APPEAL OF FARMERS DEPOSIT NATIONAL BANK, Docket No. 6220.

• Decision Date: 16 November 1926
• Docket Number: Docket No. 6220.
• Citation: 5 BTA 520
• Parties: APPEAL OF FARMERS DEPOSIT NATIONAL BANK AND AFFILIATED BANKS.
• Court: U.S. Board of Tax Appeals

5 B.T.A. 520 (1926)

APPEAL OF FARMERS DEPOSIT NATIONAL BANK AND AFFILIATED BANKS.

Docket No. 6220.

Board of Tax Appeals.

Decided November 16, 1926.

Maynard Teall, Esq., for the petitioner.

E. C. Lake, Esq., for the Commissioner.

This is an appeal from the determination of deficiencies for the years 1919 and 1920, aggregating $47,834.60. The questions for determination are whether the gain realized on the sale of stock of an affiliated company constitutes income, and whether the proceeds of such sale may be included in invested capital.

FINDINGS OF FACT.

The Farmers Deposit National Bank, hereinafter called the petitioner, is a national bank incorporated under the laws of the United States, with its principal office at Pittsburgh, Pa. In 1919 it was affiliated, under the provisions of the Revenue Act of 1918, with the Farmers Deposit Trust Co. and the Farmers Deposit Savings Bank, and for that year the three banks filed a consolidated return.

On January 1, 1919, the Farmers Deposit Trust Co. owned 232 shares of stock of the petitioner which it had purchased prior thereto for $24,492. On April 17, 1919, the Farmers Deposit Trust Co. purchased 2,183 additional shares of stock of the petitioner company for $218,300, making a total of 2,415 shares acquired at a total cost of $242,792. On October 15, 1919, it sold all of the 2,415 shares for $338,003.40, which is $95,211.40 in excess of the cost of the stock. This amount ($95,211.40) has been included by the Commissioner in income for the year 1919. The Commissioner has not included the sale price of the stock ($338,003.40) in invested capital for 1919.

OPINION.

ARUNDELL:

The record shows that the Farmers Deposit Trust Co., the Farmers Deposit Savings Bank, and the Farmers Deposit National Bank were affiliated throughout the years 1918 and 1919, and that these affiliated companies filed consolidated returns of net income and invested capital for those years. The Commissioner's deficiency notice indicates that he regarded the affiliation as still existing throughout the year 1920, for he has computed the tax liability of the three companies on the basis of a consolidated return of net income and invested capital, and this action is not contested by the petitioner and affiliated companies. At the beginning of the taxable year 1919, the Farmers Deposit Trust Co. owned but 232 shares of the capital stock of the Farmers Deposit National Bank. On April 17, 1919, it acquired 2,183 additional shares, making a total of 2,415 shares owned in the Farmers Deposit National Bank. On October 15, 1919, it sold its entire holdings. If the three companies were affiliated throughout the years 1918 and 1919, as admitted by the parties, as well as during the year 1920, as the deficiency letter indicates, then it is obvious that the ownership by the Farmers Deposit Trust Co. of this stock in the Farmers Deposit National Bank was not the basis for the affiliation of those two companies, and the sale of that stock did not effect a "break-up" of the affiliation. Consequently, we will assume what we think is apparent in this case — that the sale by the Farmers Deposit Trust Co. of its stockholdings in the Farmers Deposit National Bank did not disturb the existing affiliation of these companies, and our decision upon the issues before us will be made in the light of that assumption.

The appeal presents two issues: (1) Where one member of the affiliated group purchases the capital stock of another member of the affiliated group and later sells that stock at a price in excess of cost, the purchase and sale of the stock having no effect whatever upon the existing affiliation of the two companies, does the amount received from the sale of the stocks in excess of the cost thereof constitute a taxable gain to the member making the sale, and, consequently, to the affiliated group? (2) Should the proceeds derived from the sale of the capital stock, referred to in (1) above, be included in the consolidated invested capital of the affiliated group?

