Seaboard Commercial Corp., et al. v. Comm.

Decisions will be entered under Rule 50.

John R. Brook, Esq., for the petitioners. Joseph Landis, Esq., for the respondent.

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In these consolidated proceedings respondent determined deficiencies as follows:

 Petitioner                       Year Tax                           Deficiency

Bolton Manufacturing Corporation, a Delaware corporation, hereafter referred to as Bolton Delaware, was a subsidiary of petitioner Seaboard Commercial Corporation, hereafter referred to as Seaboard. The following issues involve Bolton Delaware:

(1) Does the decision in Docket No. 25481, National Fireworks, Inc. and Affiliated Corporations, T. C. Memo. 1956-1, affd. (C. A. 1) 243 F. 2d 295, act as an estoppel by judgment concerning issues 2, 3, 4, and 5, infra?

(2) If not estopped by judgment, did Bolton Delaware sustain a loss on sale of surface grinders in 1943?

(3) If not estopped by judgment, did Bolton Delaware sustain a loss on sale of Frankel lathes in 1943?

(4) If not estopped by judgment, did Bolton Delaware incur costs of 84,909 in connection with U-6 Hob Thread milling machines deductible in 1943?

(5) If not estopped by judgment, did Bolton Delaware properly deduct in 1943 deferred labor costs incurred in 1942? Other issues still in contention are:

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(6) Whether either Seaboard or any subsidiary is entitled to carry over to 1943 net operating losses of Automatic Machinery Manufacturing Corporation, hereafter referred to as Automatic, ¹ for fiscal periods ending before January 1, 1943.

(7) Whether respondent properly disallowed excess profits tax deductions for amounts paid by Bolton Delaware and Coastal to Seaboard in 1943 purportedly as interest on indebtedness.

(8) Whether respondent properly disallowed deductions in 1944 and 1945 for amounts paid to Seaboard by Coastal purportedly as interest on indebtedness.

(9) Whether Coastal can deduct amounts it paid in 1945 to Seaboard purportedly as service charges.

(10) Whether respondent erroneously failed to allow Seaboard to carry over an unused excess profits credit from each of 1941 and 1942.

(11) Whether Coastal incurred contract termination expenses deductible either in 1945 or 1946, so as to increase the 1946 net operating loss.

(12) Whether Coastal sustained an ordinary loss in 1947 due to worthlessness of stock of another Seaboard subsidiary corporation, later known as Coastline Manufacturing Corporation, hereafter referred to as Coastline, which Seaboard transferred to Coastal in 1947.

(13) Whether in 1947 Coastal is entitled to a bad debt deduction on Coastline indebtedness.

(14) Whether respondent erred in determining the addition to tax for 1943 against Coastal for failure to file a timely declared value excess-profits tax return.

Each party has conceded certain issues and settlement of others has been stipulated. The issues that have been conceded or settled will be given effect in the Rule 50 computation. FINDINGS OF FACT. The stipulated facts are found accordingly.

Seaboard is a corporation organized under the laws of Delaware. For 1943, as common parent of the following subsidiaries, it joined them in making consolidated income and excess profits tax returns filed on June 15, 1944, with the collector of internal revenue for the third district of New York. Lincoln Exchange, Inc., New York, New York Seaboard Consultants, Inc., New York, New York Coastal, Bridgeport, Connecticut

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Bolton Delaware, West Haven, Connecticut Peerless Tools, Inc. (inactive), West Haven, Connecticut, hereafter referred to as Peerless Pacific Iron Works, Inc. (inactive), West Haven, Connecticut, hereafter referred to as Pacific

Bolton Delaware, which changed its name to Coastal in 1947, ² filed its separate returns for 1944 and 1945 with the collector of internal revenue for the district of Connecticut.

On July 31, 1942, National Fireworks, Inc., hereafter referred to as Fireworks, acquired all of the stock of Automatic which owned all the stock of Peerless and Pacific. On December 22, 1942, Fireworks sold, for 10,000, all of the Automatic stock to Bolton Manufacturing Company, a Connecticut corporation, hereafter referred to as Bolton Connecticut, a wholly owned subsidiary of Seaboard. Prior to December 31, 1942, Automatic liquidated Peerless and Pacific and had all of their assets distributed to it. After December 22, 1942, a new corporation, Bolton Delaware, organized on December 16, 1942, acquired all assets of Bolton Connecticut, including the Automatic stock, and assumed all liabilities in exchange for Bolton Delaware's voting stock. Seaboard liquidated and dissolved Bolton Connecticut about December 31, 1942, and had distributed to it all the stock of Bolton Delaware. On December 31, 1942, Automatic merged into Bolton Delaware pursuant to Delaware corporation law.

Seaboard incorporated Coastal in July or August 1943, becoming its 100 per cent stockholder. Seaboard invested 300,000 in cash for the Coastal stock, and agreed to advance any additional funds needed. In August 1943, Seaboard advanced to Coastal 800,000 to enable it to purchase the plant and machinery of Bolton Delaware. Coastal purchased all the physical inventory from Bolton Delaware for cash.

Coastal, from August 1943, successfully operated throughout the war on contracts for the Air Force and Navy on aircraft components. Coastal completed production of Collier Multipurpose machines as a subcontractor because the machines were located on its property. Later, Coastal became a subcontractor to Eastman Kodak Company in the manufacture of Navy proximity fuses, and operated on that item until 1946.

