Howes Bros. Hide Co. v. Commissioner , 17 B.T.A. 129 ( 1929 )

HOWES BROTHERS HIDE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

HOWES BROTHERS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Howes Bros. Hide Co. v. Commissioner

Docket Nos. 25483, 28972.

United States Board of Tax Appeals

17 B.T.A. 129; 1929 BTA LEXIS 2350;

August 22, 1929, Promulgated

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Affiliation denied.

Robert A. Littleton, Esq., and James A. Councilor, C.P.A., for the petitioners.

E. C. Lake, Esq., for the respondent.

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MORRIS

These proceedings were consolidated for hearing and decision since the question presented in each case is whether the petitioners, together with the Huntington Shoe & Leather Co., should be considered an affiliated group for the calendar years 1918 and 1920. The respondent denied that the companies were entitled to affiliation and determined a deficiency against the petitioner, Howes Brothers Hide Co., for 1918 in the amount of $3,978.23. Against the petitioner, Howes Brothers Co., respondent determined a deficiency for 1920 in the amount of $25,035.72.

FINDINGS OF FACT.

The petitioner, Howes Brothers Co., sometimes hereinafter referred to as the Company, was incorporated under the laws of the State of Massachusetts, and has its principal office and place of business at 321 Summer Street, Boston, Mass. The petitioner, Howes Brothers Hide Co., hereinafter referred to as the Hide Co., was incorporated in 1917 under the laws of the State of Maine, but its principal place of business is 321 Summer Street, Boston. The Huntington Shoe & Leather Co. was incorporated under the laws of the State of Indiana and its principal office and place of business is in Huntington, Ind.

The petitioners herein occupy the same office space and have the same employees. The company buys raw hides in domestic and foreign markets and ships them to tanneries where they are manufactured into leather. The leather is then shipped to the Company's warehouses at St. Louis or Boston. Upon sale of the leather by the Company it is shipped to the customer, the sale being made by the Company for the account of the tannery. The Company derives its profits primarily from the commissions which it receives for selling the leather, and from interest charged upon the total cost of the hides from their purchase until their sale as leather. If the completed transaction shows a loss the Company collects the deficit from the tannery, but if there is a balance after deducting the cost, commissions and interest from the sale price of the leather such balance is paid over to the tannery.

The Company's authorized capital stock was $3,000,000, par value $100 per share. The stock was divided into first preferred series A, $600,000, first preferred series B, $900,000, second preferred $350,000, and common, $1,150,000. The stock was owned during 1918 and 1920 as follows:

	1918
		First preferred
Stockholder	Common	Series A	Series B	Second preferred
Ernest G. Howes	1,920			1,355
F. L. Howes	1,920			1,355
H. S. Howes	887	5		370
S. C. Howes	886	32		370
G. C. Howes	887			50
Howes Brothers Hide Co
Sundry small stockholders		5,774	4,189
Total	6,500	5,811	4,189	3,500

	1920
		First preferred
Stockholder	Common	Series A	Series B	Second preferred
Ernest G. Howes	1,920			1,355
F. L. Howes	1,920			1,355
H. S. Howes	887	5		370
S. C. Howes	886	32		370
G. C. Howes	887			50
Howes Brothers Hide Co	5,000
Sundry small stockholders		5,774	9,189
Total	11,500	5,811	9,189	3,500

The first preferred stock was sold by the Company to secure additional capital for its business, which required a large amount of available cash. The first preferred series A stock paid 7 per cent cumulative dividends, and the 5,811 shares outstanding were principally held by stockholders owning 50 or more shares. The first preferred series B stock paid 6 per cent cumulative dividends and about 75 per cent of the stock was held by stockholders owning less than 50 shares. The first preferred shareholders almost without exception were absent from stockholders' meetings, and as a number of them were relatives, friends or business associates of the five Howes brothers, or were employees of the Company, the preferred stock that was voted at stockholders' meetings was by proxies given two of the Howes brothers.

