for the respective years, and supports his recommendation by the following comments:

I have disallowed all of these charges because it is my opinion that a concrete dam is a permanent improvement on the property the same as a sidewalk or a paved street, and in my investigation of the N Company their engineer was of this same opinion. A permanent improvement would not be subject to depreciation, and the loss would be shown when the property is disposed of. This property is still held, but the company has gone out of the ice business, and in 1917, therefore, they considered the dam as a lost investment and charged off the whole balance at that time; in fact, the last season in which they cut ice was 1915 and 1916, and if this is an allowable loss it occurred in 1916.

Practically the same interests are connected with the O Company, and it is the public opinion that the M Company surrendered the ice business to the other company without any loss of profit to themselves, and in order to segregate the ice business, which has practically no connection with their present activities, which in fact cover anything other than the name implies.

Although they agree that there is very little depreciation in a dam they claim that this dam is an entire loss and should be chargeable against profit. It was constructed for the purpose of making an ice lake, and since they have gone out of that business they claim it should be charged off.

They claim that the dam did not improve the property and was built entirely for business purposes, and when they quit that business the investment was a loss; I can not tell the monetary value of the property with or without the dam, but I do know that without it they would not have any land to use because they own only the creek bottom, and if it wasn't flooded it would merely be a small stretch of rocky creek bottom, only a few feet wide, as their holdings go only as high on each side of the creek as the flood stage, and the dam is only a six-foot structure.

It is my claim that this is not the same as a loss on abandoned machinery or buildings, which would be allowed, but it is a permanent improvement, and if there is a loss on account of this additional investment in the property, they can take it when the transaction is closed by sale or possibly by some accident the dam might be destroyed.

The records of the company are in good condition, and I found the officers to be fair-minded, and the only question on which we could not agree was that of the loss of the dam investment. They would not sign an amended excess profits tax return on account of this difference and they made their decision upon advice.

The Unit sustained the agent in his recommendation that the loss charged off and claimed in 1917 be disallowed upon the ground that the dam constitutes a permanent improvement upon which no determinable loss can be computed until such time as the asset is disposed of (sold or otherwise converted). However, the Unit overruled the examining officer in respect to depreciation charges and allowed a loss deduction for depreciation each year from 1909 to 1917, inclusive, such annual deduction being computed on the basis of cost and an estimated life of fifty years.

The taxpayer in filing claim for abatement accompanied by an amended return accepts the Unit's adjustment of depreciation allowances, but contends for the right to deduct a "loss of useful value " as hereinbefore outlined.

By accepting the Unit's adjustments respecting depreciation on the dam, the balance or residual value as of January 1, 1917, is shown to be 2 dollars and it is this amount which the taxpayer now claims as a loss deduction instead of 14 dollars claimed in the original return.

The taxpayer in supporting this contention quotes article 143 of Regulations 45 and supplements by the following argument:

The cause for the loss was a concrete dam which we constructed during 19— for the sole purpose of making an ice lake.

At that time we were in the ice business and stored ice, which was cut from the lake whenever the winters made it available, but in the winter of 1916 and 1917 we did not cut any because of the weather and decided at that time to discontinue that business as it was not profitable and we have not handled any ice, either natural or manufactured, since.

The location of this ice lake is entirely worthless for any other purpose and in fact the land we own is bounded by the high-water mark of the lake and our entire property there is covered by water.

The ruling cited above contemplates, we believe, that a "loss of useful value" is an allowable deduction and whether the property in question is machinery (which is specifically mentioned in the quotation) or a dam we do not think should change the spirit of the ruling.

As was no doubt shown by the findings of your agent, this dam was entirely charged off our books in 1917 and it is still charged off and we consider it an absolute loss which is covered exactly by the ruling.

Since we made no protest to you before, probably the circumstances of the case were not before you, but with our explanation we hope that you will see that our claim is just and worthy of favorable action.

In considering the question involved the Committee has given care. ful attention to the language of article 143, Regulations 45, under which the taxpayer claims the right to deduct the disputed item. Article 143 reads:

When through some change in business conditions the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in the business, he may claim as a loss for the year in which he takes such action the difference between the cost or the fair market value as of March 1, 1913, of any asset so discarded (less any depreciation sustained) and its salvage value remaining. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property must be prematurely discarded, as, for example, where an increase in the cost of or other change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such as permanently abandoned. Any loss to be deductible under this exception must be charged off on the books and fully explained in returns of income. But see articles 181-189.

