City Machine & Tool Co. v. Commissioner

The City Machine & Tool Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

City Machine & Tool Co. v. Commissioner

Docket No. 20385

United States Tax Court

21 T.C. 937; 1954 U.S. Tax Ct. LEXIS 265;

March 19, 1954, Promulgated

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Decision will be entered under Rule 50.

1. Standard Issue. -- Under mandate of United States Court of Appeals, standard issue under section 713, Internal Revenue Code, is determined upon the authority of City Machine & Tool Co. v. Commissioner, 194 F.2d 535">194 F. 2d 535.

2. Sec. 713 (f), I. R. C. -- Upon authority of National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, and upon the facts, held, that petitioner had income during base period years so as to be entitled to compute excess profits credit for years 1941 through 1944 based upon income under section 713 (f).

3. Estoppel. -- Petitioner is a wholly owned subsidiary of another corporation. During the years 1936-1939, it operated a business and paid rent, under a lease, to its parent in amounts equal to all of its net income after operating charges. In its returns for the years 1936-1939, petitioner reported no taxable income because of its erroneous understanding of the law which it believed made its net income taxable to its parent corporation under the terms of the lease agreement. But petitioner advised the Commissioner in its return for 1936 about the lease and its treatment of the excess of sales over costs as rental expense. Petitioner filed excess profits tax returns for 1941-1944 in which it computed excess profits credit on the invested capital method under the erroneous belief that it had no base period income under law. In this proceeding, petitioner claims that it had base period income under law, relying upon National Carbide Corp. v. Commissioner, supra, so as to be entitled to compute excess profits credit based upon base period income. Held, that with respect to the question whether petitioner had income in any of the base period years, both the petitioner and the Commissioner made the same mistake in interpreting the law; held, further, that, therefore, petitioner is not estopped to have its excess profits credit for 1941-1944, inclusive, computed on the income method under section 713 (f) where the Commissioner, with full knowledge of the facts, failed to collect taxes due for the years 1936-1939 because he made a mistake of law in concluding that petitioner did not have any taxable income for any of the years 1936-1939. Tide Water Oil Co., 29 B. T. A. 1208, and American Light & Traction Co., 42 B. T. A. 1121, followed.

E. R. Effler, Esq., L. E. Eastman, Esq., V. J. Dobson, C. P. A., and L. T. Konopak, C. P. A., for the petitioner.

L. K. Bloomenthal, Esq., and James A. Scott, Esq., for the respondent.

Harron, Judge.

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HARRON

This proceeding involves a redetermination of the petitioner's excess profits tax liability for the years 1941 to 1944, inclusive. The Commissioner issued a combined notice of deficiency and notice of disallowance of applications for relief under section 722, Internal Revenue Code, on June 21, 1948. The only year in which respondent determined a deficiency in excess profits tax was 1942; he determined that there were overassessments in each of the years 1941 and 1943 and that there was no change in petitioner's excess profits tax liability, as reported , for 1944. Petitioner filed its petition in this Court on September 17, 1948, and it assigned as error only the respondent's disallowance of its applications for relief under section 722 for the years 1941 to 1944, inclusive. The petitioner, on August 25, 1949, filed a motion asking leave to amend its petition to raise a standard issue. The motion was taken under advisement by the Court; it was denied, and petitioner appealed from the order denying this motion. The United States Court of Appeals for the Sixth Circuit reversed the action of this Court in denying the motion to amend the petition. See City Machine & Tool Co. v. Commissioner, 194 F.2d 535">194 F. 2d 535.

This proceeding is now before the Court under remandment by the Court of Appeals. After the remandment, we granted a motion of petitioner to separate the issues so as to consider first the standard issue raised in the amended petition. The standard issue thus presented is whether the petitioner had taxable net income during each of the base period years so as to be entitled to compute its excess profits credit under the income method.

FINDINGS OF FACT.

The facts which have been stipulated are found as facts. The stipulations together with attached exhibits are incorporated herein by reference.

Petitioner is an Ohio corporation, with its principal office at 5130 Detroit Avenue, Toledo, Ohio. The returns for the years involved, 1941 to 1944, inclusive, were filed with the collector for the tenth district of Ohio at Toledo.

