Appeal from the Board of Tax Appeals.
Before L. HAND, SWAN, and CHASE, Circuit Judges.
Three unrelated questions are presented for review. They will be considered separately and the essential facts as to each stated in connection with the point discussed.
E. F. Simms, a man interested in the oil business in Texas, in 1919 bought a considerable number of leases on what it was hoped would prove to be profitable oil-bearing land scattered through twenty counties in Texas. All but one were adjoining counties. The general location of the land was favorable and the time auspicious for a development not only of oil production but of a stock holding and stock selling scheme which would bring in a large amount of money from the public. Simms paid $972,012.94 for the leases. He then discussed finances and development with a Mr. Bronner, who brought him in touch with men of finance in New York City. Arrangements, it is now unnecessary to relate in extended detail, were finally made which led to the organization of the petitioner, Simms Oil Company, a Texas corporation having 10,000 shares of capital stock of a par value of $100 per share, and to the organization of Simms Petroleum Company, a Delaware corporation with a capital stock of 500,000 shares of no par value. The Simms leases were assigned in 1919 to the petitioner for all of its stock except six qualifying shares of directors. Then Simms transferred all of the petitioner's stock which he had received in exchange for the leases to Simms Petroleum Company for 280,990 shares of its stock. Out of this block of stock so received he had agreed to, and did, transfer to Mr. Bronner, his associate in the venture, 56,000 shares, leaving 224,990 shares as the consideration finally received by Simms for his leases. The stock of Simms Petroleum Company was listed on the New York Curb Exchange and large amounts were sold to the public. During the summer of 1919, a pool in this stock was operated by Simms and his associates and later a second pool was organized. The stock was thus sold on the market at prices ranging from $28.50 to $73.50 per share. None of the stock of the petitioner was sold.
In 1923 some of the leases were found to be worthless, and they were abandoned. So, too, some were abandoned in 1925 for the same reason. Part of the losses so claimed to have been sustained in 1923 were carried over and deducted from income in 1925 by the petitioner in a consolidated income and profits tax return it filed as a member of an affiliated group of corporations. All of the losses so claimed to have been suffered in 1925 were also deducted, leaving no tax due. The percentage of the losses sustained in 1923 and 1925 were stipulated, but the amount in each year is disputed. The Commissioner refused to accept the cost of leases as claimed by the petitioner and determined a deficiency based upon a lower basis. The Board of Tax Appeals found the cost of the leases to petitioner to be the same as their cost to Simms, and this finding is now claimed to have been arbitrarily made without due regard to the evidence. Accordingly, the first issue is whether or not the Board based its finding of cost upon substantial evidence. We think it did. While it is apparent that the cost of the leases to Simms was not necessarily the cost to the petitioner and that the petitioner's cost was the fair market value of its stock at the time the stock was exchanged for the leases provided that stock then had a fair market value, the fact is that none of the petitioner's stock was sold and no fair market value was shown. An attempt has been made to persuade us that, because the petitioner's stock was immediately exchanged for stock in the holding company, Simms Petroleum Company, which has been plausibly computed to have had a fair market value of $5,624,750, the petitioner's stock had a par value of $10,000,000 and all but six shares of it was issued in exchange for the leases which were taken as payment in full for the stock which had to be issued fully paid for under the laws of Texas, the leases actually cost the petitioner $9,999,400, though this theory of cost seems to have been advanced only as a makeweight to help establish the contention that the leases must have cost the petitioner more than the amount the Board found. The cost now seriously urged is the claimed fair market value of the Simms Petroleum Company stock which was exchanged for the petitioner's stock.
We need not do more than point out that the Board was not required to accept any such theoretical value for the petitioner's stock. It was essential to the plan for a market operation in the holding company's stock to have the petitioner's stock transferred to the holding company and to have the holding company thus control the Simms leases. But to say that, when the petitioner's stock was issued for the leases, it had a fair market value in excess of the actual value of the leases loses sight of realities. The acquisition of the leases was an absolute necessity in carrying out the stock selling operation contemplated and subsequently indulged in. Any value the petitioner's stock may subsequently have had in excess of the value of the leases has not been so conclusively proved to have existed at the time it was issued that other evidence of value before the Board could not overcome it. There was other evidence.
