Peavey-Byrnes Lumber Co. v. Commissioner , 14 B.T.A. 625 ( 1928 )

PEAVY-BYRNES LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

PEAVY-WILSON LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

PEAVY-MOORE LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Peavey-Byrnes Lumber Co. v. Commissioner

Docket Nos. 15822-15824, 16354-16356, 25984-25986.

United States Board of Tax Appeals

14 B.T.A. 625; 1928 BTA LEXIS 2950;

December 7, 1928, Promulgated

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">*2950 1. Certain corporations held affiliated.

2. The Peavy-Byrnes Lumber Co. entered into a contract with the Krause & Managan Lumber Co. for the purchase of certain timber rights, which contract contained an option for payment of one-half of the assets of the Peavy-Byrnes Lumber Co. and one-half of the future profits, or one-half of its capital stock, as part of the purchase price of said timber rights. The latter option was accepted. Held, that payments made to the Krause & Managan Lumber Co. thereafter and entered on the books as dividends were in fact dividends, and not capital payments made on the purchase price of the timber rights.

3. A tentative tax computed in the determination of invested capital of the Peavy-Byrnes Lumber Co. for 1920 and 1921 was improper. See L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135.

4. Value of lumber inventory of Peavy-Wilson Lumber Co. on December 31, 1920, determined.

Joseph W. Bailey, Esq., and Walter E. Barton, Esq., for the petitioners.

J. E. Marshall, Esq., L. L. Hight, Esq., and A. S. Lisenby, Esq., for the respondent.

---

TRAMMELL

">*625 This proceeding involves nine different">*2951 appeals which were consolidated for hearing, covering the years 1916 to 1922, inclusive, in the case of the Peavy-Byrnes Lumber Co.; 1918 to 1922, inclusive, ">*626 in the case of the Peavy-Wilson Lumber Co.; and 1919 to 1922, inclusive, in the case of the Peavy-Moore Lumber Co. The Commissioner determined deficiencies and overassessments as follows:

Company	Year	Deficiency	Overassessment
Peavy-Byrnes Lumber Co	1916	$181.48
Peavy-Byrnes Lumber Co	1917		$45,167.31
Peavy-Byrnes Lumber Co	1918	14,567.10
Peavy-Byrnes Lumber Co	1919		162,463.34
Peavy-Byrnes Lumber Co	1920	171,277.81
Peavy-Byrnes Lumber Co	1921	37,444.93
Peavy-Byrnes Lumber Co	1922	41,457.22
Peavy-Wilson Lumber Co	1918		32,471.91
Peavy-Wilson Lumber Co	1919	166,969.63
Peavy-Wilson Lumber Co	1920	84,406.56
Peavy-Wilson Lumber Co	1920	84,406.56
Peavy-Wilson Lumber Co	1921		10,834.68
Peavy-Wilson Lumber Co	1922	20,967.94
Peavy-Moore Lumber Co	1919	24,256.29
Peavy-Moore Lumber Co	1920	1,260.87
Peavy-Moore Lumber Co	1922	7,970.67

The overassessment for 1917, indicated in the case of the Peavy-Byrnes Lumber Co., was occasioned by an additional">*2952 assessment of $121,143.18 made prior to June 3, 1924, by the respondent, and a later determination of overassessment of $45,167.31. The difference between these two amounts, $75,975.87, therefore, represents a deficiency in the tax determined by the respondent for the year 1917.

A motion to dismiss the appeals of the Peavy-Byrnes Lumber Co. for the year 1919, and the Peavy-Wilson Lumber Co. for the years 1918 and 1921, made by the respondent, was granted, and the appeals for those years were accordingly dismissed.

Petitioners allege error on the part of the Commissioner -

(1) In failing to find that the three lumber companies, and also the Christie & Eastern Railway Co., were affiliated and entitled to file consolidated returns for the years 1917 to 1921, inclusive.

(2) In failing to find that one-half of the net profits of the Peavy-Byrnes Lumber Co. for the years 1916 to 1922, inclusive, constituted part of the cost of the timber cut by that company during each of the years respectively, which timber was purchased from the Krause & Managan Lumber Co., Ltd., under a contract executed November 20, 1909, and in refusing to allow those amounts as deductions from gross income">*2953 during each of the years under appeal.

(3) As an alternative to issue No. 2, in failing to find that the value of the stock, of a par value of $250,000, which the Peavy-Byrnes Lumber Co. issued to the Krause & Managan Lumber Co., Ltd., July 28, 1913, pursuant to paragraph 14 of a contract with that company, was $562,500, July 28, 1913, and in failing to allow such value in determining invested capital for the years 1917 to 1921, inclusive, and use such value as a basis for a deduction due to exhaustion or depletion on account of timber cut during the respective years, and for each year from 1916 to 1922, inclusive.

">*627 (4) In holding that the payments of $110,177.36 in 1919, $74,425.36 in 1920, and $6,533.43 in 1921, made by the Peavy-Byrnes Lumber Co. to the Krause & Managan Lumber Co. pursuant to paragraph 13 of the contract between those companies, constituted selling expenses of lumber sold instead of the cost of timber cut during such years.

(5) In failing to allow the Peavy-Byrnes Lumber Co., as a deduction for exhaustion or depletion in the year 1922, an amount of $49,548.37.

(6) In failing to allow a deduction to the Peavy-Byrnes Lumber Co. in 1922, in the">*2954 amount of $60,701.70, as an expense of operating a logging railway.

(7) In failing to allow the Peavy-Byrnes Lumber Co. in 1922 a loss of $3,500 on the sale of a locomotive to the Peavy-Moore Lumber Co.

(8) In reducing invested capital of the Peavy-Byrnes Lumber Co. during the years 1920 and 1921 by applying a tentative tax in determining the amount of current earnings available for distributions of dividends.

(9) In failing to compute the inventory of the Peavy-Wilson Lumber Co. of December 31, 1920, on the basis of cost or market, whichever was lower.

(10) In failing to allow the Peavy-Wilson Lumber Co. in 1922 a deduction of $117,391.59 as an expense of operating a logging railway.

(11) In failing to allow the Peavy-Wilson Lumber Co. in 1922 a depletion rate of $7 per thousand feet on its timber.

(12) In failing to allow proper depreciation deductions to the Peavy-Wilson Lumber Co. for all of the years involved.

(13) In reducing invested capital of the Peavy-Byrnes Lumber Co. in 1920 by an amount of $54,312.72, and in 1921 by an amount of $45,048.58, on the theory that payments to nominees of the Krause & Managan Lumber Co., Ltd., of $225,000 in 1920, and $250,000">*2955 in 1921 constituted the payments of dividends.

(14) In failing to allow the Peavy-Moore Lumber Co., in 1922, a deduction of $51,335.23 as the expense of operating a logging railway.

Issues Nos. 5 and 11 above were waived by the petitioner, and also issue No. 1 was waived in so far as it relates to the year 1922. Issues Nos. 6, 10 and 14 were settled by stipulation of the parties at the hearing. Issue No. 12 was settled by stipulation. A further issue relating to the affiliation of the Sabine & Naches Valley Railway Co. with the other companies for the year 1921 was waived.

">*628 FINDINGS OF FACT.

The Peavy-Byrnes Lumber Co. is a corporation organized November 8, 1909, under the laws of the State of Louisiana, with principal offices in Shreveport. The authorized capital stock consisted of 5,000 shares of a par value of $100 per share, of which 2,500 shares were issued fully paid in 1909, and the remaining 2,500 shares issued for assets July 28, 1913. The Peavy-Byrnes Lumber Co. owned all of the capital stock of the Kinder & Northwestern Railroad Co., which was organized March 1, 1910, and the Commissioner determined that the two companies were affiliated during">*2956 the years 1917 to 1922, inclusive, and were entitled to file consolidated returns.

The Peavy-Wilson Lumber Co. is a corporation organized December 6, 1916, under the laws of the State of Louisiana, with principal offices in the Commercial National Bank Building, Shreveport, La. The authorized capital stock consisted of 10,000 shares of a par value of $100 per share, of which 9,630 shares were originally fully paid. Later the remaining stock was issued.

The Christie & Eastern Railway Co. was organized February 1, 1917, with an authorized capital stock of 150 shares of a par value of $100 per share, which was increased to 1,000 shares in 1920. It was organized as a necessary facility to the conduct of the business of the Peavy-Wilson Lumber Co. The Commissioner has refused to permit the Peavy-Wilson Lumber Co. and the Christie & Eastern Railway Co. to file consolidated returns for the years 1917, 1918, and 1919.

