author: Graüpner

text:
    Appeals of BRANDEIS INVESTMENT CO. and J. L. BRANDEIS & SONS.
    Docket Nos. 1545 and 1546.
    Submitted December 1, 1925.
    Decided March 31, 1926.
    Two corporations held to be affiliated.

      Albert L. Hopkins, Esq., J. O. Halls, Esq., John M. Gilchrist, G, P. A., and Aloysius Oongdon, G. P. A., for the taxpayers.

      Percy 8. Orewe, Esq., for the Commissioner.
    Before Grattpner, Trammell, and Phillips.
    These appeals are from deficiencies in income and profits taxes in the respective amounts of $8,275.29 and $53,922.17 for the fiscal year ended January 31, 1920. The only issue involved is the right of the taxpayers to file consolidated returns. On stipulation between counsel, the two appeals were ordered consolidated for hearing and decision.
    FINDINGS OF FACT.
    1. Jonas L. Brandéis and his sons Arthur D. and Emil engaged as copartners in a merchandising business in Omaha, Nebr., about 1883. Later on, when another son, H. Hugo Brandéis, became of age, he was admitted to the firm. In 1901 the business was incorporated under the laws of Nebraska with the name of J. L. Brandéis & Sons. This corporation is one of the taxpayers and will hereinafter be referred to as the store company. The capital stock was $350,000, divided into 3,500 shares of a par value of $100 each. All of the stock was taken by the father and his three sons. Jonas L. Brandéis died January 23, 1903, leaving his shares of stock to the three sons, the respective holdings of whom then became as follows: Arthur D. Brandéis, 1,333½ shares; Emil Brandéis, 1,333½ shares; and H. Hugo Brandéis, 833½ shares. Emil Brandéis died April 15, 1912, leaving his shares to his brother Arthur D. for life, and then to go to Arthur’s son, J. L. Ervine Brandéis. H. Hugo Brandéis died July 21, 1912, leaving a life interest in his shares to his wife, Lyela, and the remainder to pass to his male heirs at her death. Shortly after the death of H. Hugo, Arthur D. Brandéis purchased the life interest of Lyela in the 833% shares. Lyela was alive during all of the fiscal year involved. Arthur D. Brandéis died June 10, 1916. His life estate in the 1,83314 shares received from his brother Emil then passed to his son, J. L. Ervine Brandéis. By his will Arthur D. Brandéis provided, among other things, an annuity of $6,000 to his sister, Sarah B. Cohn, to be paid to her during her life; an annuity of $50,000 to his wife, Zerlina Bran-déis, now Mrs. Joseph Helfman, for her life; an annuity of $25,000 to his daughter, Ruth B. Stern, for life; and an annuity of $25,000 to his daughter, Leola Brandéis, for life. Subject to these bequests, he devised and bequeathed his entire estate to J. L. Ervine Brandéis, George Brandéis and John L. Kennedy, as trustees, conditioned upon the transfer of all the trust property to J. L. Ervine Brandéis upon his reaching the age of 29 years. This trust had not expired during the taxable year involved.
    The trust thus controlled 2,166% shares of the 3,500 shares of the store company, and the annuities of Sarah B. Cohn, Lyela Brandéis, Ruth B. Stern, and Leola Brandéis became chiefly dependent upon the earnings of the store company.
    2. The taxpayer, Brandéis Investment Co., hereinafter called the investment company, was incorporated under the laws of Nebraska in 1917, with an authorized capital stock of $4,000,000; $2,000,000 common and $2,000,000 preferred, both of which classes of stock had voting rights. This company was organized for the purpose of taking over and consolidating into one ownership the business properties which were owned by the store company and various other corporations which had been organized by the Brandéis brothers. With the exception of the property occupied by the store company, the real estate and leaseholds consolidated into the ownership of the investment company had been acquired, improved, and rented with the definite purpose of the Brandéis father and sons to create a high-class business center that would improve the location of, and insure business for, the store, which had been established in a section of the city apart from the then retail shopping district. Among the enterprises developed for this purpose were subways under the streets adjacent to the main store building, a theatre, two moving-picture theatres, store and office buildings, and structures which would house and promote trade and direct custom to the store, which was a general department store with restaurant and amusement facilities. On the organization of the investment company, all of the properties were appraised and its preferred and common stock were issued to the holders of stock of like character in the predecessor corporations, share for share, and the store company received stock of both classes for its real property. The investment company became the owner of the real property of all the corporations and the holding company. The store company became its tenant, paying, during the taxable year in question, $275,000 for the main store building and some additional space, and paying no rent for other space used by it. This rental was arbitrarily fixed at this amount in order, to provide an amount only sufficient for the investment company to pay carrying charges, interest on its mortgage indebtedness, dividends on the preferred stock, and a low dividend on the common stock. The rent charged was considerably less than the fair rental values of the property occupied, because the shareholders in the two companies desired to see the large earnings come from the store company in order that the annuities under the trust might be met without impairing the efficiency of that company or affecting its credit. The store company was to be the money-making concern. While the investment company had other tenants, the store company was the principal one. The credit of the investment company was utilized to borrow money for purposes of the store as well as for itself.
    3. When the investment company was organized, the shares of preferred stock other than those issued to J. L. Ervine Brandéis and the trustees of the estate of Arthur D. Brandéis, the largest stockholder in both companies, and to the store .company, the largest stockholder in the investment company, were indorsed by J. L. Ervine Brandéis and the store company, with the following guaranty:
    Dividends on the Stock represented by this Certificate are cumulative and are hereby guaranteed at 6% per annum, payable January 1 and July 1. The undersigned reserves the right to purchase, and agrees to purchase, the Stock at par, on any dividend date, on demand, on or after July first, 19 — .
    The dates when the right to purchase became effective were varied in different certificates. The object of the guaranty was to keep the preferred stock under the control of the store company.
    4 The holders and holdings of stock in the two companies at the beginning and end of the taxable year involved in these appeals were as follows:

      February 1, 1919.

      January 81, 1920

    5. At the stockholders’ meeting of the investment company held on January 21,1919, the stock represented and voted was as follows: 902 shares preferred and 11,274½ shares common of the store company, by George H. Malchien, treasurer; 687 shares preferred and 4,804½ shares common of trustees of Arthur D. Brandéis estate, by John L. Kennedy, trustee; 1,078 shares preferred and 3,921½ shares common of J. L. Ervine Brandéis, by George H. Malchien, proxy; 1,000 shares preferred of George Brandéis, by Karl ]Si. Louis, proxy; 400 shares preferred of George H. Malchien, in person, and 1,110 shares preferred of Sarah B. Cohn, in person. The total shares represented and voted was 25,167.
    At the meeting on January 20, 1920, the stock was represented and voted as follows: 1,122 shares preferred and 11,274½ shares common of the store company, by Geoi’ge Brandéis, president; 887 shares preferred and 4,804½ shares of common of trustees of Arthur D. Brandéis estate, by George Brandéis and John L. Kennedy, trustees; 1,078 shares preferred and 3,921½ shares common of J. L. Ervine Brandéis, by George Brandéis, proxy; 1,000 shares preferred of George Brandéis, in person; 3,564 shares preferred of Lyela Brandéis Turner, by Howard H. Baldridge, proxy; 240 shares of Mrs. Joseph Helfman, 400 shares of Leola Brandéis, 20 shares of Louise Brandéis, 40 shares of Walter Cohn, 5 shares of Anna Bresman, 38 shares of Ben W. Edelman, 25 shares of Helen Gwin, 11 shares of N. Kenny, 70 shares of Emma Marcus, 50 shares of estate of S. Steinfeld, 100 shares of Carrie Seligman, 5 shares of Lottie Teweles, 5 shares of Clara Teweles, 5 shares of Carrie Teweles, and 5 shares of Rose Teweles, all preferred, by George Brandéis, proxy. The total number of shares represented and voted was 28,640.
    6. The directors elected by the store company in January, 1919, were George Brandéis, J. L. Ervine Brandéis, G. H. Malchien and John L. Kennedy. In January of 1920, Malchien was dropped because he had retired from the store and George Brandéis, J. L. Ervine Brandéis, and Kennedy were elected directors. For 1919, George Brandéis was elected president, J. L. Ervine Brandéis, vice president, and Malchien, secretary and treasurer. At the 1920 election the only change was the election of E. J. Malone to take the place of Malchien as secretary and treasurer.
    7. The directors elected by the investment company in January, 1919, were George Brandéis, J. L. Ervine Brandéis, John L. Kennedy, George H. Malchien, Sarah B. Cohn, and Lyela Brandéis Turner. The directors elected in January, 1920, were the same, except that Karl N. Louis was substituted for Malchien, who had withdrawn. The officers elected for both years were the same as those elected for the same years by the store company. Sarah B. Cohn and Lyela Brandéis Turner, though notified of directors’ meetings, never appeared at such meetings unless especially requested to do so for the purpose of making a quorum.