Petitioner's business is that of designing and manufacturing large automotive dies. Petitioner's predecessor, also bearing the name of "The City Machine & Tool Company," was originally incorporated in 1916. It was reincorporated in a reorganization in 1925. It owned and operated a jobbing die plant and business located in the Toledo Factories Building, Toledo, Ohio. Early in 1929 petitioner's officers and principal shareholders formed The City Auto Stamping Company, also an Ohio corporation, which was a separate, independent organization engaged in the manufacture of sheet metal stampings, with a plant located at Lint and Dura Avenues on the outskirts of Toledo. The two companies were affiliated by reason of the identity of the officers, directors, and principal shareholders of the two corporations. On June 30, 1931, the corporations were merged into The City Auto Stamping Company, which continued as the surviving corporation.

Petitioner was incorporated on July 9, 1931, following the merger for the sole purpose of preserving the name and good will of the jobbing die business and to permit the surviving corporation to continue the business without interference under the designation of "The City Machine & Tool Company," or the "City Machine & Tool Division." Petitioner's entire capital stock was then, and ever since its incorporation has been and now is, owned by The City Auto Stamping Company.

At the time of its organization, 50 shares of petitioner's capital stock were issued to The City Auto Stamping Company for a consideration of $ 500.

Throughout the period from 1916 to the present time, and notwithstanding the corporate changes mentioned above, the jobbing die business has continued to be a separate, distinct, and continuing enterprise, housed and operated in separate buildings or plants, with separate machinery, equipment, and other assets, and with separate operating personnel. All business transactions have been recorded and accounted for in separate books of account and as separate business operations. Throughout the period prior to 1940, when petitioner's new plant was constructed, the enterprise occupied portions of the building known as the Toledo Factories Building. The plant of The City Auto Stamping Company was located several miles away. Following the merger in 1931, there was no change in the physical or operating characteristics of the die enterprise. The machinery, equipment, and other assets came under the ownership of The City Auto Stamping Company by virtue of the merger, but were never physically commingled with the other assets of the Stamping Company. The machinery and equipment were not moved to the factory of the Stamping Company, but continued to be located in the Factories Building, continued to be operated by separate personnel, and all transactions in connection therewith continued to be recorded and accounted for as a separate business. Bank accounts, purchase orders, cost sheets, job cards, invoices, contracts, letterheads, checks, and vouchers pertaining to the enterprise continued in the name of The City Machine & Tool Company, but sometimes with the added designation "Division of The City Auto Stamping Company." During the period from the date of the merger, June 30, 1931, until April 30, 1940, The City Auto Stamping Company carried on its books an investment account representing its investment in the assets of the die enterprise in which there was entered annually an amount equal to the net profit or loss for the year, as shown by the separate books of account of the die enterprise.

On October 26, 1936, petitioner executed a Lease and Agreement (hereinafter referred to as lease) with its parent, The City Auto Stamping Company, which lease provided as follows:

In consideration of the payment of rent hereinafter reserved, and of the covenants herein, the Stamping Company hereby lets and leases unto the Tool Company, its successors and assigns, for the period to December 31, 1937, the following property:

All that property now owned by the Stamping Company and situated in that portion of the Factories Building, Toledo, Ohio, occupied by the Tool Company under lease from Daco Investment Company, consisting of machinery, fixtures, implements, utensils and things which are now or which may be hereafter placed in or upon said premises.

The Stamping Company also transfers and assigns to the Tool Company all of its right, title and interest in and to the business and good will heretofore conducted in said premises by it or its predecessors in the jobbing die business, and transfers and assigns to the Tool Company all accounts receivable, and all choses in action growing out of, or arising in connection with, said jobbing die business, whether now existing or hereafter arising.

TO HAVE AND TO HOLD the same unto the said Tool Company, its successors and assigns, in consideration of the rentals and covenants and conditions hereinafter set forth.

The Tool Company agrees to operate said jobbing die business and conduct the same in said premises with the use of said machinery, fixtures, implements, utensils and things, under its name as heretofore, and to keep said machinery and equipment in good condition and repair, to pay all operating expenses, including taxes, insurance, governmental charges, payrolls, bills for electricity, water and gas, repairs, materials and other operating costs, and to turn over said property hereby leased and reassign to the Stamping Company said intangible property, business and good will at the expiration of this lease.

The Tool Company further agrees to pay as rent under this lease and agreement all of the net income, issues and profits of said business and property, the same to be paid from time to time at convenient periods, and, in any event, at least semi-annually on the 30th day of June and the 31st day of December of each year.

The Tool Company agrees to keep accurate books, records and accounts of all its transactions in the operation of said business, which shall be open to the inspection of the Stamping Company, its officers, agents and accountants at all times.

