of 1928, which permit as a deduction from gross income " a reasonable allowance for the exhaustion * * of property used in business." It is not denied that the leases were used in business or that they were subject to exhaustion. The question here is whether there is a basis for exhaustion of these leases under section 204 (a) of the Revenue Act of 1926, which provides that such basis, for property acquired subsequent to March 1, 1913, shall be its cost. Petitioner contends that the cost of these leases, and therefore the basis for computing the deduction for their exhaustion over their remaining term of 54 months, is $49,740.93. Respondent contends that the leases have no cost basis, for the reason that they were acquired in the first instance by the Hancock company without cost, that they remained the property of that company, unaffected by the purchase of its capital stock, and that the transaction gave rise to no new basis whereby a revaluation of the company's assets was permissible for the purpose of computing exhaustion allowance for existing leases. In short, he contends that the intervening events were of no consequence. We agree with respondent. It is apparent that petitioner desired and intended to purchase the leases, and that it agreed to purchase all of the assets of the Hancock company, except those specifically excepted, in order to accomplish its purpose. But it was discovered that one of the leases could not be transferred and that fact prevented consummation of the sale of assets. Possibly the consent of the lessor to a modification of the lease which would permit of its transfer might have been obtained, but it was not. Apparently, neither of the parties was aware of the restriction in the lease when the agreement for purchase and sale of the assets was made and, because of that mutual mistake respecting the possibility of making valid delivery of the assets, the first agreement was rescinded and a new contract made covering the purchase and sale of the capital stock of the Hancock company. That second agreement was carried out and the transaction before us is plainly a purchase by the old Pugh company of all the capital stock of the Hancock company, which gives rise to no new basis for the leaseholds owned by the latter corporation. It appears also that, immediately upon obtaining the first agreement, the old Pugh company took possession of the merchandise of the Hancock company, and of the store premises, and dealt with them as if they were its own. These activities continued after the transaction was changed to one of purchase and sale of capital stock and included the disposal of part of the Hancock merchandise upon sale and intermingling it with the stock of the Pugh company. This, petitioner contends, constituted a liquidation of the Hancock company to its sole stockholder, thus establishing as the cost basis for the assets received the cost of the capital stock. That argument must fall because the restriction which prevented the consummation of the first agreement, namely, the nontransferability of the lease, likewise prevented a complete distribution of the assets of the Hancock company. Finally, petitioner urges that the recapitalization and change of name of the Hancock company effected a reorganization; that the transfer of its assets and the dissolution of the old Pugh company effected a merger; and that, as a consequence, a new basis was established for the assets in the hands of the new Pugh company, this petitioner. In other words, it contends that the sum paid for the capital stock in excess of the book value of the Hancock assets was paid for the leases, and in the merger carried over as the cost basis of the leases. Assuming that a reorganization and merger were accomplished, it does not follow that the basis for the leases was thereby changed. Ownership of the leases did not change, it remained in the Hancock company and was unaffected when, by change of name and recapitalization, that company was reorganized to become this petitioner. The assets of the old Pugh company, on the other hand, were brought into petitioner in the merger, presumably in consideration of the exchange of petitioner's stock for the stock of the old Pugh company. Doubtless, these additional assets increased the value of petitioner's stock, but the stockholders are not before us. There was no additional cost to petitioner of the assets, including the leases, which it theretofore owned, whether under the old name or the new, nor was their value increased, and, as we are not concerned with the cost or value of the assets of the old Pugh company, we see no reason upon which to bottom a finding that the merger effected a change in basis of the Hancock leases or other assets. Judgment will be entered for the respondent. 27 B. T. A. CO-OPERATIVE CENTRAL EXCHANGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Docket Nos. 46479, 53366. Promulgated November 7, 1932. The petitioner is a share capital cooperative corporation under A. A. Toivonen, Esq., for the petitioner. The respondent asserts deficiencies for the years 1925, 1926, 1927, 1928 and 1929 in the respective amounts of $142.30, $198.36, $362.80, $433.17 and $499.65. The only issues involved are (1) whether dividends on the share capital of a cooperative society are deductible as interest, and (2) whether the petitioner is an exempt corporation under the provisions of section 231 (12) of the Revenue Act of 1926 and section 103 (12) of the Revenue Act of 1928. The issue pleaded at each docket number being identical, the two proceedings were consolidated for hearing. FINDINGS OF FACT. The petitioner is a cooperative wholesale society incorporated under sections 185.01 to 