Commissioner of Internal Rev. v. Terre Haute Elec. Co.

• Decision Date: 05 January 1934
• Docket Number: No. 4973,4975.,4973
• Citation: 67 F.2d 697
• Parties: COMMISSIONER OF INTERNAL REVENUE v. TERRE HAUTE ELECTRIC CO., Inc. TERRE HAUTE ELECTRIC CO., Inc., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Seventh Circuit

67 F.2d 697 (1933)

COMMISSIONER OF INTERNAL REVENUE v. TERRE HAUTE ELECTRIC CO., Inc.

TERRE HAUTE ELECTRIC CO., Inc., v. COMMISSIONER OF INTERNAL REVENUE.

Nos. 4973, 4975.

Circuit Court of Appeals, Seventh Circuit.

November 16, 1933.

Rehearing Denied January 5, 1934.

Pat Malloy, Asst. Atty. Gen., and Sewall Key and Helen R. Carloss, Special Assts. to Atty. Gen., for the Commissioner.

A. E. James and Harry A. Fellows, both of Washington, D. C., for Terre Haute Electric Co.

Before EVANS, SPARKS, and FITZHENRY, Circuit Judges.

EVANS, Circuit Judge.

Were the taxpayer, the Terre Haute Electric Company, and its parent company, the Terre Haute, Indianapolis and Eastern Traction Company, affiliated within the meaning of that word as used in the Revenue Act?

The taxpayer is an Indiana corporation having 20,000 shares of common and 10,000 shares of preferred stock. During the years 1922 and 1923, all of its common stock was owned by the parent company. In 1922, 18.16 per cent. of taxpayer's preferred stock was held by stockholders of the parent company. During 1922, sixty-five preferred stockholders of taxpayer (representing 24.56 per cent. of the preferred stock) owned no stock in the parent company, but owned 49.96 per cent. of the stock of a co-subsidiary, whose common stock was also completely owned by the parent company. The subsidiary owned no stock of the parent company. All stock of the subsidiaries held equal voting privileges.

Section 240 of the Revenue Act of 1921 (40 Stat. 1081, 1082), permitting the filing of consolidated returns by affiliated companies, reads as follows:

"(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 * * *."

In addition to showing stock ownership, it appears that the taxpayer leased its property to the parent company for 999 years. The officers of the two companies were the same, and the parent company selected the officers of the subsidiary company. Both companies were operated as an economic unit. The terms of the long lease gave control of the lessor's property to the lessee and reduced the former's function to nominal activity.

In Handy & Harman v. Burnet, 284 U. S. 136, 52 S. Ct. 51, 52, 76 L. Ed. 207, the court said:

"* * * The section requires control of substantially all of the stock; control of the corporations is not enough. The carrying on of a business unit by two or more corporations does not in itself constitute affiliation. * * * We assume in favor of petitioner that they, through their power over Hamilton's official position and salary, their ability to dominate both corporations or by other means, were in position effectually to influence him in respect of the voting, use or disposition of the stock issued to him, and thus as a practical matter to exert a kind of control called by counsel `actual' to distinguish it from a legally enforceable control.

"* * * It would require very plain language to show that Congress intended to permit consolidated returns to depend on a basis so indefinite and uncertain as control of stock without title, beneficial ownership or legal means to enforce it. Control resting solely on acquiescence, the exigencies of business or other considerations having no binding force is not sufficient to satisfy the statute."

In Atlantic City Electric Co. v. Commissioner, 288 U. S. 152, 53 S. Ct. 383, 384, 77 L. Ed. 667, the court said:

"With respect to control of stock, as creating the affiliation which affords a basis for a consolidated return * * *. The requirement of control, in the absence of legal title or beneficial ownership, is not satisfied by acquiescence or by business considerations without binding force. There must be a control that is legally enforceable. * * * And it must be control of `substantially all the stock.' * * *

"* * * In establishing ownership or control of substantially all the stock as the criterion of a business unit, the statute made no distinction between preferred and common stock. It referred simply to `stock,' and we perceive no ground upon which stock with voting right can be treated as excepted. * * *

"* * * The statute is not concerned with a failure to exercise existing rights * * *."

In the light of these decisions, we conclude that the Commissioner and the Board correctly found that the taxpayer and the parent company were not affiliated within the meaning of section 240 of the Revenue Act of 1921.

Deduction for...