Throughout 1944, 1945, 1946, and 1947, Bolton Delaware was Seaboard's wholly owned subsidiary. From its organization in 1943 through November 1947, Coastal was Seaboard's wholly owned subsidiary.

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For 1944 and 1945, when it did not file consolidated returns, Seaboard had unused excess profits credits of 203,064.24 and 153,558.57, respectively. Issue 1. Estoppel by Judgment.

On July 27, 1949, respondent sent a statutory notice of deficiency to Fireworks regarding its taxable year ended August 31, 1943. The notice did not adjust Automatic's ending inventory for the period September 1 through December 31, 1942. Fireworks timely petitioned the Tax Court to redetermine the deficiencies, Docket No. 25481, but raised no issue respecting the December 31, 1942, valuation of Automatic's inventory. Fireworks filed amended petitions, first contending that it had overstated Automatic's closing inventory as of December 31, 1942, with respect to U-6 Hob Thread millers, Frankel multiple purpose lathes, SG-2B surface grinders, and Collier Multipurpose machines by approximately 460,000, and finally alleging that it had overstated that inventory by approximately 740,000. The Tax Court decided on the merits that Automatic had not overstated its closing inventory (Memorandum Findings of Fact and Opinion filed January 10, 1956, T. C. Memo. 1956-1). The Court of Appeals for the First Circuit affirmed the Tax Court decision, 243 F. 2d 295. Issues 2, 3, and 4. Inventory Loss.

The 1943 return contained a statement that the inventories at the beginning and end of 1943 had been valued at the lower of cost or market.

Seaboard's accountant prepared its 1943 return and followed the same procedures used in earlier returns for Automatic, according to good accounting practice commonly accepted in the machine tool industry. Seaboard claimed losses in its 1943 return for surface grinders, Frankel lathes, U-6 Hob Thread milling machines, and deferred labor trainee costs in accordance with its accountant's opinion. Fireworks did not claim these losses in its return for the year ended August 31, 1943.

The accountant who prepared the Fireworks consolidated returns for the period ended August 31, 1942, which included Automatic, took facts and figures directly from Automatic's books. He prepared those returns in accordance with recognized accounting practices.

The return for the period ended December 31, 1942, included the following computation of Automatic's cost of goods sold:

 Inventory at beginning of year           $ 1,393,269.84

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Automatic's inventory at December 31, 1942, used to calculate its cost of goods sold on the consolidated return filed by Fireworks, included the following items:

 U-6 Hob Thread millers          $ 166,242.79

Automatic's books show a cost accumulation for surface grinders as of March 31, 1942, of 90,480.81, and the following additional cost accumulations through December 31, 1942:

 1942

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account balance of 97,286.03 at the close of 1943, which it charged to 1943 cost of goods sold and did not include in closing inventory at December 31, 1943.

Automatic valued its inventory at December 31, 1942, at lower of cost or market. This method was followed in the machine tool industry for an inventory item of the surface grinder type. Automatic used a market value for raw material which then generally exceeded cost. It recorded work-in-process inventory at cost, as no market value was available.

About May 1, 1942, Automatic received a purchase order from the Defense Plant Corporation, hereafter referred to as Defense, for the manufacture of 140 U-6 Hob Thread millers for an aggregate selling price of 818,650. The contract quoted selling prices from 5,750 to 6,150 for each machine. It provided that upon completion of each machine, Defense would advance 82 1/2 per cent of the selling price. Automatic was to hold the machines for sale to others upon approval by Defense. Upon each sale the purchaser would reimburse Defense for its advances. In 1942, Automatic completed 108 machines. It completed the remaining 32 in 1943. In 1942, it actually sold 36 completed machines to customers approved by Defense. It sold the remaining 104 machines in 1943.

Automatic accumulated the manufacturing costs in its work-in-process account. Upon completing each machine and receiving the advance from Defense, it credited work-in-process and charged cost of goods sold in an amount averaging 4,400 per machine. By December 31, 1942, the accumulated costs aggregated 647,041.55. Automatic charged 480,798.76 to 1942 cost of goods sold and carried the balance of 166,242.79 in work-in-process inventory. In 1943, it charged additional costs of 89,830.26 to work-in-process and credited to work-in-process and charged to cost of goods sold, 139,300. This book treatment left 116,573.05 uncharged to cost of goods sold. After crediting work-in-process for proceeds from sale of parts of 22,562.24, Bolton Delaware included in its 1943 cost of goods sold a total of 99,648.29, consisting of the balance of work-in-process of 94,010.31, deferred tools and jigs of 4,003.11, and deferred engineering costs of 1,614.57. Respondent disallowed 77,409 of that amount and further reduced the claimed loss of 7,500 attributed to proceeds from sale of patterns.

The price of U-6 Hob Thread machines sold exceeded the contract price in many instances because additional parts were sold. The basic prices for these machines were never less than those listed in the contract. The continuous sales during 1942 and 1943 of these machines established a market value which at the end of 1942 exceeded their inventory valuation.