      8. The two taxpayers occupied the same offices in the building used by the store company. The salaries of the executive officers of both were paid by the store company, except that the president drew an annual salary of $100,000 from the store company and $4,000 from the investment company.
    9. John L. Kennedy, one of the trustees of the Arthur D. Brandéis estate and attorney for the taxpayers, made a practice of preparing the minutes for the stockholders’ and directors’ meetings of both companies prior to the times of such meetings. This was done after consultation with George Brandéis and, when present, J. L. Ervine Brandéis, as to the matters to be considered and acted upon at the meetings. These three, as officers, trustees, and. individuals, controlled all of the stock of the store company and approximately 80 per cent of the stock of the investment company, and, by reason of family relationships, dependency of some of the preferred stockholders in the investment company on the earnings of the store company for their annuities and the consent and proxies of the other stockholders, controlled substantially all of the remaining stock of the investment company. During the entire period of existence of the two companies, action upon every proposition submitted at the directors’ and stockholders’ meetings thereof had been unanimous.
    10. The management and direction of the two companies rested on George Brandéis, in whom all the stockholders placed complete confidence and in whom was placed the entire control of the business affairs of both. He came into the management of the store business under contract made between the store company and him during the life of Arthur D. Brandéis and had been continued in that capacity under contract and election as a result of his efficiency and the confidence which all of the stockholders reposed in him.
   OPINION.

Graüpner

: This appeal results from the refusal of the Commissioner. to affiliate two corporations, which have been developed as the result of family ambition and design to establish business preeminence and family prestige in a community, and which have been operated with remarkable consistency of purpose to accomplish those ends. The family solidarity, the mutual confidences reposed, the consistent cooperation throughout the years, and the concentration on accomplishment, as disclosed by the testimony, have produced a unity of purpose which has resulted in the two companies operating in common interest.

The investment company was organized to hold and operate the real property acquired for the purpose of developing a business district around and housing the merchandising concern. It has been the expressed intent of all of its stockholders that the store company should carry on the department store around which the family pride and ambition centered and on which all of the stockholders in the store company and the holders of over 86 per cent of the stock in the investment company depended for their incomes.

The entire circumstances disclosed by the record show that the realty company was the child of the store company, conceived for its purposes, developed for its convenience, and dominated by its necessities. While it is true that there are stockholders in the investment company who hold no stock in the store company, yet the store company and its closely knit stockholders own over 80 per cent of the stock in the investment company, and three other stockholders, who are dependent for their income on the earnings of the store company, own over 6 per cent. These three stockholders, by interest, confidence, action, proxies, and expressed wishes, have left the voting of their stock and the control of the investment company in the hands of the stockholders and officers of the store company. Lyela Brandéis Turner, who owned 3,564 shares of the preferred stock in the investment company, as evidenced by her requests and actions, placed entire confidence in George Brandéis and voted as a director, and had her stock in that company voted, in accordance with his suggestions. The record shows that during the years of existence of the two companies, there has never been a dissenting vote cast at the stockholders’ or directors’ meetings of either. It further shows that during the same period the officers of the store company have dictated the operations of the investment company and that none of the stockholders of the latter have ever protested this control.

Considering all of the circumstances disclosed in this appeal, we are of the opinion that the two companies were affiliated within the taxable year involved, and that they are entitled to file a consolidated return.

Order- of redetermmation will ~be entered on 15 days’ notice, wnder Rule 50.


source: Caselaw Access Project

author: Trammell:

license: Public Domain

text:
    Appeal of KIMBALL & SHERMAN CO.
    Docket No. 3997.
    Submitted December 7, 1925.
    Decided March 31, 1926.
    Deductions claimed by the taxpayer on account of salaries disallowed.

      David A. BucTcley and Percy E. Gleason, Esqs., for the taxpayer. George G. Witter, Esq., for the Commissioner.

      Before TRAmmell and Love.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1917 in the amount of $4,965.59. The return was made for the calendar year which included that part of the two fiscal periods referred to in the findings of fact which were in the calendar year 1917. The deficiency results from the disallowance by the Commissioner of certain deductions claimed by the taxpayer on account of salaries.
    FINDINGS OF FACT.
    The taxpayer is a Massachusetts corporation and successor to the Wentworth-Swett Co., with its principal office at Haverhill. The officers and directors of the corporation, during the taxable year 1917, were Boger Sherman, Jr., Everett M. Swett, Helen A. W. Sherman and Morris E. Swett.
    In September, 1918, Everett M. Swett sold his entire interest in the corporation to Joseph C. Kimball and severed his connection with it.
    In its income and profits-tax return for the calendar year 1917 the taxpayer deducted, as salaries to its officers, the proportionate part of the amounts claimed to have been accrued on account of salaries for the two fiscal periods which made up the calendar year. For the period July 11, 1916, to July 10, 1917, the taxpayer claimed to have incurred a liability for salary in the amount of $14,859.48, and claimed that the amount of $15,239.25 was properly accruable for the period July 11, 1917, to July 6, 1918. The amount of $14,-359.48, for the period July 11, 1916, to July 10, 1917, was never at any time authorized by the board of directors to be paid to its officers and was not entered on the books until June 30, 1919, after the taxpayer had employed accountants to prepare its return. ■ This was about nine months after Swett had left the company and his stock had been sold to another person. No liability for the salary for that period or for any accrued salary was considered in determining the book value of the stock when it was sold.
    No entry was made on the books of the taxpayer of the amount of $15,239.25, deducted as salary for the period July 11, 1917, to August 6, 1918, until June 30, 1919. Neither of the amounts above stated were paid nor was any entry made on the books with respect thereto, within the taxable year for which the taxpayer deducted them, and, as far as Swett is concerned, no part thereof was ever at any time paid.
    The taxpayer’s minute book shows the following resolution of the board of directors:

      Haverhill, Mass., June 28, 1918.

    Special Meeting of Directors:
    Upon motion duly made and seconded it was voted that the salary of the president, Roger Sherman, Jr., for the fiscal year ending July 1, 1918, be fixed at the sum of Twelve Thousand Five Hundred Dollars, and that the salary of the Treasurer, Everett M. Swett for the fiscal year ending July 1, 1918, he fixed at the sum of Twelve Thousand and Five Hundred Dollars, and that the difference between what each of said officers have heretofore drawn this year and the salaries above fixed be paid to them forthwith.
    Upon motion duly made and seconded it was voted to adjourn.
    Attest:
    Mobris E. Swett, Olería.

    To give effect to the resolution above set out, the following journal entry was made:
    June 30, 1919.
    Debits: profit and loss_e_$15,239.45
    Credits:
    Roger Sherman, Jr., note a/c_ $7,619.72
    E. M. Swett, note a/c_ 7, 619. 73
    To charge P. & L. for the period ended August 5, 1918, with the amounts of unpaid salaries for the period.
    The taxpayer’s books also contain the following entry:
    June 30, 1919.
    Debits: Profit and Loss Old Acct_$14, 843. 85
    Credits:
    Roger Sherman, Jr., note a/c_ $7,179. 74
    E. M. Swett, note a/c_ 7,179, 73
    W. M. Davis- 434. 38
    To charge profit and loss account of 1917 with balance of salaries due for past fiscal year’s services which were by error entered as a dividend.
    The following journal entry appears with respect to the Swett account:
    June 30, 1919.
    Debits — E. M. Swett, note a/c_$7,619. 73
    Credits — J. C. Kimball-Per_$7, 619. 73
    To close E. M. Swett’s note account into J. O. Kimball’s personal account.
    The increase in salary which was provided for in the above resolution was to be distributed on the books in the same proportion in which the two officers owned stock. The taxpayer in its original return reported no net income in 1917.
   OPINION.

