
    Appeal of HAYES TEXTILE CO., INC.
    Docket No. 844.
    Decided September 30, 1926.
    1. The same individual owned and controlled the stock of the Hayes Textile Oo., Inc., and the Hayes Knitting Oo. during 1918 and 1919. Held, that the two corporations were affiliated for 1918.
    2. The same individuals constituted the board of directors of each corporation; in 1917 they decided to effect a merger of the two corporations and subsequently dissolve the Knitting Oo., it being the intention that the Textile Co. take over all assets and business of the Knitting Co. and assume its liabilities and issue to the stockholders of the Knitting Co. its stock in exchange for the stock held by them in the Knitting Oo. Pursuant to advice of counsel, the Textile Co. took over the assets and business of the Knitting Co. and assumed its liabilities on January 1, 1919, and issued its stock to the stockholders of the Knitting Co. par for par. The outstanding shares of stock of the Knitting Co. were not, however, formally surrendered to the Textile Co., and the Knitting Co. continued its legal existence during 1919. On or about March 15, 1919, it filed a separate tentative income and profits-tax return, showing an estimated net income of $10,226.34, and an estimated tax of $5,140.37, — $1,325 of which was paid, and at the same time it secured an extension of time to file the complete return. Subsequently, the inventory showed a loss of $18,417.92, and the Knitting Co. filed a return for 1918, which showed a net loss for 1918 resulting from a reduction from $82,574.20 to $64,156.28 of the value of its inventory at December 31, 1918, as shown by a disposition thereof in the first part of 1919 by the Textile Co., and it filed with its return a claim for the abatement of the tax of $5,140.37 and for a refund of $1,325 paid on the tentative return. Held, that the two corporations should have filed a consolidated return for 1918, and, as they remained affiliated throughout 1919, the loss of $18,417.92 resulting from the disposition in 1919 of the 1918 inventory should be allowed in computing the consolidated net income for 1918.
    
      Chartes E. Cooney, Esq., for tlie petitioner.
    
      B. EL. Saunders, Esq., for the Commissioner.
    The deficiency in this appeal is for the calendar year 1918, in the amount of $62.38. It is alleged, first, that the petitioner and the Hayes Knitting Co. were affiliated corporations during 1918 and that they should have filed a consolidated return for that year. Secondly, that a loss claimed by the Knitting Co. at the time of filing its return for 1918, in the amount of $18,417.92, resulting from a reduction of the value of the December 31, 1918, inventory, should have been allowed.
    FINDINGS OF FACT.
    The Hayes Knitting Co., a New York corporation, was organized on February 28, 1911, by Thomas J. Hayes, his wife, and son, for the purpose of manufacturing hosiery, underwear, and other cotton and wool garments, and it thereafter, throughout the year 1918, regularly carried on such business at Oswego. The above-named individuals constituted the board of directors. All of the capital stock of the company, consisting of 300 shares of the par value of $30,000, was issued as follows: Thomas J. Hayes, 297 shares; E. A. Hayes, his wife, 2 shares; and Neil T. Hayes, his son, 1 share. The three shares issued to the two persons last mentioned were issued to qualify them as directors and were indorsed to and held by Thomas J. Hayes. Thereafter, under the terms of a written agreement, certain banks loaned to the Knitting Co. sums of money on its notes, indorsed by Thomas J. Hayes, who pledged as collateral for such loans certain stock owned by him in the company. The instrument provided that “ said Thomas J. Hayes shall retain the right to vote upon such stock at any and all times, except only in default of the payment of any part of the principal or interest on said notes, or the observance of any of the conditions of said mortgage; and all the right, title and interest of said Thomas J. Hayes has been foreclosed therein.” There was no default.
    From time to time after the organization of the company, Hayes borrowed from certain of his friends small amounts of money for use in connection with the company’s business and, although they desired no security, he insisted that they hold certain shares of his stock in the company as collateral. The number of persons to whom he owed money on this account varied from time to time, being at no time greater than ten. The amount of stock placed with them ranged from one share to seven shares, and at no time exceeded a total of 25 shares. The persons holding this stock as collateral never considered themselves the legal owners of the same. It was understood that Hayes should control the stock and vote it. The stock was voted by Hayes during the time it was held by others as collateral.
    The Hayes Textile Co., also a New York corporation, was organized by Hayes, his wife, son, and daughter, on February 16, 1918, with a capital stock of 100 shares of the total par value of $10,000, for the same purpose as that of the Knitting Co., and, in addition, “ to purchase or rent real estate and carry on any business connected therewith.” The entire capital stock was issued to the above-named individuals as follows:
    Shares.
    Thomas J. Hayes_70
    Ella A. Hayes, his wife_15
    Ella M. Hayes, his daughter_ 5
    Neil T. Hayes, his son_10
    Stock was issued to the three persons last mentioned to qualify them as directors. The 15 shares issued to Ella A. Hayes were immediately indorsed and delivered to Thomas J. Hayes. He also controlled the stock standing in the name of his daughter and son. The stock was thus held from the date of incorporation throughout the year 1918.
    Certain land and buildings constituted the only assets of the Textile Co., until after the end of the year 1918. This property was rented to the Knitting Co. and the rent received therefor constituted the only income of the Textile Co. for 1918 and prior years.
    The same persons constituted the board of directors of both companies until the Knitting Co. was dissolved in 1920.
    