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During 1943, Bolton Delaware sold patterns for U-6 machines to Universal Machine Company for 7,500. This sale had no connection with the sale of the inventory. The asset account for drawings and patterns included the cost of these patterns in its January 1, 1943, balance of 36,643.31. As the records did not clearly indicate which patterns were for the U-6 Hob Thread milling machine, when those patterns were sold, Bolton Delaware credited the asset account with 7,500, leaving a balance at December 31, 1943, of 29,143.31. The drawings and patterns account had a contra-account, reserve for depreciation, of 23,249.31 as of December 31, 1943.

On July 28, 1941, Automatic contracted with the Navy Department to manufacture 50 Frankel lathes for a total of 436,750. In 1942, the Navy advanced 30 per cent of the contract price.

Automatic refused a Navy request on October 20, 1942, that it agree to cancel the contract due to delinquency in deliveries. At a requested conference on October 31, 1942, Automatic demonstrated to Navy representatives the completed lathe which met with their satisfaction. On November 23, 1942, they set up a new delivery schedule. On January 9, 1943, the Navy advised Automatic that it would take only 10 lathes and that Automatic could dispose of the others to individual purchasers. On May 4, 1943, the Navy canceled its contract. Bolton Delaware (Automatic) refunded to the Navy all advances received, less 9,140, the price of 1 lathe which the Navy accepted for delivery in October 1943.

On December 24, 1942, Automatic contracted to ship to National Machine Works, Inc., hereafter referred to as National, some parts and material in process in January and February 1943 for National to complete lathes for the Navy. Automatic invoiced the parts shipped at an aggregate of 86,643.69. On February 2, 1943, National declined to manufacture the machines and requested disposition of the material shipped by Automatic. National paid no part of the invoice price for parts shipped by Bolton Delaware.

Automatic issued a pamphlet which it and Bolton Delaware used during 1942 and 1943 in efforts to sell the lathes already manufactured. Automatic and Bolton Delaware received orders including one for 10 lathes from General Motors. Bolton Delaware continued its efforts to sell the lathes but they were unsuccessful. All purchasers subsequently canceled their orders in 1943.

After the cancellation of all contracts for Frankel lathes, Bolton Delaware, having decided to abandon the entire project, subsequently in 1943 liquidated the entire inventory of parts and material.

Frankel Machinery Corporation, hereafter referred to as Frankel, licensed Automatic (Bolton Delaware) to manufacture Frankel lathes, using Frankel's drawings and know-how. Upon terminating the project in 1943, Bolton Delaware settled the contract with

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Frankel by paying 39,312 to Frankel and turning over jigs, fixtures, drawings, and patterns having an aggregate cost to Bolton Delaware of 47,636.16.

On December 31, 1942, costs on the Automatic books for the lathes, other than tools, jigs, fixtures, and drawings, aggregated 191,321.24. After charging additional costs and crediting recoveries during 1943, the book balance of work-in-process inventory of Frankel lathes totaled 186,441.09 on December 31, 1943. Bolton Delaware included this amount in its cost of goods sold for 1943, together with 47,636.16 which, as of December 31, 1943, represented the aggregate cost of tools, jigs, drawings, and patterns; the 39,312 paid to Frankel; and 3,517.72 of uncollectible charges.

Respondent determined that 191,321.24, the aggregate cost as of December 31, 1942, reduced by the 9,140.13 paid in 1943 by the Navy for 1 machine, and by 86,643.69, the unpaid contract price for sale of parts to National, or a net amount of 95,537.42, did not properly enter Bolton Delaware's 1943 cost of goods sold. He further determined that 47,636.16, ³ the cost of tools, jigs, fixtures, and patterns, was not part of Bolton Delaware's 1943 cost of goods sold.

Automatic kept its records respecting Frankel lathes according to generally accepted accounting practices and procedures in the machine tool industry. Issue 5. Deferred Labor Costs.

In March or April 1942, Automatic enlarged its work force by hiring "trainees," resulting in unduly increased direct labor costs on the jobs on which these trainees worked. Automatic charged to work-in-process wages earned by trainees engaged in producing Collier Multipurpose machines and U-6 Hob Thread milling machines.

Automatic's accountant agreed that the corporation was not getting full value from the trainees' services. On the accountant's recommendation, Automatic deferred the portion which it felt was unproductive to be charged off during the succeeding 12 months when it supposedly would receive the benefits of the trainee program. Beginning on May 13, 1942, Automatic charged only 25 per cent of each trainee's wages for his first 3 months of employment to the job he was working on. Automatic's books reflected the recommendations.

Automatic paid all deferred labor costs in the months incurred to the trainees who actually worked. The training was meant to make the trainees skillful enough to properly operate machines. Although the period varied among individual trainees, the management felt that 3 months was the average time needed to train semiskilled laborers. None of these deferred costs represented prepaid wages. Automatic

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regarded a new employee as a trainee for 3 months and thereafter charged none of his wages to deferred labor training costs.

As of March 31, 1942, it transferred a portion of wages, 48,740.18, from work-in-process inventory accounts, to a deferred labor training account. Thereafter for each month, April through August 1942, it charged 75 per cent of trainees' wages to the deferred labor cost account. The amounts charged to that account, and later charged to costs, follow:

 Original period of deferred labor

For the period April 1 through August 31, 1942, a consolidated income and declared value excess-profits tax return was filed for Automatic, Peerless, and Pacific. The return set forth for Automatic and its two subsidiaries income and deductions, including a net operating loss deduction of 108,219.51. That return indicates a consolidated net loss of 375,190.54. An attached schedule explaining the net operating loss deduction shows a consolidated net operating loss for the year ended March 31, 1942, of 108,219.51, including a net operating loss deduction of 75,350.10 for the year ended March 31, 1941, and of 32,869.41 for the year ended March 31, 1942.