The Peavy-Moore Lumber Co. was a corporation organized August 30, 1919, under the laws of the State of Louisiana, with principal offices in the Commercial National Bank Building, Shreveport, La. Its authorized capital stock consisted of 9,000 shares of a par value">*2957 of $100 per share, all of which was issued fully paid and was outstanding during the years 1919, 1920, and 1921. The Sabine & Naches Valley Railway Co. was organized October 4, 1921, as a necessary facility for the conduct of the business of the Peavy-Moore Lumber Co. No stock was issued until 1922.

The Commissioner refused to permit the Sabine & Naches Valley Railway Co. and the Peavy-Moore Lumber Co. to file consolidated returns for the year 1921. At the hearing the petitioner waived its claim to affiliation of the two companies for that year.

When the Peavy-Byrnes Lumber Co. was organized in 1909, it purchased approximately 23,000 acres of timber; the Peavy-Wilson Lumber Co. purchased approximately 40,000 acres of timber in 1916, when it was organized; and when the Peavy-Moore Lumber Co. was organized in 1919, it acquired approximately 107,000 acres of timber. These holdings later were increased. A railroad was necessary for ">*629 each of the lumber companies, and in order to secure the advantages of eminent domain, a separate railroad company was organized in each case.

Some time prior to November 8, 1909, A. J. Peavy made arrangements with the Krause & Managan">*2958 Lumber Co., which owned large tracts of pine timber in Louisiana, which resulted in the formation of the corporation by Peavy on November 8, 1909, known as the Peavy-Byrnes Lumber Co. The Peavy-Byrnes Lumber Co., as party of the second part, entered into a contract with the Krause & Managan Lumber Co., party of the first part, which provided in part as follows:

PARAGRAPH ONE

The party of the first part does by these presents sell, transfer and deliver with full guaranty of title, and with complete transfer and subrogation of all rights and action of warranty against all former proprietors of the property herein below described, to wit: - all sound merchantable pine timber measuring twelve (12) inches and upwards in diameter at the stump on the following described lands lying and situated in the Parish of Calcasieu, State of Louisiana, to wit: - (Description follows)

PARAGRAPH TWO

The consideration for which this sale is made is as follows: Said party of the second part is to pay the party of the first part four ($4.00) dollars per thousand sand feet as cut (and other considerations herein below set out) * * *

* * *

PARAGRAPH SIX

Sec. 1. The party of the second part">*2959 binds itself to build a double band saw mill and a planing mill of sufficient capacity to handle the output of the mill in a modern manner, and dry kilns of sufficient capacity to handle the upper grades of the output of the mill; and to erect necessary storage sheds etc., * * *

PARAGRAPH SEVEN

It is further stipulated and agreed if either party shall purchase any timber in the territory below defined, the same shall belong to the party of the second part at cost, and shall be paid for by the party of the second part when acquired. (Description follows)

* * * and all timber purchased by either party in such territory shall be manufactured at the mill of the party of the second part subject to the provisions and stipulations of this contract, except as to price of stumpage and size of trees to be cut.

* * *

PARAGRAPH TEN

The party of the second part binds itself to cut a minimum of twenty million (20,000,000) feet, log scale, annually, but the party of the second part shall have the right to cut as much more than such minimum as conditions may justify. * * *

* * *

PARAGRAPH ">*630 THIRTEEN

It is agreed and stipulated by and between the parties hereto, as a">*2960 further consideration of this sale, that if the lumber sawed from said timber should reach an average of Sixteen ($16.00) Dollars per thousand feet f.o.b. the cars at the mill of the party of the second part for any full semi-annual period as shown by the semi-annual statement of the party of the second part, then the party of the first part shall receive in addition to the Four ($4.00) Dollars per thousand feet hereinabove stipulated, twenty five cents per thousand feet for said timber, and twenty-five per cent of any advance in average price for any semi-annual period over and above Sixteen ($16.00) Dollars per thousand. * * *

PARAGRAPH FOURTEEN

As a further consideration of this sale it is expressly stipulated and agreed that when the net profits from the operation of the mill of the party of the second part shall have repaid the total original investment in said mill and appurtenances and belongings, then the party of the second part will pay to the party of the first part one half of all net profits from further operation of said mill and shall transfer a half interest in all the property and assets of the party of the second part or one half of its capital stock * * * to">*2961 the party of the first part, as its option * * * Dividends equalling at least ninety per cent of the cash profits shall be declared annually, after repayment of the original investment as hereinabove provided.

PARAGRAPH FIFTEEN

It is further stipulated and agreed that if the party of the second part shall refuse or fail to operate the mill for the period of six months consecutively without legal cause this contract shall be thereby revoked at the option of the party of the first part.

PARAGRAPH SIXTEEN

It is expressly agreed that upon the termination of the operation of said mill the party of the first shall have the option to buy the mill and appurtenances; * * *

Pursuant to this agreement the Peavy-Byrnes Lumber Co. installed a sawmill and appurtenances and proceded to operate the property. The profits from the operation of the property up to July 1, 1913, were as follows:

Year	General profit	Store profit	Turpentine profit
1910	$36,456.64	$4,685.61
1911	53,056.18	7,939.18	$22,718.72
1912	123,726.96	13,571.56	22,000.00
1913 to July 1	232,199.46	11,070.81	32,509.00

On July 28, 1913, by which time the total investment of the Peavy-Byrnes">*2962 Lumber Co. had been repaid from the operations of the property, the Krause & Managan Lumber Co. proceeded to exercise the ">*631 option set forth in paragraph 14 of its contract with the Peavy-Byrnes Lumber Co. and elected to take one-half of the capital stock in lieu of its right to accept one-half of the plant assets and appurtenances and one-half of the future expected profits. The capital stock was issued pursuant to a resolution adopted at a special meeting of the directors of the Peavy-Byrnes Lumber Co., the minutes of which meeting were as follows:

A special meeting of the Directors of the Peavy Byrnes Lumber Company was held at Shreveport, Louisiana, July 26th, 1913, with the following directors present:

A. J. PEAVY S. G. SAMPLE R. KRAUSE W. H. MANAGAN

and a quorum.

The meeting was called for the purpose of authorizing the Officers to issue additional stock of the Peavy Byrnes Lbr. Company in amount of $250,000.00 to Krause & Managan Lumber Company as per contract.

On motion by S. G. Sample, seconded by W. H. Managan, the following resolution was unanimously adopted:

WHEREAS, the Peavy Byrnes Lumber Company has distributed to its stockholders dividends">*2963 to the amount of 100% of the capital stock amounting to $250,000.00, and

WHEREAS, a certain contract between Peavy Byrnes Lbr. Company and Krause & Managan Lumber Company provides that after the Peavy Byrnes Lumber Company shall have earned and paid to the stockholders 100% of the then outstanding stock in dividends, that the Krause & Managan Lumber Company may exercise its option of accepting title to one-half of the property of the Peavy-Byrnes Lumber Company and one-half of the profits of the Peavy-Byrnes Lumber Company over and above the $250,000.00 which has been paid in dividends, and

WHEREAS, the Krause & Managan Lumber Company has exercised its option to take an equal amount of the capital stock of the company to the amount that has been issued as evidence of their ownership of one-half of the property and future earnings, therefore be it

RESOLVED: That the President and Secretary of this company be authorized and instructed to issue to the Krause & Managan Lumber Company, or as they direct, stock of the Peavy-Byrnes Lumber Company to the amount of $250,000.00.

There being no further business before the meeting on motion duly made and seconded, the meeting was adjourned.

">*2964 (Signed) J. S. WELSH

Ass't Secretary.

(Signed) A. J. PEAVY

President.

The Peavy-Byrnes Lumber Co. acquired the timber rights from the Krause & Managan Lumber Co. in 1909, for which stock was issued in July, 1913. The value of these timber rights, when acquired, was $319,930, which should be considered in the determination of invested capital, as set out in the opinion.

">*632 The Peavy-Byrnes Lumber Co. cut the following footage, log scale, from the timber purchased from the Krause & Managan Lumber Co. under the above mentioned contract:

Year	Feet
1910	3,880,674
1911	14,082,035
1912	18,679,872
Jan. 1 to Mar. 1, 1913	4,391,553
Mar. 1 to July 28, 1913	11,090,568
July 28 to Dec. 31, 1913	8,923,295
1914	21,532,816
1915	22,876,518
1916	28,073,498
1917	15,274,316
1918	13,710,172
1919	27,322,363
1920	11,144,730
1921	3,744,991
1922	1,377,836
1923	34,990

The timber reserve at November 20, 1909, was 206,140,227 feet. At March 1, 1913, the timber reserve was 165,106,093 feet, and the amount remaining uncut at July 28, 1913, was 154,015,525 feet.