Trammell:

It is essential for the taxpayer to show that the amount it seeks to deduct as salary was paid out or that a liability, was incurred therefor as compensation for services rendered. Proof on this point is wholly lacking, and we can not find as a fact that the amount sought to be deducted was for services in the absence of evidence as to what the services consisted of and other essential facts.

Even if the amount constituted compensation for services rendered, the evidence discloses no authorization of any kind within or after the taxable year for the payment of the amount of $14,359.48 for the fiscal period ending July 10, 1917. Ho record was made upon the hooks of the corporation until June 30, 1919, two years after the period for which it is claimed.

The taxpayer contends that the amount of $15,239.45 for the fiscal year ended August 6, 1918, was authorized at a meeting of the board .of directors held on June 28, 1918. In support of this contention the taxpayer introduced its minute book containing a resolution dated June 28, 1918, authorizing the payment of this salary. Ho book entries were made, however, with respect thereto until June 30, 1919.

E. M. Swett was one of the officers of the company in June, 1918, and is one of those who was to receive one-half of the salary in question. In September, 1918, he sold his entire interest in the corporation to Kimball and at that time had not received any portion of the above-mentioned salary, nor had any entry been made on the books with respect thereto. Ho consideration was given the resolution referred to in the findings of fact in determining the book value of Swett’s stock.

From all the evidence we are of the opinion that the taxpayer has not shown that the action of the Commissioner in disallowing the deduction was erroneous.

The deficiency for the calendar year 1917 is $1,965.59. Order of redetermination will 5e entered accordingly.


text:
    Appeal of MITCHELL ADVERTISING AGENCY, INC.
    Docket No. 560.
    Submitted December 15, 1925.
    Decided March 31, 1926.

      Arnold L. Guesmer, Esq., for the taxpayer.

      J. Arthur Adams, Esq., for the Commissioner.
    Before GkahpneR and Trammell.
    This is an appeal from the determination of a deficiency in income and profits taxes for 1918 and 1919, amounting to $1,554.82 and $3,529.95, respectively. The deficiency results from disallowance by the Commissioner of the taxpayer’s claim for classification as a personal service corporation.
   BINDINGS OB BAOT.

The taxpayer is a Minnesota corporation with its principal office in Minneapolis. In 1903, J. H. Mitchell, formerly employed by various concerns for the purpose of carrying on their advertising, engaged in the advertising agency business at St. Paul. In February, 1908, the taxpayer corporation was organized, and Mitchell turned over to it for stock his individual business and the property connected therewith, including about $3,000 in office furniture, accounts and other personal property, and good will, which he had built up in his business. At the time the taxpayer corporation was organized, others were taken in who took small amounts of stock, some of them paying therefor in cash and others in services. The attorney took stock for his fees for organizing the corporation. All of the stockholders, except those named below, had withdrawn from the corporation before 1918. When they left they took out what they had put in and surrendered their stock. In 1918 and 1919 the stockholders and their respective holdings were as follows:

The compensation paid officers and stockholders for services dur* ing 1918 and 1919, was as follows:

During 1918 the taxpayer paid to 21 employees, who were not stockholders, compensation in the amount of $14,353.17. During 1919 it had 41 employees, to whom salaries amounting to $25,239.32 were paid.

Thirty-five shares of preferred stock were assigned by Mitchell to Mary E. Skinner, wife of F. W. Skinner. One certificate for three additional shares was made out to Mary E. Skinner. F. W. Skinner made arrangements for the acquisition of the stock, retained the certificates in his possession, and in 1920 surrendered them and received new certificates for common stock in his own name. All of the corporation’s dealings were with Skinner and not with Mrs. Skinner. The understanding between Skinner and the corporation was that the preferred stock was to be issued temporarily and that later common stock was to be issued to him, which was done in 1920.

The taxpayer, during both years involved in this appeal, was engaged in the business of advertising, and in carrying on that business rendered service in giving advice as to advertising and sales policies; planning advertising and sales campaigns; selecting advertising media; preparing advertising copy and supplying the copy to the media and seeing that it was run correctly and properly the correct number of times; measuring the advertising and checking bills for space received from the advertising media; collecting from advertisers the amounts of the bills and remitting amounts due to the media; attending to and adjusting disputes, and giving information and keeping clients informed.

. Space was ordered for advertisers. Each order had to specify and did specify for what advertiser it was ordered. It could not be used by the taxpayer, nor could it be used by anyone else in the event it was not used according to contract, unless the publisher accepted another order for it.

The income of the taxpayer consisted of compensation paid, in part by the advertisers, in the form of special fees, but, in the main, by way of commissions allowed by publishers and others from whom space was taken, which commissions were computed at a certain rate, usually 15 per cent of the amount of the bill.

During the period involved, Mitchell, Sann, and Skinner were engaged in procuring clients and serving them along the lines above set out. More than 50 per cent of the volume of the business came from clients obtained by and who relied on Mitchell. Murdock wrote copy and was in immediate charge of the work of preparing copy. After copy had pas^gd Murdock, it also was passed upon by Mitchell, Sann, or Skinner, whichever of them happened to be in charge of the copy under consideration. Mitchell actively and extensively entered into the work of planning copy, making criticisms, corrections, and changes.

Kobert W. Foulke was employed by the taxpayer but did not work independently on his own responsibility. Mitchell actively partid-pated in Foulke’s solicitations. Foulke sought prospects whom he could contrive to have Mitchell meet. Richter was also employed by the taxpayer, tie was sent by Mitchell, in specific instances, to get for him information which he used in making recommendations to clients. Copy writers worked under the supervision of Murdock. They were furnished with requisitions showing what was necessary and did detail work in writing up advertisements. Their work was inspected by Mitchell, Sann, or Skinner, who made corrections and changes, if necessary. There was also an artist, who worked under the supervision of Mitchell, and a cashier and other clerks in the office.

The balance sheets submitted with the' taxpayer’s returns are as follows:

In. the fall of 1918 the taxpayer moved its office from St. Paul to Minneapolis and paid out a substantial sum of money in the building of walls and partitions in the new offices. The taxpayer secured loans as follows: $1,000 borrowed from the bank August 1, 1918, and repaid August 16, 1918; $1,500 borrowed from the bank August 30,1918, and repaid October 23,1918; $2,000 borrowed from the bank November 14, 1918, repaid, $1,000 May 7, 1919, and $1,000, July 25, 1919.

The taxpayer accepted short-time notes from 76 customers in payment for advertising space, amounting to $51,179.-61 for 1918, and accepted short-time notes from 72 customers amounting to $65,-169.06 for 1919, which were indorsed by the taxpayer and deposited by it. The amounts of bills paid by the taxpayer before collections had been made from customers were approximately 20 per cent of the total business during 1918 and 18 per cent of the total business during 1919.

Contracts with publishers were made in the name of the taxpayer, although every space order was given in behalf of a named advertiser in accordance with an agreement previously made by the taxpayer with such advertisers. The taxpayer rendered bills to its customers in its own name and received bills from publishers made out to it, and when it could not collect from customers the taxpayer sustained the loss. When customers were late or slow in paying, the taxpayer paid the bills to the publishers without waiting to collect the amount. The publisher looked to the taxpayer for payment of all advertising space, and no bills were rendered by the publisher to the advertiser.

Losses sustained by the taxpayer resulting from bad debts, and claimed on its returns, amounted to $6,069.52 for 1918 and $7,641.64 for 1919. The bad debts allowed by the Commissioner were $3,755.77 for 1918 and $6,833.41 for 1919.

The deficiencies for the years 1918 and 1919 are $1,554.81} and $3,589.95, respectively. Order of redetermination will 5e entered accordingly.


author: Thttssell:

text:
    Appeal of NORTHERN HOTEL CO.
    Docket No. 2768.
    Submitted July 10, 1925.
    Decided March 31, 1926.
    1. The March 1, 1913, value of taxpayer’s estate determined on the basis of capitalizing the difference between the rent reserved in the lease and the rent which a lessee making a like lease on March 1, 1913, would have been required to pay over a period of 76 years and a deduction for an aliquot part of such value allowed for each taxable period subsequent to January 1, 1918.
    2. Evidence presented in support of a claimed good will of a hotel bar examined and held to be inadequate to support a finding of any good will value.
    3. The deduction for exhaustion, wear and tear of taxpayer’s building, constructed on ground leased for a period of 99 years from completion of construction, for the period from May 1, 1892, to December 31, 1913, for each twelve-month period, held to be 1/97 of the construction cost.
    4. Obsolescence of this hotel building began when better hotels were built, and from that time to the date of expiration of the useful life of such building obsolescence should be included in the annual deductions under the provisions of the Revenue Act of 1918 and subsequent laws. The taxpayer and the Commissioner, having agreed that the useful life of the building will end in the year 1942, the unextinguished construction cost as of January 1, 1914, should be spread uniformly over the years between 1914 and 1942, inclusive.