Consolidated income and declared value excess-profits tax returns were filed for Automatic, Peerless, and Pacific for the period December 23 to December 31, 1942, which W. H. Carney and H. S. Elder signed as "President" and "Treasurer," respectively. The handwritten

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notation, "as officers of the successor company," appeared below the signatures. An attached rider stated that the returns filed by Fireworks for its fiscal year ended August 31, 1943, included Automatic's operations from September 1 through December 22, 1942, and that this return was being filed within the extensions of time granted of Fireworks.

About March 15, 1944, Forms 1122 and 1122 E, consents by subsidiaries to inclusion in consolidated income and excess profits tax returns, were filed with the collector of internal revenue for the district of Massachusetts, purportedly on behalf of Automatic, Peerless, and Pacific, for the period September 1 through December 22, 1942. These forms named Fireworks as common parent and stated that the consolidated return was to be filed in the Massachusetts district. C. W. Wannen, as vice president, and H. S. Elder, as treasurer, signed these forms.

The Fireworks consolidated return for the year ended August 31, 1943, included the income, deductions, and losses of Automatic from September 1 through December 22, 1942, taken from the accountant's working papers, in turn taken from the books. The items reflected on the return accorded with good accounting practice commonly accepted in the machine tool industry and conformed to an accrual method of accounting.

The receipts, cost of goods sold, deductions, and net income of Automatic and its subsidiaries were ascertained for the period September 1 through December 31, 1942. The books were not closed as of December 22, 1942. From the income determined for the period September 1 through December 31, 1942 --

9 (the number of days from December 22 through December 31) 122 (the number of days from September 1 through December 31)

was eliminated. Fireworks included the balance of Automatic's loss, 181,840.82 out of 196,323.70, in its consolidated returns for its year ended August 31, 1943.

Prior to April 1, 1942, Automatic filed its income, declared value excess-profits, and excess profits tax returns for fiscal years ended March 31. Fireworks included Automatic's income and deductions for the period April 1 through August 31, 1942, in its consolidated income and excess profits tax returns for its fiscal year ended August 31, 1942. Upon examination of those returns, the Bureau of Internal Revenue eliminated from the consolidated net income --

122 (the number of days from April 1 through July 31) 153 (the number of days from April 1 through August 31)

of Automatic's income.

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Issues 8 and 9. Interest and Service Charges.

At December 31, 1942, Bolton Delaware owed Seaboard 1,918,357.13. At December 31, 1943, Coastal and Bolton Delaware owed Seaboard 355,747.54 and 845,914.66, respectively. By December 31, 1944, Bolton Delaware had reduced its indebtedness to 50,731.88. The average borrowed capital schedule in Bolton Delaware's 1944 excess profits tax returns shows the following:

 Balance Dec. 31, 1943            $ 700,000

During 1945, 1946, and 1947, Bolton Delaware paid interest on its indebtedness to Seaboard. During 1945, Bolton Delaware paid interest of 15,526.11 to Seaboard.

In 1945, Seaboard maintained standby financial reserves for Bolton Delaware, for which it collected a service charge of 11,427.70. The latter deducted the service or standby charge in its 1945 income tax return. The purpose of maintaining these standby reserves, a common banking practice, was to facilitate postwar conversion to civilian business. Seaboard collected similar charges from commercial clients in which it had no financial interest.

Deductions taken for amounts paid by Bolton Delaware to Seaboard during 1944 and 1945 as interest on indebtedness and in 1945 as service charges were reasonable and did not tend to distort petitioners' income. Issues 12 and 13. Loss on Coastal Stock and Loans.

On November 12, 1947, Seaboard contributed the Coastal stock, for which it had paid 300,000, to Bolton Delaware as a contribution to capital surplus. On November 12, 1947, Bolton Delaware accepted from Seaboard 4,000 shares of preferred stock and 5,000 shares of common stock of Coastal to be carried in its capital surplusaccount.

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On December 23, 1947, Bolton Delaware agreed to take over the assets of Coastal and assume its liabilities. Coastal assigned all intangible property not covered by the agreement of December 23, 1947. Also on that day, Coastal executed a bill of sale for office furniture and fixtures, tools, jigs, and small tools not covered by the other agreements. Coastal had several products in process on which work continued from November to December 1947.

To give continuity to Coastal's customer relations, Bolton Delaware changed its name to Coastal and the former Coastal became Coastline, a corporation without assets or liabilities.

At December 31, 1947, Coastal (formerly Bolton Delaware) had total assets of 1,408,380.76, liabilities of 889,059.10, and capital stock and surplus of 519,321.66. Its liabilities at December 31, 1947, included the following:

 Demand notes payable to Seaboard                $ 300,000.00

Just prior to the transfer on December 31, 1947, of the Coastal assets to Bolton Delaware, Coastal (later Coastline) had total assets of 1,205,093.96 and liabilities, exclusive of reserves for contingencies and amounts owing to Bolton Delaware, of 1,195,676.91. In addition, listed under its liabilities were reserves for contingencies of 142,968.80, and notes and accounts payable to Bolton Delaware of 191,419.90.

