American Water Works Co. v. Commissioner , 25 T.C. 903 ( 1956 )

American Water Works Company, Inc. and Affiliated Companies, Petitioners, v. Commissioner of Internal Revenue, Respondent

American Water Works Co. v. Commissioner

Docket Nos. 54065, 56532

United States Tax Court

25 T.C. 903; 1956 U.S. Tax Ct. LEXIS 273;

January 31, 1956, Filed

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Decisions will be entered for the respondent.

1. Where capital distributions were made by corporations in an affiliated group, both in years when the distributing corporations were included in the consolidated income tax returns filed for the group and in years when such corporations were not so included, to the parent corporation on stock held by the parent in those corporations, held, the unadjusted basis of such stock shall be reduced by the total amount of such capital distributions.

2. Where net operating losses are sustained by a corporation in an affiliated group in years when consolidated income tax returns were filed and such losses were availed of by the affiliated group, held, that the unadjusted basis of the stock of that corporation held by the parent shall be reduced by the amount of such operating losses, even though it appears that the stock in question was issued subsequently to the years in which the losses occurred.

George Craven, Esq., for the petitioners.

Stephen P. Cadden, Esq., for the respondent.

Mulroney, Judge. Murdock and Raum, JJ., dissenting.

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MULRONEY

The Commissioner determined deficiencies in income tax for the calendar year 1948, in the amount of $ 79,497.05, and for the calendar year 1949, in the amount of $ 78,123.69. Docket No. 54065, involving the deficiency for 1948, and Docket No. 56532, involving the 1949 deficiency, were consolidated in this proceeding. Certain of the adjustments set forth in the statutory notice are uncontested. The issues are (1) whether there should be a reduction of the basis of stock held by a member of an affiliated group of corporations in another member of the affiliated group where distributions are made from the capital of the issuing corporation to the stockholder corporation in years when consolidated income tax returns were filed which included the two corporations, and (2) whether there should be a reduction of the basis of shares of stock held by a member of an affiliated group of corporations in another member of the affiliated group where net operating losses are sustained by the issuing corporation in years when consolidated income tax returns were filed which included the two corporations but before the shares of stock in question were issued.

FINDINGS OF FACT.

All the facts have been stipulated and they are incorporated herein by this reference.

The petitioner is a Delaware corporation with its principal office at Wilmington, Delaware. During the calendar years 1948 and 1949, petitioner's principal office was at New York, New York.

The petitioner was incorporated in 1936 as a holding company for stocks and securities of water utility companies. During 1948, petitioner owned more than 95 per cent of the stock of approximately 80 companies.

Consolidated income tax returns for the calendar years 1948 and 1949 were filed by the petitioner for itself and 69 affiliated corporations on Forms 1120 and 1122 with the then collector of internal revenue for the second district of New York.

In 1948 the petitioner was the owner of 5,200 shares of common stock of Texarkana Water Corporation (hereinafter referred to as Texarkana), which was all the outstanding stock of Texarkana. These shares were sold by the petitioner on August 27, 1948, for a total consideration of $ 1,816,748.14. Deductible expenses in connection with this sale of 5,200 shares of stock amounted to $ 6,600.

The petitioner acquired such 5,200 shares of stock September 1, 1947, on a nontaxable transfer from the American Water Works and Electric Company, Incorporated (hereinafter referred to as the transferor), and held such stock at the same basis at which it was held by the transferor. The unadjusted basis of the stock to the petitioner in 1948 was $ 84,558.54 for the 4,000 shares and $ 115,755.55 for the 1,200 shares. The transferor acquired 4,000 shares of such stock in 1926, at which time this was all the outstanding stock of Texarkana, and in 1941 purchased an additional 1,200 shares of newly issued stock, making a total of 5,200 shares and constituting all the outstanding stock of Texarkana.

Texarkana was a member of the affiliated group of corporations for which the petitioner filed consolidated returns for the calendar year 1948, and it was included in the consolidated returns filed by the petitioner and its transferor corporation for prior years for which consolidated returns were permitted under the Federal income tax laws.