The timber covered by the agreement between the Peavy-Byrnes Lumber">*2965 Co. and the Krause & Managan Lumber Co. had a fair market value of $4 per thousand feet log scale as of November 20, 1909. The timber remaining uncut on March 1, 1913, had a fair market value of $5 per thousand feet log scale, and the timber remaining uncut on July 28, 1913, had a fair market value of $6 per thousand feet, log scale.

The fair market value of the timber rights of the Peavy-Byrnes Lumber Co., at March 1, 1913, was $421,350.75, which is the amount returnable as depletion on 165,106,093 feet of timber.

During the years 1919, 1920, and 1921, the amounts paid to the Krause & Managan Lumber Co. pursuant to paragraph 13 of their contract were as follows:

Year for which paid	Date of payment	Amount of payment
1919	Apr. 11, 1919	$10,000.00
1919	May 11, 1919	10,000.00
1919	June 18, 1919	10,000.00
1919	July 26, 1919	16,152.68
1919	Oct. 31, 1919	15,000.00
1919	Dec. 16, 1919	10,000.00
1919	Jan. 15, 1920	41,582.25
Total for 1919		112,734.93
Less amount applicable to 1918		2,557.57
Adjusted total 1919		110,177.36
1920	May 7, 1920	10,000.00
1920	June 15, 1920	10,000.00
1920	July 17, 1920	14,868.61
1920	Oct. 26, 1920	15,000.00
	Dec. 15, 1920	15,000.00
	Jan. 12, 1921	9,556.75
Total or 1920		74,425.36
1921	July 16, 1921	509.55
	Jan. 11, 1922	6,023.88
Total for 1921		6,533.43

">*2966 ">*633 Dividends were paid by the Peavy-Byrnes Lumber Co. during the years 1913 to 1922, inclusive, as follows:

1913	$300,000
1914	75,000
1915	125,000
1916	230,000
1917	250,000
1918	$130,000
1919	310,000
1920	450,000
1921	250,000
1922	375,000

In December, 1916, the Peavy-Wilson Lumber Co. was organized, and erected a separate sawmill plant and operated a separate tract of timber. On August 30, 1919, the Peavy-Moore Lumber Co. was organized, which also erected a separate sawmill plant and operated a separate tract of timber.

A. J. Peavy, R. J. Wilson, J. S. Wells, S. G. Sample, R. Krause, W. H. Managan, R. T. Moore, C E. Jenkins, S. W. Henderson, J. H. Buchanan, W. F. Johnson, S. B. Hicks, J W. Parker, Eli Wiener, and J. O. Cupples, and members of their respective families, were the principal stockholders of the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co., and the Peavy-Moore Lumber Co. during the years involved in these proceedings. Some of the stock of the said companies was also held by employees, who were assisted financially by A. J. Peavy in the purchase of such stock.

The approximate percentages of stock of the said">*2967 companies owned by the foregoing individuals, members of their respective families, and employees, in the various years indicated, were as follows:

	1916 percentage		1917 percentage
	Com-	Com-	Com-	Com-
	pany	pany	pany	pany
	P-B	P-W	P-B	P-W
A. J. Peavy et al	21.70	27.17	21.70	17.40
R. J. Wilson et al	7.40	9.04	7.40	13.41
J. S. Welsh et al	.50	2.11	.50	3.94
S. G. Sample	3.00	8.70	3.00	5.19
R. Krause et al	24.90	13.06	24.90	10.64
W. H. Managan et al	25.44	13.06	25.44	12.73
R. T. Moore et al	.20	1.74	.20	2.49
C. E. Jenkins et al	1.26	2.62	1.26	1.57
S. W. Henderson	.50	1.74	.50	1.05
J. H. Buchanan	2.00	1.74	2.00	1.05
W. F. Johnson et al	1.00	1.74	1.00	1.04
W. B. Hicks et al		3.65		2.20
J. W. Parker	4.00	1.74	4.00	2.08
J. O. Cupples	.40	.17	.40	1.05
Eli Wiener et al	.50	1.76	.50	5.09
Principal stockholders and families	92.80	90.04	92.80	80.93
Employees	1.60	3.51	1.60	5.83
Total, principal stockholders, families, and	94.40	93.55	94.40	86.76
employees

1918 percentage		1919 percentage			1920 percentage
Com-	Com-	Com-	Com-	Com-	Com-	Com-	Com-
pany	pany	pany	pany	pany	pany	pany	pany
P-B	P-W	P-B	P-W	P-M	P-B	P-W	P-M
22.70	17.32	22.70	18.35	20.27	22.70	18.66	20.28
7.40	13.08	7.40	12.48	5.55	7.40	12.60	5.56
.50	3.86	.50	3.86	3.22	.50	3.80	3.74
3.00	5.07	3.00	5.08	11.11	3.00	5.00	11.13
25.16	10.66	25.16	10.66	4.57	25.16	10.80	4.57
25.18	12.19	25.18	10.69	5.27	25.17	11.81	4.72
.20	2.43	.20	2.42	10.73	.20	2.60	10.73
1.26	1.53	1.26	1.53	5.00	1.26	1.50	3.91
.50	2.44	.50	2.45	.28	.50	2.55	.28
2.00	1.02	2.00	1.02	.56	2.00	1.00	.55
1.00	1.01	1.00	1.01		1.00	1.00
.30	2.14	.30	2.14	1.12	.30	2.10	1.10
4.00	2.04	4.00	2.03		4.00	2.00
.40	.40	1.02	2.22	.40	1.00	2.23	.40
.50	.499	.50	4.98		.50	4.90
94.10	80.80	94.10	79.72	69.90	94.09	81.32	68.80
.60	3.90	.55	3.59	15.61	.55	4.15	15.30
94.70	84.70	94.65	83.31	85.51	94.64	85.47	84.10

">*2968

1921 percentage
Com-	Com-	Com-
pany	pany	pany
P-B	P-W	P-M
22.70	20.56	22.37
7.40	12.60	5.34
.50	3.80	3.45
3.00	5.00	11.11
25.16	10.80	4.57
25.94	11.05	5.45
.20	2.60	10.72
1.26	1.50	3.89
.50	2.55	.27
2.00	1.00	.56
1.00	1.00	.22
.30	2.10	1.12
4.00	2.00
1.00	2.22
.50	4.90
94.86	81.46	71.29
.55	4.25	12.52
95.41	85.71	83.81

4

">*635 In addition to the majority stockholders, members of their families, and employees of the companies, above mentioned, there were minority stockholders including W. H. Booth, F. R. Hodges, E. K. Smith, L. S. Loeb and Mrs. W. H. Booth, who were business associates of Sam Wiener, Jr., who was the brother of Eli Wiener. Mrs. W. H. Booth was also a business associate of Hodges and E. F. Bullard. Other minority stockholders were associated as follows: Ben Johnson was a business associate of R. T. Moore. J. B. Ardis was a business associate of S. B. Hicks, and S. W. Henderson was a partner of Eli Wiener. R. Krause and W. H. Managan were officials and stockholders of the Krause & Managan Lumber Co. which sold the timber to the Peavy-Byrnes Lumber Co. under the">*2969 contract hereinabove referred to. E. K. Smith, during a portion of the time, was president of the Commercial National Bank, of Shreveport, La. Ben Johnson was also president of the same bank during a portion of the time, and managing officer of the Bank of Commerce & Trust Co. of Mansfield, La. A. T. Kahn and E. R. Bernstein were vice presidents, A. H. Van Hook was cashier, M. Ricks was assistant cashier, and Thomas C. Barrett, Abe Meyer, and A. J. Peavy were directors of the Commercial National Bank during a part of the time involved herein. The Commercial National Bank and the Bank of Commerce & Trust Co. were the active depositories or principal depositories of the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co., and the Peavy-Moore Lumber Co. These banks financed the Kinder & Northwestern Railroad Co. and the Christie & Eastern Railway Co., and also some of the employees of the lumber companies in the purchase of stock.

The names of the officers of the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co. and the Peavy-Moore Lumber Co. from January 1, 1917, or from the date of organization thereof, respectively, if organized subsequent thereto, to December 31, 1921, inclusive, ">*2970 are as follows:

Year	Company	President	Vice president	Vice president	Vice president
1917	Peavy-Brynes	A. J. Peavy	R. J. Wilson	J. O. Cupples	R. T. Moore
	Peavy-Wilson	do	do	do	do
1918	Peavy-Brynes	do	do
	Peavy-Wilson	do	do
1919	Peavy-Brynes	do	do
	Peavy-Wilson	do	do
	Peavy-Moore	do	do
1920	Peavy-Brynes	do	do		R. T. Moore
	Peavy-Wilson	do	do		do
	Peavy-Moore	do	do		do
1921	Peavy-Byrnes	do	do	S. G. Sample	do
	Peavy-Wilson	do	do	do	do
	Peavy-Moore	do	do	do	do

Vice president	Vice president	Secretary-treasurer
		J. S. Welsh.
		Do.
		Do.
		Do.
		Do.
		Do.
		Do.
		Do.
		Do.
		Do.
W. H. Managan	R. Krause	Do.
do	do	Do.
do	do	Do.