Coastal (formerly Bolton Delaware) in 1947 deducted on its return 300,000 as loss on investment in Coastline (formerly Coastal). It also claimed a 191,419.90 loss on notes and accounts receivable from Coastline.

Bolton Delaware's amended income tax return for 1947 reported a net loss of 510,300.88. The return included in item 29 (c) other deductions of 509,439.08. Schedule K stated that 491,419.90 of item 29 (c) represented "[loss] on investment in and advances to wholly-owned subsidiary company determined to be worthless." This was disallowed by respondent. OPINION

Issues 1, 2, 3, and 4. Estoppel by Judgment and Inventory Loss.

In the consolidated return filed by petitioner Seaboard, the parent, losses on the liquidation of the inventory of one of its subsidiaries were deducted by the taxpayers and disallowed by respondent. There

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is no controversy as to the amount received but respondent claims that petitioner's basis was smaller than the one it used and hence that a portion of the loss is unallowable. The issue arises in two ways, a claim of res judicata or estoppel by judgment being advanced, as well as a contention on the merits.

The losses in question relate to Bolton Delaware, the successor of Bolton Connecticut, which in turn was the sole stockholder of Automatic. With respect to the year 1942, Automatic, then a member of a different affiliated group, and its then parent, Fireworks, litigated in a proceeding before the Tax Court an issue raised because Fireworks claimed that Automatic's inventory as of December 31, 1942, was overstated. Holding that there was no overstatement and thereby upholding respondent's contention there, the Tax Court employed the same figures for Automatic's closing inventory in 1942 as petitioners contend for here.

We think petitioners must be sustained on the plea of estoppel by judgment. Although some of the parties to this litigation are different, there can be no question that Bolton Delaware, being a successor in interest, is bound by the previous judgment, Hawkins v. Glenn, 131 U.S. 319; D. Bruce Forrester, 4 T. C. 907, 918; Mills Automatic M. Corporation v. United States, (Ct. Cl., 1937) 19 F. Supp. 247; Estate of Henry G. Egan, 28 T. C. 998, and hence is in a position to contend that the prior proceeding is likewise binding upon the other party, who of course was the same in both cases. The issue in the prior proceeding, involving as it did the content and basis of Automatic's inventory, determined that the basis of that inventory was no smaller than the amount carried on Automatic's books. The same inventory is in issue here. Moreover, the opening inventory pertaining to the first instant of the calendar year 1943 is necessarily the same figure. ⁴ "Of course, the closing inventory becomes the opening inventory of the next year * * *." McMullen, Federal Income Tax Accounting, p. 200. The determination in the prior case is hence conclusive here as to the fact there determined. The Evergreens, 47 B. T. A. 815, affd. (C. A. 2) 141 F. 2d 927, certiorari denied 323 U.S. 720; and see Commissioner v. Sunnen, 333 U.S. 591; Tait v. Western Md. Ry. Co., 289 U.S. 620.

It does not call for a different result that in the prior proceeding the decision went against petitioners there because of a failure of proof. Fairmont Aluminum Co., 22 T. C. 1377, affd. (C. A. 4) 222

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F. 2d 622, certiorari denied 350 U.S. 838. We accordingly determine the inventory issues in petitioners' favor without the necessity of examining the merits. Issue 5. Deferred Labor Costs.

Under the first issue (estoppel by judgment) petitioners argue on brief that --

Respondent is estopped from reducing or eliminating * * * the loss sustained by Bolton Manufacturing Corporation on Collier Multiple Purpose and U-6 Hob Thread Milling Machines referred to as deferred labor trainee costs in the sum of 43,023.88 or in any amount, in that the value of these items as they appear in the inventory of Automatic (predecessor of Bolton, Delaware), at the close of the year ending December 31, 1942, upon which value these claimed losses are predicated, has been judicially determined * * * [by the decision in the Fireworks case]. [Emphasis added.]

We have held, as to the first issue, that the Fireworks decision conclusively determines, for purposes of this proceeding, the value of Automatic's (Bolton Delaware's) closing and opening inventory for 1942 and 1943, respectively. Any value for the work-in-process opening inventory of the Collier Multipurpose and U-6 Hob Thread milling machines representing deferred labor training costs will consequently be included in the allowable loss. The item is apparently advanced by petitioners as a separate question only in the alternative. Having decided the primary issue with respect to the Fireworks decision in accordance with petitioners' claim, the present contention need not be further discussed. If there is any dispute as to the amounts to be included in the inventory, that may be settled in the recomputation under Rule 50. Issue 6. Net Loss Carryover of Automatic.

Petitioners claim to be entitled to the benefit of a net loss carryover by reason of the operations of Automatic in the year 1942. The factual background is somewhat complicated. Automatic's original fiscal year ended March 31, 1942. On July 31, 1942, Automatic's stock was acquired by Fireworks and Automatic became a part of Fireworks' consolidated group. The fiscal year of this group ended August 31, 1942, and a consolidated return including the aliquot part of Automatic's income for the short fiscal "year" was set up by the Fireworks group.