The petitioner and its transferor filed consolidated income tax returns with Texarkana for the years 1926 through 1933 and for the years 1942 to 1948, inclusive. The petitioner and its transferor in the years 1934 to 1941, inclusive, when no consolidated returns were filed with Texarkana, received distributions from the capital of Texarkana, which distributions amounted to $ 114,306.90 on the 4,000 shares and $ 13,200 on the 1,200 shares. In the years when consolidated returns were filed with Texarkana, the petitioner and its transferor received distributions from the capital of Texarkana amounting to $ 54,407.57 on the 4,000 shares and $ 15,122.27 on the 1,200 shares. Total distributions made to the petitioner and its transferor from the capital of Texarkana are as follows:

Year	4,000 shares	5,200 shares
1933	$ 4,000.00
1934	5,000.00
1935	2,000.00
1936	4,000.00
1937	12,000.00
1938	18,821.03
1939	10,451.08
1940	18,034.79
1941		$ 57,200.00
1942		16,546.55
1943		14,736.63
1944		11,477.29
1945
1946		9,021.90
1947		13,747.47
Total	$ 74,306.90	$ 122,729.84

In the years for which the petitioner filed consolidated returns with Texarkana, Texarkana sustained the following net losses which were allowed as deductions in arriving at the net consolidated income of the petitioner and its affiliated companies:

1929	$ 831.25
1930	3,365.59
1931	8,310.09
1932	8,908.29
1933	15,581.90
Total	$ 36,997.12

In the determination of the adjusted basis for computing the gain on the sale of Texarkana stock, the petitioner is entitled to include the sum of $ 50,643.46 on account of Federal income taxes and interest of Texarkana assumed by the petitioner, plus the allocated portion of any deficiency in Federal income tax for the calendar year 1948 of the petitioner and its affiliated companies.

The petitioner in the years 1948 and 1949 owned 20,000 shares of common stock of City Water Company of Chattanooga (hereinafter referred to as Chattanooga). The petitioner acquired this stock on September 1, 1947, in a nontaxable transfer from American Water Works and Electric Company, Incorporated, and such stock had the same basis to the petitioner which it had to the transferor. The unadjusted basis of this stock to the petitioner was $ 1,102,497.50, of which the unadjusted basis of 15,000 shares of such stock, acquired by the petitioner's transferor in 1914, was $ 641,452.50, and the unadjusted basis of the remaining 5,000 shares, acquired by the petitioner's transferor after 1914, was $ 461,045. The 15,000 shares of stock acquired by the petitioner's transferor in 1914 and the remaining 5,000 shares acquired by the petitioner's transferor after 1914 constituted all the outstanding common stock of Chattanooga. The 5,000 shares of common stock were newly issued stock acquired by the petitioner's transferor as follows:

Year	Shares	Consideration
1917	1,160	$ 116,000
1919	1,243	124,300
Dec. 30, 1940	2,597	220,745
Total	5,000	$ 461,045

Chattanooga also had voting preferred stock outstanding, and in 1948 and 1949 the petitioner owned 58.82 per cent of the total outstanding shares of the voting stock of Chattanooga.

Chattanooga was not a member of the affiliated group for which the petitioner filed consolidated returns for the calendar years 1948 and 1949 and other years subsequent to 1933, but was a member of the affiliated group for which the petitioner and its transferor filed consolidated returns for 1933 and prior years for which consolidated returns were permitted under the income tax laws.

The petitioner and its transferor in years prior to 1948 for which no consolidated returns were filed with Chattanooga received distributions of $ 399,048.05 from capital of Chattanooga on the 15,000 shares of common stock, and in the years for which consolidated income tax returns were filed with Chattanooga, petitioner and its transferor received distributions of $ 290,994.68 from capital of Chattanooga, making a total of $ 690,042.73. Total distributions received by the petitioner and its transferor from the capital of Chattanooga on the remaining 5,000 shares of common stock of Chattanooga in 1949 and prior years amounted to less than $ 461,045. Total distributions made to the petitioner and its transferor from capital of Chattanooga are as follows:

Year	17,403 shares	Year	20,000 shares
1925	$ 1,749.45	1938	$ 23,579.46
1926	20,225.33	1939	36,310.84
1927	12,527.48	1940	46,988.10
1928	18,841.93	1941	67,277.80
1929	44,069.93	1942	25,209.91
1930	42,292.27	1943	67,087.97
1931	121,821.00	1944	18,220.04
1932	47,087.86	1945	26,199.44
1933	28,996.92	1946	19,227.71
1934	43,014.19	1947	21,701.04
1935	61,274.24	1948	26,163.46
1936	3,248.62	1949	33,687.27
1937	35,439.66

The petitioner in 1948 received distributions of $ 19,622.59 from the capital of Chattanooga on the 15,000 shares of common stock, and in 1949 received distributions of $ 25,265.45 from the capital of Chattanooga on such 15,000 shares of common stock.