">*637 The directors of the various companies for the various years are shown in the following table as indicated by the letter D. Company 1 is the Peavy-Byrnes Lumber Co.; Company 2, the Peavy-Wilson Lumber Co.; and Company 3, the Peavy-Moore Lumber Co. Company 1 had the same directors in 1917 as in 1918.

	1918		1919		1920			1921
	Com-	Com-	Com-	Com-	Com-	Com-	Com-	Com-	Com-	Com-
	pany	pany	pany	pany	pany	pany	pany	pany	pany	pany
	1	2	1	2	1	2	3	1	2	3
A. J. Peavy	D	D	D	D	D	D	D	D	D	D
R. J. Wilson	D	D	D	D	D	D	D	D	D	D
J. S. Welsh		D		D	D	D	D	D	D	D
S. G. Sample	D	D	D	D	D	D	D	D	D	D
R. Krause	D	D	D	D	D	D	D	D	D	D
W. H. Managan	D	D	D	D	D	D	D	D	D	D
R. T. Moore					D	D	D	D	D	D
E. K. Smith		D		D		D	D		D	D
C. E. Jenkins		D		D		D
S. W. Henderson		D		D		D	D		D	D
D. L. Handley						D			D
Ben Johnson									D
J. O. Cupples					D			D

">*2971 During the years 1917 to 1921, inclusive, the majority stockholders, hereinabove mentioned, voted in person and by proxy the following percentages of stock on the dates indicated:

	Peavy-Byrnes Lumber Co.		Peavy-Wilson Lumber Co.		Peavy-Moore Lumber Co.
	Stock represented	Stock outstanding	Stock represented	Stock outstanding	Stock represented	Stock outstanding
	Per cent	Per cent	Per cent	Per cent	Per cent	Per cent
Jan. 16, 1917	97	94
Jan. 15, 1918	99	86	96.8	83
Jan. 21, 1919	98.6	89	96.7	74
Aug. 30, 1919					87	1 87
Jan. 20, 1920	100	100	96.8	77	95.7	86
Jan. 18, 1921	99	94	99.8	88	96	88

A. J. Peavy voted proxies during the various years, as follows:

	1917	1918	1919	1920	1921
Peavy-Byrnes	1,910	680	360 1/2	3,325	625
Peavy-Wilson		1,620	1,162	3,777 1/2	2,516 1/2
Peavy-Moore				3,167 1/2

Proxies represented chiefly shares of stock owned by the members of the families of the principal stockholders, and employees of the companies, who were assisted by A. J. Peavy in financing">*2972 the purchase of their stock.

">*638 The Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co., and the Peavy-Moore Lumber Co. had separate sawmills and separate mill offices. They had the same executive and sales offices in Shreveport, La. The Kinder & Northwestern Railroad Co., the Christie & Eastern Railway Co., and the Sabine & Naches Valley Railroad Co. also had their executive offices jointly with the lumber companies. A. J. Peavy directed the policies and supervised the business of all of the companies, including the railroad companies, from the same desk in the executive offices. No record was kept of the amount of time which he devoted to each company. This also was true with respect to the other officers and employees in the executive offices.

The bookkeepers, stenographers, and other office employees worked for all of the companies as their services were required. The salaries of the salesmen, bookkeepers, stenographers, and other employees, as well as the general office expenses and traveling expenses, were paid by the Peavy-Byrnes Lumber Co. At the end of each month the latter company charged the Peavy-Wilson Lumber Co. and the Peavy-Moore Lumber Co. each">*2973 a portion of such expenses, based upon the quantity of lumber shipped by the three companies respectively during the month. In some instances the salesmen performed more services for one company than for the others. Frequent trips were taken by various officers and employees in connection with the business of one company alone on which expenses were incurred, and such expenses were allocated to the three lumber companies on the same basis as the other expenses.

The Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co., and the Peavy-Moore Lumber Co. had the same sales manager. The salesmen represented all these companies. They were provided with stock sheets of all three companies, but took orders in the name of the Peavy-Byrnes Lumber Co. When the orders were received at the home office, the sales manager allocated the orders to the three companies as the stock sheets justified. The company to which an order was allocated shipped the lumber and collected therefor.

In order better to secure the cooperation of worthy employees of the three lumber companies, A. J. Peavy, during the years involved, assisted them in financing the purchase of stock in the respective companies. ">*2974 The employees borrowed the necessary money and bought the stock outright. In some instances Peavy endorsed their paper at the bank; in other instances he wrote letters to the bank guaranteeing the loans, and in a few instances he loaned the money to the employees directly.

It was the practice of the three lumber companies to loan money to one another, and on the dates indicated the intercompany balances were as follows:

End of year	Peavy-Wilson	Peavy-Moore	Peavy-Moore
	owed	owed	owed
	Peavy-Byrnes	Peavy-Byrnes	Peavy-Wilson
1918	$74,159.02
1919	123,123.65
1920	107,191.52
1921	64,183.42	$8,977.81
1922	60,000.00		$10,927.94
1923	60,000.00	322,470.05	59,907.27
1924		22,496.63	35,753.98
1925			22,903.74

">*639 Interest was charged on the loans at 6 per cent to maturity, and at 8 per cent after maturity on overdue amounts.

The Peavy-Byrnes Lumber Co. and the Peavy-Wilson Lumber Co. were affiliated during the calendar years 1917 and 1918, and the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co., and the Peavy-Moore Lumber Co. were affiliated during the calendar years 1919, 1920, and 1921.

Prior to the organization">*2975 of the Christie & Eastern Railway Co on February 1, 1917, the Peavy-Wilson Lumber Co. began the construction of a railroad which was necessary before its sawmill could be located. Six of the directors, who were also stockholders of the Peavy-Wilson Lumber Co., took out a charter for a corporation to be known as the Christie & Eastern Railway Co., with an authorized capital of $15,000. The railroad was thereupon turned over to and completed by the Christie & Eastern Railway Co. All of the original authorized stock of the railway company was issued in the names of the directors of the lumber company, and was held in trust by them for the lumber company, except 10 shares issued to J. E. Peavy, a brother of A. J. Peavy, and one share issued to an employee who was not a stockholder of the lumber company. The amount of stock of the lumber company subscribed for by said directors was reduced by an amount equal to the par value of the railway company stock issued to and held in trust by them for said lumber company. Subsequently, in February, 1920, the authorized capital stock of the Christie & Eastern Railway Co. was increased to $100,000 and the stockholders of the Peavy-Wilson Lumber">*2976 Co. were issued one share of stock of the railway company for each ten shares of stock which they held in the lumber company. During the years 1917 to 1919, inclusive, approximately 84 per cent to 90 per cent of the revenues of the railway company was derived from the business of the lumber company.

For the purpose of building its railroad and purchasing necessary equipment, the Christie & Eastern Railway Co. borrowed money ">*640 from the Peavy-Wilson Lumber Co. either on notes or open account, the amounts so borrowed on the dates indicated being as follows:

Date	Notes	Open account
March, 1917		$45,967.21
Dec. 31, 1917		163,786.69
Feb. 1, 1918	$150,000.00
Dec. 31, 1918	170,000.00	6,287.43
Dec. 31, 1919		13,846.84

On February 1, 1918, the railway company gave its notes to the lumber company in the aggregate amount of $150,000, and took up an equal amount of its accounts payable. During 1919 it paid its notes to the lumber company by borrowing $170,000 at the Commercial National Bank, which the lumber company endorsed. These notes, or renewal notes, were still unpaid at the end of 1920.

The Christie & Eastern Railway Co. sustained losses">*2977 during 1917, 1918, and 1919 as follows:

1917	$6,341.54
1918	10,125.82
1919	18,927.38
	35,394.74

At the end of the years 1917, 1918, and 1919 there were 150 shares, or 100 per cent, of the capital stock of the Christie & Eastern Railway Co. outstanding. This stock was issued for cash, paid in as follows:

Feb. 1, 1917, R. J. Wilson	$3,000
Feb. 8, 1917, R. T. Moore	1,000
Feb. 8, 1917, J. E. Peavy	1,000
Feb. 8, 1917, A. J. Peavy	3,000
Feb. 9, 1917, S. W. Henderson	1,000
Feb. 12, 1917, W. H. Managan	3,000
Feb. 12, 1917, R. Krause	3,000
	15,000

The Peavy-Wilson Lumber Co. and the Christie & Eastern Railway Co. were affiliated during the years 1917, 1918, and 1919.