      In the latter part of 1917, it was decided that the Knitting Co. and the Textile Co. should be merged and the Knitting Co. dissolved. Counsel was employed to advise the companies in this regard and as to the steps to be taken to effect the merger. The steps taken pursuant to his directions were not strictly in compliance with the New York Corporation Law, chapter 59, section 15, relating to mergers, or chapter 4, section 7, relative to consolidation, or chapter 59, section 16, relative to voluntary sale of franchise and property. It was the desire of the parties in interest that the Textile Co. take over the business and assets of the Knitting Co., assume its liabilities, and issue additional shares of its stock to the stockholders of the Knitting Co. in exchange for the stock held by them in that company, par for par, and thereafter to dissolve the Knitting Co.
    On December 25,1917, the directors of the Textile Co. adopted the following resolution:
    WHEREAS, an offer Raving been made to tbis Company by the Hayes Knitting Company of Oswego, N. Y., to transfer all its property of every name and nature to this Company for $30,000.00 of the increased capital of this corporation, provided that all the indebtedness of said Hayes Knitting Company is assumed and agreed to be paid by this corporation.
    AND WHEREAS, all of the stockholders of this Company have unanimously consented thereto;
    AND WHEREAS, that these two corporations are already now closely allied, and it seems to be for the mutual benefit of both Companies and their stockholders that the proposal or offer be accepted.
    IT IS HEREBY RESOLVED, That said offer be accepted and that such proceedings be had as are necessary to increase the capital stock of this Company, from $10,000 to $40,000.00 — $30,000.00 thereof being increased stock issued for the purpose of acquiring the property of said Hayes Knitting Company.
    AND IT IS FURTHER RESOLVED, That on receiving a bill of sale or transfer in due form of all of the property of said Hayes Knitting Company, that said stock be issued to the holders of stock in said Hayes Knitting Company, share for share, and that the President of this Company in its behalf be and hereby is authorized to execute an agreement assuming and agreeing to pay all the indebtedness of said Hayes Knitting Company which has been duly audited and ascertained, and indemnifying the said Hayes Knitting Company of and from the payment thereof or any part thereof.
    The capital stock of the Textile Co. was duly increased on September 18, 1918. Thereafter, on January 1, 1919, the following resolution was ádopted by the directors of the Knitting Co.:
    The capital stock of the Hayes Textile Company, Inc., on whose real estate this company is doing business as tenant having been increased .or is in process of being increased from $10,000 to $40,000 said amount par value as the stock of the Hayes Knitting Company and the said increased capital stock in the Hayes Textile Company, Inc., being regarded of equal value of the capital stock of the Hayes Knitting Company and an offer having been made by said Hayes Textile Company, Inc., to transfer to the stockholders of said Hayes Knitting Company said increased capital stock of $30,000 par for par, on the transfer to said Hayes Textile Company, Inc., by this company of all of its property of every name and nature wherever situate, together with ail its right, title and interest therein and upon the expressed agreement that said Hayes Textile Company, Inc., assumes and agrees to pay at maturity all the obligations of said Hayes Knitting Company it is therefore