Special thought has been given to the terms of this article wherein it states that a taxpayer "may claim as a loss for the year in which he takes such action the difference between the cost or the fair market value as of March 1, 1913, of any asset so discarded (less any depreciation sustained) and its salvage value remaining."

A review of the facts at present before the Committee fails to adduce any evidence which establishes a real determinable and determined loss. The Committee is of the opinion that article 143 contemplates a determinable and determined loss, and it is evident. that such article prescribes a method for such determination in that portion thereof which reads in part:

1, 1913 maining.

* the difference between the cost or the fair market value as of March * (less any depreciation sustained) and its salvage value re

*

The taxpayer submits that:

The location of this ice lake is entirely worthless for any other purpose, and in fact the land we own is bounded by the high-water mark of the lake and our entire property there is covered by water.

The Committee, however, can not conceive that property so improved can as a matter of fact be worthless, that is to say, valueless. While the asset under consideration may be of no useful value in the conduct of the company's business in that the line of business for which it was constructed has been voluntarily abandoned, the Committée is of the opinion that there is a substantial salvage or cash value still existing in such asset.

In conclusion the Committee is of the opinion after consideration of the matter hereinbefore stated that the taxpayer has failed to establish a deductible loss such as is contemplated by article 143, Regulations 45; and therefore it is recommended in the appeal of the M Company that the action of the Unit in disallowing a deduction claimed in 1917 for a loss due to "loss of useful value" be sustained, and accordingly that the claim of the taxpayer be rejected.

SECTION 214(a) 4, 5, 6, ARTICLE 144: Shrinkage in securities and stocks.

14-21-1548 L. O. 1062

INCOME TAX-SECTION 12(a) SECOND, REVENUE ACT OF 1916.

The fact that a new corporation organized for the purpose of taking over a branch of the business of an existing corporation has the same stockholders as the existing corporation does not, in the absence of fraud, effect a merger of the two corporations nor so destroy their separate identities as to prevent the realization of gain or loss from the sale of stocks and bonds held by the existing corporation to the new corporation.

Law Opinion 1035, revised, overruled in part.

The question is again presented whether the M Company can be permitted a deduction for the year 1917 of a loss of 475 dollars on securities sold by it that year to the N Company.

Section 12(a) Second, of the Revenue Act of 1916, permits a corporation to deduct from gross income "All losses actually sustained and charged off within the year and not compensated by insurance or otherwise,

The M Company is a corporation engaged in a mercantile business. For many years prior to November, 1917, it also engaged quite extensively in the business of buying and selling and dealing in bonds, stocks, and other corporate securities, this branch of the business being an outgrowth of an established policy of carrying its capital reserves in part in readily marketable securities. Subsequent to the passage of the Revenue Act of 1917, upon advice of counsel that it could not include in its invested capital, as defined by that Act, the large amount invested by it in stocks of other corporations, in pursuance of a plan previously considered, the stockholders of the company organized a corporation known as the N Company to purchase the securities of the M Company and engage in the business of buying and selling securities. The N Company had an authorized capital stock of 12 dollars, all paid in in cash at the time of its organization. In November, 1917, the M Company transferred and delivered the securities then owned by it of an aggregate market value of 1289 dollars to the N Company at the market value plus accrued interest amounting to 7 dollars, the purchase price being paid 12a dollars in cash and the balance in collateral promissory notes se

cured by the pledge of the same securities. The cost of these securities to the M Company or their value on March 1, 1913, was 1764 dollars and the M Company in its return for the year 1917 claimed a deduction for a loss of 475x dollars.

This case has heretofore been before this office and in Law Opinion 1035, revised (C. B. 3, p. 160), it was held, upon the evidence then on file that this transaction was to be regarded as "a sham and a subterfuge to evade taxation" and the right to the deduction was denied. It is to be noted, however, that the Bureau has accepted the returns of the N Company in which its profits from sales of the securities taken over from the M Company were computed upon the basis of the price at which they were purchased and has computed its taxes upon that basis. Following this holding and in accordance with it, it was recommended by this office that the M Company be assessed the ad valorem penalty provided by section 3176, R. S., as amended by the Revenue Act of 1916 for willfully making a false and fraudulent return. Upon the basis of the statement made by the taxpayer's attorney at a hearing and the evidence contained in a brief filed on December 1, 1920, it is now proposed to revoke this recommendation upon the ground that the necessary basis for holding fraud in making the return is lacking. This conclusion necessarily involves an admission that the proceeding upon which the return was based was not "a sham and a subterfuge to evade taxation" and the question arises whether the fact of the identity at the time of the stockholders of the two corporations prevents the realization of a loss from the sale of stocks and securities by the M Company to the N Company.