At practically the end of 1942 (December 22), Automatic's stock was acquired from the Fireworks group by the Seaboard group. And when, in 1944, a consolidated return for the fiscal year 1943 was filed by the Fireworks group, it purported to include the continuing loss of Automatic for the portion of that year in which it was a member

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of the Fireworks consolidation. This was precisely in accordance with respondent's regulations and comports with the concept of income and losses of consolidated groups and the effect of possible changes in their composition. Regs. 104, sec. 23.13 (e).

Petitioners, nevertheless, contend that they are entitled to carry over into their own fiscal year 1943 the net losses suffered by Automatic for the fiscal periods ended August 31, 1942, and December 31, 1942. The statement of their contentions in this respect in their brief (p. 84) is as follows:

122/153rds of the net operating loss of 375,190.54 for the fiscal year ended August 31, 1942, or 299,171.54 may be carried over to the calendar year ended December 31, 1942. Since this was also a loss year, said sum may be carried over to the calendar year 1943.

The net operating loss for the calendar year ended December 31, 1942 of 196,243.70 may be carried over to the calendar year 1943 and to the extent not utilized in 1943 may be carried over to Bolton, Delaware's 1944 taxable year.

As we understand the contention, petitioners are claiming a total of net loss carryovers on account of Automatic's operations in 1942 of slightly less than 500,000, notwithstanding that these losses were suffered during a period virtually all of which found Automatic in a different consolidated group. Although Automatic was acquired by Bolton Connecticut, and subsequently merged into Bolton Delaware, and although the parties advance arguments dealing with the situation where a merged corporation attempts to take the loss carryover of a predecessor, Stanton Brewery v. Commissioner, (C. A. 2) 176 F. 2d 573, reversing 11 T. C. 310; Koppers Company v. United States, (Ct. Cl., 1955) 134 F. Supp. 290, certiorari denied 353 U.S. 983; Newmarket Manufacturing Company v. United States, (C. A. 1) 233 F. 2d 493, certiorari denied 353 U.S. 983; Libson Shops, Inc. v. Koehler, 353 U.S. 382, we think the issue must be disposed of on different grounds.

Petitioners contend that the consolidated return filed by the Fireworks group for the fiscal year beginning September 1, 1942, could not properly include the net losses suffered by Automatic between that date and the end of 1942 and claimed as carryovers here by petitioners. This contention is made on the related grounds that the consents purporting to include Automatic in the Fireworks group were signed by unauthorized officers, and that by the time the Fireworks consolidated return was filed, Automatic had been liquidated and hence was incapable of participating in that action. But we emphasize that the losses sought to be availed of were suffered while Automatic was a subsidiary of Fireworks, not of Seaboard. As we have seen, the entire concept of consolidated returns involves a continuation of that procedure as long as any of the participating corporations are associated

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with the group. ⁵ To this arrangement Fireworks and Automatic necessarily agreed when they filed a concededly valid return for their fiscal year ended August 31, 1942.

While there seems to be a dearth of cases dealing with the matter, we see no escape from the conclusion that, whether a positive or negative figure, Automatic's income while it was affiliated with Fireworks, which was until virtually the end of the calendar year 1942, had to be included by Fireworks when it filed a subsequent return, notwithstanding that as of the filing of the return Automatic was no longer an affiliate. Regs. 104, sec. 23.13 (e). Automatic's losses for both August 1942 and September-December 1942 were presumably used by the Fireworks group to reduce its net income, through the filing of consolidated returns. ⁶ This being so, it could not reasonably be concluded that the net operating loss of a part of a different business could be carried over by petitioners for any period prior to Automatic's affiliation with the present petitioners. See Lisbon Shops, Inc. v. Koehler, supra (decided since the briefs herein were submitted). This conclusion is by no means unjust but rather precludes an otherwise inequitable result. The economic loss during Automatic's prior affiliation was borne not by petitioners but by the Fireworks group. That it should be entitled to the tax consequences of the practical realities seems a not unreasonable outcome.

There were, it is true, a few days between December 23 and December 31, 1942, when Automatic was an affiliate of petitioners. We find no claim for the allowance of a net loss limited to that short period. Nor is there in the record any proof that losses were actually suffered during this time, consisting possibly of no more than 4 or 5 working days, or, if there were, what was their amount. ⁷ As the case is presented, both from the evidence of record and the arguments on the brief, we treat that limited area as not in controversy.

Respondent's action on this issue seems to us to have been correct. Issue 7. Interest Deduction.

During 1943, petitioner Seaboard claims to have received from its affiliates Bolton Delaware and Coastal interest totaling approximately

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212,000. It reported these amounts as income on its consolidated excess profits tax return, and at the same time attributed them as deductions to the two subsidiaries. The latter were disallowed by respondent.

Since respondent at the same time reduced Seaboard's income by an identical figure, it may seem puzzling that petitioner resists his action. The explanation lies in the benefit to which the subsidiaries would be entitled by way of excess profits credit carryover in subsequent years when they did not file consolidated returns.

