Columbia Theatre Co. v. Commissioner

OPINION.

Lansdon:

This appeal involves the correct determination of the statutory invested capital of a group of affiliated companies, which made a consolidated income and profits-tax return for the year 1919 through the taxpayer, which is the parent corporation. The questions involved must be resolved by ascertaining the correct invested capital of the Mid-City Realty Co. and the Middleton Theatre Co.

The Mid-City Realty Co. had capital paid in for shares in the amount of $100,000, concerning which there is no controversy. The taxpayer contends that the amounts of $75,000 loaned to the company by its stockholders, who received therefor the notes of the company which subsequently were voluntarily surrendered and canceled without any payments having been made thereon, and $10,800 paid in by the shareholders in response to assessments legally made by the directors, should also be included in the computation of its statutory invested capital, together with any earned surplus indicated by its books on January 1, 1919.

Each of the amounts in question was embarked in and at risk in the business. Except in the event of liquidation, none of the contributors had any legally enforceable claim against the company for any part of the principal amounts so paid in, or for dividends or interest thereon. Their only hope of repayment or profit was in the success of the company. If it earned substantial profits, they might receive dividends sufficiently large to pay them some return on their entire contributions. If it made enough profits, such dividends could be paid and the surplus resulting from the transactions now under consideration would continue to represent tangible property and be evidenced to the shareholders in the book value and market price of the shares of the company. From every point of view, it would seem that these amounts were actually embarked in the business and were at risk, in exactly the same way as the money originally paid in for shares.

It has been argued that corporate funds obtained as set forth in our findings of fact can not, from their very nature, become unchangeable capital items. Why not? The law provides that property paid in for shares of stock shall be included in the computation of invested capital for excess-profits tax purposes, even though such assets may thereafter entirely disappear. We have held above that, in the circumstances of this appeal, there is no inherent difference between the nature of paid-in surplus and of property paid in for shares. Together they make up the total capital contributions embarked in an enterprise and are entitled to a fair return before the provisions of the excess-profits tax law are applied, and therefore must be regarded as a single and inseparable body of statutory invested capital. In this connection, the Board has recently held, in the Appeal of Guarantee Construction Co., 2 B. T. A. 1145:

We are of the opinion, therefore, that capital and surplus actually paid in remain part of the invested capital of a corporate taxpayer, except where such capital or surplus has been directly or indirectly returned to the stockholders.

In the case at bar, there has been no such return, by distribution of dividends or otherwise. We are of the opinion that the payments here in question were contributions to capital, and, as they are not specifically excluded as inadmissibles under section 325 of the Revenue Act of 1918, they must be included in the taxpayer’s statutory invested capital. Lincoln Chemical Co. v. Edwards, 289 Fed. 458; Appeal of Guarantee Construction Co., supra; United States v. Oregon-Washington R. & Nav. Co., 251 Fed. 211.

The expenditure of $63,874.56 by the Columbia Theatre Co., for capital additions to the property of the Mid-City Realty Co., after it had become the owner of all the capital stock of such Mid-City Realty Co., which the taxpayer also seeks to have included in the consolidated invested capital of the affiliated group, must be regarded as an inter-company transaction. Before this money was so used, it was a part of the capital or surplus of the Columbia Theatre Co. Its investment in capital assets belonging to an affiliated-company does not change its status. It is already included in the consolidated invested capital of the group.

The taxpayer also, contends that the amount of $24,000 paid on the bonded debt of the Mid-City Realty Co., for the most part out of operating income, should be included in the computation of invested capital. Since the repayment of borrowed money out of profits results in the inclusion of the assets represented by such borrowed capital in the earned surplus of the company, the Board holds that this item is already included in the invested capital of the company, if the books of account properly reflect such transactions.

The Board is of the opinion that the statutory invested capital of the Mid-City Realty Co. for the year involved in this appeal was made up of the amounts of $100,000 paid in for shares of capital stock, $85,800 paid-in surplus, and such earned surplus as may be disclosed by the company’s balance sheet as of December 31, 1918.

The taxpayer contends that certain expenditures and investments made by the Middleton Theatre Co. should be included in the consolidated invested capital of the affiliated companies. These expenditures fall into three groups: (1) Payments made to obtain the use and enjoyment of the unexpired term of a 30-year lease on the premises occupied by the Grand Opera House and the American Annex Hotel; (2) payments in the form of bonus and expenses, to secure a 99-year lease on tbe same premises; and (3) certain so-called carrying charges, incurred during the period of construction of the hotel and reconstruction of the theatre.

The 30-year lease, which was acquired by the taxpayer at a cost of $99,500, expired on July 1, 1912. Its cost or value can not be regarded as an element of invested capital for the year 1919.

Although the 99-year lease on the same property is frequently designated by the witnesses of the taxpayer as the “ 105 year lease,” there is nothing in the evidence to indicate that it was anything more than a 99-year lease, which began to run on July 1, 1912. This lease was not offered in evidence. Any expenditures, in the way of cost or bonus, incurred in connection with its acquisition, should be capitalized and exhausted ratably over the 99-year period beginning July 1, 1912. The $10,000 bonus paid to secure this lease and the $9,999 paid to the St. Louis Theatre Co., in order that the lessee company might enter into full possession of the premises and begin its building operations in season to enable it to enjoy its 99-year lease for the full term thereof, are costs in connection with the acquisition of such lease, and should be included in the consolidated invested capital of the affiliated group.

During the period of its building operations, from 1910 to 1913, the taxpayer was without any substantial income from its property, and was required to make disbursements for ground rentals, taxes and other expenses incident to its ownership of the two leases and its improvement of the ground, as required by the terms of its contract with the owner of the fee. These payments, in the total amount of $103,522.60, the taxpayer seeks to have included in its invested capital. The Board is of the opinion that the amounts of $6,350 attorneys’ fees, paid in connection with the acquisition of leases; $5,028.59, cost of insurance during ■ building operations; and $5,-067.01, sundry expenses in connection with contracts, are capital expenditures, and, to the extent that they are reflected in the surplus for the years in question, should be included in the statutory invested capital of the taxpayer. The remaining items, listed as carrying charges, appear to be ordinary -and necessary expenses. Westerfield v. Rafferty, 4 Fed. (2d) 590; Appeal of Hotel De France Co., 1 B. T. A. 28.

The Board is of the opinion that the following amounts, as the invested capital of the Middleton Theatre Co., should be included in the consolidated invested capital of the affiliated group: $250,000 paid in for common and preferred stock; $19,999 cost of securing 99-year lease and the earned surplus of the Middleton Theatre Co. as of December 31, 1918, with proper adjustment resulting from deducting accrued exhaustion of the 99-year leasehold from July 1,1912, to December 31, 1918.