The first preferred stock carried with it certain limitations and preferences such as the right of the Company at any time to redeem the stock upon written notice of not less than 90 days at $11o per share plus accumulative dividends and interest at 7 per cent per year from the last date for payment of a dividend to the date of redemption. No mortgage could be created by the Company unless authorized by a vote of 75 per cent of all first preferred shares then outstanding. No dividends could be paid on second preferred or common stock which would reduce the Company's quick assets to less than 150 per cent of the par value of all first preferred stock outstanding. Neither the first nor second preferred stockholders were entitled to share in any issue of additional stock or increase of capital, and it was expressly provided on the back of each share of first preferred stock that, "If the dividend for any quarter is not paid in full on all the first preferred stock at the time outstanding and such default continues for a period of eighteen (18) months, the holders of first preferred stock shall thereafter, as long as any default in the payment of dividends thereon continues, be entitled to exclusive voting power."

The directors of the Howes Brothers Co. were the five Howes brothers and John B. Fallon.

The Hide Co. was primarily a holding company which the five Howes brothers had organized to hold stock that they owned individually in various tanneries, chemical enterprises, and a shoe company. The Hide Co. financed the tanneries and companies in which it held stock, and in addition purchased hides through the Company.

The Hide Co. had only one class of stock - common, and it was held during 1918 and 1920 as follows:

E. G. Howes	5,669
F. L. Howes	5,670
S. C.Howes	2,619
H. S. Howes	2,618
G. C. Howes	2,619
Total	19,195

The Huntington Shoe & Leather Co. had three classes of stock - first preferred, second preferred, and common, but from and after April 22, 1918, only the latter had voting rights. During 1918 and 1920 the common stock was held as follows:

Stockholder	1918	1920
Eldora W. Howes	75	75
George C. Howes	105	105
Henry S. Howes		10
E. P. Melson	250	125
C. A. Sawyer, jr	680	680
H. M. Webster		125
Edna M. Webster	40	40
Clarence A. Howell	25	25
Helen B. Howes	10
Other stockholders	15	15
	1,200	1,200

The above stockholders bore the following relationship to the five Howes brothers: Eldora Howes, wife of George C. Howes; George C. and Henry Howes, two of the five Howes brothers; E. P. Melson, father of Edna Webster; C. A. Sawyer, jr., nephew of Ernest G. Howes; H. M. Webster, brother-in-law of George C. Howes; Edna Webster, wife of H. M. Webster; Clarence A. Howell, employee of Howes Brothers Co. The 680 shares of stock standing in the name of C. A. Sawyer, Jr., were purchased with funds advanced by the Hide Co., the advance being made either to Sawyer, G. C. Howes, or both. Eldora Howes held 40 shares of first preferred, series A, inHowes Brothers Co., and Clarence A. Howell owned 100 shares of the same stock, while C. A. Sawyer, Jr., owned 50 shares of the Howes Brothers Co.'s first preferred, series B, stock.

Since its organization the Huntington Shoe & Leather Co. has been financed by the petitioners. At the close of 1918 the Huntington Co. owed Howes Brothers Co. approximately $325,000 for leather purchased. At the close of 1920 the Huntington Co. had received advances from Howes Brothers Co. of $375,000 and from the Hide Co. of $150,000, in addition to approximately $325,000 of leather from Howes Brothers Co. None of this indebtedness had been liquidated by the Huntington Co. up to 1920, and only about $100,000 since then.

The balance sheets attached to a revenue agent's report of the three companies show a surplus or deficit for each company at the end of the year as follows:

Company	Dec. 31, 1917	Dec. 31, 1918	Dec. 31, 1919	Dec. 31, 1920
Howes Brothers Co.
surplus	$957,680.09	$1,045,399.29	$1,281,529.08	$1,413,099.67
Howes Brothers Hide
Co. surplus	196,620.95	359,618.34	540,576.44	498,250.46
Huntington Shoe &
Leather Co. deficit	-813.60	-192,385.80	-195,809.61	-341,591.86

The balance sheets also show that the assets of the Howes Brothers Co. consisted almost entirely of cash, accounts receivable and Liberty bonds.