We have been unable to find any facts upon which to base a conclusion on this issue in petitioner's favor. As far as appears, the record contains no figures as to the amount of interest involved; nor indeed whether any was actually paid or accrued; nor even whether there existed a bona fide indebtedness on which interest could be predicated. See Autenreith v. Commissioner, (C. A. 3) 115 F. 2d 856, affirming 41 B. T. A. 319. If these interest figures lurk somewhere in the evidence, it was incumbent upon petitioner to request findings setting forth the necessary facts and to accompany them by appropriate record reference. Rule 35 (e) (3), Tax Court Rules of Practice (Jan. 1, 1951). No such findings have been requested; no such references appear; and we are apprised of no source available to supply them. Clearly, the tax return itself, besides being inconclusive here, cannot be regarded as more than a statement of petitioner's original claim, Watab Paper Co., 27 B. T. A. 488, 506, appeal dismissed (C. A. 8) 68 F. 2d 998, 1021; Louis Halle, 7 T. C. 245, 247, affd. (C. A. 2) 175 F. 2d 500, certiorari denied 338 U.S. 949; Leonard B. Willits, 36 B. T. A. 294, 297, and the deficiency notice as no more than its denial and possibly respondent's stated reasons therefor. Jamaica Water Supply Co., 42 B. T. A. 359, 367, affd. (C. A. 2) 125 F. 2d 512, certiorari denied 316 U.S. 698; Charles F. Ayer, 7 B. T. A. 324, 328, affd. (C. A., D. C.) 26 F. 2d 547. This is especially true here where the effect of the two items was merely an offset so that the consolidated return showed no greater or smaller income as a result, and respondent's disallowance merely parrots the return. For failure of any proof, we are forced to reject petitioner's contention on this issue.

Petitioner's brief makes a similar claim as to Bolton Delaware's declared value excess-profits tax. In addition to what has already been said, this matter is not even in issue, no assignment of error having been included in the petition. Rule 7 (c) (4) (D), Tax Court Rules of Practice (Jan. 1, 1951). Issues 8 and 9. Interest and Service Charges.

In 1944 and 1945 Bolton Delaware was indebted to Seaboard in a considerable amount. It deducted the interest charges which the

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proof shows and our findings state were paid in those 2 years. In 1945 Seaboard also established standby financing for Bolton Delaware, and for that it charged and Bolton Delaware paid a service fee. All three deductions were disallowed by respondent acting on the authority of section 45, I. R. C. 1939. ⁸

There seems no dispute as to the underlying facts, and from the evidence we have found that the charges in question were those which would have been made between unrelated enterprises dealing at arm's length. It follows that the amounts were reasonable and the purpose justified. Even if section 45 would otherwise be applicable, a point which we do not reach, respondent was not authorized to deny petitioner's right to the deductions. Chelsea Products, Inc., 16 T. C. 840, affd. (C. A. 3) 197 F. 2d 620; Welworth Realty Co., 40 B. T. A. 97. Respondent's determination in this respect is accordingly disapproved. Issue 10. Carryovers From 1941 and 1942.

Petitioners allege that respondent erroneously disallowed excess profits credit carryovers of Seaboard from 1941 and 1942. This contention was so summarily referred to as to lead respondent to assume it had been abandoned. Although petitioners protest that assumption, they still request no findings concerning the facts justifying these carryovers, as is their obligation. Rule 35 (e) (3), Tax Court Rules of Practice (Jan. 1, 1951). The record apparently contains no evidence relative to these issues; not even the tax returns reporting the pertinent figures are presented. Without requested findings or evidence of record we must, as in Issue 7, supra, uphold respondent's determination on this issue for failure of petitioners to sustain their burden of proof. Issue 11. Contract Termination Expenses.

Petitioner disputes respondent's disallowance of a 1945 deduction of 29,633.20 for expenses purportedly incurred in connection with contract terminations. Alternatively, it contends that this amount should be allowed in computing the net operating loss carried back from 1946.

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The evidence concerning these allegations consists solely of two noncommittal answers by the former president of Bolton Delaware. ⁹ His testimony does not characterize the expenses involved, nor even confirm that they were related to termination of contracts. The witness does not even state unequivocally that the amount deducted on the return was correct.

We find it unnecessary to decide to which year these items properly pertain, since the same burden of proof rests upon petitioner under either alternative. The evidence offered in support of that burden being clearly inadequate, we must decide this issue in accordance with respondent's determination, for failure to any proof on which to base the essential findings. Issues 12 and 13. Loss on Coastal Stock and Loans.

The facts on these issues are claimed by petitioner to be as follows.

Seaboard, which owned all of the stock of Coastal (here called Old Coastal), transferred its stock in 1947 to another wholly owned subsidiary, Bolton Delaware, which had in the meantime made loans and advances to Old Coastal. Thereupon Old Coastal merged into Bolton Delaware, and to compound the confusion, Bolton Delaware changed its name to Coastal (here called New Coastal). Petitioner claims that upon the happening of this event, the Old Coastal stock and the advances became worthless and it has taken a deduction in the year of merger for these amounts. The issue is raised by respondent's disallowance.

Petitioner's contention in this respect may best be summarized by its requested finding of fact which, incidentally, we are unable to make:

Bolton, Delaware, claimed as a loss in its income tax return for the year 1947, the sum of 300,000.00 for its investment in the former Coastal Machine Works, Inc. It also claimed as a loss the sum of 191,419.90 for a loss on notes receivable and accounts receivable from former Coastal Machine Works, Inc. When the assets and liabilities of old Coastal were taken over by Bolton, Delaware, the capital stock disappeared and at that time, the book valuation of liabilities exceeded the asset value on the books. The 191,419.90 of notes and accounts receivable which had been owed Bolton Delaware, by the old Coastal were washed out in the merger and were worthless. It was the judgment of the company's accountants and counsel that they were worthless and were deductible for tax purposes, and these amounts were deducted in the income tax return.