      Edward Thompson, O. P. A., for the taxpayer.

      Briggs G. Simpich, Esg., for the Commissioner.

      Before James, Littleton, Smith, and TRUssell.
    This is an appeal from the determination of deficiencies in income and profits taxes for the period of four months from January 1, 1918, to April 30, 1918, in the amount of $1,344.15, and for the fiscal year beginning May 1, 1919, and ending April 30, 1920, in the amount of $4,791.42. The petition alleges specific errors as follows:
    1. The disallowance as a deduction from gross income of a proportionate part of the March 1, 1913, value of a leasehold acquired by the taxpayer in the year 1890 for the period of 99 years.
    2. The disallowance of a deduction from gross income of a claimed loss arising out of the destruction of the good will of the hotel bar as a result of prohibition legislation, 3/17 of such loss being claimed for the period ended April 30, 1918, and 14/17 of such loss being claimed for the period ended April 30, 1919.
    3. By computing depreciation on the building, power plant, and elevators, at a composite rate of 2 per cent per annum, instead of using the following rates:
    On building: 1/97 of original cost to cover ordinary wear and tear, plus 2 per cent for obsolescence beginning with 1918 when the Revenue Act permitted such a deduction.
    On power plant and elevators: 5 per cent per annum.
    4. Failure to credit against alleged deficiencies the amount of an overassessment for period ended April 30, 1919.
    The deficiency letter appealed from was dated and issued January 13, 1925, and in view of the Act approved March 3, 1925, amending section 281 of the Revenue Act of 1924, the Commissioner admitted that the taxpayer was entitled to have credited against deficiencies asserted the overassessment for the year 1919.
    FINDINGS OF FACT.
    The taxpayer is an Illinois corporation, with its principal office in the City of Chicago. It has since May 1,1890, owned and operated the Great Northern Hotel, located on the northeast corner of Jackson Boulevard and Dearborn Street, in what is known as the Loop district of Chicago. On May 1, 1890, it acquired a 99-year lease of land having a frontage on Jackson Boulevard of 100 feet, a depth of 165 feet, and a frontage on Quincy Street of 100 feet, the area of which is 16,500 square feet, and it pays therefor an annual rental of $50,000 plus taxes through the whole term of the lease. Upon the land so acquired, and during the years 1890 to 1892, inclusive, the taxpayer constructed a 14-story hotel building then and now known as the Great Northern Hotel. This building was of so-called steel construction and was built according to the best methods of hotel building construction then known. To May 1, 1892, the construction cost was $1,118,612.29. Since 1900 additions to the building have been made costing, during the several fiscal years ending April 30, as follows:
    1901_$60, 684. 56 1912_$25,243. 38
    1902_ 21,261. 87 1913_ 30, 909.87
    1903_ 35,991.07 1914_ 28,133.68
    1904_ 15,824.25 1915_ 18,359.25
    1905_ 4,557.30 1916_ 3,164.25
    1906_ 18,285. 61 1916_ 3,201. 49
    1907_ 17,122.92 1917_  7, 751.92
    1908_ 18,910.25 1918_ 1, 637.43
    1909_ 21, 563. 83 1919_  3, 827.52
    1910_ 68, 673.57 1920_  3, 827. 52
    1911_ 24, 086. 00
    Since 1900 expenditures for construction and replacement of power plant and elevators have been made during several fiscal periods ending April 30 of each year as follows:
    1903_$16, 506. 00 1908_ $607. 90
    1904_ 4, 600. 00 1906_ 174,457.14* 1915_ 1,589.93 1920_ 35,400. 00
    1907_ 8, 532.36
    The elevators installed in 1903, at a cost of $16,506, were discarded in 1920.
    During the years from 1893 until June 30, 1919, at which latter date war-time prohibition legislation made it unlawful, the taxpayer conducted, within the hotel building, the Great Northern Hotel bar, where intoxicating and other beverages were sold, and the conduct of this bar contributed to a considerable degree to the profits derived from the operation of the hotel.
    In his adjustment of net income for the taxable periods here under consideration the Commissioner allowed deductions from gross income, on account of exhaustion, wear and tear, a uniform rate of 2 per cent upon all the building, power plant, and elevator construction.
    In a letter dated December 15, 1923, the Commissioner advised the taxpayer that he had found for the fiscal year beginning May 1, 1918, and ending April 30, 1919, an overassessment of income and profits taxes in the amount of $691.06.
    On March 1, 1913, the above-mentioned lease still had a remaining life of 76 years and 2 months, and the then fair market value of said leasehold was $400,000.

       Eight months ending Dec. 31.

       Calendar year.

       Four months ending Apr. 30.

       Twelve months ending Apr. 30.

   OPINION.

Thttssell:

(1) The record of this appeal contains the testimony of three men who qualified, by reason of their long experience in the real estate business in Chicago and their dealings in and negotiations of sales and leases of properties in the Loop district, to give expert-opinion evidence as to property values, both with regard to the taxpayer’s property and other properties in that vicinity. They testified that they were acquainted with the taxpayer’s property, not only in the year 1913, but for years both prior to and since that date. They compared the taxpayer’s property values in connection with other property values as disclosed by the record of known transactions in the same business district during and prior to the year 1913. They met together and discussed such values. They had before them the records of seven other leasing transactions in the near neighborhood where long leases had been made, either during or prior to the year 1913, at square-foot values ranging from $82.47 per square foot for a small inside tract leased in the year 1909 to a valuation of $190 a square foot for a corner tract leased in the year 1913. Between these minimum and maximum figures were other transactions at valuations of $165 per square foot and $171.88 per square foot. On State Street, near taxpayer’s property, they considered two transactions, one at $211.60 per square foot and another at $234 per square foot. They also took into consideration rental values and earnings of properties similarly situated and improved, and, as a result of their investigations, inquiries, and conversations, they united in testifying that on March 1,1913, the land embraced in the taxpayer’s lease had a value of $125 per square foot, and that, in their opinion, the taxpayer’s lease on that date had a fair value of $812,500. Thpy also testified that both at the time of the making of the taxpayer’s lease on May 1,1890, and on March 1,1913, it was the established practice of those persons owning and dealing in lands in the Loop district of Chicago to enter into and make long-term leases of such properties on a basis of a rental return of 4 per cent upon the true value of the land to be leased.

The capitalization of the rent reserved in the taxpayer’s lease of $50,000 per year at 4 per cent indicates a land value in 1890 of $1,250,000. The valuation of $125 per square foot on March 1, 1913, indicates a total value of $2,062,500. The difference between these figures is $812,500. Whether this is the method which the witnesses used in arriving at the lease valuation of $812,500 is not disclosed by the record.

The value of a lessee’s interest in property at any given period must be the amount which a purchaser, having the choice of acquiring the lessee’s interest or entering into negotiations for acquiring a lease of some other comparable property, would be willing to pay, in order tó acquire the lessee’s interest. It appears from the testimony that, if this particular tract of land had been in the market for the purposes of a long-term lease on March 1, 1913, at the then prevailing money values of 4 per cent, a prospective lessee would have been required to pay an annual rental equivalent to 4 per cent on $2,062,500, or $82,500 per year, which, for 76 years, would amount to $6,270,000. In the same 76 years this taxpayer must pay an annual rental of $50,000 per year, or a total of $3,800,000. The difference between these figures is $2,470,000 of total rents, which a lessee making a lease on March 1, 1913, would have had to pay in excess of the total amount to be paid under the taxpayer’s lease. We are of the opinion that, under the facts and circumstances existing in the case of this taxpayer, these figures constitute a fair basis upon which may be computed the March 1, 1913, value of the taxpayer’s equity in the property held by it. The difference between the payments of rent under the taxpayer’s lease and under a lease which might have been made on March 1, 1913, -is $32,500 per year for a period of 76 years, at the end of which time the capital value of the lease will be exhausted.