The Peavy-Byrnes Lumber Co. incurred in 1922 the amount of $60,701.70 as ordinary and necessary expense of operating a logging railway.

The Peavy-Wilson Lumber Co. in 1922 incurred the amount of $117,391.59 as ordinary and necessary expense of operating a logging railway.

The Peavy-Moore Lumber Co. in 1922 incurred the amount of $51,335.23 as ordinary and necessary expense of operating a logging railway.

">*641 For the years 1920 and 1921 in the case of">*2978 the Peavy-Byrnes Lumber Co., the respondent computed a tentative tax for each of the years, which he applied against the income in order to determine the net earnings available for distribution as dividends. This resulted in a reduction of invested capital for those years.

As at December 31, 1920, the Commissioner determined the inventory of the Peavy-Wilson Lumber Co. on a basis of cost to be $405,138.82. The petitioner claimed a right to take its inventory on the basis of cost or market whichever was lower. A detailed inventory of lumber on hand taken on the basis of market price f.o.b. cars at the mill at December 31, 1920, amounted to $311,129.56. This amount included $26,668.15 which represented the estimated cost of shipping and selling the lumber, and also included the sum of $17,168.30 which represented the estimated cost of hauling to the planer and of planing in the planing mill 11,445,534 feet of rough lumber. In computing the inventory on the basis of market the amount of $311,129.56 should be reduced by the sums of $26,668.15 and $17,168.30.

The net income of the Peavy-Wilson Lumber Co. for 1917 was $16,587.05, and the invested capital, $878,940.28.

The depreciation">*2979 allowed the Peavy-Wilson Lumber Co. in the deficiency letters should be increased and decreased as follows:

Years	Increase	Decrease
1918	$13,385.77
1919	17,508.14
1920		$67.31
1921	328.26
1922	48,764.92

On February 16, 1922, the Peavy-Byrnes Lumber Co. sold to the Peavy-Moore Lumber Co. a locomotive for $5,000, which the former company acquired on December 6, 1919, at a cost of $8,500. Depreciation was sustained on said locomotive at the rate of 10 per per cent per annum.

OPINION.

TRAMMELL: The petitioners claim affiliations between the Peavy-Byrnes Lumber Co. and the Peavy-Wilson Lumber Co. for the years 1917 and 1918, and between the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co. and the Peavy-Moore Lumber Co. for the years 1919, 1920, and 1921, on the ground that substantially all of the stock of these companies was owned or controlled by the same or closely affiliated interests. The petitioners allege that there were 15 principal stockholders, whose names are set out in the findings ">*642 of fact, who owned or controlled substantially all of the stock of the three lumber companies.

Sections 240(b) and (c) of the Revenue Acts">*2980 of 1918 and 1921, respectively, which are controlling here for the years 1918 to 1921, inclusive, provide as follows:

For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

The only statutory provision for filing consolidated returns for 1917 is contained in section 1331 of the Revenue Act of 1921 (), which reads as follows:

SEC. 1331. (a) That Title II of the Revenue Act of 1917 shall be construed to impose the taxes therein mentioned upon the basis of consolidated returns of net income and invested capital in the case of Domestic corporations and domestic partnerships that were affiliated during the calendar year 1917.

(b) For the purpose of this section a corporation or partnership was affiliated with one or more corporations or partnerships (1) when such corporation or partnership owned directly or controlled">*2981 through closely affiliated interests or by a nominee or nominees all or substantially all the stock of the other or others, or (2) when substantially all the stock of two or more corporations or the business of two or more partnerships was owned by the same interests; Provided, That such corporations or partnerships were engaged in the same or a closely related business, or one corporation or partnership bought from or sold to another corporation or partnership products or services at prices above or below the current market, thus effecting an artificial distribution of profits, or one corporation or partnership in any way so arranged its financial relationships with another corporation or partnership as to assign to it a disproportionate share of net income or invested capital.

It is shown in the findings of fact that the 15 stockholders mentioned, and the members of their respective families, owned of the total stock of the three lumber companies amounts varying from a minimum of approximately 68.80 per cent to 94.86 per cent, during the years under review. A small amount of stock was owned by employees, who were enabled to purchase the stock through financial assistance">*2982 rendered by A. J. Peavy. Taking this stock into consideration, we find that during 1919, which may be regarded as fairly representative of the stock ownership during the various years, the 15 principal stockholders, their families and the employees owned approximately 94.65 per cent of the stock of the Peavy-Byrnes Co., 83.31 per cent of the stock of the Peavy-Wilson Co., and 85.51 per cent of the stock of the Peavy-Moore Co.

During 1919 the majority stockholders voted in person and by proxy 98.6 per cent of the stock of the Peavy-Byrnes Co. represented, which was 89 per cent of the total stock outstanding; and of the stock of the Peavy-Wilson Co. they voted in that year 96.7 per cent of the ">*643 stock represented, which constituted 74 per cent of the total stock outstanding. In 1920 these same stockholders so voted 100 per cent of the stock of the Peavy-Byrnes Co., both represented and outstanding; 96.8 per cent of the stock of the Peavy-Wilson Co. represented, which was 77 per cent of the stock outstanding; and 95.7 per cent of the stock of the Peavy-Moore Co. represented, which was 86 per cent of the total stock outstanding. In 1921 the majority stockholders voted 99">*2983 per cent, 99.8 per cent, and 96 per cent of the stock of the respective companies represented at the stockholders' meetings, which constituted 94 per cent, 88 per cent, and 88 per cent of the total stock of the three companies, respectively, then outstanding.

It thus appears that only negligible percentages of stock were actually voted by minority stockholders either in person or by proxy, and the record further discloses that entire harmony prevailed at all times, all of the stockholders working together under the leadership of A. J. Peavy and his associates among the mojority stockholders, for the joint welfare and best interests of the three corporations considered collectively. No effort was made at any time by any minority or other stockholder to secure preferred treatment for one company at the expense of any other.

The three companies were operated as one large enterprise, composed of three producing units. The three lumber companies, together with the three railroad companies which served the sawmill plants, maintained joint executive offices in Shreveport, La., although each lumber company had a separate mill office at its plant. The three lumber companies had the">*2984 same sales manager, and their products were sold by the same salesmen. The salesmen were provided with stock sheets of all three companies, but took orders only in the name of the Peavy-Byrnes Lumber Co. When the orders were received at the executive offices, the sales manager allocated them to the three companies according to the lumber on hand as shown by the stock sheets. The company to which an order was allocated shipped the lumber and made collection therefor.

A. J. Peavy directed the policies and supervised the business of all the companies, including the railroad companies, from the same desk in the executive offices. No record was kept of the time which he devoted to each company's affairs. The other officers and employees in the executive offices rendered services upon the same basis. All office and traveling expenses were paid by the Peavy-Byrnes Co., and at the end of each month were allocated to the three lumber companies in proportion to the amount of lumber shipped by each. Items of traveling and other expenses incurred solely for the benefit of one particular company were nevertheless ">*644 allocated among the three companies on the same basis as other">*2985 general expenses. There was considerable borrowing of funds by one company from another. Particularly, the Peavy-Byrnes Co. loaned large sums to the other two. However, interest was charged on the loans at 6 per cent to maturity, and at the rate of 8 per cent after maturity.

The three lumber companies had identically the same executive officers, and substantially the same boards of directors during all the years involved.

In , we had facts before us similar in many respects to those presented here. In considering the question whether substantially all the stock of the two corporations there involved was owned or controlled by the same interests, within the meaning of section 240(b) of the Revenue Act of 1918, supra, we said:

Immediately after the organization of the companies Osborne and Skelly owned 90 per cent of the stock of the Midland and 78.26 per cent of the stock of the Inland. A part of this stock was sold to employees, business associates, and close personal friends of the two men named. From the evidence it is clear that these two individuals so disposed of their stock as to assure themselves of the actual">*2986 control and domination of both companies. * * * Skelly, Osborne and Pielsticker were practically the only stockholders who ever attended meetings. They owned 62.71 per cent of the stock of the Midland and 51.07 of the stock of the Inland. At these meetings they voted by proxy all stock not standing in their own names.

