1. The purpose of requiring consolidated returns by affiliated
corporations was to impose the war profits tax according to true
net income and invested capital of what was, in practical effect, a
single business enterprise, even though conducted by means of more
than one corporation. P.
287 U. S.
547.
2. Primarily, the consolidated return was to preclude reduction
of the total tax payable by the business, viewed as a unit, by
redistribution of income or capital among the component
corporations by means of inter-company transactions.
Id.
3. A manufacturing corporation bought all the shares of another
corporation and used it as its subsidiary for selling the goods
manufactured. The subsidiary, after netting losses in several years
preceding 1917, was liquidated in that year, and, in the year next
following, dissolved.
Held that the two corporations did
not cease to be "affiliated" during the year 1917 (Rev. Act 1921, §
1331; Treas.Reg. 41, Arts. 77 and 78), and that, in making up their
consolidated return of excess profits for that year, the loss of
the
Page 287 U. S. 545
parent company's investment in the stock of the subsidiary, and
the loss of moneys advanced by the one to the other for the
business and not repaid were properly deducted from gross income
after subtracting from their sum the subsidiary's operating loss in
that year (Rev. Acts, 1916, § 12; 1917, § 206; Treas.Reg. 33, 1918
ed., Art. 147.) P.
287 U. S. 548
et seq.
56 F.2d 568 affirmed.
Certiorari to review the reversal of an order of the Board of
Tax Appeals, 22 B.T.A. 1, sustaining the Commissioner's finding of
a deficiency in a consolidated tax return.
MR. JUSTICE STONE delivered the opinion of the Court.
In 1914, respondent, a New Jersey manufacturing corporation,
purchased all the capital stock of the Aluminum Sales &
Manufacturing Company, a New York corporation. From that time until
its liquidation, carried on in 1917, the sales company was
principally engaged in selling goods manufactured by respondent. In
February, 1918, it was dissolved. The operation of the sales
company reflected net losses during the years 1914, 1915, and 1916,
as well as in the year 1917. At a result of the operating losses
and the liquidation of the sales company,
Page 287 U. S. 546
respondent suffered the loss of certain sums advanced to the
sales company, and of the total investment in its stock.
For 1917, the two corporations filed separate returns for
computation of the normal income tax and a consolidated return for
the purposes of the excess profits tax. In its separate return,
respondent claimed, and the Commissioner allowed, deduction of an
aggregate loss made up of respondent's advances to the sales
company, and the cost of its stock, less the value of equipment and
goodwill realized on its liquidation. This loss, reduced by the
1917 operating loss of the sales company, was deducted from gross
income in the consolidated return. The Commissioner's refusal to
allow the deduction was sustained by the Board of Tax Appeals, 22
B.T.A. 1, whose determination was reversed by the Court of Appeals
for the Seventh Circuit, 56 F.2d 568. The Court of Appeals held
that respondent's affiliation with the sales company was ended by
the liquidation in 1917, so that the loss was suffered "outside the
period of affiliation," and that, in any case, as the loss did not
result from an "inter-company" transaction, it could be deducted in
the consolidated return. This Court granted certiorari to resolve
an alleged conflict with the decision of the Court of Claims in
Utica Knitting Co. v. United States, 68 Ct.Cls. 77,
and see Autosales Corp. v. Commissioner, 43 F.2d 931,
933.
Title 2 of the Revenue Act of 1917, 40 Stat. 300, 302, imposed a
war excess profits tax in addition to the normal tax upon the
income of corporations. The statute made no provision for
consolidated returns by affiliated corporations, but Articles 77
and 78 of Treasury Regulations 41, adopted pursuant to the Act, did
authorize the Commissioner to require affiliated corporations,
including those, the stock of one of which was owned by another, to
file a consolidated return of net income and invested capital. And
§ 1331 of the Revenue Act of 1921, 42 Stat. 227, 319,
Page 287 U. S. 547
provided that, for the purpose of determining excess profits
taxes, the Revenue Act of 1917
"shall be construed to impose the taxes therein mentioned upon
the basis of consolidated returns of net income and invested
capital in the case of domestic corporations and domestic
partnerships that were affiliated during the calendar year 1917.