With these facts before us, we are of the opinion that the record of this appeal may be taken to establish, and we have therefore found, that the taxpayer’s equity in the property held under a lease had on March 1, 1913, a fair market value of $400,000; and that, in accordance with the decisions of the Board in the Appeals of Hotel de France Co., 1 B. T. A. 28; and Grosvenor Atterbury, 1 B. T. A. 169; and in Henrici Co. v. Reinecke, 3 Fed. (2d) 34, this taxpayer is entitled, under the Revenue Act of 1918 and in subsequent years here involved, to a deduction from gross income on account of the exhaustion of its lease equity in the amount of 1/76 of $400,000 per year.

(2) We have no hesitation in accepting the proposition that the operation of the hotel bar contributed materially to the profits of the taxpayer during the years prior to June 30, 1919. It appears, however, that no separate accounts had been kept respecting the operation of the bar, as distinct from the operation of the hotel. The testimony produced for the record of this appeal was given by an accountant who had undertaken to pick out from the general hotel books of account items appearing to have relation particularly to the operation of the bar. And while it may be that his work in this regard was done as carefully and completely as possible after a lapse of several years, it has not seemed proper for the Board to adopt his conclusions and computations as findings of fact.

It seems probable, also, that the good will of the hotel, its advertising, and its general reputation among the traveling public may have contributed as much, if not more, toward the profitableness of the bar as the operation and good will of the bar contributed to the income and profits of the hotel business as a whole. The record further shows that when the sale of intoxicating beverages ceased the same space in the hotel building was continued to be used for lunchroom purposes, thus making the loss of the privilege of selling intoxicating beverages impossible of definite proof. In respect of this case, we are of the opinion that the good will value, if any existed, is of such an uncertain and elusive character as to make the computation of such value practically impossible where the liquor business was conducted in conjunction with other business, the conduct of which was not interfered with by prohibition legislation. The Board is therefore of the opinion that, so far as disclosed by the record of this appeal, the Commissioner did not commit any error in disallowing a deduction from gross income arising from the alleged enforced discontinuance of the sale of intoxicating beverages.

(3) The Kevenue Act of 1918 provides in section 234 (a) (7) as follows:

A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

Accepting the testimony contained in the record of this appeal to the effect that the Great Northern Hotel building was of the well-known steel-frame construction, built in accordance with the best architectural methods known in the years 1890 and 1891, deductions for exhaustion, wear and tear, and obsolescence, under the provisions of this Act, should be such a reasonable amount as the experience of business men, architects, and building engineers can estimate in advance as covering the probable average of deductions from the causes named in the statute.

We believe that it may be assumed that a fair and conservative estimate of exhaustion, wear and tear caused by weather, time, and actual use may not exceed approximately 1 per cent of the construction cost. This building, however, was erected upon leased ground, and the owner’s rights under the lease had only 97 years to run after the completion of the building. We are therefore of the opinion that the deduction from gross income growing out of wear and tear and use of this building should be first computed upon the basis of 1/97 of its cost for each annual accounting period, and that, for the period of the life of this building from 1892 to the close of the year 1913, this deduction should be the amount of 1/97 of the cost of original construction plus a similar proportion of additions and improvements from the date the same were made to the end of the life of the lease.

We believe further that the obsolescence of a hotel building frequently begins at a time when better hotels are built and offered for the accommodation for the same traveling public. The record shows' that during the years 1910 to 1914 four newer, better, and more modern hotels were constructed and put into operation in the business district of Chicago, thereby becoming competitors of the older hotels, which fell into a second rank in the hotel business. This drop into a rear rank in the hotel business is the kind of reduction in value caused by factors which can not be controlled or retarded.

The purpose of the deduction for losses arising from wear and tear and obsolescence is to provide free of tax a fund out of earnings and profits, the annual additions to which will at the end of the estimated period of the useful life of a property equal the cost or the March 1, 1913, value of such property. Appeal of Grosvenor Alterbury, 1 B. T. A. 169.

The life of the building here under consideration began on May 1, 1892. .Both the Commissioner and the taxpayer have agreed that its useful life should be considered as limited by a period of 50 years from its inception, and thus ending in 1942. The Commissioner has proposed to provide the replacement fund contemplated by the statute by allowing a uniform rate of deduction for exhaustion, wear and tear of 2 per cent over the 50-year period from 1892 to 1942. The taxpayer, agreeing that 1942 will mark the limit of the useful life of its building, contends, however, that its deductions for exhaustion, wear and tear, due to the usual causes, such as action of the weather, time, and actual use, should prior to the year 1914 be computed on the basis of 1/97 of the building construction cost, while during the period from 1914 to 1942, inclusive, the deduction should be increased by an allowance for obsolescence as provided for by the Revenue Act of 1918.

During the years when this hotel building stood in the front rank of the first-class hotels of its city, there was nothing affecting its useful life other than the action of such causes as the weather, time, and actual use. When, on the other hand, it ceased to be one of the first-class hotels of its city, its economically useful life was shortened. In view of the fact that the Commissioner and the taxpayer are agreed as to the final limit of its useful life, we are of the opinion that the proper allocation of the deductions for exhaustion, wear and tear, and obsolescence should be determined and allowed as follows:

(1) For the period from May 1, 1892, to December 31, 1913, afe the rate of 1/97 of the construction cost per annual period of 12 months.

(2) That the remaining unextinguished cost on January 1, 1914, should be prorated over the number of twelve-month periods between that date and May 1, 1942; thus accounting for not only the gradual wearing out and decay of the building, but also its deterioration in value due to that form of obsolescence caused by conditions over which the taxpayer can have no control.

The record in this appeal shows capital expenditures for power plant and elevators only during the period of 1900 to 1920, inclusive, and that the elevators which were installed in the year 1903 were discarded and replaced in the year 1920. We are of the opinion that the capital cost of power plant and elevators may be fairly considered as having a life not in excess of 20 years, and that the deduction for exhaustion, wear and tear of such properties may be properly taken at the uniform fate of 5 per cent for each annual period of 12 months.

Order of redetermination will be entered on 16 days' notice, under Rule 50.


author: Sternhagen:

text:
    Appeal of JOHN HOOD & CO., INC.
    Docket No. 6496.
    Submitted March 3, 1926.
    Decided March 31, 1926.
    The profits tax of foreign corporations should be computed under the provisions of section 328 of the Revenue Act of 1918.

      E. St. Glair Thompson, Esq., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before SteRNpiagen and Lansdon.
    The Commissioner, in accordance with section 328 of the Revenue Act of 1918, determined a deficiency in income and profits taxes of $3,979.48 for the year 1919. Petitioner claims computation under section 301.
    FINDINGS OF FACT.
    The petitioner was in 1919 a corporation, created and organized in 1912 under the laws of Ireland.
   OPINION.

Sternhagen:

Section 327 of the Revenue Act of 1918 provides “ that in the following cases the tax shall be determined as provided in section 328: * * * (b) in the case of a foreign corporation.” Section 1 provides, “ that when used in this Act * * * the term foreign ’ when applied to a corporation or partnership means created or organized outside the United States.”

Clearly this is a foreign corporation within the statutory definition. The facts relied upon by the petitioner that all its business is done in this country and that it has complied with the laws of New York to do business in that State, are matters which can not serve to take the case out of the clear language of the statute. Appeal of Frederick Warne & Co., Ltd., 1 B. T. A. 1097; Appeal of Josiah Wedgwood & Sons., Ltd., 3 B. T. A. 355.

The defioienoy is $3,979.^8. Order will he entered accordingly.


text:
    Appeal of MARIE M. LINS.
    Docket No. 2700.
    Submitted January 26, 1926.
    Decided March 31, 1926.

      T. E. Lyons, Esq., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before Sterniiagen, Lansdon, and Artjndell.
    This appeal is from the determination of a deficiency in income tax for the year 1918 in the amount of $470.60.
   FINDINGS OF FACT.

On the basis of the original return filed by the petitioner for the taxable year, the Commissioner determined,- assessed, and collected tax in the amount of $603.89. Of this amount $518.76 was refunded on February 23, 1923. Subsequently, the case was reopened, and the Commissioner then determined that the true tax liability for the year in question was $555.73, and that the refund had been made in error. On such redetermination the taxpayer was indebted to the Treasury in the amount of the true tax liability, plus the refund, minus the $603.89 paid when the return was filed, or $470.60.

