Petitions for Review of Decisions of the United States Board of Tax Appeals.
Before MAJOR and TREANOR, Circuit Judges, and LINDLEY, District Judge.
These cases are here on petitions for review of decision of the United States Board of Tax Appeals. The decisions were rendered in proceedings for the redetermination of income tax deficiencies.Causes No. 6435 and 6436 were docketed as one cause by the United States Board of Tax Appeals, the consolidated causes presenting two issues. One issue was decided in favor of the taxpayer, and the Commissioner petitions for review thereof in our cause No. 6435. The other issue was decided in favor of the Commissioner and the taxpayer petitions for review in our cause No. 6436. Cause No. 6437 in this court is here on petition of the taxpayer for a review of an adverse decision in a separately docketed cause before the Board. The causes before the Board of Tax Appeals were consolidated for hearing and the appeals to this court are likewise consolidated. Causes No. 6436 and 6437 present the same question of law and will be discussed together.
In this cause the petitioner is the Commissioner of Internal Revenue and the respondent-taxpayer is Trustees of Lumber Investment Association which holds stock in various corporations. By reason of its large holdings in other corporations it has become a "parent" corporation which operates subsidiary corporations; and in numerous instances the parent and subsidiaries have qualified as "affiliated corporations" under the Revenue Acts of 1924 and 1926.*fn1 And the decision in cause No. 6435 depends upon whether three corporations, including Trustees of Lumber Investment Association,*fn2 taxpayer-respondent, were affiliated during the years 1924, 1925 and the first seven months of 1926. And the answer to the foregoing question depends upon the ownership of 2,000 shares of one of the subsidiary corporations.
The 2,000 shares, the ownership of which is in question, were part of an issue of 34,500 shares of stock of Park Falls Lumber Company. The taxpayer owned and held 32,250 of these shares during the period herein involved. If the taxpayer owned the 2,000 shares, as it claims, then it owned more than 95% of the stock of Park Falls Lumber Company. It also appears from the facts that the Taxpayer-respondent and the Park Falls Lumber Company owned all of the stock of the second subsidiary, the Edward Hines Farm Land Company; and it is assumed by both petitioner and respondent that if respondent held more than 95% of the stock of Park Falls Lumber Company "the same interests" would then have the ownership of more than 95% of the stock of Edward Hines Farm Land Company. The issue as to the ownership of 2000 shares arises from the following facts:
On January 1, 1920, a written instrument was executed by Park Falls Lumber Company*fn3 and one W. B. Clubine. By the terms of the instrument Clubine agreed to enter Park Falls Lumber Company employ as general manager of its business for a period of five yearsf and Park Falls agreed to employ him as its general manager for the term at a salary of $12,000 a year. The instrument contained further recitals as follows: "As further consideration of this agreement and because of the particular qualifications of (Clubine) * * * and as an inducement to * * * (Clubine) * * * to render efficient service and to continue such employment for the full five years, the Trustees of Lumber Investment Association agrees to transfer to (Clubine) as of this date, $200,000 in par value of the capital stock of Park Falls Lumber Company, in consideration whereof (Clubine) agrees to and does give to said Trustees of Lumber Investment Association his promissory note of even date for the sum of $200,000 payable on or before five years from date with interest at the rate of 5% per annum." The instrument further provided that the certificate or certificates of stock should state that the stock was issued "conditioned upon and subject to the terms of the instrument of contract dated January 1, 1920." It was further agreed that the certificates of stock should be indorsed in blank by Clubine and should remain in the custody of the Trustees of Lumber Investment ASsociation, taxpayer-respondent, "as collateral security for the note hereinbefore described." All dividends declared on the stock were to be applied first to payment of interest on the note, and the remainder if any was to be applied on the principal. It was agreed further that in case Clubine's employment should terminate for any reason, including death, before five years, or before the payment of the note by the application of the dividends thereto, then cthe party of the second part, or his estate, if he shall have died, shall have the right to elect either (1) to purchase the said stock or (2) to sell it to the Trustees of the Lumber Investment Association." If the election should be to purchase, the purchase price was to be the unpaid balance of the note; and if the election should be to sell, the trustees were to pay Clubine or his estate the excess of the book value of the stock over the unpaid balance of the note.But in case the book value of the stock should be less than the unpaid balance of the note, the note and all mutual claims concerning the stock were to be cancelled; and neither Clubine nor his estate was to be held for any deficiency.