In the event that the Tool Company shall renew or extend its lease on said premises with the owners thereof, then this lease and agreement shall be extended and continued for a further period beyond the 31st day of December 1937, coextensive with the lease of the Tool Company for said premises.

The lease was authorized by the board of directors of petitioner at a meeting held on October 25, 1936, and by resolution of the board of directors of The City Auto Stamping Company at a meeting on the same date. No entries were made on the books of account of petitioner or of The City Auto Stamping Company at or after October 26, 1936, reflecting the lease.

The purpose of the lease was to establish or define the separate manufacturing plants of the parent, The City Auto Stamping Company, namely, the stamping plant and the die plant in the Factories Building as separate bargaining units under the National Labor Relations Act in furtherance of labor relations and collective bargaining with the employees in the plants. The stamping plant was a union shop, the local union of the United Automobile Workers having been certified as the bargaining agent by the National Labor Relations Board, while the die division in the Toledo Factories Building was then a nonunion shop. Some efforts were then being made by the union to organize the employees of the die division, and the management was apprehensive that an attempt would be made by the union to have both plants certified as a single bargaining unit under the National Labor Relations Act.

Prior to the date of the lease, October 26, 1936, petitioner had three directors. From the date of the organization of petitioner, July 9, 1931, to October 26, 1936, the corporate minutes of petitioner show no actions taken by the shareholders or directors of petitioner, except the following: The minutes of the annual meetings of the shareholders at which directors were elected and the financial reports and actions of the board of directors and officers were approved, and the annual meetings of the board of directors at which officers were elected and financial reports were approved. At the annual meeting held on April 13, 1938, the board of directors was increased to five, and two additional directors were added to the board. On May 1, 1937, petitioner's board of directors adopted a depositary resolution designating The Toledo Trust Company as depositary for the commercial account and payroll account of petitioner, which accounts had theretofore been and then were carried in that bank, the commercial account being under the designation "The City Machine & Tool Co., Div. City Auto Stamping Co." and the payroll account being under the designation "The City Machine & Tool Co., Payroll Acc't." The accounts continued in The Toledo Trust Company under the above designations until they were closed on June 30, 1940, and May 31, 1940, respectively. On October 11, 1938, petitioner's board of directors adopted a depositary resolution designating the National Bank of Detroit as a depositary for petitioner. A commercial account was opened in the National Bank of Detroit on September 21, 1938, under the designation "The City Machine & Tool Company, Division of City Auto Stamping Co.," which account continued until it was closed on June 30, 1940. On November 2, 1939, petitioner's board of directors adopted a depositary resolution designating The Ohio Citizens Trust Company, Toledo, Ohio, as a depositary for petitioner. A commercial account was opened in The Ohio Citizens Trust Company on October 30, 1939, under the designation "The City Machine & Tool Company," which account continued in the bank until it was closed on May 2, 1940. The bank accounts in the National Bank of Detroit, The Toledo Trust Company, and The Ohio Citizens Trust Company were closed after May 1, 1940, and new accounts were opened in the banks on the dates and under the designations shown on exhibit 61. Payroll checks drawn against the payroll accounts in the banks sometimes carried the designation "The City Machine & Tool Company, Division of City Auto Stamping Company." In all other cases, both payroll and commercial checks drawn against all of said accounts carried only the name of "The City Machine & Tool Company." The year-end bank balances in the commercial accounts were for substantial amounts.

The payroll reports, settlement sheets, and detailed statements, showing wages earned, as appearing on time and account books, were filed with the Industrial Commission of Ohio under the name of "The City Machine & Tool Company." These reports show a large number of employees engaged in the die enterprise which were reported to the Ohio Industrial Commission as employees of petitioner.

In August 1939, John S. Bradley of Toledo, Ohio, a real estate agent acting on behalf of petitioner, initiated negotiations with The Pere Marquette Railroad Company of Detroit, Michigan, for the purchase of a tract of land in Toledo, Ohio, as a site for a new plant, which petitioner constructed in 1940. The negotiations were continued by Bradley until about April 1, 1940, and were thereafter continued by petitioner's counsel until a contract for the purchase and sale of the land between The Pere Marquette Railroad Company and petitioner was executed on May 23, 1940.

