Rocco, Inc.  v. Comm'r of Internal Revenue, Docket Nos. 4328-75—4330-75.

• Decision Date: 23 April 1979
• Docket Number: Docket Nos. 4328-75—4330-75.
• Citation: 72 T.C. 140
• Parties: ROCCO, INC. (FORMERLY ROCCO FEEDS, INC.), et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

72 T.C. 140

ROCCO, INC. (FORMERLY ROCCO FEEDS, INC.), et al.,1 PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 4328-75—4330-75.

United States Tax Court

Filed April 23, 1979.

Rocco, Inc., the parent corporation, operated primarily as a poultry feed mill and contract grower of poultry, principally broilers. In 1971, for business reasons, Rocco, Inc., decided to go into the broiler processing business. Rocco, Inc., and Marval, a turkey processor and customer of Rocco, Inc., formed Rocco Farm Foods, Inc., to operate the broiler processing business, Rocco, Inc., acquiring 80 percent of the stock and Marval 20 percent of the stock of Farm Foods. Rocco Broiler Farms was then formed as a wholly owned subsidiary of Farm Foods, to raise the broilers which were sold to Farm Foods.

Rocco Turkeys, Inc., a wholly owned subsidiary of Rocco, Inc., was engaged in range production of turkeys. In 1971, for business reasons, Turkeys, Inc., decided to go into confinement growing of turkeys, which differs from range growing. Rocco Turkey Farms was formed, as a wholly owned subsidiary of Turkeys, Inc., to conduct the confinement growing business.

Prior to 1971, all of the Rocco companies used the accrual method of accounting, and none of them had filed consolidated returns. Upon incorporation, Broiler Farms and Turkey Farms elected to use the cash method of accounting. Both suffered operating losses for 1971, primarily as a result of not taking closing inventories into consideration in computing income. Rocco, Inc., and its subsidiaries filed a consolidated return for 1971, thereby permitting Rocco, Inc., and Turkeys, Inc., to offset the operating losses of Broiler Farms and Turkey Farms against their operating incomes, past and present. Respondent, relying on section 269, I.R.C. 1954, increased the consolidated taxable income by eliminating from the cost of goods sold the value of the closing inventories of Broiler Farms and Turkey Farms. Held: The principal purpose for acquiring Broiler Farms and Turkey Farms was not evasion or avoidance of tax by securing the benefit of deductions, credits, or other allowances which Rocco, Inc., and Turkeys, Inc., would not otherwise have enjoyed. Sec. 269, I.R.C. 1954, is not applicable to permit respondent to add to the taxable income of the consolidated group the value of the closing inventories of Broiler Farms and Turkey Farms. Carle E. Davis and Joseph C. Wool, Jr., for the petitioners.

Stephen M. Friedberg, for the respondent.

DRENNEN, Judge:

In these consolidated cases respondent determined deficiencies in petitioners' income tax as follows:

+---------------------------------------------+
                ¦Docket No.  ¦Petitioner  ¦Year  ¦Deficiency  ¦
                +------------+------------+------+------------¦
                ¦            ¦            ¦      ¦            ¦
                +------------+------------+------+------------¦
                ¦4328-75     ¦Rocco, Inc. ¦1970  ¦$13,631.90  ¦
                +---------------------------------------------+
                

                4329-75 Rocco Turkeys, Inc 1968 61,207.60
                

                           1969 162,833.18
                                           1970 138,510.42
                4330-75 Rocco, Inc., et al 1972 171,317.00
                

Concessions were made by both parties, leaving for our consideration only one issue. In 1971, petitioners Rocco, Inc., and Rocco Turkeys, Inc., both of which were on the accrual method of accounting, each formed a controlled corporate subsidiary to conduct certain phases of their integrated broiler chicken and turkey growing businesses. Both of the subsidiaries adopted the cash method of accounting, as authorized by section 1.471-6(a), Income Tax Regs., and both reported large operating losses for 1971, primarily because they did not reduce cost of goods sold by inventories, which losses the parent corporations utilized through the filing of a consolidated return for the entire controlled group. The issue is whether respondent, under the authority of section 269, I.R.C. 1954,² can require the reduction of cost of goods sold by the value of the closing inventories of the two subsidiaries.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by reference.