[
Footnote 1]"
The purpose of requiring consolidated returns by affiliated
corporations was, as the government contends, to impose the war
profits tax, according to true net income and invested capital of
what was, in practical effect, a single business enterprise, even
though conducted by means of more than one corporation. Primarily,
the consolidated return was to preclude reduction of the total tax
payable by the business, viewed as a unit, by redistribution of
income or capital among the component corporations by means of
inter-company transactions.
See Handy & Harman v.
Burnet, 284 U. S. 136,
284 U. S. 140;
Appeal of Gould Coupler Co., 5 B.T.A. 499, 514-516;
cf.
Treasury Regulations 41, art. 77; Treasury Regulations 45, Art.
631.
It is not denied that the two corporations became affiliated
when respondent acquired all the capital stock of the sales
company. But, on the basis of the finding of the Board of Tax
Appeals that the sales company was chiefly engaged during 1917 in
closing up its business preparatory to formal dissolution, which
took place in February, 1918, that all its assets and liabilities
were disposed of by the end of 1917, and that it did not do any
business after that date, petitioner argues that the affiliation of
the two companies was terminated by the liquidation.
Page 287 U. S. 548
Since complete stock ownership is made the test of affiliation
applicable here under Article 77 of Treasury Regulations 41 and §
1331 of the Revenue Act of 1921, no ground is apparent for saying
that the corporations ceased to be affiliated, merely because,
without change of corporate control, one of them was being
liquidated. The findings do not reveal that the liquidation of the
sales company was completed, that it ceased to do any business, or
to function as a corporation before the end of 1917. Neither
statute nor regulations recognize that affiliation may be
terminated by the mere fact that such liquidation is being carried
on, and the reasons for requiring the consolidated return may be
quite as valid during that liquidation as before. During that
period the unitary character of the business enterprise is not
necessarily ended, and inter-company manipulations are not
precluded.
In the present case, even though the affiliation continued, it
does not follow, as a matter of law, that the loss was not rightly
deducted in the consolidated return. Section 12, Revenue Act of
1916, 39 Stat. 756, 767, governs the computation of the excess
profits tax under § 206, Revenue Act of 1917, 40 Stat. 300, 305.
That section and the regulation under it (
see Article 147,
Treasury Regulations 33, 1918 ed.) direct that taxable net income
of a corporate taxpayer shall be ascertained by deducting, from
gross income losses sustained within the year. It is conceded that
the loss of respondent's advances to the sales company and the
investment in its stock was sustained in 1917, was deductible,
therefore, if at all, in that year, and might properly have been
deducted by respondent in a separate return, if a separate return
had been permissible. But the government insists that the loss
cannot be deducted in the mandatory consolidated return for 1917
because it occurred as the result of "inter-company"
transactions.
Page 287 U. S. 549
We need not decide whether the loss resulted from inter-company
transactions within the meaning of the regulations under later
statutes [
Footnote 2] which
broadly exclude from the consolidated returns profit or loss upon
all such transactions. For neither the Revenue Act of 1917, nor §
1331 of the Revenue Act of 1921, nor the regulations under them,
[
Footnote 3] prescribes
specifically the method of making up the consolidated return, or
requires the elimination from the computation of the tax of the
results of all inter-company transactions. Article 77 of Treasury
Regulations 41 required every corporation to describe in its return
"all its intercorporate relationships with other corporations, with
which it is affiliated," and to
"furnish such information in relation thereto as will enable the
Commissioner of Internal Revenue to compute the amount of the tax
properly due from each corporation on the basis of an equitable and
lawful accounting."
Article 78 authorizes the Commissioner to require consolidated
returns of affiliated corporations "wherever necessary to more
equitably determine invested capital or taxable income," and
provides that "the total tax will be computed in the first instance
as a unit on the basis of the consolidated return."
