Fred Fear & Co. v. Commissioner

FRED FEAR & CO., INC., AND BOYCE EXTRACT CO., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Fred Fear & Co. v. Commissioner

Docket No. 9327.

United States Board of Tax Appeals

9 B.T.A. 34; 1927 BTA LEXIS 2679;

November 10, 1927, Promulgated

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1. The petitioners held to be affiliated with J. H. Doxsee & Sons, Inc., for the years 1919, 1920, and 1921.

2. In 1918 Fred Fear & Co., Inc., acquired 60 per cent of the capital stock of J. H. Doxsee & Sons, Inc., for $30,000 under an agreement that the $30,000 should be deemed as a loan and should be returned from the profits and earnings, and not otherwise, of J. H. Doxsee & Sons, Inc., in an amount not to exceed $10,000 per year. The operations of J. H. Doxsee & Sons, Inc., for the years 1918, 1919, and 1920, resulted in aggregate net losses of $29,725.06. Fred Fear & Co., Inc., charged off in 1920 as a loss $22,738.34 of the amount advanced to J. H. Doxsee & Sons, Inc. Held, that the amount charged off is not a legal deduction from gross income in the income-tax return of Fred Fear & Co., Inc., for the year 1920.

Benjamin Mahler, Esq., and Maxwell Shmerler, C.P.A., for the petitioners.

P. J. Rose, Esq., for the respondent.

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SMITH

This proceeding is for the redetermination of deficiencies in income and profits tax as follows:

Fred Fear & Co., Inc.:
1919	$517.44
1920	8,149.86
1921	31.72
		$8,699.02
Boyce Extract Co.:
1919	517.57
1920	1,240.38
1921	20.38
		1,778.33
Total		10,477.35

The points in issue are (1) whether the petitioners and J. H. Doxsee & Sons, Inc., were affiliated corporations for the calendar years 1918, 1919, and 1920, and (2) whether Fred Fear & Co., Inc., is entitled to deduct from its gross income of 1920 ($30,000) an amount alleged to represent its loss from its loan to J. H. Doxsee & Sons, Inc., or $22,738.34, the amount of such loss actually charged off its books of account in 1920.

FINDINGS OF FACT.

1. Fred Fear & Co., Inc., hereinafter referred to as Fear & Co., was organized in 1895 or 1896, and during the tax years in question was carrying on the business of selling agents of grocery specialties.

2. J. H. Doxsee & Sons, Inc., hereinafter referred to as the Doxsee Co., was organized in 1897, and during the tax years in question was engaged in the business of packing clam products, canned clams and kindred products.

3. For many years prior to 1918, Fear & Co. was the sole selling agent for the Doxsee Co. and handled that company's products on a commission basis. For some time prior to 1918, and in fact since 1907, it was entrusted by the Doxsee Co. with a power of attorney authorizing it to sign checks on behalf of that company and in general to manage its affairs.

4. In 1918 the affairs of the Doxsee Co. were in such shape that unless outside assistance was forthcoming it would have been obliged to discontinue business.

5. Fear & Co. decided to put up $30,000 to be used by the Doxsee Co. in buying new boilers, process kettles, and other machinery necessary for the proper care and conduct of its business.

6. At a special meeting of the stockholders of the Doxsee Co. held July 13, 1918, it was -

RESOLVED, that the capital stock of J. H. Doxsee & Sons, be increased from the present amount thereof, to wit: Twenty Thousand ($20,000.00) Dollars, consisting of four hundred shares of the par value of fifty dollars each to fifty thousand ($50,000.00) Dollars, to consist of one thousand shares of common stock of the par value of fifty dollars each.

It was further -

RESOLVED, that new certificates of stock be issued to the stockholders instead and in place of the old certificates of stock now outstanding, and on the books in the names of the respective stockholders, and that each stockholder shall have the option within sixty days to sell to the company or to Fred Fear & Company his shares of stock at the present book value of Twenty One and 51/100 ($21.51) Dollars, a share.