Rocco, Inc. (hereinafter Rocco), is a corporation organized under the laws of the Commonwealth of Virginia on June 8, 1939, under the name of Rocco Feeds, Inc. Its name was changed to Rocco, Inc., on December 11, 1970. The principal office of Rocco is at 1 Kratzer Road, Harrisonburg, Va. Rocco was formed by R. B. Strickler and others. His son, R. H. Strickler (hereinafter Strickler) was Rocco's executive vice president and chief policy-making officer during 1969 through 1971. He became president of Rocco in 1972. Rocco is the common parent of an affiliated group of corporations consisting of Rocco, Rocco Turkeys, Inc., Rocco Turkey Farms, Inc., Rocco Farm Foods, Inc., Rocco Broiler Farms, Inc., and Rocco Building Supplies, Inc. Rocco and its affiliated corporations filed consolidated income tax returns for calendar years 1971 and 1972 with the Internal Revenue Service Center, Philadelphia, Pa. None of these corporations filed consolidated returns before 1971.

Until 1971, Rocco operated principally as a poultry feed mill and contract grower of poultry, principally broilers. The growers bought feed and other supplies from Rocco to raise the chicks which were at times supplied by Rocco. In keeping its books and records and preparing its income tax returns, Rocco used the accrual method of accounting on a calendar year basis. Its income tax returns for the taxable years 1968, 1969, and 1970 were filed with the Internal Revenue Service Center, Philadelphia, Pa.

Prior to 1967, Rocco operated feed mills and warehouses in various parts of Virginia and West Virginia as well as in Harrisonburg. Each of these was operated by corporate subsidiaries of Rocco. Separate corporations were formed because of differences in the State laws of Virginia and West Virginia and because it was important to Rocco that these operations have local identity. Also, R. B. Strickler believed in an entrepreneurial approach to business and would give the manager and assistant manager of the corporations a percentage of the profits that were earned by the corporations which employed them.

Rocco experienced its first operating loss in 1961. At that time it became apparent to Rocco that the poultry business as a whole was shifting from separate and independent businesses dealing with the various aspects of the business (i. e., feed, hatcheries, growers, processers, marketers) to an integrated approach whereby one or more companies would combine all the phases into related organizations. Consequently, Rocco decided to liquidate all of the then-existing outlying feed mills over a 5-year period and build toward an integrated business. By the late 1960's, Rocco owned and operated breeder flocks, a hatchery, a feed mill, and had contract growers in the broiler chicken business. At that time Rocco's feed sales were approximately one-third retail, one-third broiler chicken, and one-third turkey. In 1967, Rocco formed a joint venture between itself, several hatcheries, and Blue Ridge Poultry & Egg Co., Inc. (hereinafter Blue Ridge), a processor,³ in an effort to achieve the benefits of complete integration without actually having to integrate. The joint venture was terminated by Blue Ridge in late 1969 at which time Rocco also lost Blue Ridge as a customer for its broiler chickens. In July 1970, Rocco also lost the Rockingham Poultry Marketing Co-op, another processor, as a customer for its feed and broiler chickens. Since Blue Ridge and Rockingham had purchased approximately 12 million broiler chickens from Rocco, the loss of these customers meant that Rocco had also lost approximately one-third of its market for feed.

However, in December 1970, Blue Ridge, which had experienced business reverses, offered to sell its processing operation to Rocco. In order to make the acquisition, Rocco had to arrange lines of credit amounting to $5 million. Because Rocco had no expertise in processing and marketing of the processed product, Rocco approached Marval Poultry Co. (hereinafter Marval), which was a processor of turkeys, with the proposition that Marval become a stockholder in the corporation Rocco was planning to form to operate the processing business. Marval wanted a 50-percent interest in the corporation but after negotiations with Rocco settled for a 20-percent interest.

As a result of the negotiations, on January 21, 1971, Rocco Farm Foods, Inc. (hereinafter Farm Foods), was incorporated by Rocco and Marval. Its principal place of business is at Edinburg, Va. It keeps its books and records and prepares its income tax returns on the accrual method of accounting and on the basis of a calendar year.

Farm Foods acquired the processing plant from Blue Ridge in February 1971. Its principal business since then has been the processing and marketing of broiler chickens. The management of Blue Ridge was employed in order to provide further expertise in the processing and marketing operation.

In order to supply Farm Foods with broiler chickens for processing and marketing, Rocco Broiler Farms, Inc. (hereinafter Broiler Farms), was formed on February 5, 1971, as a wholly owned subsidiary of Farm Foods. The principal office of Broiler Farms is at 1 Kratzer Road, Harrisonburg, Va. From the time of its incorporation, Broiler Farms adopted and continues to keep its books and records and prepares its income tax returns on the cash method of accounting and on the basis of a calendar year. Broiler Farms is a contract grower of broilers and Farm Foods is its only customer. Upon its incorporation Broiler Farms purchased Rocco's broiler contracts for their book value.

For several reasons, the decision was made to operate the contract broiler phase and the processing phase in corporations separate from each...