Greenwich Water System, Inc. (hereinafter referred to as Greenwich), and Cohasset Water Company (hereinafter referred to as Cohasset) were members of the affiliated group for which consolidated returns were filed by the petitioner for the year 1949 and prior years for which consolidated returns were permitted under the income tax laws.

In 1949 Greenwich owned 196 shares of preferred stock and 804 shares of common stock of Cohasset, which was all the outstanding stock of Cohasset. This stock, which was acquired by Greenwich in 1929, was sold by Greenwich in 1949 for $ 249,337.63. Deductible expenses incurred in this sale amounted to $ 3,554.59. The unadjusted basis of this stock to Greenwich was $ 213,563.82, which it is entitled to increase by the amount of $ 751.15 on account of Federal income tax of Cohasset assumed by Greenwich. Such basis is reduced by the amount of $ 6,353.19, due to net losses of Cohasset in years for which consolidated returns were filed by it and Greenwich and which were allowed as income tax deductions.

In years for which consolidated returns were filed which included Greenwich and Cohasset, Greenwich received distributions from the capital of Cohasset, on the stock held by Greenwich, in the amount of $ 17,686.27, and in the years when no consolidated income tax returns were filed which included Greenwich and Cohasset, Greenwich received distributions of $ 10,450.72 from capital of Cohasset. Total distributions to Greenwich from the capital of Cohasset were as follows:

Year	Amount
1931	$ 2,291.72
1932	1,442.88
1933	4,400.52
1934	1,397.70
1935	1,246.00
1936	1,051.32
1937	2,486.32
1938	2,055.84
1939	$ 1,157.45
1941	1,056.09
1942	724.00
1945	1,115.60
1947	4,750.00
1948	1,761.55
1949	1,200.00

The respondent determined an increase of $ 149,877.93 in petitioner's gain on the sale of Texarkana stock in 1948 by reducing the adjusted basis of such stock in that amount under section 23.34 of Regulations 104. A total of $ 168,714.47 had been distributed out of capital by Texarkana to petitioner and its transferor on the 4,000 shares of Texarkana common in years when consolidated income tax returns were filed by Texarkana and the petitioner as well as in years when no such returns were filed, and a total of $ 28,322.27 had been distributed out of capital on the 1,200 shares. Respondent applied the capital distributions of $ 168,714.47 to the unadjusted basis of the 4,000 shares, $ 84,558.54, reducing such basis to zero, and respondent also applied the capital distributions of $ 28,322.27 to the unadjusted basis of the 1,200 shares, reducing such basis ($ 115,755.55) by that amount. Petitioner, in reporting the gain from the sale of 5,200 shares of Texarkana stock in 1948, did not reduce the basis of such stock for any distributions made out of capital by Texarkana to the petitioner. Respondent also reduced the basis of the 1,200 shares of Texarkana common stock held by petitioner by the amount of $ 36,997.12, which represented net operating losses sustained by Texarkana in the years 1929 to 1933 and availed of in the consolidated income tax returns filed in those years. Petitioner made no reductions in the basis of the 1,200 shares for these net operating losses.

The respondent determined in the statutory notice a further increase of $ 19,662.59 in petitioner's capital gains for the calendar year 1948. Prior to 1948, a total of $ 690,042.73 had been distributed out of capital by Chattanooga to the petitioner on its 15,000 shares of common stock, in years when consolidated income tax returns were filed by Chattanooga and the petitioner as well as in years when no such returns were filed. Respondent applied these distributions against petitioner's basis in the 15,000 shares, $ 641,452.50, reducing such basis to zero. Distributions of $ 19,662.59 to the petitioner on the 15,000 shares in 1948 out of Chattanooga's capital, being in excess of the basis of such shares, were determined by the respondent to be taxable as capital gains to the petitioner in that year. Distributions of $ 25,265.45 to the petitioner on the 15,000 shares out of Chattanooga's capital in 1949, being in excess of the basis of the 15,000 shares, were also determined by the respondent to be taxable to the petitioner as capital gains in 1949. Petitioner did not apply against the basis of the 15,000 shares the distributions out of Chattanooga's capital, amounting to $ 290,996.68, in those years when consolidated returns were filed, and did not include in income for 1948 and 1949 the distributions made in those 2 years.