On March 8, 1939, petitioner's board of directors adopted a resolution authorizing the officers to execute a form of lease with The Daco Investment Company covering 11,000 square feet of additional floor space on the second floor of the Toledo Factories Building for a term of 2 years and 10 months from the 1st day of March 1939, to the 31st day of December 1941, at a monthly rental of $ 375. The first lease between petitioner's predecessor and the owner of the Toledo Factories Building was dated January 1, 1919, and the last lease thereon was dated March 1, 1939, hereinbefore referred to. Prior to the merger effective June 30, 1931, the lessee in each of the leases was The City Machine & Tool Company, the last of the leases prior to the merger being for a term from January 1, 1928, to December 31, 1932. The lease for the space for the term beginning January 1, 1933, and ending December 31, 1936, named as lessee "City Auto Stamping Company, an Ohio corporation, for its Tool and Die Division, known as The City Machine & Tool Company, Toledo, Ohio." On the 30th day of July 1936, the lease was extended by written "Extension of Lease" for 1 year from the 1st day of January 1937, to the 31st day of December 1937. The lessee named in the Extension of Lease was "The City Machine & Tool Company, Division of The City Auto Stamping Company." Under date of June 25, 1937, the lease was extended for the further period of 1 year from December 31, 1937, to December 31, 1938, the lessee in the Extension of Lease being designated "The City Machine & Tool Company." Under date of April 7, 1938, an Extension of Lease was entered into for the space for a 3-year period from January 1, 1939, to December 31, 1941, the lessee therein being "The City Machine & Tool Company, Division of The City Auto Stamping Company." Under date of February 17, 1939, a lease for additional space on the second floor of the Toledo Factories Building was entered into between the same parties for the period beginning March 1, 1939, and ending on December 31, 1941.

Under date of February 20, 1940, the board of directors of The City Auto Stamping Company adopted a resolution reading as follows:

RESOLVED, that the officers of the Company, with the concurrence of the officers and Directors of The City Machine & Tool Company, be, and they hereby are, authorized and empowered to take such steps as may be necessary to increase the capital stock of The City Machine & Tool Company by increasing the number of common shares without par value, and, if deemed advisable, to create additional classes of shares, in the amounts and with such restrictions, preferences or limitations as may be deemed advisable, and to transfer the machinery and equipment, inventories, accounts receivable, or other property, used in the Tool and Die Division and now and heretofore operated under lease to The City Machine & Tool Company for such considerations consisting of shares of stock of evidences of indebtedness as said officers may deem advisable, and to terminate said lease arrangement, and also to purchase such additional shares of stock of any class or to make loans or advances to said The City Machine & Tool Company as may be deemed necessary or proper to supply said Company with working capital and additional facilities or equipment.

At the same meeting, the board of directors of The City Auto Stamping Company adopted a resolution reading as follows:

RESOLVED, that the officers of the Company be, and they are, authorized and empowered to purchase a site, erect a building and purchase additional equipment for the Die Division at an estimated expenditure of not to exceed Five Hundred Thousand ($ 500,000.00) Dollars; and that, in the exercise of the power and authority hereby conferred, said purchases may be made either in the name of this Company or in the name of The City Machine & Tool Company, as the officers may deem advisable, in accordance with the arrangements for the handling of the business of that Company as provided by resolution adopted at this meeting.

On April 23, 1940, petitioner's board of directors was advised by the secretary that petitioner's articles of incorporation had been amended pursuant to unanimous consent of all shareholders to increase its capital stock to 10,000 common shares without par value, and resolutions were adopted authorizing the acquisition from The City Auto Stamping Company of the jobbing die business, machinery, equipment, inventories, and good will, and approving a form of agreement for such acquisition. The agreement was approved on the same date by the board of directors of The City Auto Stamping Company. The agreement was executed on April 23, 1940, and, pursuant thereto, the jobbing die business was conveyed by The City Auto Stamping Company to petitioner in exchange for 5,925 shares of petitioner's common stock, effective April 30, 1940.

The net income and excess profits net income of the die enterprise during the period of the lease from October 27, 1936, to December 31, 1939, which were included in the income tax returns of The City Auto Stamping Company for the years 1936 to 1939, inclusive, were as follows:

		Excess profits
Year	Net income	net income
1936 $ 2,864.77	$ 2,504.45
1937	110,382.12	110,060.37
1938	139,261.07	139,226.93
1939	480,319.42	477,786.36

If the above amounts (after payment of all operating expenses, but before Federal taxes or payments or accruals to The City Auto Stamping Company, lessor under said lease) were includible in the income of petitioner and taxable to petitioner for the years 1936 to 1939, inclusive, the net income and excess profits net income of petitioner during the period of the lease would be as follows:

		Excess profits
Year	Net income	net income
1936	$ 2,839.77	$ 2,479.45
1937	110,357.12	110,035.37
1938	139,236.07	139,201.93
1939	475,894.42	473,361.36

If the above amounts of net income for the years 1936 to 1939, inclusive, were taxable to petitioner, the excess profits credit of petitioner, based on income computed under section 713 (f), Internal Revenue Code, would be $ 409,729.08.