Mr. Simms became involved in disputes with his associates because of some claimed secret profits made by him and by them in the conduct of the operations, and he also had litigation with the government regarding taxes assessed against him as a result of income received in connection with these transactions. It was stipulated that, so far as material and relevant, the evidence introduced in the case of E. F. Simms v. Commissioner of Internal Revenue before the Board should be treated as in this case. While the right to object to any portion of it was reserved to both parties, that right was not exercised. This evidence shows that witnesses qualified to express opinions on the subject placed the value of the leases when acquired by the petitioner at an amount ranging from less to more than Simms paid for them. In view of this evidence, it is reasonable to believe that they were worth, when the petitioner acquired them, at least what Simms paid for them, but no more. We therefore are bound to accept the Board's finding that the value of the petitioner's stock used to pay for the leases was the same as the value of the assets underlying the stock immediately after the leases were transferred to it, since there was substantial evidence to support the finding. The losses deductible in 1925 then become simply a matter of computation from facts either stipulated or properly found, and the Board's decision on this issue is affirmed.
The second issue related to a deduction claimed in the return for 1925 based on a loss alleged to have been sustained by the petitioner in 1923 as a result of its purchase from Simms Petroleum Company of the capital stock of Rowe Oil Corporation.
In 1923, Simms Petroleum Company not only owned, a few qualifying shares being ignored, all of the stock of the petitioner, but also owned all of the stock of Rowe Oil Corporation, an operating company. This stock of Rowe had been acquired by Simms Petroleum Company in part in December, 1919, and in part in December, 1920. Payment for it had been made in part in cash and in part in stock of Simms Petroleum Company. Rowe Oil Corporation was financially unsuccessful. Simms Petroleum Company made cash advances to it in excess of half a million dollars and forgave and canceled, without other consideration than the resulting benefit to it as the sole stockholder, such advances to the amount of $356,767.77. On December 31, 1923, Rowe Oil Corporation still owed Simms Petroleum Company $145,158.59 on account of such loans. On that day Simms Petroleum Company and the petitioner agreed that Simms Petroleum Company would immediately surrender, or cause to be surrendered, for cancellation, all of the outstanding shares of Rowe Oil Corporation, and that in consideration the petitioner would pay Simms Petroleum Company $1,182,053.24. On that day Rowe Oil Corporation transferred all of its assets to the petitioner in consideration of the assumption by petitioner of all the obligations of Rowe Oil Corporation and its undertaking to cause all the outstanding shares of Rowe Oil to be surrendered for cancellation. Rowe Oil Corporation was then dissolved, and the fair market value of its assets as of December 31, 1923, the date of dissolution, in excess of all its obligations other than its indebtedness to Simms Petroleum Company, was $99,669.38. Simms Petroleum Company sustained net losses in 1923, 1924 and 1925. The petitioner had net income in each of those years. The loss claimed by the petitioner has been computed by adding the amount of the indebtedness on December 31, 1923, of Rowe Oil Corporation to Simms Petroleum Company, $145,158.59, to the $1,182,053.24 which petitioner paid to Simms Petroleum for the Rowe Oil Corporation stock which was canceled, and then taking from the total the liquidation value of Rowe Oil Corporation computed as $99,669.38 by disregarding the amount Rowe owed Simms Petroleum Corporation. When this indebtedness is taken into consideration in determining the liquidation value of Rowe Oil Corporation on the day the petitioner purchased its stock for $1,182,053.24 in cash, it appears that the petitioner paid that amount for stock in a corporation whose liabilities exceeded its assets by $45,489.21.
The Board held that the form of the transaction by which this loss was created was not controlling in determining whether the loss was deductible from petitioner's gross income, but that, being in substance a transfer of a loss from Simms Petroleum Corporation, which had no net income from which it could be deducted, to the petitioner which did have such income, it was not deductible by the petitioner.