The respondent determined in the statutory notice an increase of $ 34,490.18 in capital gains for 1949 on the sale by Greenwich of its stock in Cohasset. Capital distributions of $ 28,136.99 to Greenwich from Cohasset, in years when consolidated income tax returns were filed which included the two companies, as well as in years when no such consolidated returns were filed, were applied in reduction of the basis of the stock sold by Greenwich, which increased in an equal amount the capital gain realized on the sale of the Cohasset stock of Greenwich in 1949. Respondent also reduced the basis of the Cohasset stock by $ 6,353.19 representing losses of Cohasset availed of in consolidated income tax returns which included the two companies. Petitioner did not apply the capital distributions of $ 28,136.99 against the basis of the Cohasset stock, nor was the $ 6,353.19 loss applied in reduction of the basis for such stock.

ULTIMATE FINDINGS.

The unadjusted basis of the 4,000 shares of Texarkana common stock sold by the petitioner in 1948 must be reduced by $ 168,714.47, the amount of the total capital distributions made by Texarkana to the petitioner, both in the years when consolidated income tax returns were filed which included the two corporations and in the years when no such consolidated returns were filed. The unadjusted basis of the 1,200 shares of Texarkana common stock must be reduced by the amount of $ 28,322.27, the total amount of capital distributions made by Texarkana to the petitioner, both in the years when consolidated income tax returns were filed which included the two corporations and in the years when no such consolidated returns were filed. The unadjusted basis of the 1,200 shares of Texarkana common stock sold by the petitioner in 1948 must be reduced by the amount of $ 36,997.12, which amount represents the net operating losses sustained by Texarkana in the years 1929 to 1933 and availed of in the consolidated income tax returns filed in those years.

The unadjusted basis of 15,000 shares of Chattanooga common stock must be reduced by $ 690,042.73, the total amount of capital distributions made by Chattanooga to the petitioner on those shares, both in the years when consolidated income tax returns were filed which included the two corporations and in the years when no such consolidated returns were filed.

The unadjusted basis of the shares of Cohasset stock, both common and preferred, sold by Greenwich in 1949, must be reduced by $ 28,136.99, the amount of total capital distributions made by Cohasset to Greenwich on such stock, both in the years when consolidated income tax returns were filed which included the two corporations and in the years when no such consolidated returns were filed.

OPINION.

The petitioner does not contest certain items and, as a result, the issues remaining are (1) whether the basis of stock held by the petitioner in affiliated corporations should be reduced by the amounts of capital distributions made by the issuing corporations to the petitioner in years when consolidated returns were filed, and (2) whether the basis of stock held by the petitioner in an affiliated corporation should be reduced by the amount of net operating losses sustained by the issuing corporation and availed of in years when consolidated returns were filed which included the two corporations, but before the particular shares of stock in question were issued.

Those items in dispute which pose the first issue shall be considered here together. Petitioner in 1948 sold 5,200 shares of the common stock of Texarkana, an affiliated corporation, which was all the outstanding stock of Texarkana. The petitioner had acquired this stock in 1947 from the transferor. The transferor had acquired 4,000 shares of the stock in 1926, at which time this was all the outstanding stock of Texarkana, and in 1941 had acquired an additional 1,200 shares of newly issued stock in Texarkana. Capital distributions amounting to $ 168,714.47 had been made in prior years by Texarkana to the petitioner and its transferor on the 4,000 shares of common stock; of this amount $ 54,407.57 was distributed in those years when consolidated returns were filed which included Texarkana and the petitioner, and $ 114,306.90 was distributed in years when Texarkana was not included in consolidated income tax returns with the petitioner. On the 1,200 shares of Texarkana common stock, the petitioner received from Texarkana a total of $ 28,322.27 in capital distributions. Of this amount, $ 15,122.27 was distributed in years when consolidated income tax returns were filed which included Texarkana and the petitioner, and $ 13,200 was distributed in years when Texarkana was not included in consolidated returns with the petitioner. The unadjusted basis of the stock to the petitioner in 1948 was $ 84,558.54 for the 4,000 shares and $ 115,755.55 for the 1,200 shares. The petitioner sold the 5,200 shares of Texarkana common stock in 1948 for a total consideration of $ 1,816,748.14. In determining the gain from this sale of stock, the respondent adjusted the basis of the 4,000 shares by the entire amount of the capital distributions made to the petitioner or its transferor, reducing such basis to zero, and the basis of the 1,200 shares was also adjusted by the entire amount of such capital distributions on the 1,200 shares, reducing the basis by that amount ($ 28,322.27). The petitioner does not dispute that the basis of the stock sold by it should be reduced by the amount of capital distributions made to it by Texarkana in those years when Texarkana was not included in consolidated income tax returns with the petitioner or its transferor. But the petitioner does contend that the basis of the stock should not be reduced by any capital distributions made in years when Texarkana was included in consolidated returns filed by the petitioner or its transferor.