On October 14, 1925, the parties stipulated that the true tax liability for the year 1918 was $555.73, and that the only remaining issue was whether the taxpayer had received a refund payment on account of the tax paid for such year in the amount of $518.76. On February 23, 1923, a disbursing clerk of the Bureau of Internal Revenue issued check No. 217063, payable to the order of the taxpayer, in the amount of $518.76. Subsequently such check, indorsed with her name, was deposited in the Areola State Bank of Areola, Ill., and collected by that bank through the Continental and Commercial National Bank and the Federal Reserve Bank of Chicago.

The deficiency is $J¡>70.60. Order will he entered accordingly.


author: Trttssell

text:
    Appeal of ATLANTIC IMPORTING CO. and SHEVERS ICE CREAM CO.
    Docket No. 3674.
    Submitted October 21, 1925.
    Decided March 31, 1926.
    1. Where a considerable portion of the capital stock of the corporation was issued in exchange for the common stock of another corporation, the value of which at .the time of exchange is not shown, and where a large portion of the preferred stock of an affiliated corporation was issued in exchange for book accounts, the amount of which is not proven, together with a cancellation of contracts having no proven value, the Commissioner properly found that he was unable to determine the invested capital of the consolidated group.
    2. The fact that the Commissioner’s adjustment of excess-profits taxes under the provisions of section 328 of the Revenue Act of 1918 did not produce any large measure of relief, is not to be taken as evidence that the Commissioner used improper comparatives, but, on the other hand, as showing that the taxpayer’s competitors in the same or similar lines of business were producing gains and profits and were subject to excess-profits taxes in amounts comparable to the apparent liability of the complaining taxpayer.

      Alex M. Hamburg, Esq., for the taxpayers.

      P. S. Orewe, Esq., for the Commissioner.
    Before Littleton, Smith, and TRUssell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the year 1919 in the amount of $6,331.97. The taxpayers allege that the Commissioner erred (1) in computing the normal tax of the two corporations at the rate of 12 per cent instead of 10 per cent; (2) in holding that they were affiliated during the year 1919; (3) that he improperly disallowed as deductions from gross income losses sustained on the sale of capital assets, and in holding that such sales were intercompany transactions; (4) and that, in computing the taxpayers’ excess-profits taxes under section 328 of the Revenue Act of 1918, he used improper comparatives, thereby failing to give the taxpayers the relief to which they are entitled. The taxpayers also allege that if the two corporations were affiliated during the year 1919 the Commissioner erred (5) in eliminating from the consolidated invested capital certain amounts on account of intangibles paid in for stock, and in making adjustments in invested capital for that year on account of income and profits taxes due or paid for prior years.
    FINDINGS OF FACT.
    The Atlantic Importing Co. is a corporation organized under the laws of the State of New Jersey in the year 1909. Its principal office is at 617-619 Eleventh Avenue, New York City, and it is, and was during the year 1919, engaged in manufacturing and selling vanilla and other extracts.
    The Shevers Ice Cream Co. is a corporation organized under the laws of the State of New York, with its principal office at 617-619 Eleventh Avenue, New York City, and it is, and has been since its organization, engaged in manufacturing and selling ice cream. The original authorized capital of the corporation was $15,000 of common stock, divided into shares of the par value of $100 each. Of the authorized capital stock, 65 shares were issued for cash at par to the Howell-Shevers Ice Cream Co., and 15 shares for cash at par to the Atlantic Importing Co. The remainder of the original authorized capital stock was not issued until the year 1914.
    In the year 1914 the capital of the Shevers Ice Cream Co. was increased to $100,000, consisting of $50,000 common stock and $50,000 preferred stock, divided into shares of the par value of $100 each. The' common stock was issued to the Howell-Shevers Co. and the Atlantic Importing Co. pursuant to a resolution adopted by the board of directors of the Shevers Ice Cream Co. on September 10, 1914, the pertinent part of which is as follows:
    Whereas this corporation was organized, promoted and developed into a going concern and placed on a firm and profitable basis by the capital supplied by the Atlantic Importing Company and Howell-Shevers Company and the said corporations since the organization of this company and until the present date, have supplied the bulk of the labor and office organization necessary to carry on its business and permitted its officers to manage and direct the affairs of this corporation without making any charge therefor which work, labor, and services so rendered by the said corporations have been of inestimable value and assistance to this company and necessary to a businesslike and profitable conduct of its business; and
    Whereas, the company desires to increase its capital stock to $100,000, consisting of $50,000 preferred and $50,000 common, granting to said preferred stock certain rights and privileges as against the common stock now held by the said aforesaid corporations to which increase it is necessary to have the consents of the said corporations; and
    Whereas, in consideration of the consents of the said corporations allowing said increase as stockholders of this company and granting and allowing to the preferred stock to be issued certain rights and privileges as against the stock now held by said companies, and in consideration of the labor already furnished and supplied to this company by said corporations; it is

      Resolved, that this company issue to the said corporations or their respective nominees, in consideration of the foregoing the said $50,000 of common stock when issued as follows:
    To the Atlantic Importing Company-$9,400
    To the Howell-Shevers Company- 40,600
    which issue includes the present holdings of said corporations in this company which is also the entire capital stock issued and outstanding; * * *.
    Under this arrangement the Howell-Shevers Co. received additional common stock of the Shevers Ice Cream Co. of the par value of $34,100, and the Atlantic Importing Co. received additional common stock of the par valne of $1,900.
    Preferred stock of the Shevers Ice Cream Co. of the par value of $25,000 was issued to Frederick Fauerbach and Arthur M. Rein, pursuant to a resolution of the board of directors adopted June 1, 1916, the material part of which is as follows:
    The President announced that Messrs. Frederick Fauerbach and Arthur M. Rein, with whom the company is under contract dated October 26th, 1914, for personal services, have offered in consideration of the issue to them forthwith of 250 shares of the preferred stock of the company, 150 shares thereof to Mr. Fauerbach and 100 shares thereof to Mr. Rein, to surrender and cancel said contract and release the company from further obligation thereunder, and to pay to the company the sum of $2,500 in addition to all sums by them earned under said contract now standing to their credit upon the books of the company, $1,500 of which further sum is to be paid by Mr. Fauerbach and $1,000 by Mr. Rein, and the matter being discussed and due deliberation had thereon upon motion duly made and seconded, and by the affirmative vote of all present, the following preambles and resolutions were unanimously adopted:
    Whereas, Frederick Fauerbach and Arthur M. Rein have offered, in consideration of the issue to them forthwith of 250 shares of the preferred stock of the company, 150 shares thereof to Mr. Fauerbach and 100 shares thereof to Mr. Rein, to surrender and cancel their contract with this company, dated October 26th, 1914, and release the company from further obligation thereunder, and to pay to the company the sum of $2,500 in addition to all sums by them earned under said contract now standing to their credit upon the books of the company, $1,500 to be paid by Mr. Fauerbach and $1,000 by Mr. Rein; and
    Whereas, it appears to the Board that such surrender and cancellation of the said contract between the company and Frederick Fauerbach and Arthur M. Rein, dated October 26th, 1914, and the payment of the said sum of $2,500 to the company, as aforesaid, by said Fauerbach and Rein, in addition to all sums by them earned under said contract now standing to their credit upon the books of the company, will be to the best interests of the company, and that the same is of the fair and reasonable value of the Twenty Five Thousand ($25,000) Dollars, be it

      Resolved, that this company accept the offer of Frederick Fauerbach .and Arthur M. Rein to surrender and cancel their contract with the company, dated October 26th, 1914, upon the payment of $2,500 jointly by the said Fauer-baeh and Rein, in addition to all sums by them earned under said contract, now standing to their credit upon the books of the company; * * *.
    The record fails to show what amounts were standing to the credit of Fauerbach and Rein on the books of the Shevers Ice Cream Co.
    Of the remainder of the preferred stock of the Shevers Ice Cream Co., shares of the par value of $24,500 were subsequently issued to the Atlantic Importing Co. for cash at par, and shares of the par value of $500 were issued to another outside party, but the record fails to show the consideration paid therefor.