The Howes Brothers Co. has never passed a dividend on its first preferred stock.

For 1918 and 1920 the three companies filed consolidated returns. The respondent denied them affiliation in each of the years, determining a deficiency of $3,978.23 against the Hide Co. for 1918, and a deficiency of $25,035.72 against Howes Brothers Co. for 1920.

OPINION.

MORRIS: These proceedings raise the question of the petitioners' right to affiliation with each other and with the Huntington Shoe & Leather Co. for the calendar years 1918 and 1920. Affiliation of two or more corporations is provided for by section 240(b) of the Revenue Act of 1918, which states that corporations shall be deemed affiliated "(1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests."

The petitioners contend that since the Howes Brothers Co. had the right to redeem its first preferred stock at any time, that the five Howes brothers, who owned all the common stock and all the second preferred, owned and controlled substantially all the stock of Howes Brothers Co.; and that the Howes brothers, together with members of their families and relatives, owned or controlled 1,035 shares out of 1,200 shares of the common stock of the Huntington Shoe & Leather Co.

We are unable to agree with the petitioners' first contention, as it is our opinion that the same interests did not own or control substantially all the stock of Howes Brothers Co. All of the capital stock of this company exercised voting rights, and the outstanding first preferred was equal to the total outstanding second preferred and common stock It is true that at all times the five Howes brothers owned and controlled 50 per cent of the voting stock, but the evidence fails to show that they ever had a beneficial interest in any substantial amount of first preferred stock. It must be admitted that the Howes brothers dominated the company, directed its policies, and managed its business, but the test of the statute makes no mention of these factors in laying down the rule governing affiliation. The statute provides that substantially all the stock must be owned or controlled by the same interests, and "substantially all" can not be construed to mean a bare majority.

Counsel would have us hold that, since the common stockholders had it within their power to call the first preferred for redemption at any time, they effectually controlled this class of stock within the meaning of section 240(b) of the 1918 Act. It is undoubtedly true that the first preferred stockholders held their stock subject to call after proper notice, but it is just as true that this power was never exercised, and that the first preferred stockholders exercised their voting rights at every stockholders' meeting. The power or ability to control is not the control required by the statute, and it can not be said from the evidence before us that the first preferred stockholders were lacking in any of the elements of ownership of their stock. The fact that as a general rule the first preferred stockholders elected to vote by proxies is proof in and of itself that the Howes brothers did not have the control over the first preferred stock required by the statute. It should be further noted that the first preferred stockholders had the exclusive voting power in case of default in payment of dividends on their stock for a period of 18 months.

With respect to the Huntington Shoe & Leather Co., it appears that only two of the Howes brothers owned shares of its common stock, and an effort was made to show that 630 of the shares held by C. A. Sawyer, Jr., a nephew of the Howes brothers, were held by him as trustee for the Hide Co. and George C. Howes. Even if it be conceded that these 630 shares were owned or controlled by the same interests, it is our opinion that this fact would be insufficient to justify us in overruling the determination of the respondent. In view of the language used in numerous opinions of the Board and the courts, it is patent that, while friends, relatives, and business associates may concur in and work harmoniously with the management of the corporation, nevertheless, this control is not the control required by the statute, which refers to stock control. ; .

In deciding these proceedings we have considered the cases cited by counsel and especially our opinion in . In that case the minority stockholders represented less than 25 per cent in one company, and less than 30 per cent in the other company, of the voting stock, while in these proceedings the minority stockholders of the Howes Brothers Co. constitute something less than 50 per cent of the voting stock. In our opinion these proceedings are governed by the principles laid down in the Hirsch case, supra, and in , and, accordingly, we approve the determination of the respondent.

Judgment will be entered for the respondent.