The respondent argues that the pertinent sections in Regulations 104, applicable here, require the reduction of the basis of stock where the issuing corporation makes capital distributions to the parent corporation on such stock in years when consolidated income tax returns are filed including both such corporations. We agree with the respondent. Consolidated returns pose some difficult and complicated problems, and in the committee report accompanying the Revenue Bill of 1928, Congress indicated that it was "necessary to delegate power to the Commissioner to prescribe regulations legislative in character covering them." S. Rept. No. 960, 70th Cong., 1st Sess., 1939-1 C. B. (Part 2) 409, 419. This Court has indicated that "In view of such specific delegation of power to administrative officers to promulgate regulations * * * a clear showing must be made of authority to cut across such regulations and to reach a result other than that spelled out by the regulations." Kanawha Gas & Utilities Co., 1017">19 T. C. 1017, revd. 214 F.2d 685">214 F. 2d 685.

Section 23.34 of Regulations 104 prescribes the basis for the determination of gain or loss upon the sale by a member of an affiliated group of stock issued by another member of such group. Subsection (c) of section 23.34 deals with sales of stock made after March 1, 1945, and it is applicable whether or not, as a result of such sale, the issuing corporation ceases to be a member of the affiliated group. Subsection (c), in such instances, determines the basis of the stock as follows:

The aggregate basis of all shares of stock of the issuing corporation held by each member of the affiliated group (exclusive of the issuing corporation) immediately prior to the sale shall be determined separately for each member of the group, and adjusted in accordance with the Code, but without regard to any adjustment under the last sentence of section 113 (a) (11) with respect to losses of the issuing corporation sustained by such corporation after it became a member of the affiliated group. [Emphasis added.]

It is the plain meaning of the regulation that the basis of stock, under the circumstances defined in section 23.34 must be adjusted in the way the Internal Revenue Code of 1939 prescribes. Provisions for adjustments to basis in determining gain or loss from the sale of property appear in section 113 of the Code. Subsection 113 (b) (1) (D) provides that in the case of stock there shall be a reduction of basis "for the amount of distributions previously made which, under the law applicable to the year in which the distribution was made, either were tax-free or were applicable in reduction of basis." Section 115 (d) of the Code provides that where a stockholder receives corporate distributions which are not out of an increase in value of property accrued before March 1, 1913, and are not dividends, the amount of such distributions must be applied in reduction of the basis of stock held by such stockholder.

The petitioner argues that there should be no reduction in the basis of its stock in Texarkana due to the capital distributions made to it by Texarkana in years when consolidated income tax returns were filed by the two corporations. No support for the petitioner's argument can be found in section 23.31 (d) (2) of Regulations 104. This section states that capital gains and losses on a consolidated return shall be determined without regard to "gains or losses arising in intercompany transactions." Such a transaction is not before us. We have in this case a sale of stock by the petitioner to a party outside the affiliated group, and any gain arising from such sale cannot be regarded as arising in an intercompany transaction. The petitioner also supports his argument on section 23.38 (a) and (b) of Regulations 104. These subsections provide as follows:

(a) General Rule.

Subject to the provisions of paragraphs (b) and (c) and except as otherwise provided in sections 23.34 and 23.39, the basis during a consolidated return period for determining the gain or loss from the sale or other disposition of property, or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed, shall be determined and adjusted in the same manner as if the corporations were not affiliated (see sections 111 to 115, inclusive), whether such property was acquired before or during a consolidated return period. * * *

(b) Intercompany Transactions.