* * *

A careful examination of the stockholdings and the relationships existing between the various holders shows that substantially all of the stock is owned or controlled by the same individuals. It seems to follow, naturally, if a group of individuals owns or controls substantially all of the stock of both corporations, and if such ownership or control is by all exercised for one purpose, namely, the joint success of the corporations, that these individuals meet the requirements of the words "the same interests."

We believe that the two corporations were affiliated and that any other conclusion would be contrary to the meaning of the statute.

In the proceedings now before us, the 15 principal stockholders, members of their families, and the employees, during 1919 owned 94.65 per cent of the stock of the Peavy-Byrnes Lumber Co., 83.31 per cent of the stock">*2987 of the Peavy-Wilson Lumber Co. and 85.51 per cent of the stock of the Peavy-Moore Lumber Co., which is fairly representative of the stock ownership in the other years. The minority stock in each company was practically all owned by close business associates of the majority stockholders, that is to say, such minority stock was mostly owned by business partners of one or more of the principal stockholders, or by the officers and/or directors of the two banks which were the depositories of the funds of ">*645 the corporations, and which financed many of their operations. Some of the majority stockholders of the petitioner corporations, including A. J. Peavy, were officers and/or directors of the banks. Only a negligible percentage of the minority stock was ever voted at any of the stockholders' meetings other than that voted by the majority stockholders by proxies. The principal stockholders were practically the only stockholders who ever attended meetings, and at such meetings they voted in person and by proxy from about 95 to 100 per cent of the stock represented. That A. J. Peavy and his associates among the majority stockholders exercised actual control and domination of">*2988 all the corporations can not be doubted from the evidence, and it is equally well established that their ownership or control was by all exercised for the joint success of the corporations.

In , it appears that the two Hirsch brothers owned 94.85 per cent of the stock of the Hirsch Company and 55.63 per cent of the stock of the Brazilian Company. The minority stock was in the hands of friends and associates of the Hirsch brothers, who had been induced to go into the venture on account of its speculative nature. In holding that the two corporations were affiliated, we quoted from our opinion in the Midland Refining Co. case, supra, and said:

The stockholdings and conduct of the two corporations involved in this proceeding meet the above requirements.

In , we held that two corporations were affiliated within the meaning of the provisions of the Revenue Acts of 1918 and 1921, quoted supra, where the facts disclosed that the owners of 72.6 per cent of the stock of one corporation owned 94.40 per cent of the stock of the other, both corporations having the">*2989 same officers and substantially the same directors, and the minority stock was held either by relatives of the principal stockholders or employees, who never cast any dissenting vote.

In , we said:

The facts here show that the petitioner and the Interstate Music Corporation had, (1) common interest, and purpose of joint success, (2) the same officers and interlocking directors, (3) minority stock held by either persons related by blood or marriage or by employees, business associates and friends, (4) business harmony evidenced by friendly minority stockholders, (5) control exercised by proxies, (6) and that the owners of the stock of the petitioner owned 66.8 per cent of the stock of the Interstate Music Corporation.

We believe from the above state of facts that all the elements of affiliation are present and that any other conclusion would be contrary to the meaning of the statute.

">*646 What was said concerning the relationship of the corporations in the case last above cited may substantially be said of the relationships of the corporations involved herein.

It is our opinion, and we so hold, that the Peavy-Byrnes">*2990 Lumber Co. and the Peavy-Wilson Lumber Co. were affiliated during the calendar years 1917 and 1918, and that the Peavy-Byrnes Lumber Co., the Peavy-Wilson Lumber Co. and the Peavy-Moore Lumber Co. were affiliated during the calendar years 1919, 1920, and 1921 within the meaning of the statutes above quoted.

The issue of affiliations raised by the petitioners in these proceedings also involves the question whether the Peavy-Wilson Lumber Co. and its subsidiary, the Christie & Eastern Railway Co., were affiliated during the years 1917, 1918, and 1919. The respondent allowed affiliation between these companies for the years 1920 and 1921, but denied affiliation for the years 1917, 1918, and 1919, now claimed by the petitioners.

The evidence shows that prior to the organization of the Christie & Eastern Railway Co. on February 1, 1917, the Peavy-Wilson Lumber Co. had begun the construction of a railroad, which was necessary before its sawmill could be located. Thereafter, it was decided that a separate corporation should be organized to construct and operate the railroad, in order to secure the right of eminent domain and to derive revenue from sources other than the business of">*2991 the lumber company. Accordingly, six of the directors of the lumber company, who were also stockholders, took out a charter for a corporation to be known as the Christie & Eastern Railway Co. This corporation had an authorized capital stock of $15,000, all of which was issued to the six directors and stockholders of the lumber company, to be held in trust for it, except 10 shares which were issued to a brother of A. J. Peavy, and one share which was issued to an employee who was not a stockholder of the Lumber company. Including the stock issued in the name of A. J. Peavy's brother, the six directors held in their names as trustees for the lumber company 99.34 per cent of the original authorized capital stock of the railroad company.

The railroad was turned over to and its construction completed by the Christie & Eastern Railway Co. The railroad company borrowed from the lumber company the funds necessary to construct and equip the railroad, and it was operated as a plant facility of the lumber company. During the years 1917 to 1919, inclusive, from 84 per cent to 90 per cent of the revenue of the railroad company was derived from the business of the lumber company.

In 1920">*2992 the authorized capital stock of the railroad company was increased to $100,000, and all the stock was thereupon subscribed for ">*647 and issued to the stockholders of the lumber company in the ratio of one share of the railroad company's stock to 10 shares of the lumber company's stock. Upon this basis, the respondent allowed affiliation of the companies for 1920 and 1921.

The question whether the railroad company and the lumber company were affiliated in the years prior to 1920 depends upon whether the directors of the lumber company held the stock of the railroad company in trust for the former. The respondent contends that the evidence is not sufficient to establish this fact.

We have carefully examined the record, and the only direct evidence on this point establishes, in our opinion, that the stock of the railroad company was so held by the directors of the lumber company. A. J. Peavy testified in substance that the six directors of the Peavy-Wilson Co. took out the charter for the Christie & Eastern Railway Co. and held the stock for the lumber company in their own names; that later, when the railroad company's charter was amended, the original subscribers received">*2993 stock in the Peavy-Wilson Lumber Co. to the amount of their investment in the railroad company, and that such was the understanding when the stock was originally issued to them. Accordingly, we have found, as set forth in our findings of fact above, that the stock of the Christie & Eastern Railway Co. issued in 1917 was held by the directors of the Peavy-Wilson Lumber Co. in trust for that company. In addition to the direct evidence referred to, this conclusion is further strengthened by the fact that the railroad company suffered losses during the years 1917, 1918, and 1919 in the aggregate amount of $35,394.74, during which years it had an authorized and outstanding capital stock of only $15,000. Yet in February, 1920, the lumber company issued its capital stock in exchange for the original capital stock of the railroad company, upon the basis of par value of both stocks, thus substantially treating the losses of the railroad company as its own.

Having reached the conclusion indicated, it follows, we think, that the Peavy-Wilson Lumber Co., during the years 1917, 1918, and 1919, "owned directly or controlled through closely affiliated interests or by a nominee or nominees" ">*2994 substantially all the stock of the Christie & Eastern Railway Co., and that the corporations during the years 1918 and 1919 were affiliated within the purview of section 240(b) of the Revenue Act of 1918, supra.

With respect to affiliations during 1917, the statute imposes further conditions, which must be considered. The restrictions on affiliations in 1917, which are in addition to those imposed under the provisions of the Revenue Acts of 1918 and 1921, supra, are set forth in section 1331(b) of the Revenue Act of 1921, the applicable part of which reads as follows:

">*648 Provided, That such corporations or partnerships were engaged in the same or a closely related business, * * * but a railroad or other public utility which was owned by an industrial corporation and was operated as a plant facility or as an integral part of a group organization of affiliated corporations which were required to file a consolidated return, shall be construed to have been affiliated.

That the corporations under consideration met these additional requirements during 1917, is, we think, too clear to require extended discussion. From 84 per cent to 90 per cent of the revenues">*2995 of the railroad company was derived from the business of the lumber company. The lumber company could not have operated its sawmill without the transporation facilities provided by the railroad company. Each was dependent upon the other for its existence. The two corporations were engaged in the same or a closely related business. The railroad was operated as a plant facility of the lumber company, which was an industrial corporation, and which also owned substantially all the stock of the railroad company.

It is our opinion that the Peavy-Wilson Lumber Co. and the Christie & Eastern Railway Co. were also affiliated during 1917, from the date of organization of the latter corporation, within the purview of section 1331(b) of the 1921 Act, supra.