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Accepting for the moment petitioner's proposed figures and even assuming that they show that the debts represented by advances to Old Coastal were worthless in 1947, but see Trinco Industries, Inc., 22 T. C. 959, 965, the record is completely barren of any evidence as to whether these obligations may not have been wholly worthless in a prior year. As we said in Estate of G. A. E. Kohler, 37 B. T. A. 1019, 1025:

But, if it be assumed that the amount in controversy represented a debt, no more of that debt is deductible in 1931 than the Commissioner has allowed. A taxpayer may not select the year in which to deduct a debt which to his knowledge has been worthless for some time. Louis D. Beaumont, 25 B. T. A. 474. If the amounts paid in prior years were a debt, it was worthless long prior to 1931 and should have been charged off and deducted in some other year or years.

For all the evidence we have, these statements apply completely to petitioner's situation. If the debt was worthless in a year prior to 1947, and there is no evidence that it was not, it should have been taken as a deduction in some prior year.

A similar though not identical ground requires disallowance of the deduction for the capital stock transferred by Seaboard to New Coastal. The only ground upon which petitioner contends that this stock had a value in 1947, which can be taken by petitioner as a deduction in that year, is that under section 113 (a) (8) (B) New Coastal acquired the basis of Seaboard, its transferor. ¹⁰ This is said to be so because the stock was a "contribution to capital" from Seaboard to New Coastal.

If in fact the stock was wholly worthless prior to 1947 and was wholly worthless when transferred to New Coastal, and there is no showing to the contrary, we think it would be a perversion of the statutory language to consider it as coming within the phrase "contribution to capital," still less as "paid-in surplus." See Hunter Manufacturing Corporation, 21 T. C. 424. A contribution of zero would not really be a contribution, nor could a payment of nothing constitute part of a paid-in surplus or, for that matter, of any kind of surplus. Without discussing the other problems obviously raised by petitioner's contention, see, e. g., Trinco Industries, Inc., supra; National Securities Corporation, 46 B. T. A. 562, affd. (C. A. 3) 137 F. 2d 600, certiorari denied 320 U.S. 794, we conclude that it has not

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shown that any amount is deductible by New Coastal on account of the worthlessness of the stock; nor that any amount is deductible in 1947 as a worthless debt.

Respondent's disallowance of the claimed loss in 1947 as a carry-back to 1945 is accordingly approved. Issue 14. Penalty.

Respondent determined against Coastal (Bolton Delaware) a deficiency in addition to tax under section 291 (a) for failure to file a declared value excess-profits tax return. It is impossible to ascertain whether or not this issue has been abandoned. If not, it must still be decided in respondent's favor in view of the complete absence of any evidence on the subject, of any argument in the brief, or even of any request to find relevant facts. There being a complete failure of proof, respondent's determination in this respect is sustained.

Decisions will be entered under Rule 50.

Footnotes ¹ Automatic merged with Bolton Delaware on December 31, 1942.

² To be distinguished from the Coastal listed among the affiliates on the 1943 consolidated return.

¹ 3,20 or 3,300 of costs represented engineering services in connection with design and development to improve the surface grinders and to make them salable.

³ Stipulated figure incorrectly set at 46,626.16.

⁴ * * * When a merchant keeps inventories, costs do in effect become suspense items, for, although he credits himself with the cost of all articles bought during the year, he charges himself in his closing inventory with the cost of those not yet sold, unless he has "written up" or "written down" the inventory. Since these two items cancel each other in the return for the year of purchase, he is free to credit himself anew with the cost of all articles carried over, and this he does by entering the cost in his opening inventory for the following year. * * * [ Commissioner v. Dwyer, (C. A. 2) 203 F. 2d 522, 523, affirming a Memorandum Opinion of this Court filed June 29, 1951.]

⁵ Regulations 104.

Sec. 23.11 (a). Consolidated Returns Required for Subsequent Years.

If a consolidated return is made under these regulations for any taxable year, a consolidated return must be made for each subsequent taxable year during which the affiliated group remains in existence unless (1) a corporation * * * has become a member of the group during such subsequent taxable year, or (2) Chapter 1 of the Code to the extent applicable to corporations, or these regulations, which have been consented to, have been amended * * *, or (3) the Commissioner * * * grants permission to change.

⁶ Parenthetically, it may be noted that petitioner here is claiming as a carryover even the loss taken in the concededly valid consolidated return filed by the Fireworks group for the period ended August 31, 1942.

⁷ Fireworks excluded 9/122 of the September-December loss from its return. But there is no proof here that this correctly apportions any actual losses.

⁸ SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.

In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income, deductions, credits, or allowances, between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.

⁹ The entire testimony on this issue is as follows:

Q. Did Bolton also incur certain expenses in connection with contract terminations in the year 1945? A. Bolton incurred a great deal of expenses.

Q. Is that in the amount claimed as an expense in the year 1945 as evidenced by the return?

A. By the return, yes, that should be in the return. [Emphasis added.]

¹⁰ SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.

(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that -- * * * *

(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation -- * * * *

(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.