All the net income of the jobbing die enterprise was included in the income tax returns of The City Auto Stamping Company, and the tax thereon was paid by that company for the years 1936 to 1939, inclusive, and for the first 4 months of 1940. Petitioner's income tax return for the year 1936 contained a statement as follows:

Under date of October 26, 1936, The City Machine & Tool Company, an inactive subsidiary of The City Auto Stamping Company, entered into a contract with The City Auto Stamping Company to take over the jobbing die business of The City Auto Stamping Company, which was previously conducted by "The City Machine and Tool Company Division" of The City Auto Stamping Company.

The aforementioned contract of October 26, 1936, provided for the leasing of certain equipment owned by The City Auto Stamping Company to The City Machine and Tool Company in consideration of the payment of a rental equal to all of the net income, issues and profits of said business and property. Therefore, while The City Machine and Tool Company had operations during the period from October 26, 1936 to December 31, 1936, it had no net profit or taxable income, as the excess of its sales over its costs constituted its rent expense.

For convenience in accounting and reporting taxable income, all of the operating accounts of The City Machine and Tool Company have been consolidated with those of The City Auto Stamping Company, instead of showing the net of these accounts as rental income to said Company.

Petitioner filed income tax returns for each of the years 1936 to 1939, inclusive, each of which showed a loss of $ 25 per year. No objection has ever been made by respondent to the income tax returns of petitioner for the years 1936 to 1939, inclusive. The income tax return of The City Auto Stamping Company for the year 1936 was examined and accepted, as filed, by respondent and the returns of the company for the years 1937 to 1940, inclusive, were examined by a revenue agent, but the revenue agent's reports for those years made no adjustments on account of the lease, and made no reference thereto.

A consolidated Federal excess profits tax return was filed for the year 1940 by The City Auto Stamping Company, including the operations of The City Machine & Tool Company and The City Forge Company. The excess profits tax liability of the consolidated group for the year 1940 has been finally determined, involving a carry-over to 1941, in the case of City Auto Stamping Co., 7 T. C. 354, and is not before the Court in this proceeding.

Petitioner's original income and excess profits tax returns, and amended returns, for the years 1941 to 1944, inclusive, were prepared and filed on the theory that petitioner had no base period net income, and on its returns, petitioner computed its excess profits taxes using an excess profits credit based on invested capital under section 714, Internal Revenue Code, as follows:

1941	$ 80,233.91
1942	88,997.76
1943	90,160.37
1944	99,226.83

The amounts of income taxes actually paid by The City Auto Stamping Company, by reason of the inclusion of the income of the die enterprise during the period October 27, 1936, to December 31, 1939, inclusive, in the income tax returns of the company, aggregated the sum of $ 104,345.80 as follows:

1936	$ 925.11
1937	16,557.31
1938	85.31
1939	86,778.07

The income taxes which would have been payable by petitioner if the taxable income of the die enterprise had been includible in petitioner's returns for 1936 to 1939, inclusive, aggregate the sum of $ 134,527.32 as follows:

1936	$ 374.78
1937	30,567.10
1938	23,280.21
1939	80,305.23

If the income of the die enterprise for the period October 27, 1936, to December 31, 1939, was taxable to petitioner, the amounts thereof remaining, after deduction of income taxes, accrued to The City Auto Stamping Company as rent under the terms of the lease agreement. The amounts of income taxes thereon for each taxable year and the balances thereof which would accrue as rent to The City Auto Stamping Company and the overpayments of income taxes made by the parent corporation by reason of the inclusion of all of the die income in its returns for each of the pertinent years were as follows:

	1936	1937	1938	1939
Taxable net income of
die enterprise *288	$ 2,839.77	$ 110,357.12	$ 139,236.07	$ 475,894.42
Income tax liability 374.78	30,567.10	23,280.21	80,305.23
Rent accrual after
income taxes	$ 2,464.99	$ 79,790.02	$ 115,955.86	$ 395,589.19