The above resolutions were unanimously adopted. The minutes of the meeting further show -

At the meeting there was present Fred Fear, Esq., of Fred Fear & Company and Mr. Fred Fear made the following offer to the company.

In consideration of the issuance and delivery to Fred Fear & Company, a New York Corporation, by J. H. DOXSEE & SONS of Thirty Thousand ($30,000.00) Dollars of the non-assessable and fully paid stock of the recapitalized company, and in consideration of the repayment of the said Thirty Thousand ($30,000.00) Dollars, to Fred Fear & Company by J. H. DOXSEE & SONS, out of the earnings of J. H. DOXSEE & SONS, said repayment not to exceed Ten Thousand ($10,000.00) Dollars, a year, it Fred Fear & Company would furnish all the money and credit necessary up to Thirty Thousand ($30,000.00) Dollars, to construct and equip a factory with the latest cooking and automatic machinery for the packing of clams and manufacturing Clam Chowder and kindred articles and preparation.

Factory to be located at Marco, Florida.

Upon delivery of the said Thirty Thousand ($30,000.00) Dollars stock to Fred Fear & Company, title to the said stock shall immediately become vested in the said Fred Fear & Company free and clear.

As a condition of this offer Fred Fear & Company is to have two directors of its own choosing to co-operate with two directors of the present company, and as a further condition the stockholders and the directors agree that no salaries are to be paid to officers until the Thirty Thousand ($30,000.00) Dollars shall be fully paid and then only by unanimous vote of all the directors.

The acceptance of the offer and the adoption of the resolutions to consummate the acceptance of this offer shall be deemed by J. H. DOXSEE & SONS and Fred Fear & Company as a part and parcel of the contract herein entered into.

At the same meeting the following resolution was adopted:

RESOLVED, that Thirty Thousand ($30,000.00) Dollars of the fully paid non-assessable common stock of the recapitalized company be issued to and to become the sole property of Fred Fear & Company in consideration of the said Fred Fear & Company furnishing and supplying credit and money up to Thirty Thousand ($30,000.00) Dollars for the equipment of a modern plant to manufacture clam chowder, pack clams, etc., as outlined in the offer above referred to. The said Thirty Thousand ($30,000.00) Dollars, shall be deemed as a loan and shall be returned from the profits and earnings, and not otherwise, of J. H. DOXSEE & SONS, in an amount not to exceed Ten Thousand ($10,000.00) Dollars a year.

7. Between July 13 and December 31, 1918, Fear & Co. advanced cash and credit to the Doxsee Co. in the amount of $30,739.31.

8. At the board-of-directors meeting following the close of 1918 held by the Doxsee Co., the resume of the 1918 events was submitted. The treasurer reported that the $30,000 contract from Fear & Co. had all been paid in by the end of 1918 but that much more money would be needed to reconstruct the factory and to place the business on a sound footing. Additional loans were arranged by the Doxsee Co. from Fear & Co., for which notes were issued. These further advances were made and notes therefor were given, which notes bore the commercial rate of interest. No notes were ever given for the original $30,000.

9. The operations of the Doxsee Co. for the years 1918, 1919, and 1920 resulted in the following losses:

1918	$5,494.40
1919	5,105.30
1920	18,259.71

10. After the Doxsee Co. had sustained the losses for 1918, 1919 and 1920, above referred to, Fear & Co. determined that pursuant to the contract made with the Doxsee Co., it had lost the $30,000 advanced to it. Its office manager, who had charge of its books, was instructed to charge off the sum of $30,000. Instead of charging off the full amount, however, only $22,738.34 of the amount was charged off.

11. Fear & Co. continued to advance a sum in excess of the $30,000. It was expected that after such advances the Doxsee Co. would become a money-making proposition.