    RESOLVED, That said offer be accepted and the president of this company be and hereby is authorized to execute a bill of sale of all the right, title and interest of said Hayes Knitting Company in said property subject to the assumption of all its debts, the said Hayes Textile Company, Inc., having agreed thereto, and said transfer of property and the issue of stock of the Hayes Textile Company, Inc., par for par, for the property of said Hayes Knitting Company having been consented to by all stockholders of both companies.
    AND IT IS FURTHER RESOLVED, that when the transaction above provided for is consummated that proceedings be taken for the dissolution of this company as required by law.
    On January 1, 1919, the stockholders of the Knitting Co., including persons holding certain shares as collateral on loans made to Hayes, signed a statement reading as follows:
    We, the undersigned, stockholders in the Hayes Knitting Company of Os-wego, New York, a corporation duly organized pursuant to the Laws of the State of New York and holders of stock therein of the number of shares set opposite our names and amounting in all to three hundred shares, the entire capital stock of said company, hereby agree for value received and in consideration of the same number of shares and of the same par value of the stock of the Hayes Textile Company, Inc., hereby consent to the transfer of all of the property of the Hayes Knitting Company to said Hayes Textile Company, Inc., as existing on this date subject however to the agreement that said Hayes Textile Company, Inc., assumes and agrees to pay at maturity all the obligations of said Hayes Knitting Company of every name and nature and consent to the exchange of the stock now held by us in the Hayes Knitting Company for the same par value of stock of the Hayes Knitting Company.
    On January 1, 1919, the Knitting Co. executed the following transfer:
    For a valuable consideration in hand paid by the HAVES TEXTILE COMPANY, INC., of Oswego, New York, to the HAYES KNITTING COMPANY, * * * said HAYES KNITTING COMPANY hereby sells, assigns, transfers, sets over and conveys unto the said HAYES TEXTILE COMPANY, INC., all of its property of every name and nature, wherever situate, together with all its right, title and interest therein;
    To have and to hold the same to the said HAYES TEXTILE COMPANY, INC., its successors and assigns forever,
    This transfer is made for the consideration of the delivery to the stockholders of the HAYES KNITTING COMPANY, who hold stock of the par value of Thirty Thousand ($30,000) Dollars therein (the whole amount hereof) in said HAYES TEXTILE COMPANY, INC., for the same amount and for the additional consideration that the HAYES TEXTILE COMPANY, INC., the assignee, of said property, hereby does assume and agree to pay at maturity all of the obligations of the said HAYES KNITTING COMPANY of every name and nature and this transfer or bill of sale is accepted on said condition.
    
