1. Where one corporation has legally enforceable control of
substantially all of the stock of another, the two are
"affiliated," and must make a consolidated return under § 1331,
Revenue Act of 1921, and § 24D, Revenue Act of 1918. P.
288 U. S.
153.
2. In determining whether the control is of substantially all of
the stock, there is no ground for excluding preferred stock
outstanding with voting rights, even though it be redeemable at any
time and have a limited interest in dividends. P.
288 U. S.
154.
3. Ownership by the one corporation of all the common stock and
none of the preferred stock of the other, giving control of only
77% of all stock outstanding,
held insufficient for
affiliation. P.
288 U. S. 156.
57 F.2d 186 affirmed.
Certiorari, 287 U.S. 582, to review a judgment reversing the
Board of Tax Appeals, 15 B.T.A. 1084, and sustaining a ruling of
the Commissioner of Internal Revenue.
MR. CHIEF JUSTICE HUGHES delivered the opinion of the Court.
The question presented is whether the petitioner, Atlantic City
Electric Company, was affiliated with the American Gas &
Electric Company so that the federal taxes for 1917, 1918, and 1919
should be determined upon the basis of consolidated returns under §
1331 of the Revenue
Page 288 U. S. 153
Act of 1921 (42 Stat. 319), as applicable to the year 1917, and
§ 240 of the Revenue Act of 1918 (40 Stat. 1081, 1082). The Circuit
Court of Appeals, reversing the order of the Board of Tax Appeals
(15 B.T.A. 1084), upheld the ruling of the Commissioner that the
corporations were not affiliated, and must make separate returns.
57 F.2d 186. The case comes here on certiorari.
The following facts were found by the Board of Tax Appeals: the
petitioner, Atlantic City Electric Company, is a public service
corporation. During the years in question, it had outstanding
12,500 shares of common stock, of the par value of $100 per share,
and 3,702 shares of preferred stock. Holders of preferred stock
were entitled to vote, and that stock was preferred to the extent
of an annual cumulative dividend of 6 percent and on final
liquidation. The preferred stock was redeemable at any time, and
had no interest in dividends except as above stated. The American
Gas & Electric Company was a holding company. It owned all the
common stock of the Atlantic City Electric Company and none of its
preferred stock. 655 to 761 shares of that preferred stock were
owned by stockholders of the American Gas & Electric Company,
but the finding is that the control exercised by that company
resulted "from its absolute ownership of the entire common stock of
its subsidiaries, and not from control or ownership of preferred
stock by its stockholders." Of the total outstanding stock of the
Atlantic City Electric Company, preferred and common, the American
Gas & Electric Company owned approximately 77 percent.
With respect to control of stock, as creating the affiliation
which affords a basis for a consolidated return, § 1331 of the
Revenue Act of 1921 is to the same effect as § 240 of the Revenue
Act of 1918. The requirement of control, in the absence of legal
title or beneficial ownership, is not satisfied by acquiescence or
by business considerations
Page 288 U. S. 154
without binding force. There must be a control that is legally
enforceable.
Handy & Harman v. Burnet, 284 U.
S. 136,
284 U. S.
140-141. And it must be control of "substantially all
the stock." In
Handy & Harman v. Burnet, supra,
legally enforceable control of somewhat more than 75 percent of the
stock was held to be insufficient. The question, then, is whether,
in the instant case, the entire voting stock, preferred and common,
should be considered in determining whether there was affiliation,
or the common stock alone.
The purpose of the Congress was to secure substantial equality
among stockholders who ultimately bear the burden of taxation, and
to prevent evasion through the manipulation of intercompany
transactions.
Handy & Harman v. Burnet, supra. See
also Burnet v. Aluminum Goods Mfg. Co., 287 U.
S. 544. The requirement of consolidated returns was
"based upon the principle of levying the tax according to the
true net income and invested capital of a single business
enterprise, even though the business is operated through more than
one corporation."
Treasury Regulations No. 45, Art. 631. [
Footnote 1]
Page 288 U. S. 155
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 Treasury Regulations under
the Revenue Act of 1918 regarded the statutory requirement as
relating to the "outstanding voting capital stock (not including
stock in the treasury) at the beginning of and during the taxable
year." Regulations No. 45, Art. 633. The same construction was
given by the Department to the corresponding provision of the
Revenue Act of 1921. Regulations No. 62, Art. 633. The Congress, in
the Revenue Act of 1924, embodied this construction in the statute
itself. [
Footnote 2] Section
240(c)(1), 43 Stat. 288.
See also Revenue Act of 1926, §
240(c)(d), 44 Stat. 46; Revenue Act of 1928, § 141(d), 45 Stat.
831; Revenue Act of 1932, § 141(d), 47 Stat. 213.
Compare
Schlafly v. United States, 4 F.2d 195, 200;
Ice Service
Co. v. Commissioner, 30 F.2d 230, 231;
United States v.
Cleveland, P. & E. R. Co., 42 F.2d 413;
Commissioner
v. City Button Works, 49 F.2d 705.
Nor are we able to conclude that, in the instant case, the
preferred stock with voting right should be excluded because it was
redeemable at any time and had a limited interest in dividends.
Compare Commissioner v. Shillito
Page 288 U. S. 156
Realty Co., 39 F.2d 830;
United States v.
Cleveland, P. & E. R. Co., 42 F.2d 413. Despite
redeemability and the limitation of dividends, the owners of the
preferred stock were not in the position of creditors, but were
stockholders with a proprietary interest in the corporate
undertaking and with a corresponding relation, through the voting
right, to the direction of that undertaking. The voting right
remained unimpaired until actual redemption. The statute is not
concerned with a failure to exercise existing rights, but with what
is deemed to be a more certain and adequate test of a unitary
enterprise. According to this test, petitioner failed to show
affiliation.
Burnet v. Howes Brothers Hide Co., 284 U.S.
583, 584.
Judgment affirmed.
[
Footnote 1]
Article 631 of Regulations No. 45 is as follows:
"
Affiliated Corporations. -- The provision of the
statute requiring affiliated corporations to file consolidated
returns is based upon the principle of levying the tax according to
the true net income and invested capital of a single business
enterprise, even though the business is operated through more than
one corporation. Where one corporation owns the capital stock of
another corporation or other corporations, or where the stock of
two or more corporations is owned by the same interests, a
situation results which is closely analogous to that of a business
maintaining one or more branch establishments. In the latter case,
because of the direct ownership of the property, the invested
capital and net income of the branch form a part of the invested
capital and net income of the entire organization. Where such
branches or units of a business are owned and controlled through
the medium of separate corporations, it is necessary to require a
consolidated return in order that the invested capital and net
income of the entire group may be accurately determined. Otherwise
opportunity would be afforded for the evasion of taxation by the
shifting of income through price-fixing, charges for services, and
other means by which income could be arbitrarily assigned to one or
another unit of the group. In other cases, without a consolidated
return, excessive taxation might be imposed as a result of purely
artificial conditions existing between corporations within a
controlled group."
[
Footnote 2]
With respect to this provision, the report of the Committee on
Ways and Means of the House of Representatives said: "The
requirement that the stock held must be
voting' stock merely
embodies in the law the present rule of the Treasury Department."
House Rep. No. 179, 68th Cong., 1st Sess., p. 24.