On Petition for Review of Decisions of the United States Board of Tax Appeals.
Before Buffington, Davis, and Biggs, Circuit Judges.
It is agreed by the parties that the issues involved in cases No. 5992 and No. 5993 are precisely those raised by the assignments of error in case No. 5991. We therefore will deal with the facts and the law relating to case No. 5991, since our rulings in this case, being equally applicable to the first two cases referred to, will dispose fully of the issues there presented.
In case No. 5991 the issues involved are set out clearly in the assignments of error.*fn1 We think that the questions of law raised can be disposed of best by dealing with the assignments of error seriatim. A preliminary statement of facts is essential, however, in order that the circumstances of the case may be understood.
The board of Tax Appeals determined that deficiencies were due from the petitioner by reason of income and excess profits tax liability for the years ending June 30, 1917 to 1923, inclusive, and for the year ending June 30, 1927.
The petitioner is a corporation of the State of Pennsylvania and at the times with which we are concerned was engaged in the mining of coal in Clearfield county, Pennsylvania. When it was organized in 1894 its stock was owned by two brothers, B. Frank Clyde and William P. Clyde, and Frank H. Wigton was employed as the executive head of the company entitled to receive compensation by way of the stock of the corporation. B. Frank Clyde died in 1906. William P. Clyde, desiring to dispose of all of his business interests so that he might retire, upon August 3, 1906, acting with the executors of his brother's estate, made an agreement with Wigton whereby it was agreed that all of the real estate, mining plants and railroad cars belonging to the petitioner should be transferred to a trustee for the purpose of effecting the terms of a contemplated sale from Clyde and Clyde's executors to Wigton for the sum of $125,000.It was agreed by the parties that until Wigton should carry out the terms of the agreement and pay the stipulated sum, the trustee should lease to him the real estate, mining plants and railroad cars referred to at a stipulated rental which should serve in lieu of interest upon the sum of the purchase price. The agreement also provided that Wigton should purchase from Clyde and Clyde's executors, who must sell, at the price of $46.50 per share, all of the stock of Morrisdale Supply Company, a New Jersey company, which had been incorporated in order to serve as a commissary company for the sale of merchandise and supplies to the employees of the Coal Company. The agreement also provided that upon its execution, all of the stock of the Coal Company owned by the Clyde brothers should be transferred to Wigton for the consideration of a dollar.
The terms of this agreement were extended to August 1, 1914, by supplemental contracts entered into by the parties.
In accordance with the provisions of the agreement of August 3, 1906, the petitioner, the Coal Company, transferred to the trustee the property heretofore referred to and the lands of the Coal Company. Upon August 13, 1906, the Coal Company and Wigton entered into an agreement whereby Wigton agreed to sell and the Coal Company agreed to purchase the real estate and personal property referred to in the agreement of August 3, 1906, for the sum of $165,000. This agreement also provided that the stipulated purchase price of $165,000 should be paid in notes, having a face value of $40,000, bearing 6 per cent. interest, payable monthly, and that the balance of the purchase price be paid within a year. The contract also provided that the trusteed property should be leased to the Coal Company at a rental of $625 per month, which was the sum of the rental required for it from Wigton by the Clyde brothers under the agreement of August 3, 1906.
Upon July 7, 1914, Clyde and Clyde's executors with Wigton sent a written communication to the trustee, to the effect that the lands and premises known as the "Morrisdale Mines property," with certain exceptions, and not including the grant of any personal property, should be transferred by the trustee for the sum of $200,000 to a company about to be created, to be known as the "Morrisdale Land Company." The sum of the consideration, biz., $200,000, was to be secured by a mortgage on the real property and bonds to the extent of $200,000 were then to be issued. Of these bonds, $115,000 face value were to be delivered immediately to Wigton and the remaining bonds were to be sent to the Philadelphia Trust Safe Deposit and Insurance Company to be held by its for the purposes of the trust, set forth in the agreement of August 3, 1906.
Two days later, as contemplated, Wigton organized the Morrisdale Land Company. All of the capital stock of this company, viz., $5,000 par value, was issued to him. The trustee thereupon conveyed all of the real property, which he held under the agreement of August 3, 1906, to the Land Company. The property thus conveyed included interests in coal lands and the fee-simple title to two hundred forty two acres of surface land. Upon July 9, 1914, there were buildings and coke ovens standing upon this surface land. The mortgage was given as contemplated and the bonds secured thereby were issued according to plan.
(1) As to the Question of Affiliation of the Coal Company with the Land Company and the Supply Company during the Calendar Year, 1917.