      This transfer is made pursuant to resolution of the Board of Directors of said HAYES KNITTING COMPANY and the unanimous consent of its stockholders and is accepted by authortiy of the resolution of the Board of Directors of said HAYES TEXTILE COMPANY, INC., and the unanimous consent of its stockholders.
    On February 1, 1919, the trustee for the three banks with whom Hayes had pledged certain stock of the Knitting Co. as collateral, as hereinbefore mentioned, was instructed by the banks as follows:
    * * * WHEREAS, it is proposed that said Hayes Textile Company, Inc., issue its thirty thousand of new stock to the stockholders of the Hayes Knitting Company par for par.. The Hayes Textile Company, Inc., taking over all of the property of the Hayes Knitting Company and assuming to pay all of its debt.
    AND WHEREAS, it seems for the best interests of the stockholders of the Hayes Knitting Company to make such exchange, you are therefore authorized by said three banks as their Trustee to accept a certificate of forty seven shares of the capital stock of the Hayes Textile Company, Inc., and in our behalf as stockholders in the Hayes Knitting Company, you are authorized to consent to the transfer of all of the property of the Hayes Knitting Company to said Hayes Textile Company, Inc., the latter company assuming and agreeing to pay all the indebtedness of the Hayes Knitting Company and to save said company and its stockholders harmless of and from all losses, costs, damage and liability therefor.
    Two hundred thirty-five and one-half shares of the additional stock of the Textile Co. were issued to Hayes, his wife, daughter and son, and the remaining 64y2 shares were issued in the names of the persons with whom Hayes had pledged that number of shares of the Knitting Co. stock as collateral. Throughout the year 1919, Hayes controlled the stock standing in the names of others in the same manner in which he controlled such stock during 1918.
    The two corporations filed separate returns for 1918.
    On December 31, 1918, the inventory of the Knitting Co., consisting of merchandise on hand and in process of manufacture, taken at cost or cost or market, whichever was lower, amounted to $82,-574.20. On or about March 15,1919, it filed a tentative return showing an estimated net income of $16,236.34, and an estimated income and profits tax of $5,140.37 — $1,325 of which it paid, and it obtained an extension of time to file the return for 1918. In the first part of 1919 the Textile Co. disposed of this inventory for $64,156.28. Subsequently, the Knitting Co. filed a complete return for 1918, and it also filed with this return claims for the abatement of the tax of $5,140.37 and for the refund of $1,325 paid on the tentative return, as a result of the reduction from $82,574.20 to $64,156.28 of the value of its inventory at December 31, 1918.
    The Commissioner denied the claims of the two companies that they were affiliated. He also denied claims of the Emitting Co. for abatement and refund as a result of the decline in inventory for December 31, 1918, and advised it of his reasons therefor as follows.
    As the Hayes Knitting Company ceased to exist as a corporation January 1, 1919, selling out its business to the Hayes Textile Company who took over all assets and assumed the liabilities at the same value they were carried on the books of the Hayes Knitting Company issuing the same number of shares of stock at the same par value, it is evident no loss occurred at the time in the exchange of assets. The claim for abatement covering 1918 taxes and also claim for refund filed in connection with decline in inventory values in 1919 and ultimate sale thereof at loss, is- therefore disallowed as a deductible loss (under section 204) to the Hayes Knitting Company in 1918, same being taken up as an operating loss on the books of the Hayes Textile Company in 1919, and adjustment accordingly made in 1918 income.
   OPINION.

Littleton:

The Hayes Knitting Co. and the Hayes Textile Co. were affiliated corporations throughout the year 1918 and remained affiliated until the Hayes Knitting Co. was dissolved in 1920. All of the ■ stock of the two companies was owned and controlled by Thomas J. Hayes. The net income and invested capital of the two companies for 1918 should have been determined upon the basis of a consolidated return.

When it was determined at the time of filing the return for 1918 that there had been a substantial reduction of the December 31, 1918, inventory of the Hayes Knitting Co., as evidenced by a disposition thereof by the Hayes Textile Co., which took over the inventory on January 1, 1919, the net income for 1918 should have been reduced by the inventory loss, amounting to $18,417.92. The fact that the Hayes Knitting Co. transferred its inventory to the Hayes Textile Co., with which company it was affiliated, did not operate to prevent the consolidated group from receiving the benefit of the inventory loss under section 234(a) (14) (a) of the Revenue Act of 1918.

Judgment for the petitioner. Order of re-determination will be entered on 15 days' notice, under Rule 50.  