The basis prescribed in paragraph (a) shall not be affected by reason of a transfer during a consolidated return period, other than upon liquidation as provided in (c) (whether by sale, gift, dividend, or otherwise), from a member of the affiliated group to another member of such group.

We do not believe that subsection (b) is applicable here. While it is true that these sections purport to govern, during a consolidated return period, the determination of the basis of property generally, an exception has been carved out in the case of stock, which is specially treated in section 23.34. Section 23.38 (a) makes this clear with the words "except as otherwise provided in section 23.34." This latter section then makes the provision that the basis of stock is to be adjusted in accordance with the Code.

In Burnet v. Aluminum Goods Mfg. Co., 287 U.S. 544">287 U.S. 544, 549, the Supreme Court had occasion to interpret articles 77 and 78 of Regulations 41. Of course, these are not the regulations before us now, but we believe that the Court's approach to the problem is relevant here. Article 78 gave to the Commissioner the authority to require consolidated returns of affiliated corporations and provided that the tax on the group would be "computed in the first instance as a unit on the basis of the consolidated return." The Court said:

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 intercompany transaction, regardless 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 intercompany manipulation which would distort invested capital or the true income of the unitary business carried on by the affiliated corporations. * * *

In the report of the Senate Finance Committee on the Revenue Act of 1928, S. Rept. No. 960, 70th Cong., 1st Sess., 1939-1 C. B. (Part 2) 409, 418, the Committee indicated that "no ultimate advantage under the tax laws really results" when corporations are granted permission to file consolidated returns. The interpretation here given to the pertinent regulations on consolidated returns adheres, we believe, to this Congressional intent.

We hold that the capital distributions made by Texarkana to the petitioner in years when consolidated income tax returns were filed including the two corporations, as well as the capital distributions made in those years when no consolidated returns were filed, reduced the basis of the Texarkana common stock held by the petitioner, and that the gain realized upon the sale of such stock by the petitioner increased in accordance with the determinations of the respondent.

The petitioner in 1948 received capital distributions from Chattanooga in the amount of $ 19,622.59, and in 1949 received similar distributions in the amount of $ 25,265.45. These distributions were made on 15,000 of the 20,000 shares of Chattanooga common stock held by the petitioner. Chattanooga was not a member of the affiliated group for which the petitioner filed consolidated returns for the years 1948 and 1949, since in those years the petitioner owned only 58.82 per cent of the total outstanding shares of voting stock of Chattanooga. The respondent determined that these distributions resulted in capital gains to the petitioner in the years received. This determination was based upon respondent's argument that the capital distributions, in the amount of $ 290,994.68, made by Chattanooga to the petitioner in years when consolidated returns were filed including the two corporations, and the capital distributions, amounting to $ 399,048.05, made to the petitioner in those years when no such consolidated returns were filed, reduced the basis of the 15,000 shares ($ 641,452.50) to zero. Therefore, the capital distributions on the 15,000 shares in 1948 and 1949, being in excess of basis, were treated by the respondent as capital gains to the petitioner under section 115 (d) of the 1939 Internal Revenue Code. The issue here is the same as in the questions involving the basis of the Texarkana stock, and our holding there is controlling. We agree with the respondent's determination that the capital distributions by Chattanooga to the petitioner in 1948 and 1949, being in excess of the basis of the 15,000 shares of stock upon which such distributions were made, were taxable as capital gains to the petitioner in those years.

Similarly, our holding with regard to the basis of the Texarkana stock is applicable in the question involving the basis of the 196 shares of preferred stock and the 804 shares of common stock in Cohasset sold by Greenwich in 1949 for a total consideration of $ 249,337.63. Both of these corporations were members of the affiliated group for which the petitioner filed consolidated income tax returns for 1949 and for prior years in which consolidated returns were permitted under the Federal income tax laws. The unadjusted basis of this Cohasset stock held by Greenwich was $ 213,563.82. A reduction of basis in the amount of $ 6,353.19 for net losses of Cohasset in years for which consolidated income tax returns were filed including the two corporations is not disputed by the petitioner. Capital distributions on such stock by Cohasset to Greenwich amounted to $ 17,686.27 in years when consolidated returns were filed for the two corporations, and $ 10,450.72 in those years when no such consolidated returns were filed. The respondent reduced by the amount of such distributions the basis of the stock sold by Greenwich in 1949, and in his determination of capital gains of the petitioner in that year, increased such gains by a similar amount. Our holding with respect to the adjustment of basis of the Texarkana is controlling here, the issue being the same. We hold, therefore, that the respondent was correct in his determinations.