The Board held that the Coal Company was not affiliated with the Land Company and the Supply Company for tax purposes during the calendar year 1917, though the Land Company and the Supply Company were so affiliated. The petitioner contends that all three companies were affiliated throughout the year 1917.
The applicable statute is the Revenue Act of 1921, c. 136, 42 Stat. 227,*fn2 which provides for the consolidation of corporations for excess profits tax purposes in 1917. The pertinent parts of the statute are as follows:
"Sec. 1331. (a) That Title II of 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.
"(b) For the purpose of this section a corporation or partnership was affiliated with one or more corporations or partnerships (1) when such corporation or partnership owned directly or controlled through closely affiliated interests or by a nominee or nominees all or substantially all the stock of the other or others, or (2) when substantially all the stock of two or more corporations or the business of two or more partnerships was owned by the same interests: Provided, That such corporations or partnerships were engaged in the same or a closely related business, or one corporation or partnership bought from or sold to another corporation or partnership products or services at prices above or below the current market, thus effecting an artificial distribution of profits, or one corporation or partnership in any way so arranged its financial relationships with another corporation or partnership as to assign to it a disproportionate share of net income or invested capital. * * *
"(c) The provisions of this section are declaratory of the provisions of Title II of the Revenue Act of 1917." 42 Stat. 319.
The parties agree, and the Board found, that throughout 1916 and 1917 Wigton owned all of the stock of the three companies involved, other than directors' qualifying shares, and that therefore the first condition of affiliation clearly was fulfilled. The Board also found that the Coal Company, as the lesser of the Land Company, was mining coal at a royalty rate of 8 cents per ton and that the Supply Company sold merchandise to the employees of the Coal Company in return for token money issued by the Coal Company.
The petitioner lays emphasis upon its contention that the royalty rate of 8 cents per ton charged by the Land Company to the Coal Company, as operating lessee, was substantially lower than the ordinary royalty rate for similar mining operations in the Clearfield district at that time and that therefore the Coal Company bought from the Land Company products at prices "below the current market, thus effecting an artificial distribution of profits" within the terms of the statute. The petitioner contends that the prevailing royalty rate was 10 cents per ton in the Clafiried district.
In respect to this contention the Board states as follows:
"What were the circumstances and conditions, the terms of the uniform lease agreements under which it might be said that there was a 'prevailing royalty rate' at 10 per ton in the Clearfield District of Pennsylvania at March 1, 1931? There is no answer to be found in the record. Are the Coal Company's leases which it owned at March 1, 1913, comparable in the rights they confer and the obligations they impose upon the lessee with the uniform lease agreements which, it might be said, establish a 'prevailing royalty rate'? That question is unanswered in the record. The leases are not in evidence, and all that we have been told about them is they run to exhaustion of the coal and provide for royalty payments of 8 per ton of coal mined. Not knowing what the provisions of the Coal Company's leases are, or the provisions of the uniform agreements which establish a 'prevailing royalty rate', we are certainly in no position to make a comparison of the former with the latter for the purpose of determining whether the Coal Company's leases called for less than what was considered a fair royalty in the Clearfield District at March 1, 1913."
This statement by the Board seems incorrect in one particular. Two leases of coal properties adjoining the property leased to the petitioner, and in one case underlying a seam leased by the petitioner, are in evidence, viz., the Ashman Coal Company lease and the Victoria Coal Mining Company lease. These two leases respectively were executed upon the 20th day of April, 1909, and the 2d day of August, 1909. But we are not satisfied that the Ashman and Victoria leases, even when considered with the testimony of Womelsdorff, an experienced mining engineer called by the petitioner, are sufficient to establish the prevailing royalty rate as contended for by the petitioner. The decision, however, as to the weight of evidence rests with the Board and we are not prepared to say that the Board in refusing to find that the prevailing royalty rate in the Clearfield district was 10 cents per ton ton of coal mined acted capriciously or arbitrarily in view of the absence from the record of the petitioner's leases.
The petitioner, however, refers to other circumstances which it alleges show a condition of affiliation between the Coal Company and the other corporations. We will discuss some of these circumstances. The three companies had their principal offices in the Real Estate Trust Building at Philadelphia. This item tends to prove affiliation, but as we have stated previously the determination of the weight of testimony is for the Board. The petitioner contends that in the year 1917, $125,500 par value of the bonds, originally issued in the amount of $200,000 by the Land Company, were outstanding, and upon these bonds the Land Company paid interest, which payments in fact were made for the benefit of the Coal Company and Wigton, the owner of the Coal Company's stock. We can find no evidence which supports the contention that interest was paid upon the outstanding bonds of the Land Company by the Land Company for this reason. As stated by the Board, the Land Company acquired its properties " * * * in exchange for its bonds of the par value of $200,000 and its stock of the par value of $5,000." There is no evidence of record tending to prove that the consideration thus given by the Land Company for the property represented anything but a fair price. It is a matter of record in the case at bar that the Board allowed the Land Company paid-in surplus because of the transaction referred to.