The Peavy-Byrnes Lumber Co. claims that either it is entitled to deduct each year, as cost of timber under the Krause & Managan Lumber Co. contract, one-half of the net profits of the Peavy-Byrnes Co., or that the 2,500 shares of capital stock issued to the Krause & Managan Lumber Co., Ltd., in 1913 were worth $562,500, and represented payment for the timber contract; and that this amount should be included in invested capital and">*2996 be subject to exhaustion or depletion based upon the quantity of timber included in the contract.

As set forth in the findings of fact, the Krause & Managan Lumber Co. entered into an agreement in 1909 with the Peavy-Byrnes Lumber Co., whereby it agreed to sell to the latter the right to cut all sound merchantable pine timber of a diameter of 12 inches and upwards at the stump upon certain described lands. The Peavy-Byrnes Co. agreed to pay a certain royalty rate and additional payments as timber was cut.

As a further consideration the contract provided that when the net profits from the operations of the mill of the Peavy-Byrnes Co. had repaid to the stockholders of the Peavy-Byrnes Co. their total original investment, the Peavy-Byrnes Co. should pay the Krause & Managan Co. one-half of all net profits from the further operations of said mill, and transfer a one-half interest in all the property and assets of the Peavy-Byrnes Co. or one-half of its capital stock, at the option of the Krause & Managan Co. Dividends equaling at least 90 per cent of the net profits were to be declared annually as ">*649 repayment of the original investment, as previously provided. On July 28, 1913, the">*2997 Krause & Managan Co. elected to take 50 per cent of the capital stock and, accordingly, there were issued to it 2,500 shares of a par value of $250,000.

From the above agreement of sale of timber rights it appears that there was an outright transfer of such rights from the Krause & Managan Co. to the Peavy-Byrnes Co., but the contract provided that additional consideration should be paid therefor upon the happening of certain events in the future. Until such condition occurred no payments were required, except the payments per thousand feet as timber was cut. The Peavy-Byrnes Co. was in possession of the property and was entitled to all of the net profits from the operation thereof until such time as the net profits had paid back the original investment to the stockholders of the Peavy-Byrnes Co. This contingency might have been predicted in the near future, or might not have occurred until the timber had been exhausted, or might not have happened at all. However, the condition was met some time prior to July 28, 1913, and on that date of the Krause & Managan Co. had the right to demand one-half of all the assets, which included mill, appurtenances, belongings, and timber rights, ">*2998 and one-half of the future net profits, or the right to demand one-half of the capital stock.

The petitioner has argued that the payment of one-half of the net profits was provided for in the contract, regardless of which option the Krause & Managan Lumber Co. chose, and, therefore, claims that one-half of the net profits each year was payment on the purchase price of the timber rights. Section 14 of the contract is clear and unambiguous. It provided that the Krause & Managan Lumber Co. had the option to take either half the assets and profits or, in lieu therof, half the capital stock. The action of the parties themselves clearly indicates that when the Krause & Managan Co. elected to take one-half of the capital stock it did not also retain its rights under the contract to one-half of the net profits separate and apart from the stock ownership. The stock ownership resulted in the Krause & Managan Lumber Co. having a right to half of the dividends declared, and placed that company on an equal basis with the other stockholders. All of the payments subsequently made to the Krause & Managan Lumber Co., except the royalty payments, were designated dividends, and were so entered">*2999 on the books, and no entries were made on the books from 1913 to 1917 of any amounts representing one-half of the net profits as being paid on the purchase price of the timber rights.

">*650 This is further brought out in the resolution adopted at the special meeting of the directors of the Peavy-Byrnes Co. on July 26, 1913, wherein it is stated:

WHEREAS, the Krause & Managan Lumber Company has exercised its option to take an equal amount of the capital stock of the company to the amount that has been issued as evidence of their ownership of one-half of the property and future earnings, therefore be it

RESOLVED: That the President and Secretary of this company be authorized and instructed to issue to the Krause & Managan Lumber Company, or as they direct, stock of the Peavy-Byrnes Lumber Company to the amount of $250,000.00

It is, therefore, our opinion that on July 28, 1913, 2,500 shares of stock of the Peavy-Byrnes Lumber Co. of the par value of $250,000, were issued to the Krause & Managan Lumber Co. in payment for certain assets consisting of timber rights, and which constituted tangible property.

The Revenue Acts of 1918 and 1921, in section 326(a), define the">*3000 term "invested capital," as meaning, in so far as material here, (1) actual cash bona fide paid in for stock or shares, and (2) actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment.

It follows that for the years 1918 to 1921, inclusive, said petitioner is entitled to include in invested capital an amount based upon the actual cash value of the assets so paid in for stock or shares, at the time of such payment. The question then arises as to the value of the assets paid in for stock, and as to when or at what time they were paid in.

It is contended by the petitioner that since the Krause & Managan Lumber Co. had the right to receive a one-half interest in all the property and assets of the Peavy-Byrnes Co. and one-half of the net profits, or one-half of the capital stock, the transaction amounted in substance to an exchange of a one-half interest in the assets and profits for one-half of the capital stock. It is argued that if the assets and the right to one-half the profits had been received by the Krause & Managan Co. and then exchanged for one-half of the capital stock of the Peavy-Byrnes Co., the parties">*3001 would have been in the same situation as if one-half of the capital stock of the latter company had been issued as additional compensation for the timber rights of the former company. But we must consider not what the parties might have done, but what they actually did. The fact is that the Krause & Managan Lumber Co. had the option to take either one-half the assets and profits, or one-half the stock. If it had taken the former and then exchanged them for stock, undoubtedly the value of those assets at the time paid in for stock should be included in invested capital, and the depletion allowance would be determinable on the basis of that transaction. However, such transaction ">*651 did not occur. The Krause & Managan Co. parted with their timber rights in 1909, and did not at any time thereafter reacquire them, or any part of them, to exchange for stock in the Peavy-Byrnes Co.

The Peavy-Byrnes Co. was liable, on the happening of a certain event, to transfer and deliver to the Krause & Managan Co. additional compensation for the timber rights, over and above the royalty rate of $4 per thousand feet of lumber cut. This liability was satisfied on July 28, 1913, when the">*3002 Peavy-Byrnes Co. issued one-half of its capital stock to the Krause & Managan Co. The transaction amounted to the paying of the contract royalty for the timber cut, and the issuing of the stock in 1913. The timber rights, however, were acquired by the Peavy-Byrnes Co. in 1909, and for invested capital purposes, under the Revenue Acts of 1918 and 1921, must be valued as of the date they were paid in. The fact that the stock was not issued until 1913 does not change the rule of the statute that only the actual cash value of the assets paid in for stock at the time of such payment may be included in invested capital. It is not important that the stock was issued at a later date, nor is it material that the assets which the Krause & Managan Co. might have demanded and received in lieu of the stock be considered as determinative of the value of the stock, as we are not here concerned with what the values might have been in July, 1913. We would have been concerned with the values as of that date only in the event that the assets were paid in for stock on that date. This the record does not warrant us in holding.

The question, then, is, What was the value of the assets paid in for">*3003 stock in 1909, for which the stock was issued in 1913?

No testimony was directed toward the value of the timber rights in 1909. However, we believe there is sufficient evidence in the record to enable us to determine such value. It was in effect testified by competent witnesses without contradiction that the fair market value of the standing timber in 1909 was $4 per thousand feet. This value, however, must be reduced by the then present worth which is assignable to the royalty interest reserved by the Krause & Managan Co. of $4 per thousand feet as the timber was cut. A value of $4 per thousand feet for the whole tract is an entirely different thing from the present worth of a royalty of $4 per thousand feet, which is to be paid only as the timber is cut over the future years.

In valuing this royalty interest, we have a timber reserve of 154,015,525 feet as of July 28, 1913, and a record of timber cut from 1909 to July 28, 1913, of 52,124,702 feet, which would give a total of 206,140,227 feet of standing timber in 1909. Under the terms of the contract, the petitioner was obligated to cut at least 20,000,000 feet of timber per year. Upon this basis, then, the life of the">*3004 timber property ">*652 would be 10 years. The fact that the amount of timber actually cut was less than the minimum provided in the contract is not material here. The only basis for an estimate in 1909 was the contract, and we can assume that the parties intended to carry out the terms of this contract. A banker who testified as to the value of the petitioner's business and stock stated that in a business of this character 8 per cent was a reasonable return on the investment.

The present value in 1909 of a royalty rate of $4 per thousand feet, on the basis of a timber reserve of 206,140,227 feet with a life of 10 years and an interest rate of 8 per cent, would be $504,630. The value of the timber, inclusive of the royalty interest, that is, 206,140,227 feet at $4 per thousand, would be $824,560. Therefore, the value of the petitioner's interest in the timber would be represented by the difference, or $319,930. This amount, then, should be considered in the computation of invested capital for the years 1918 to 1921, both inclusive, as representing the value of the assets paid in for stock in 1909.