The agreement also provided for its extension for a further period of five years if Clubine, at the end of the first five year period, had not then fully paid for the stock according to the method prescribed in the agreement and if Clubine continued in the employment of the company for a further term of five years.
On the same date that the written instrument of contract was executed by PArk Falls Company and Clubine, Trustees of Lumber Investment Association adopted and approved same by a written statement which was endorsed on the written instrument.
In accordance with the terms of the foregoing three party agreement Trustees of Lumber Investment Association issued to Clubine certificate No. 10 for 2,000 shares of stock of the Park Falls Lumber Company and obtained Clubine's receipt therefor. The certificate of stock carried a written notation that it was issued subject to the terms of the aforesaid contract. Later Clubine endorsed the certificate in blank and delivered it to the trustees as collateral security for the payment of his note.*fn4
After execution of his note and receipt of certificate No. 10 for the shares of stock Clubine, at the request of a representative of Trustees of Lumber Investment Association, gave his check payable to the Association to cover United States Revenue Stamps of $40, which were required for the stock transfer.
On January 2, 1920, there was entered a credit of $200,000 on the books of Trustees of Lumber Investment Association. The credit was designated as "W. B. Clubine folio, J. 1;" the "J. 1" being a cross reference to a journal entry which read in part "a Sale 200 shares, stock to W. B. Clubine." Also the "Walter B. Clubine" account on the books of Lumber Investment Association was charged with interest on account of Clubine's note.
On July 17, 1924, a second written agreement was executed between the Park Falls Lumber Company and Clubine which continued the original agreement for five years with some modification of its terms. Under the modified agreement, in case of Clubine's death or his incapacity by accident or sickness, he, or his estate, was given the additional options first of having the Trustees of Lumber Investment Association hold the stock until such time as the dividends should pay the purchase price, or second, or selling the stock to outside parties subject to payment of any unpaid balance thereon at the time of such transfer.Further the price at which Clubine "purchased the said stock" was revised as of January 1, 1920, from $100 to $80 per share and interest was recomputed from January 1, 1920 at 5% based on the price so revised. In making the necessary adjustments a payment of $10,000 for interest was credited to Clubine's account and a $40,000 credit was indorsed on his note.
During the period between January 1, 1920, and August 2, 1926, no cash payments were made by Clubine or by anyone on his behalf on account of either the principal of the $200,000 note or interest thereon. Nor during that period were there any dividends declared on the 2,000 shares of stock, nor were there any credits applied on the note except the $40,000 adjustment credit of July 7, 1924.
From January 1, 1920, to August 2, 1926, there were three formal stockholders meetings and Clubine voted in person as a stockholder at two of the meetings and by proxy at the other.
In the affiliated questionnaires that were filed with the Commissioner of Internal Revenue for the years 1921, 1923, 1924, Trustees of Lumber Investment Association was reported as the owner of only 32,250 of the 34,500 outstanding shares of the capital stock of the Park Falls Lumber Company; and the remaining 2,250 shares were reported in the 1921 questionnaire as being owned by "minority interests," and in the 1923 and 1924 questionnaire as being owned as follows: Walter B. Clubine, 2,000 shares. Gertrude W. Bennett, 250 shares.
No more questionnaires were filed until June 18, 1928, when one was filed by Park Falls Lumber Company (name then being Edward Hines Hardwood and Hemlock Company) advising of change in the ownership of its corporate stock as a result of the acquisition by Trustees of Lumber Investment Association of 2,000 shares in 1926 from Walter B. Clubine.
In the stipulation of facts is the recital that in 1920, when Trustees of Lumber Investment Association accrued on its books $10,000 as interest due from Walter B. Clubine on his note of $200,000, it was then thought that said note and accrued interest would be paid, and it was not determined until 1926 that the note (which on July 17, 1924, had been ...