The petitioner also refers to certain accounts due and owing between the three companies, totaling $90,073.18, and refers to these as "inter company indebtedness." The existence of such accounts does no of itself prove affiliation, but again the weight of such evidence is for the determination of the Board.
The petitioner also lays emphasis upon the fact that the Supply Company served as a commissary, that token money was used at the commissary by the employees of the Coal Company and was redeemed by the Coal Company from the wages of its employees, and that therefore the Supply Company functioned as an integral part of the Coal Company. If so, the petitioner did by indirection that which the law of Pennsylvania prohibited it from doing directly.*fn3 But in our opinion there is no sufficient ground for this court to set aside the ruling of the Board by reason of this particular issue. In the last analysis, we deem that the test of affiliation of these companies is there economic necessity to each other. Business may be so related despite divergent corporate purposes. In the case at bar, however, the economic connection between the Coal Company and the Supply Company was superficial in its nature and did not exist of necessity. Nor were the Coal Company and the Supply Company engaged in closely related business. In this connection the Board stated:
"In the instant proceeding there is lacking proof of facts necessary to show that the Coal Company and the Supply Company were engaged in a closely related business. Not only does the proof fail to show that the Supply Company was an essential adjunct to the Coal Company, but, on the contrary, under the statutes of Pennsylvania, a coal mining company is prohibited from operating a commissary for the purpose of selling merchandise to its employees. We need not inquire into the reasons of this legislation, although one of them, at least, may be obvious. Furthermore, there is no evidence showing that the Coal Company bought from or sold to the Supply Company, or that the Supply Company brought from or sold to the Coal Company. It does appear that the Supply Company was selling merchandise to third parties, namely, employees of the Coal Company. It does not appear, however, that the Supply Company was selling to all of the employes of the Coal Company or that those employees of the Coal Cmpany who bought from the Supply Company bought all of their necessary merchandise from that company. It does not appear that there were no other commissary stores there or nearby where the employees of the Coal Company could, if they wished, do their trading for merchandise. Nor is there any showing that the Supply Company did not dealt with others than the employees of the Coal Company. The evidence shows that the employees of the Coal Company could draw their wages in token money which the Supply Company would accept for merchandise. This token money was redeemed by the Coal Company out of funds withheld from the employees' wages. By this arrangement the Coal Company did not guarantee or obligate itself to pay the Supply Company for merchandise purchased by any employee of the Coal Company. It merely obligated itself to pay its own obligations, as evidenced by the tokens, by redeeming them when presented for redemption. It does not appear that the Supply Company had one only commissary or store there or nearby which thus accepted such token money for redemption by the Coal Company. Clearly the petitioners have not shown that the Coal Company and the Supply Company were engaged in a closely related business."
Further we can see no sufficient basis in the evidence for holding that the Coal Company was affiliated with the Land Company. Certainly they were not engaged in the "same" business within the meaning of subsection (b) of section 1331. Nor were the respective businesses of the companies "closely related" within the meaning of the first provision of subsection (b).
We think that the principles enunciated in the case of United Thacker coal Co. v. Commissioner, 1 Cir., 46 F.2d 231, govern the fact situation presented by the case at bar. See also Montgomery Cotton Mills v. United States, 67 Ct.Cl. 169, certiorari denied 280 U.S. 560, 50 S. Ct. 18, 74 L. Ed. 615; Nowland Realty Co. v. Commissioner, 7 Cir., 47 F.2d 1018; Brownsville Coal & Coke Co. v. Heiner, D.C., 38 F.2d 248.
We concur in the ruling of the Board of Tax Appeals. (2), (3), (4) and (5) As to the Value for Tax Purposes of Coal, Buildings, Coke Ovens and Surface Land Conveyed to the Land Company.
On July, 9, 1914, coal in the ground, buildings, coke ovens and surface lands were conveyed by the trustee, puissant to the written instructions of Cycle, Clyde's executors and Wigton, to the newly incorporated Land Company. The consideration paid by the Land Company consisted of $5,000 par value (all) of its capital stock, and $200,000 par value of bonds secured by the mortgage on the properties conveyed.
The Commissioner determined the values of these properties as follows:
Coal in the ground $136,359.76
The Board of Tax Appeals supported this determination of values made by the Commissioner, and held that deductions for depreciation and depletion must be based upon such values and that these values when depleted and depreciated should be used as the basis for computing the consolidated invested capital for the years 1917 and 1921, ...