Overpayments of Income Taxes by The City Auto Stamping Company
Year	Amount
1936	$ 116.26
1937	4,585.06
1938	85.31
1939	15,257.99
Total	$ 20,044.62

The excess profits tax credits of The City Auto Stamping Company computed under section 713, Internal Revenue Code, were based on the income reported in its returns filed for the years 1936 to 1939, inclusive. If the taxable income of the die enterprise was includible in the income of petitioner and taxable to petitioner for the period October 27, 1936, to December 31, 1939, the excess profits credit of The City Auto Stamping Company would have been reduced for the year 1941 by the amount of $ 26,569.84 and for the years 1942 to 1945, inclusive, by the amount of $ 33,026.50. As a result of such decrease in the excess profits tax credit of The City Auto Stamping Company, the income and excess profits tax liability of that company would have been greater than the amounts previously assessed and paid by that company as follows:

1941	$ 17,718.65
1942	-0-
1943	17,184.15
1944	23,735.95

On July 22, 1949, petitioner filed with the collector for the tenth district of Ohio at Toledo its claims for refund covering the years 1941 to 1944, inclusive, based on the decision of the United States Supreme Court in the case of National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, decided March 28, 1949, and on the terms of the lease. In the claims for refund, petitioner computed its excess profits tax liabilities using the excess profits credit based upon the income of the die enterprise during the period October 27, 1936, to December 31, 1939, as computed under section 713, Internal Revenue Code. On August 2, 1951, petitioner filed with the collector for the tenth district of Ohio at Toledo amended claims for refund for the year 1941 and for the year 1943. Copies of the claims and amended claims for refund are attached as exhibits to the amendment and second amendment to the petition herein. The claims for refund (Form 843, which are referred to in the proposed amendment to the petition and which were filed on July 22, 1949) have not been acted upon by the Commissioner, but are being held in abeyance pending decision of this proceeding.

Petitioner and the Commissioner, within the statutory time, entered into original agreements, Form 872, and into several extension agreements relating to each of the years 1941 through 1944, which extended the period of limitations for the making of assessments of deficiencies by the Commissioner to June 30, 1949. On June 21, 1948, respondent mailed to petitioner by registered mail a notice of deficiency, together with notice of disallowance of petitioner's applications for relief under section 722, Internal Revenue Code, a copy of which, with accompanying statements, is attached to the petition herein, marked "exhibit A." The period of limitations for the filing of claims for refund does not expire until after the decision of this Court in this cause becomes final. The periods of limitation for assessment of income taxes for the years 1936 to 1939, inclusive, have expired.

Petitioner conducted business under the lease and operated the die enterprise thereunder from the date of the lease, October 26, 1936, to December 31, 1939, and thereafter, until the assets of the die enterprise were conveyed to petitioner in exchange for its stock effective April 30, 1940. The net income and excess profits net income of the die enterprise during the term of the lease in the base period years were earned by petitioner and were taxable to petitioner.

OPINION.

The only issue raised originally by the petitioner in its petition is whether petitioner is entitled to relief from excess profits tax under section 722. The petitioner filed its petition on September 17, 1948. On March 28, 1949, the Supreme Court entered its decision in National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422. Thereafter, the petitioner filed a motion for leave to amend its petition to raise a standard issue. The petitioner's motion was denied by this Court on the ground that it was not timely made and because this Court considered that it did not have jurisdiction. See Mutual Lumber Co., 16 T.C. 370">16 T. C. 370. The petitioner appealed from the order of this Court denying its motion to amend the petition. The Court of Appeals for the Sixth Circuit remanded the proceeding with directions to grant the petitioner's motion. City Machine & Tool Co. v. Commissioner, 194 F.2d 535">194 F. 2d 535. In compliance with the mandate of the Court of Appeals for the Sixth Circuit, we granted a motion of the petitioner to separate the standard issue from the 722 issue.

The standard issue now before us is whether, under the decision of the Supreme Court in National Carbide Corp. v. Commissioner, supra, the petitioner had taxable net income during each of the base period years (1936-1939) so as to be entitled to compute its excess profits credit, based on such income, under section 713 (f) of the Code.