The real question here involved is whether by reason of the identity of the stockholders the separate identities of the two corporations in question can, in the absence of fraud, be ignored and the stockholders regarded as dealing directly with themselves.

This question was directly decided in the case of Pittsburgh and Buffalo Company v. Duncan, 232 Fed. 584, 587, where it was held:

The mere fact that the stockholders in two corporations are the same, or that one corporation exercises a control over the other through ownership of its stock or through identity of its stockholders, does not make either the agent of the other, nor does it merge them into one, so as to make a contract of the one binding upon the other, where each corporation is separately organized under a distinct charter. (Italics ours.)

This holding is in accord with the general principle of the separate legal identity of a corporation and its stockholders which has been consistently recognized by the Federal courts. Peterson v. Chicago, Rock Island & Pacific Railway, 205 U. S. 364, 392. Conley v. Mathieson Alkali Works, 190 Ú. S. 406, 409. Pullman Car Company v. Missouri Pacific Co., 115 U. S. 587, 597.

It is also the position which was consistently taken by this Bureau prior to the Revenue Act of 1918 which provides for consolidated returns (section 240, Act February 24, 1919). Regulations 33, article 80: T. D. 2090: T. D. 2137; Regulations 33, revised, article 207. In article 207, Regulations 33, revised, construing the Revenue Act. of 1916 it was prescribed:

For the purpose of the tax and for the purpose of a return, every corporation is held to be and is a separate and distinct entity.

**

Unless this principle has been modified by the recent decisions of the Supreme Court in the cases of Southern Pacific Company v.

Lowe, 247 U. S. 330, and Gulf Oil Corporation v. Lewellyn, 248 U. S. 71, we are forced to the conclusion that the M Company and the N Company are to be considered, in spite of the identity of their stockholders, distinct corporations and that the transaction here considered, in the absence of fraud, was a sale giving rise to gain or loss.

The real basis of decision in the Southern Pacific case, supra, was (pp. 335, 336):

That the dividends in question were paid out of a surplus that accrued to the Central Pacific prior to January 1, 1913, is undisputed; and we deem it to be equally clear that this surplus accrued to the Southern Pacific Company prior to that date, in every substantial sense pertinent to the present inquiry, and hence underwent nothing more than a change of form when the dividends were declared. (Italics ours.)

The court further said (p. 337):

We base our conclusion in the present case upon the view that it was the purpose and intent of Congress, while taxing "the entire net income arising or accruing from all sources" during each year commencing with the first day of March, 1913, to refrain from taxing that which, in mere form only, bore the appearance of income accruing after that date, while in truth and in substance it accrued before: (Italics ours.)

*

*

The Court expressly recognized that the identity of a corporation is not merged in that of its stockholder when it said (p. 337):

While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control. And, besides, the funds represented by the dividends were in the actual possession and control of the Southern Pacific as well before as after the declaration of the dividends. The fact that the books were kept in accordance with the provisions of the lease, so that these funds appeared upon the accounts as an indebtedness of the lessee to the lessor, can not be controlling, in view of the practical identity between lessor and lessee;

and again (page 338):

The case turns upon its very peculiar facts, and is distinguishable from others in which the question of the identity of a controlling stockholder with his corporation has been raised. Pullman Car Co. v. Missouri Pacific Ry. Co. 115 U. S. 587, 596; Peterson v. Chicago, Rock Island & Pacific Ry. Co., 205 U. S. 364, 391.

So also in the Gulf Oil Case, supra, the basis of the decision was that (p. 72):

It is true that the petitioner and its subsidiaries were distinct beings in contemplation of law, but the facts that they were related as parts of one enterprise, all owned by the petitioner, that the debts were all enterprise debts due to members, and that the dividends represented earnings that had been made in former years and that practically had been converted into capital, unite to convince us that the transaction should be regarded as bookkeeping rather than as “dividends declared and paid in the ordinary course by a corporation." (Italics ours.)

And in the most recent case of Eisner v. Macomber, 252 U. S. 189, 213, 214, the court said:

We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right, in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form, we can not disregard the essential truth disclosed; ignore the substantial difference between corporation and stock. holder; treat the entire organization as unreal; look upon stockholders as partners, when they are not such; treat them as having in equity a right to a partition of the corporate assets, when they have none; and indulge the fiction that they have received and realized a share of the profits of the company which in