Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part * * *."
See, also, T.R. 62; articles 632, 633, and 634.
The claim of the petitioner that a consolidated return could be filed for these four corporations in 1923 is untenable. At no time during that year did the petitioner own or control substantially all the stock in all of them, though it did own all of the Maxwell stock until May 14, 1923. Ignoring the period of 100 per cent. Maxwell ownership for the present, the right to file a consolidated return depends upon whether 75.54 per cent. in Menhaden, 66 2/3 per cent. in Maxwell, and 67.89 per cent. in Orchards was enough. This was not substantially all. Good Mfg. Co. v. Burnet, 61 App. D.C. 133, 58 F.2d 685; Burnet v. Bank of Italy (C.C.A.) 46 F.2d 629, 630; United States v. Cleveland, P. & E.R. Co. (C.C.A.) 42 F.2d 413; Jos. Denunzio Fruit Co. v. Commissioner (C.C.A.) 49 F.2d 41; Atlantic City Electric Co. v. Commissioner, 288 U.S. 152, 53 S. Ct. 383, 77 L. Ed. 667; Handy & Harman v. Burnet, 284 U.S. 136, 52 S. Ct. 51, 76 L. Ed. 207. Nor can business control, nor the permitted control of stock not legally enforceable satisfy the requirement of the statute. See Handy & Harman v. Burnet, supra; Ice Service Co. v. Commissioner (C.C.A.) 30 F.2d 230; Commissioner v. Adolph Hirsch & Co. (C.C.A.) 30 F.2d 645. Consequently there could be no consolidated return for the group based on ownership or control of substantially all the stock by the petitioner. The stock owned by the manager of Maxwell and held by the petitioner as collateral for a loan was not controlled under Handy & Harman v. Burnet, supra. The agreement of the manager to sell it if the petitioner sold its stock did not give the statutory control, for, though the petitioner could control its sale by selling its own stock, if it enforced that right it thereby ceased to have any stock interest in Maxwell itself. Permitting the stock to be voted as the petitioner desired was not enough for proxies revocable at will do not give statutory control. Commissioner v. City Button Works (C.C.A.) 49 F.2d 705. Even if the stock of Waugh in Orchards could be added to that of the petitioner, there would be only an 87.46 per cent. ownership in the two and that would still be less than substantially all. See Good Mfg. Co. v. Burned, supra.
Nor can the claim of right to file a consolidated return be supported on the ground that the same interests owned or controlled substantially all the stock. This must be in substantially the same proportions in the units in the group. Handy & Harman v. Burnet, supra; ...