      In the year 1916 the Howell-Shevers Co. decided to dissolve, and it entered into an arrangement with the Atlantic Importing Co. pursuant to which the $40,600 of common stock of the Shevers Ice Cream Co. held by the Howell-Shevers Co. was transferred to the Atlantic Importing Co., and in exchange therefor the Atlantic Importing Co. issued to the Howell-Shevers Co. shares of its, the Atlantic Importing Co.’s, stock of the par value of $40,600. As a result of this transaction, the Atlantic Importing Co. became the owner of all of the common stock of the Shevers Ice Cream Co. of the par value of $50,000, and of $24,500 of the preferred stock of the company of a total authorized issue of $50,000. The total outstanding capital stock of the Atlantic Importing Co. at the close of this transaction was $110,800.
    During the entire year 1919, the total outstanding capital stock of the Shevers Ice Cream Co. was $50,000 common stock and $50,000 preferred stock, and during that period the Atlantic Importing Co. owned and held all of the common stock and $24,500 of the preferred stock. The preferred stock had no voting rights.
    The Atlantic Importing Co. and the Shevers Ice Cream Co. filed separate income and profits-tax returns for the year 1919. The Commissioner determined that the two corporations were affiliated during that year and that their tax liability should be computed upon the basis of a consolidation of their incomes and invested capital. In adjusting invested capital he eliminated therefrom the amount of $74,500, representing the par value of the capital stock of the Shevers Ice Cream Co., owned by the Atlantic Importing Co., and also eliminated the amount of $43,200, as representing stock issued in 1916 to the Howell-Shevers Co. and Fauerbach and Hein, for intangibles developed by the company since its organization, and for cancellation of contracts for which no value was shown. He also made certain adjustments in invested capital for the year 1919 on account of Federal taxes due or paid for prior years.
    The Commissioner, upon application of the taxpayers, computed their profits taxes under section 328 of the Revenue Act of 1918.
    The Commissioner computed the taxpayers’ income tax for the year 1919 at the rate of 12 per cent, instead of at the rate of 10 per cent, as provided by section 230 (a) (2) of the Revenue Act of 1918.
    Upon the basis of the adjustments and computations set forth above, the Commissioner determined that for the year 1919 there is, as to the Atlantic Importing Co., an overassessment of tax in the amount of $225.56, and as to the Shevers Ice Cream Co., a deficiency in tax in the amount of $6,557.53, making a net deficiency of $6,331.97.
   OPINION.

Trttssell

: The taxpayers’ petition sets forth five specific allegations of error, recited serially in the introductory statement herein. Error number one has been conceded by the Commissioner, and in the final adjustment of deficiencies a corporate tax rate of 10 per cent should be applied. Respecting assignment of error number three, the taxpayers produced no evidence in support of their allegations, and it is, therefore, our opinion that the net consolidated taxable income of taxpayers for the year 1919 is $77,642.44, as determined by the Commissioner. There is thus left for our consideration the following issues: Whether the two appealing taxpayers were, during the year 1919, affiliated corporations and subject to having their liability to income and excess-profits taxes computed upon the basis o'f a consolidated return; whether the Commissioner’s computation of the consolidated invested capital was erroneous; and whether the Commissioner’s adjustment of excess-profits-tax liability under section 328 accorded to the appealing taxpayers the statutory measure of relief intended to be granted by said section.

During the year 1919 the Atlantic Importing Co., hereinafter called the Atlantic Co., was the owner of all of the common stock of the Shevers Ice Cream Co., hereinafter called the Shevers Co., and the Atlantic Co. also owned $24,500 par of the preferred stock of the Shevers Co. The preferred stock possessed no voting rights and its owners were entitled to no share in the management of its business.

In the Appeal of Canyon Lumber Co., 1 B. T. A. 473, the Board held that the statutory control meant the control of voting rights, all of which in the instant case were vested in the common stock and all owned by the Atlantic Co. In the Appeal of Schloss Brothers Co., 1 B. T. A. 581, the Board held that, when the ownership and control of substantially all of the common voting stock of two corporations is held by the same interests, the law required that such corporations have their income and excess-profits taxes computed on the basis of consolidated returns. We are therefore of the opinion that during the year 1919 the Atlantic Co. and the Shevers Co. were affiliated corporations, and that the Commissioner’s action in computing income and excess-profits taxes on the basis of a consolidated return must be approved.

In the reconstruction of the capital account of the Shevers Co., which took place during the years 1914 to 1916, inclusive, $25,000 par value of preferred stock was issued to two persons who are said to have had a contract with the company for selling its products and credit balances on the books of the company. Upon receiving the stock these accounts were balanced, the selling contract was canceled, and they paid to the company the sum of $2,500. The record is silent as to the amount of the credit balances, as well as to the value of the selling contract. It thus appears that of the $25,000' of preferred stock so issued $22,500 in amount was issued without any known or proven consideration.

At or about the same time, $34,100 par value of common stock was issued to the Howell-Shevers Co., apparently without the issuing company receiving any consideration whatever. This block of common stock was later acquired by the Atlantic Co. in exchange for its stock at par. But the record does not show whether, at the time the Atlantic Co. acquired this stock, it had a value equal to par, or any value whatever. And, if we may accept the balance sheets of the Shevers Co., as attached to its income-tax returns, it is the sum of these two items which the company set up in its •accounts as deferred charges.

We are therefore of the opinion that the Commissioner properly found that he was unable to determine the true invested capital of the two taxpayers, and that he was, therefore, required to determine the excess-profits tax as provided in section 328 of the Revenue Act of 1918.

Order of redetermination will he entered on 15 days’ notice, under Rule 50.

James took no part in the consideration or determination of this appeal.


author: Trussell

text:
    Appeal of UNIOLA REAL ESTATE CO.
    Docket No. 3457.
    Submitted December 28, 1925.
    Decided March 31, 1926.
    A reasonable deduction of the compensation of the taxpayer's president for the year 1921, held, upon the record of this appeal, to be the amount of $12,000.

      Franklin G. Parks, Esq., for the taxpayer.

      George G. Witter, Esq., for the Commissioner.
    Before Smith, Littleton, and Teussell.
    This is an appeal from the determination of a deficiency for the year 1921 in the sum of $9,734.57. The deficiency arose from the refusal of the Commissioner to allow the taxpayer to deduct as expenses additional compensation to its president in the sum of $21,-817.30, claimed for commissions on the purchase and sale of real estate and collection of rentals.

      FINDINGS OF FACT.
    1. The taxpayer is a Louisiana corporation with its principal place of business at New Orleans. It was engaged in the business of buying and selling real estate and collecting rents from its properties. The outstanding capital stock consisted of 500 shares, of which 374 shares were owned by E. Perrin, Sr., as president. The remainder of the stock was owned by members of the Perrin family.
    2. For 1921 the taxpayer claimed deductions for compensation to the said E. Perrin, Sr., as follows:
    Salary-$6,000.00
    5 per cent on rents collected_ 3, 269. 30
    3 per cent on purchase and sale of property_ 18, 568.00
    Total_27, 817. 30
    The Commissioner allowed the $6,000 as salary, but refused to allow the balance of $21,817.30.
    3.The circumstances surrounding additional compensation so claimed were as follows:
    On or about April 5, 1921, the board of directors of the taxpayer passed the following resolution:

      Be it resolved, that,in view of the great increase in the business of this corporation and the prosperous condition of the corporation that the President, Emilien Perrin, be voted a salary of Six Thousand ($6,000.00) dollars per annum for the active management of this corporation in addition to a salary equal to 3% on the purchase or sales of real estate and 5% on rent collections.
    The said E. Perrin, Sr., was also a licensed real-estate broker and engaged in the buying and selling of real estate for clients. He also conducted three other corporations. No entries were put upon the books putting into effect the above resolution until the closing entries of the taxable year, at which time taxpayer entered in its journal the following entries:
    Expense to Emilien Perrin_,_101 $3, 259. 30
    For 5% bonus additional salary on total amount of all rents collected and accrued during the year of 1921 as per resolution dated April 5th, 1921_ 33 3, 259. 30
    Expense to Emilien Perrin_ 101 18, 558. 00
    For bonus additional salary equal to 3% on amounts of purchases and sales of various properties listed below as per resolution of April 5th, 1921:
    #811 Iberville Street- 18, 000.00
    Waveland property_ 3, 800. 00
    #539 Bienville Street_ 13, 000. 00
    #901-9 Poydras Street-1- [96, 000. 00] purchase.
    #901-9 Poydras Street- [106, 500. 00] sale.
    #901-9 Poydras Street- [103, 000. 00] repurchase.
    #229 Dryades- 7,000.00
    #1324-32 Gravier Street_ 10,000. 00
    Broad Street bldg, site_ 3,175.09