There can be no doubt whatever that under the provisions of section 213(a) of the Revenue Act of 1918, a corporate taxpayer is liable for taxes upon any gain derived from the sale of the capital stock owned by it in another corporation with which it is not affiliated. The gain resulting from such a transaction is a gain derived from dealings in personal property, which is specifically made subject to the tax by the provisions of section 213(a). That a corporate taxpayer realizes no taxable gain from the sale of its own capital stock is a well established principle of the taxing statutes. It is a principle which the Commissioner has consistently adhered to in all of the regulations promulgated under the several Revenue Acts. In the Appeal of Simmons & Hammond Mfg. Co., 1 B. T. A. 803, this Board held that the sale by a corporate taxpayer of its own capital stock constituted a capital transaction and that no deductible loss resulted therefrom. It follows, per contra, that a corporate taxpayer realizes no taxable gain from the sale of its own capital stock. If, then, the Farmers Deposit Trust Co. and the Farmers Deposit National Bank are to be regarded and treated, for the purpose of the income and profits taxes, as separate and distinct entities, the liability of the Farmers Deposit Trust Co. for taxes on the gain derived from the sale of the capital stock owned by it in the Farmers Deposit National Bank is hardly open to question. On the other hand, if it is the purpose of the statute to disregard the separate entities of these two companies and to treat them, other than for the actual assessment and payment of the taxes, as one business enterprise and one taxpayer, then any capital stock emanating from either one, irrespective of the name its shares may bear, emanates from and is the capital stock of the consolidated group; and a sale by one member of shares of capital stock owned by it in another member of the group is a sale by the consolidated group of its own capital stock, and, a fortiori, a sale by a corporate taxpayer of its own capital stock, which can not result in either a taxable gain or a deductible loss.

Let us proceed to an examination of the statute to determine the status of these affiliated companies for the purpose of the income and profit taxes. The statute, pertinent in its parts to the matter under consideration, reads as follows:

Sec. 240. (a) That corporations which are affiliated within the meaning of this section shall, under regulations to be prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income and invested capital for the purposes of this title and Title III, and the taxes thereunder shall be computed and determined upon the basis of such return: Provided, That there shall be taken out of such consolidated net income and invested capital, the net income and invested capital of any such affiliated corporation organized after August 1, 1914, and not successor to a then existing business, 50 per centum or more of whose gross income consists of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive. In such case the corporation so taken out shall be separately assessed on the basis of its own invested capital and net income and the remainder of such affiliated group shall be assessed on the basis of the remaining consolidated invested capital and net income.

In any case in which a tax is assessed upon the basis of a consolidated return, the total tax shall be computed in the first instance as a unit and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income properly assignable to each. There shall be allowed in computing the income tax only one specific credit of $2,000 (as provided in section 236); in computing the war-profits credit (as provided in section 311) only one specific exemption of $3,000; and in computing the excess-profits credit (as provided in section 312) only one specific exemption of $3,000.

Here in the provisions of section 240(a) we have the key to the whole situation. Underlying these provisions of the statute is a purpose which must be ascertained, and the statute must be construed in such a manner as to make that purpose effective. While the return required by the provisions of section 240(a) is "a consolidated return of net income and invested capital," it is entirely clear from other provisions of the same section that the return contemplated is a return of "consolidated net income and invested capital." For instance, Congress has specified that the net income and invested capital of certain affiliated corporations shall be taken out of "such consolidated net income and invested capital," and that the remainder of the affiliated group shall be assessed on the basis of the remaining "consolidated invested capital and net income."

What is meant by "consolidated invested capital and net income"? To consolidate is defined as "to combine; to cause to become united; to merge." Appeal of Frank G. Shattuck Co., 2 B. T. A. 7. "Invested capital" and "net income" are statutory concepts and are clearly defined by the statute. Section 326(a) defines "invested capital" as: (1) Actual cash paid in; (2) actual cash value of tangible property paid in for stock or shares; (3) paid-in or earned surplus and undivided profits; (4) and (5) intangible property paid in for stock or shares, subject to certain limitations. Section 232 states that, in the case of a corporation, the term "net income" means the gross income, as defined in section 233, less the deductions allowed by section 234. From these definitions we are able to deduce the meaning of "consolidated invested capital and net income."...