12. The Doxsee Co. has never repaid any of its advances to Fear & Co.

13. As a result of the offer made by Fear & Co., previously referred to and accepted by the company at its meeting of July 13, 1918, a reorganization took place. After such reorganization the stock of the Doxsee Co. was held as follows:

	Shares
Fred Fear & Co.	600
Charles O. Doxsee	63
J. Harvey Doxsee	62
John C. Doxsee	5
Mrs. Carrie Doxsee	124
Wm. H. Doxsee	47
Helen C. Doxsee	48
Chas. M. Scarboro	3
	952

Mabel O. Redfern (neeDoxsee) had not been heard from and the 48 shares to which she was entitled were never issued.

14. At the time of the reorganization of the Doxsee Co. in 1918, it was the understanding of the former stockholders, members of the Doxsee family, that their stock was to be voted 100 per cent as directed by Fear & Co. It was their opinion that the stock had little or no value during the period and that if it should come to have any value in subsequent years the value would be ascribable entirely to the financial assistance given to the corporation by Fear & Co. There was also an understanding that Fear & Co. was not to be interfered with in the management of the subsidiary company. Fear & Co. was to have final and absolute say in all matters.

15. After the reorganization in 1918, Fred Fear became vice president and treasurer of the Doxsee Co. and Gabriel Lowenstein, the other stockholder of Fear & Co., became secretary. Charles O. Doxsee, who had acted as superintendent of the business of the subsidiary company, was retained as president. The latter had first assisted at the factory in Marco, Fla., but within a year after the reorganization occurred he left and thereafter had nothing to do with the business. No member of the Doxsee family which owned all the stock not owned by Fear & Co., other than J. Harvey Doxsee had anything to do with the management of the business. He was the superintendent of the factory and took his orders from Fear & Co., in New York during this period.

16. Throughout the taxable years Fear & Co. ran the affairs of the Doxsee Co. In detail, that consisted of marketing the goods, determining the unit measure in which the product was to be sold, collecting the accounts, keeping financial and manufacturing records, etc. Fear & Co. sold the product on a commission basis. It could and did fix the rate of commission which it was to get as such agents. This averaged from 5 per cent to 12 1/2 per cent of the selling price. Fear & Co. banked and drew all checks on behalf of the Doxsee Co. The latter's books were kept at the office of Fear & Co., and the same men kept both the Doxsee Co. and the Fear & Co. books.

OPINION.

SMITH: During the taxable years Fear & Co. conducted the business of the Doxsee Co. as a department of its own business. At the time of the organization of the latter company in 1918 the stockholders of the company recognized that their shares of stock had no value except such as might be given to them by the financial assistance which was to be given to the corporation by Fear & Co. The assets of the latter company consisted of a strip of land on the Island of Marco, off the coast of Florida, of a building and some equipment which had little value. The evidence shows that if Fear & Co. had insisted upon acquiring all of the stock of the subsidiary company at the time of the reorganization in 1918, it could have done so. Out of sentimental reasons the two stockholders of Fear & Co. were willing that the members of the Doxsee family holding shares of stock in the old company should have a like number of shares in the new company but only with the provision that Fear & Co. should have complete control of the policies and management of the subsidiary company and vote its stock as it desired. There is no reason to question the arrangement that was made. Under the facts the petitioners must be held to be affiliated with the subsidiary company during the calendar years 1919, 1920, and 1921.

Fear & Co. claims that it made a loan to the Doxsee Co. in 1918, of $30,000, and that there was a complete understanding that in case the loan could not be paid out of profits of the subsidiary company before additional amounts were advanced upon notes given to it by the subsidiary company, the loan was a loss. We think that the evidence does not warrant such an interpretation of the agreement made. Fear & Co. acquired $30,000 par value of the capital stock of the subsidiary company. Apparently the $30,000 was advanced to the subsidiary company as a consideration for the stock. In 1920 Fear & Co. retained this stock interest in the subsidiary company. But if it might be held that the loan was payable only out of profits there apparently was no reason to suppose that that loan might not be paid out of profits subsequent to 1920. From a consideration of the entire evidence we are of the opinion that the action of the Commissioner in disallowing the deduction of any loss in 1920 is correct.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by LITTLETON, TRUSSELL, and LOVE.