The remaining issue is whether the net operating losses of $ 36,997.12 sustained by Texarkana in the years 1929 to 1933 are to be applied in reducing the basis of the 1,200 shares of common stock in Texarkana which were acquired by petitioner's predecessor corporation in 1941. Consolidated returns filed by the affiliated group in the years 1929 to 1933 included Texarkana, and the net operating losses of Texarkana were allowed in full as deductions in arriving at the net income for those years of the consolidated group. Capital distributions from Texarkana to the petitioner, under our holding in that issue of the case, reduced the basis of the 4,000 shares of Texarkana common to zero, and also reduced the basis of the 1,200 shares ($ 115,755.55) by the amount of $ 28,322.27. The respondent now makes a further reduction in the unadjusted basis of the 1,200 shares of Texarkana common, which was sold by the petitioner in 1948, in the amount of the net operating losses sustained by Texarkana.

Section 23.34 (c) (2), (3), and (4) of Regulations 104 is applicable. After the adjustments to basis are made under section 23.34 (c) (1), a further adjustment to basis, on account of losses, is provided for under section 23.34 (c) (2) of the regulations:

(2) From the combined aggregate bases as determined in paragraph (1), there shall be deducted the sum of the losses of such issuing corporation sustained during taxable years for which consolidated income tax returns were made or were required * * * after such corporation became a member of the affiliated group and prior to the sale of the stock to the extent that such losses could not have been availed of by such corporation as a net loss or net operating loss * * *

(3) The sum of the aggregate bases of all shares of stock, after making the deduction under paragraph (2), shall then be apportioned among the members of the affiliated group which hold stock of the issuing corporation, by allocating to each such member that proportion of the sum of the aggregate bases so reduced which the aggregate basis of the stock in the issuing corporation held by such member bears to the sum of the aggregate bases;

(4) The aggregate basis as determined under paragraph (3) for each member of the affiliated group shall then be equitably apportioned among the several classes of stock of the issuing corporation held by such member according to the circumstances of the case -- ordinarily by allocating to each class of such stock that proportion of the aggregate basis which the basis of each class of such stock held by it at the time of the sale is to the sum of the bases of the several classes of such stock held by it;

It is evident from the regulations that no attempt is made to segregate stock according to the time of acquisition of such stock. Furthermore, it appears in section 23.34 (c) (4) that the aggregate basis is allocated to each class of stock held by a member of the affiliated group "at the time of the sale." The obvious purpose of this portion of Regulations 104 is to prevent a consolidated group from enjoying the tax advantage of a double deduction, or its equivalent, from the same net operating loss.

We conclude that the unadjusted basis of the 1,200 shares of Texarkana common stock sold by the petitioner in 1948 is to be reduced by $ 36,997.12, the amount of the net operating losses sustained by Texarkana in the years 1929 to 1933, and that the gain on the sale of such stock is to be increased accordingly.

Decisions will be entered for the respondent.

MURDOCK; RAUM

Murdock and Raum, JJ., dissenting: We cannot agree with the holding that the basis of the after-acquired stock, obtained by the investment of fresh capital, must be reduced instantly by net operating losses sustained during earlier years. Losses of a subsidiary in prior years were absorbed by other income on consolidated returns. The limits of the tax effects of those losses on the basis of the stock of the subsidiary which the parent then owned (or even subsequently acquired as the result of a split-up of such stock) were fixed. Yet the prevailing opinion holds that the basis of entirely new stock of the subsidiary, subsequently purchased by the parent, is not the cost thereof to the parent, but that it is the cost as simultaneously reduced by old losses of the subsidiary which produced tax benefits in the consolidated return. In effect, the investment of new money is penalized since the investor is required to wipe out past tax benefits which are wholly unrelated to the investment in the new stock. The result is extraordinary; it is not called for by the statute; and the regulations do not focus upon the problem one way or the other.