The facts are not in dispute. The petitioner, a wholly owned subsidiary of The City Auto Stamping Company was inactive prior to October 1936. The parent company was engaged in two principal business activities; it manufactured sheet metal stampings in a plant located on the outskirts of Toledo, and it operated a jobbing die business in leased premises in the Toledo Factories Building. In October 1936, the parent company leased the jobbing die business to the petitioner. The lease agreement provided for the payment of rental by the petitioner in an amount equal to all the net income and profits of the business after the payment of operating charges. Petitioner operated the jobbing die business under the lease agreement for the remainder of the base period years, and paid over to its parent, as rent, all of the operating net income of the business. The parent reported the income which it received from petitioner's operations in its tax returns in each of the years 1936 to 1939, inclusive. The petitioner filed income tax returns for each of the years 1936 to 1939, inclusive, but did not report any gross or net income from its operations. Each return filed by petitioner disclosed a net loss of $ 25 representing a deduction for the payment by petitioner of its franchise tax. The petitioner's 1936 return contained a notation advising the respondent of the lease agreement with its parent, and of petitioner's treatment of the excess of its sales over its costs as rental expense. In April 1940, the lease agreement was canceled, and the die enterprise, including all the assets employed in the business, was transferred to the petitioner in exchange for additional shares of petitioner's capital stock. A consolidated excess profits tax return filed by the parent for 1940 reflected petitioner's operations for that year. For each of the years 1941 through 1944, petitioner filed an excess profits tax return in which it computed its excess profits credit on the invested capital method.

The petitioner now contends that it acted under an erroneous interpretation of the law both in failing to report and to pay tax on the income which it earned during the base period years, and in assuming, for excess profits tax purposes, that its exces profits credit based on income was zero. Petitioner argues that, under the decision of the Supreme Court in National Carbide Corp. v. Commissioner, supra, the lease agreement between petitioner and its parent must be considered as having had no validity for tax purposes, in which event, petitioner had taxable net income during the base period years, which entitles petitioner to compute its excess profits credit under the income method, since its credit thus computed would be greater than its credit based on invested capital. Petitioner concedes in its argument that it is taking an inconsistent position with respect to an item or transaction affecting the computation of its excess profits credit, and that, if petitioner prevails, adjustments under section 734 of the Code will be necessary.

The respondent does not seriously contest the petitioner's argument, but pleads in defense that the petitioner is estopped to disclaim the validity for tax purposes of the lease arrangement with its parent, and to assert now that it had taxable net income during the base period years which entitled it to an excess profits credit based on income.

We will consider first the petitioner's contention which is based upon the decision of the Supreme Court in the National Carbide Corporation case, supra.

We agree with the petitioner that its tax treatment of the income which was earned by it during the base period years was erroneous as a matter of law. In National Carbide Corp. v. Commissioner, supra, the Supreme Court held that wholly owned subsidiary corporations, which were utilized by the parent for busines purposes, as operating companies, were taxable on the income which was earned by them. In its opinion the Supreme Court observed (p. 429) that

we have held that a corporation formed or operated for business purposes must share the tax burden despite substantial identity, in practical operation, with its owner. Complete ownership of the corporation, and the control primarily dependent upon such ownership -- the important ingredients of the Southern Pacific case -- are no longer of significance in determining taxability. Moline Properties, Inc., v. Commissioner, supra;Burnet v. Commonwealth Improvement Co., 287 U.S. 415 (1932) * * *

The fact that the parent corporation retains direction of the affairs of the subsidiary, provides the subsidiary with all of its assets, and treats all the profits of the subsidiary as its own does not alter the tax consequences. It is now well settled that "the tax laws require taxation of the corporate entity if it engages in 'business activity'." Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436; National Carbide Corporation, supra.The only possible exceptions to the stated rule are where there is a true corporate agent or trustee. National Carbide Corporation, supra.Neither of those relationships are present here.

It is not disputed that the petitioner was engaged in business activity in each of the base period years, nor is it contended that petitioner corporation was "a sham or unreal" under the doctrine of Higgins v. Smith, 308 U.S. 473">308 U.S. 473. Therefore, we do not have in this case the problem referred to in the twentieth footnote to the opinion of the Supreme Court in the National Carbide Corporation case, supra. Petitioner was utilized by its parent as an operating company, as were the subsidiaries in the National Carbide Corporation case, supra. The fact that the parent-subsidiary arrangement in the instant case was called a lease, while in the National Carbide Corporation case, supra, it was called a sales contract and the subsidiaries were referred to as agents of the parent, is not, in our opinion, a material difference. The form employed by the parent in utilizing the subsidiary for business purposes cannot control the tax consequences. National Carbide Corporation, supra.