These provisions plainly do not lay down any rigid rule of
accounting to be applied to consolidated returns which would
exclude from the computation of taxable income the results of every
inter-company transaction, regardless
Page 287 U. S. 550
of its effect upon the capital or the net gains or losses of the
business of the affiliated corporations. Instead, they merely
disclose the purpose underlying regulations and statute to prevent,
through the exercise of a common power of control, any
inter-company manipulation which would distort invested capital or
the true income of the unitary business carried on by the
affiliated corporations. Hence, no method of accounting, in
calculating taxable income upon the consolidated return, can be
upheld which would withhold from the taxpayer all benefit of
deduction for losses actually sustained and deductible under the
sections governing the computation of taxable income, and which, at
the same time, would not further in some way the very purpose for
which consolidated returns are required.
Such, we think, is the effect of the method adopted by the
Commissioner. The sales company suffered losses during the years
1914, 1915, and 1916 which could not be deducted in its separate
returns for those years because they were net losses, and which
could not be deducted from the profits of the parent company
because there was no consolidated return in those years. While it
may be assumed that those losses affected the value of the stock
owned by the parent company, the loss of its investment in the
stock of the sales company and in advances to it could not be
deducted by the parent company in its separate return for those
years because the loss had not then been sustained with such
finality as to permit its deduction under the applicable statute
and regulations. So far as the loss from operation of the sales
company in earlier years contributed to respondent's capital loss
in 1917, deduction of the latter in the consolidated return
involved no double deduction of losses of the business of the two
companies during the period of their affiliation. As respondent's
total loss in 1917 was reduced, before deduction in the
consolidated return, by the amount of the
Page 287 U. S. 551
operating loss of the sales company for that year, there was no
duplication of any losses accrued or sustained in that year.
The loss was a real one, suffered by respondent as a separate
corporate entity, and it was equally a loss suffered by the single
business carried on by the two corporations during the period of
their affiliation, ultimately reflected in the 1917 loss of capital
invested in that business. While equitable principles of accounting
applied to the calculation of the net income of the business unit
do not permit deduction of the loss twice, they do require its
deduction once. Hence, the loss was deductible in 1917 under the
statute and regulations controlling computation of taxable income,
and its deduction is not forbidden by the regulations applicable to
the consolidated return. Articles 77 and 78 of Treasury Regulations
41 would, indeed, require the elimination of any losses resulting
from inter-company transactions, the inclusion of which would
defeat the purpose of consolidated returns to tax the true income
of the single business of affiliated corporations, calculated by
correct accounting methods. The deductions claimed here had no such
effect.
Affirmed.
[
Footnote 1]
Subsequent to 1917, affiliated corporations were required to
file such a return for all purposes for any taxable year prior to
January 1, 1922 (§ 240, Revenue Act of 1918, 40 Stat. 1057, 1081; §
240, Revenue Act of 1921, 42 Stat. 227, 260). Thereafter, it became
optional whether to file consolidated or separate returns. Section
240, Revenue Act of 1921; § 240, Revenue Act of 1924, 43 Stat. 253,
288; § 240, Revenue Act of 1926, 44 Stat. 9, 46; §§ 141, 142,
Revenue Act of 1928, 45 Stat. 791, 831, 832.
[
Footnote 2]
See Art. 637, 864 of Treasury Regulations 45 under the
Revenue Act of 1918; Art. 635, 864 of Treasury Regulations 62 under
the Revenue Act of 1921; Art. 636 of Treasury Regulations 65 under
the Revenue Act of 1924; Art. 635 of Treasury Regulations 69 under
the Revenue Act of 1926; Art. 734 of Treasury Regulations 74 and
Art. 15, 31, 37(a), 38(b) of Treasury Regulations 75 under the
Revenue Act of 1928.
[
Footnote 3]
Article 1735 of Treasury Regulations 62, under § 1331 of the
Revenue Act of 1921, merely refers to Treasury Regulations 41 under
the Revenue Act of 1917.