185.22, inclusive, of the Wisconsin statutes. Its authorized capital stock is $250,000, divided into 2,500 shares of the par value of $100 each. At December 31, 1927, its member stockholders consisted of 54 farmers' cooperatives, 5 cooperatives in which a majority of the stockholders were farmers, 2 city consumers' cooperative organizations, 11 city cooperative organizations in which a majority of the members were consumers, 1 cooperative boarding house, 2 cooperative publishing houses and one cooperative bank. In all the years involved the stockholders were substantially as set out above. None of the petitioner's shares are owned by individuals. The by-laws of the petitioner contain the following provisions: ARTICLE II. Purpose and Field of Activity. SEC. 1. The purpose of this society is: to obtain and furnish commodities or necessities of life for societies affiliated with it by arranging and providing for joint purchases in accordance with orders furnished by the affiliated societies; to manufacture and sell all kinds of bakery products primarily for and to the affiliated societies; to establish a wholesale and warehouses or depots needed in connection with it, as well as productive establishments, as the need may be; to buy, sell and job at prevailing market prices agricultural products, particularly when offered for sale by or through the affiliated societies; also to provide or furnish implements and supplies needed in agriculture and other branches of production, such as agricultural machinery, tools, seed, pure-bred stock, etc., to co-operate with other American co-operative wholesale societies and co-operative establishments of production and to enter into agreements with them or through them concerning the supplying of goods or the selling of products. It is among the duties of the Co-operative Central Exchange also to supervise the internal development of societies affiliated with it, to enlarge their field of activity and to help them in every manner. Similarly also to organize and to carry on co-operative propaganda and advisory work in general; this work to be taken care of and to be supervised by a special educational department in accordance with the decisions of the general meetings and the Board of Directors. ARTICLE V. Distribution of Surplus Savings. SEO. 1. From the net surplus savings shown by the balance sheet for the fiscal year, at least 10% shall be placed in the surplus fund until the surplus fund is 30% of the paid-in capital; from the remainder, 5% shall be placed in the educational fund; 6% interest shall be paid on paid-in capital stock; and the balance remaining to be used according to the recommendation of the board of directors and approved by the annual meeting. The petitioner sells to both members and nonmembers. In the taxable years the percentages of its sales to members were: 1925, 82.29; 1926, 91.81; 1927, 91.33; 1928, 94.22; 1929, 94.41. In each of these years the sales to nonmembers were made to two groups, viz., cooperative societies owning no stock, but eligible to membership, and individuals and/or buying clubs not eligible to become stockholders. In each of the years under review rebates based on sale prices were given to all purchasers from the petitioner and the gross sales reported on its income tax returns for each of such years was the gross sale price less the total rebates to patrons. In each year involved the operations of the petitioner resulted in profits or savings in excess of rebates. Such savings were distributed in conformity with article 5 of petitioner's by-laws, as set out above. At the end of the several taxable years in question the petitioner had undistributed surplus as follows: 1925, $8,806.57; 1926, $10,498.17; 1927, $12,553.59; 1928, $15,323.22; 1929, $18,360.72. OPINION. LANSDON: In its brief the petitioner abandons the contention that the 6 per cent dividend which it paid to each of its shareholders in the several taxable years is deductible from income as interest. This issue, therefore, is determined in favor of the respondent. Sacred Heart Cooperative Mercantile Co., 2 B. T. A. 24; Farmers Cooperative Assn., 5 B. T. A. 61; Cloquet Cooperative Society, 21 B. T. A. 744. The second contention of the petitioner is that, under the provisions of section 231 (12) of the Revenue Act of 1926 and section 103 (12) of the Revenue Act of 1928, it is an exempt corporation. The statutory provision relied on by petitioner in the Acts of 1926 and 1928 is as follows: Farmers', fruit growers', or like associations organized and operated on a cooperative basis (a) for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonable reserve for any necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, and may purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 per centum of the value of all its purchases. The language of the statutes and of the interpretive regulations indicates very clearly that Congress intended to exempt cooperative associations organized to act as marketing and/or purchasing agents for producers. Consumers' cooperative associations may be highly beneficial to their members, but certainly are not included in the provisions of the law upon which the petitioner relies. It follows, therefore, that the 13 members of the petitioner function as distributive cooperations for city consumers and must be eliminated for consideration here, and this applies also to the two cooperative publishing houses, the cooperative store and the cooperative bank, all of which we think have the status of nonproducers. The law and the regulations are generously elastic, but can not be stretched to cover business activities with such a large number of patrons who are not 27 B. T. A. |