We conclude that a proper treatment of the income earned by the petitioner in each of the base period years would require that the income be taxed to the petitioner. It follows that petitioner had taxable net income in each of the base period years.

We turn next to consideration of whether, as respondent contends, the petitioner is now estopped to assert a position which is inconsistent with its tax treatment of income in the base period years.

We have discussed the question of estoppel at some length in Tide Water Oil Co., 29 B. T. A. 1208, 1220; Sugar Creek Coal & Mining Co., 31 B. T. A. 344, 346; and American Light & Traction Co., 42 B. T. A. 1121, 1122, affd. 125 F. 2d 365. No useful purpose would be served by repetition here. The respondent seeks to invoke either an estoppel in pais, or a doctrine analogous to estoppel. He argues that the essential elements of a technical estoppel are present in this case, and that, in any event, the petitioner should be barred now from disclaiming the validity for tax purposes of the lease agreement which it entered into with its parent. We think the respondent's argument is without merit.

There is no basis in the record before us to support a plea of estoppel in any of its variations. There was no misrepresentation or concealment of material facts on the part of petitioner, nor was the respondent induced to change his position to his detriment in reliance on any representations by the petitioner. Respondent was not ignorant of the true facts. He had knowledge of the lease arrangement between petitioner and its parent at an early date. Petitioner's return for 1936, the first taxable period during which the lease was in effect, disclosed the existence of the lease agreement, and advised the respondent of the petitioner's proposed treatment, under the terms of the lease, of the excess of its sales over its costs as rental expense. The return also contained the notation that "for convenience in accounting and reporting taxable income, all of the operating accounts of The City Machine and Tool Company have been consolidated with those of The City Auto Stamping Company." The income tax return of The City Auto Stamping Company for 1936 was examined by the respondent and accepted as filed; its returns for the years 1937 to 1940, inclusive, were also examined by revenue agents and no adjustments were made on account of the lease arrangement between petitioner and its parent. The only fair inference to be drawn from the facts is that the petitioner, by taking an erroneous legal position, filed incorrect tax returns in each of the base period years, and that the respondent acquiesced in the error. The mistake made was one of law, and "neither the taxpayer nor the Commissioner is estopped by the previous taking of an erroneous legal position." Commissioner v. American Light & Traction Co., 125 F. 2d 365, and cases therein cited. See, also, Commissioner v. Mellon, 157">184 F. 2d 157, affirming 12 T. C. 90; Tide Water Oil Co., supra;Mahlon D. Thatcher, 46 B. T. A. 869; Estate of Isadore L. Myers, 1 T. C. 100. Capital National Bank of Sacramento, 16 T. C. 1202. We conclude that the petitioner is not estopped here.

There is a further reason why the doctrine of estoppel may not be invoked here. Congress in enacting the excess profits tax contemplated situations in which either the taxpayer or the Commissioner might take an inconsistent position with respect to an item or transaction affecting the taxpayer's excess profits credit. Section 734 authorizes adjustments in certain cases where the treatment of an item or transaction for excess profits tax purposes is inconsistent with a prior erroneous treatment for income tax purposes, and the correction of the error is prevented by some provision or rule of law such as the statute of limitations. See S. Rept. No. 1631, 77th Cong., 1st Sess. (1942), p. 211. "Section 734 is an equitable provision designed not to prevent inconsistency but to discourage such inconsistency by depriving the guilty party of any pecuniary benefit therefrom." S. Rept. No. 1631, supra. The Commissioner in the situation here presented is not without his remedies.

It is held that the petitioner had taxable net income in each of the base period years, and that it is entitled to compute its excess profits credit based on such income.

In view of our conclusions under the standard issue, it is not necessary to consider the issues relating to relief under section 722. Petitioner concedes that its excess profits credit based on income will approximate the constructive average base period net income which it alleges in its petition for relief under section 722. See Irwin B. Schwabe Co., 12 T. C. 606.

The petitioner concedes that adjustments, resulting from its taking an inconsistent position with respect to an item or transaction affecting its excess profits credit, will be necessary under section 734 of the Code. Therefore, recomputation under Rule 50 is necessary.

Decision will be entered under Rule 50.

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Footnotes

• 1. Oct. 27 to Dec. 31, 1936.↩

• 1. Supplemental stipulation, paragraph 1.↩

• 2. Supplemental stipulation, paragraph 8.↩