The petitioner would justify its claim of right to take the deduction on the theory that intercompany transactions between affiliates should not be judged on principles applying to the acts of separate and distinct legal entities, and that at the time this loss was created the law had not been definitely construed to the effect that a net loss could be carried over and deducted in a subsequent year only by an affiliate out of its own income in the subsequent year. See Woolford Realty Co. v. Rose, 286, U.S. 319, 52 S. Ct. 568, 76 L. Ed. 1128, decided in 1932. This seems only to be an attempt to support the deduction on the ground that the petitioner could not have been sure on December 31, 1923 that the only way the then existing Simms Petroleum loss could be used to reduce taxation was by transferring it to the petitioner, and so that it could not have been a deliberate attempt to distort the petitioner's net taxable income in the year in question. Even so, the real character was not changed. As much would follow from the apparent fact that the petitioner could not have been sure in 1923 either that Simms Petroleum Corporation would not have net income in 1925 from which to deduct its loss or that the petitioner would. Whenever a loss of one affiliate is in whole or in part taken over by another under circumstances which show that in so far as the loss was shifted the affiliate taking it over has simply made a contribution in the nature of a gift to the other, no deductible loss results. If what happened in fact amounted to more than the making of bookkeeping entries, the petitioner made a gift to Simms Petroleum Company of what it claims to be a loss. To be sure it was then out of pocket to the extent of the amount claimed. In that sense it sustained a loss, but to recognize it as a loss deductible from income for taxation purposes would permit a computation of net income on a basis other than that provided by Congress. There would be no point in requiring the deduction of a loss by an affiliate only out of its own income if losses could be shifted within the group as affiliates might desire and agree. We think that to give effect to the limitation upon carry-over deductions shown by the decision in Woolford Realty Co. v. Rose, supra, it must follow that losses by one affiliate cannot be transferred to another in the consolidated group. Not all intercompany dealings are disregarded in determining the net income of a consolidated group for purposes of taxation, Helvering v. Post & Sheldon Corporation (C.C.A.) 71 F.2d 930, but those which would distort the actual net income of the group by permitting a loss to be deducted other than from the income of the unit which sustained the loss are not to be given effect. See Burnet v. Aluminum Goods Co., 287 U.S. 544, 53 S. Ct. 227, 77 L. Ed. 484.The actual loss had been sustained before December 31, 1923, it was merely rearranged within the group with the loss remaining the same as before from the standpoint of a consolidated return. On this issue the decision of the Board is affirmed.
ON October 19, 1922, Clayton Oil & Refining Company acquired from Gasoline Products Company, Inc., the right to install a plant of daily capacity of 30,000 barrels and to manufacture that quantity of gasoline under certain gasoline cracking patents owned by Gasoline Products Company, Inc.On October 9, 1924, Clayton assigned to Atlantic Oil & Refining Company two-thirds of its rights to manufacture gasoline under the patents and Atlantic took a license from Gasoline Products. The contracts entered into need not be outlined except to say that provisions satisfactory to all were incorporated in their agreements which fixed the number and size of the units and the time within which they should be installed. Gasoline Products was to receive a royalty from Atlantic, and, pursuant to an agreement to discharge the liabilities of Atlantic to Clayton arising under the assignment, bound itself to pay to Clayton, as and when the royalties were paid to it by Atlantic, $8 per unit of one thousand barrels of the capacity assigned by Clayton to Atlantic. What is now important is only the fact that, as a result of these agreements and payments made by Atlantic to Gasoline Products, Clayton became entitled to receive in all $160,000 from Gasoline Products.
On May 14, 1925, G. M. Murphy & Co., which owned a controlling amount of the stock of Clayton, agreed to sell to Simms Petroleum Company a minimum of 5,000 of the 7,500 shares of Clayton preferred stock and a minimum of 13,000 of the 19,630 shares of Clayton common stock outstanding. Agreements were made, the validity of which is not questioned, which provided that all sums to be paid to Clayton as a result of the assignment to Atlantic and the promise of Gasoline Products to pay Clayton as and when it received the royalties from Atlantic were to become the property of the persons who were Clayton stockholders just prior to the delivery of Clayton shares to Simms Petroleum under the Murphy & Co. contract to sell such shares to Simms Petroleum. Provision was made for the purchase by Simms Petroleum of any rights reverting to Clayton because not exercised and paid for by Atlantic; and Simms Petroleum agreed ...