The Revenue Act of 1917, which is controlling here for that year, provides">*3005 in section 207(a), in so far as pertinent to these proceedings, that "invested capital" means, (1) actual cash paid in, (2) the actual cash value of tangible property paid in other than cash, for stock or shares in a corporation, at the time of such payment, but in case such tangible property was paid in prior to January 1, 1914, the actual cash value of such property as of January 1, 1914, but in no case to exceed the par value of the original stock or shares specifically issued therefor, and (3) paid-in or earned surplus.

The tangible property here in question (that is, the timber rights of the Krause & Managan Co.) was paid in for stock of the Peavy-Byrnes Co. in 1909, which was prior to January 1, 1914. The actual cash value of such property, as of January 1, 1914, was in excess of the par value of the original stock or shares in the amount of $250,000 specifically issued therefor in 1913. This conclusion is supported by the fact that the timber rights transferred to the petitioner had a net value in 1909 of $319,930, and as hereinafter shown, the value of the petitioner's timber at March 1, 1913, was $421,350.75, which was based upon a value of $5 per thousand feet, unincumbered">*3006 by any royalty interest, while said value was $6 per thousand feet on July 28, 1913.

At July 28, 1913, the uncut timber reserve was 154,015,525 feet, and from that date to January 1, 1914, the petitioner cut 8,923,295 feet. From these facts, it is apparent, we think, that the value of the petitioner's timber at January 1, 1914, was in excess of $250,000.

">*653 Therefore, under the provisions of the Revenue Act of 1917, supra, the petitioner is entitled to include in invested capital for the year 1917 the actual cash value, as of January 1, 1914, of the property paid in for stock in 1909, but not to exceed the par value of the stock issued therefor in 1913, or the amount of $250,000.

The Revenue Act of 1917, supra, also provides that paid-in surplus may be included in invested capital, and the amount by which the value of the property paid in for stock in 1909 exceeded the par value of the stock subsequently issued therefor constituted paid-in surplus.

The value of said property in 1909, when paid in, was $319,930, and the par value of the stock issued therefor in 1913 was $250,000. The difference between these two amounts, or the sum of $69,930, less the">*3007 exhaustion or depletion sustained from 1909 to the taxable year, may be included in the petitioner's invested capital for 1917, as paid-in surplus.

The petitioner did not claim a depletion allowance based on the March 1, 1913, value of its timber, for the reason that it took the position that the timber rights were paid in for stock in July, 1913. It did, however, claim that it was entitled to a deduction on account of exhaustion, based upon the cost of such timber rights, which it contended were acquired on that date. Taking the position as we do, that the timber rights were acquired in 1909 and not in 1913, the petitioner is entitled to have the determination of the deduction to which it is entitled on account of the exhaustion of its timber rights then acquired for stock.

At March 1, 1913, there remained uncut 165,106,093 feet of timber. This timber, according to the undisputed testimony, had a value, unincumbered by any royalty interest, of $5 per thousand feet, or a total of $825,530.46. The value of the royalty interest of $4 per thousand feet must then be determined and deducted from the total value of the timber to arrive at the value of the petitioner's interest">*3008 therein at March 1, 1913.

According to its past operating history, the petitioner was cutting approximately 16,000,000 feet per year, which would indicate an estimated remaining life of 10 years. This is further supported by the fact that it actually required 10 years to cut the timber, the cut having been finished in 1923. The record does not disclose whether the petitioner secured a waiver of the terms of the original contract entered into in 1909, or whether the terms of the contract were subsequently altered in order to permit a cutting of less than the 20,000,000 feet therein provided for. But here we have the actual conditions and evidence upon which to base an estimate of the expected life.

">*654 To make a valuation of the royalty interest, we have a royalty rate of $4 per thousand feet, a life of 10 years, and an interest rate of 8 per cent. From these figures, we conclude that the fair market value of the royalty interest at March 1, 1913, was $404,179.71. This amount deducted from $825,530.46, which is the value of the timber per thousand feet multiplied by the quantity of timber, leaves $421,350.75, which represents the fair market value of the petitioner's">*3009 timber at March 1, 1913, and which is the amount returnable as depletion on 165,106,093 feet of timber.

Pursuant to paragraph 13 of the contract between the Peavy-Byrnes Co. and the Krause & Managan Co., set out in our findings of fact above, certain payments were made in 1919, 1920, and 1921, in excess of the $4 royalty rate, based upon the sales price of lumber. The respondent allowed these amounts as deductions from gross income during those years, as selling expense. The petitioner claims that they represent additional cost of timber cut, and under issue 4 assigned said action of the respondent as error. Not one dollar of these payments was ever expended in connection with the sale of the lumber; they were made as additional purchase price thereof and should be so treated.

In computing the invested capital of the Peavy-Byrnes Lumber Co. during the years 1920 and 1921, the respondent computed a tentative tax for the year 1920 of $251,674.09 and for the year 1921 a tentative tax of $41,349.82, and reduced the current earnings available for distribution of dividends by those amounts. We have frequently passed on this question, and held that the computation of a tentative">*3010 tax and the reduction of current earnings thereby is improper. The action of the respondent on this point is disapproved. .

The respondent computed the inventory of the Peavy-Wilson Lumber Co. as of December 31, 1920, on the basis of cost, to be $405,138.82. At the hearing, the respondent conceded the right of this petitioner to inventory at cost or market, whichever was lower, and it was stipulated that the market price of the inventory f.o.b. cars at the mill on December 31, 1920, was $311,129.56, which included the cost of shipping and selling in the amount of $26,668.15 and the cost of hauling to planer and planing in the amount of $17,168.30. Said amount of $311,129.56 should, therefore, be reduced by $26,668.15, representing the cost of shipping and selling, and the sum of $17,168.30, representing the cost of hauling to the planer and the planing of the rough lumber, since these costs, which entered into the market price, had not been paid nor incurred. The lumber on hand in its rough condition is what is to be included in the inventory. When these costs are subtracted, the market value of the lumber is then shown to have">*3011 been only $267,293.11, as the petitioner ">*655 contends. The lumber in question had not been shipped or sold, nor hauled to the planer or planed and the respondent, computing the inventory on the basis of cost, did not include charges of this nature in his computation.

The petitioner alleges that the respondent erroneously reduced invested capital of the Peavy-Byrnes Lumber Co. in 1920 by an amount of $54,312.72 and in 1921 by an amount of $45,048.58, on the theory that payments to nominees of the Krause & Managan Co. of $225,000 in 1920 and $250,000 in 1921 constituted payments of dividends. The effect of the payments of the above amounts upon income was fully discussed under issues two and three above, where we held that they were in fact dividends, as they purported to be. It follows that the action of the respondent in reducing invested capital on the theory that said amounts constituted dividends must be approved.

In accordance with the stipulation of the parties entered at the hearing, the Peavy-Byrnes Lumber Co. is entitled to a deduction from income for the year 1922 in the amount of $60,701.70 as ordinary and necessary expenses of operating a logging railroad; ">*3012 and the Peavy-Wilson Lumber Co. and the Peavy-Moore Lumber Co. are entitled to deductions from income for 1922 in the amounts of $117,391.59 and $51,335.23, respectively, as ordinary and necessary expenses of operating logging railroads.

Under issue No. 7, the Peavy-Byrnes Lumber Co. contends that it is entitled to a loss on a locomotive sold to the Peavy-Moore Lumber Co. in 1922. In his brief the respondent concedes that the uncontroverted evidence shows a cost price of $8,500 for the locomotive on December 6, 1919, and a sales price of $5,000 February 16, 1922. A 10 per cent rate of depreciation was stipulated at the hearing. The respondent further concedes a loss by the petitioner, based upon said facts. We have held that the Peavy-Byrnes Lumber Co. and the Peavy-Moore Lumber Co. were affiliated for the years 1919 to 1921, inclusive. It does not follow, however, that under the Revenue Act of 1921 these corporations filed consolidated returns for 1922, and it appears that the corporations did not claim that they were affiliated and entitled to file consolidated returns for that year. It further appears that the respondent now concedes that the petitioner, Peavy-Byrnes Lumber">*3013 Co., is entitled to this deduction, which should be computed on the basis of the facts above stated.

Reviewed by the Board.

Judgment will be entered under Rule 50.

SMITH, STERNHAGEN, PHILLIPS, and MURDOCK dissent.

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Footnotes

• 1. Charter subscription on Aug. 30, 1919. ↩