      #918-20 St. Louis Street_^_¿$22, 500.00]
    #1320 St. Andrew Street_[20, 000.00 purchase.]
    #1320 St. Andrew Street_[15, 000. 00 sale.]
    #745 Baronne Street
    #745 Baronne Street
    #801 Baronne Street_ [10, 600. 00 purchase.]
    #801 Baronne Street_ [20,600.00 sale.]
    #2042-4 Magazine Street_[12, 000. 00]
    #425 Gravier Street_ [18, 375.00]
    Perdido and Dryadas Street_[70, 000. 00]
    Words and figures in the foregoing tabulation which are here shown in brackets appear upon the taxpayer’s journal in lead pencil.
    In 11 of the above sales the taxpayer paid commissions to other brokers for effecting the sales, in addition to the commission claimed by the president of the taxpayer. For the prior year 1920 the taxpayer claimed $1,500 as compensation to its president.
    The taxpayer, in its income and profits-tax return for 1921, reported gross income from sales of real estate in the amount of $41,-930.08, and gross income from rents received in the amount of $26,-904.35. In the same return it also reported compensation of officers, E. Perrin, Sr., $4,000; S. F. Perrin, $4,300; and in the general expense account it reported an item of other salaries, $2,500. In the schedule attached to the return, and in connection with the figures respecting one of the real-estate sales, it is shown that a commission was paid thereon in the amount of $3,210.97, and in the schedule of general expenses there is an item of commission in the amount of $2,376.50. The total gross income is stated as $68,832.43, and the net income as $6,000.93, upon which the taxpayer computed a tax of $400.09.
   OPINION.

Trussell

: The record of this appeal contains testimony to the effect that the customary charges, or commissions, for the collection of rents in the City of New Orleans in 1921 was 5 per cent of the rents collected, and that usual commissions upon sales of real estate were approximately 3 per cent of the sale prices. In this connection, however, it will be observed that the taxpayer is claiming a deduction for commissions upon rents collected in the amount of $3,259.30, and reporting gross income from rents in the amount of $26,904.35. Five per cent upon the gross rent collection does not equal the amount of commissions claimed as a deduction. It is also observed that the total of all the figures of purchase and selling prices of real estate transactions described is not such an amount that 3 per cent thereof will equal the $18,558 claimed as a deduction for commissions thereon. It must further be observed that, although a res©-lution of the taxpayer’s board of directors authorizing compensation ■of officers fixed the executive salary of the president at $6,000, in making its original income-tax return it only claimed $4,000 as ■compensation paid to such officer.

Upon the record as herein shown it appears that the question for •our determination is not what the corporation authorized to be paid to its president, or what amount was actually paid to him, but what is the reasonable compensation which the law authorizes the taxpayer to take as a deduction. The gross income of the taxpayer for the year was $68,832.43. It paid to one of its officers, a son of the president, a salary of $4,200. It appears to have paid $2,500 to other persons employed by it. The president owned more than two-thirds of the stock of the taxpayer corporation. He appears to have been its principal managing and directing head, and to a considerable extent his activities produced the gains and profits which made up its gross income. We are of the opinion that a reasonable compensation for his services, under the circumstances disclosed by the record, is the amount of $12,000 for the year 1921, and that the taxpayer’s net income should be readjusted upon that basis.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.


author: Lansdon:

text:
    Appeal of INDEPENDENT ELECTRIC MACHINERY CO.
    Docket No. 2742.
    Submitted December 12, 1925.
    Decided March 31, 1926.
    Salary and bonus authorized by directors held to be proper deduction as ordinary and necessary expenses.

      Phil D. Morelock and Dudley Doolittle, Esqs., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before Steenhagen, Lansdon, and Aeundell.
    This appeal is from the determination of a deficiency in income and profits taxes for the years 1919, 1920, and 1921, in the amount of $1,350.99.
    The deficiency letter covers the three years above enumerated, but no additional tax liability is asserted, except for the year 1920. The only issue involved is the taxpayer’s contention that the Commissioner erroneously disallowed deductions for salaries alleged to have been credited and paid to officers during the years in question as ordinary and necessary expenses.

      FINDINGS OF FACT.
    The taxpayer is' a Missouri corporation with its principal office at Kansas City. It was incorporated prior to the year 1909, with an authorized capitalization in an amount of $10,000, divided into 100 shares of the par value of $100 each. J. E. Launder acquired 51 shares of the stock in 1909, 10 shares in 1912, and 10 shares in 1915, and the remaining 29 shares in 1920. Since that date, except for three qualifying shares, he has been the owner of all the outstanding stock of the taxpayer, which has been a close corporation since its organization.
    In 1917 and 1918, the directors fixed the annual compensation of the president of the taxpayer at $6,000, plus a bonus of 20 per cent of the net profits. Without further corporate action, the president fixed his own salary for the years 1920 and 1921 at $11,000 and $10,400, respectively, and such amounts were accrued on the books and credited to the personal account of the president, together with other items representing bonus, in the form of commissions on sales, all in the total amounts of $13,817.75 and $10,400, respectively. During the years 1920 and 1921, the president withdrew the respective amounts of $16,076.62 and $6,800.78, which were charged against his personal account. In his personal income-tax returns for the years 1920 and 1921, he included the amounts of $13,317.75 and $10,400 in his gross income for the respective years.
    In its income and profits-tax returns for 1920 and 1921, the taxpayer deducted from its gross income the amounts of $14,133.33 and $10,400, accrued on its books for compensation of officers in such years, as ordinary and necessary expenses. Upon audit of such returns by the Commissioner several minor adjustments, not now in question, were made, and the deductions on account of the president’s compensation were reduced in the amounts of $5,000 and $4,400 for the respective years, which amounts were added to the taxpayer’s income.
    After the addition to income of the amounts disallowed for compensation of officers, the taxpayer’s net income for the years 1920 and 1921 was $14,488.77 and $24,703.21, respectively.
   OPINION.

Lansdon:

The issue in this appeal is whether the Commissioner erred in adding the amounts of $5,000 and $4,400 to the taxpayer’s taxable income for the years 1920 and 1921, respectively. The petitioner asserts that such amounts were accrued on its books as compensation of its president, and were either drawn by such officer or available for his withdrawal and use during the taxable years involved. The Commissioner contends that the amounts in question were never authorized as compensation and were not received by the president, either actually or constructively, during such years. The reasonableness of the compensation is not in question.

The parties agree that the compensation of the president for the years 1917 and 1918 was fixed by the taxpayer’s directors at $6,000 per annum, with a bonus of 20 per cent of the net earnings. No subsequent corporate action is asserted by the taxpayer which concedes that the amounts of $11,000 and $10,400, accrued on its books as compensation of its-president for the years 1920 and 1921, were determined by the president without any action by the directors, and that the only record of such action is the accrual on its books of the amounts so determined. The president testified that the matter of his compensation was never considered by the directors after the year 1918, and that, as he was the owner of substantially all the stock, he believed himself to be within his rights in fixing and paying his own compensation without conferring with the other directors. The hearing was held in Kansas City, where the principal office of the taxpayer is located, but no minutes of any meeting of stockholders or directors or any books of account were offered in evidence.

The Board is of the opinion that the taxpayer was entitled to deduct the amount of $6,000 as salary paid to its president for each of the years 1920 and 1921, as an ordinary and necessary expense, and to an additional deduction of 20 per cent of $14,448.77 from its gross income for 1920, and of 20 per cent of $24,703.21 from its gross income for 1921, on account of the bonus voted by the directors to its president in 1918.

Order of redetermination will he entered on 20 days’ notice, under Rule 50.


text:
    Appeal of BLANCHE BURBANK.
    Docket No. 4406.
    Submitted February 4, 1926.
    Decided March 31, 1926.

      Edw. Thompson, O. P. A., for the taxpayer.

      W. PL. Lawder, Esq., for the Commissioner.
    Before SterNhageN and LaNsdoN.
    This appeal is from the determination of a deficiency in income taxes for the year 1920 in the amount of $3,701.58. It arises from the Commissioner’s addition to income of the amount of $16,676, deducted by the taxpayer as cost of repairs and alterations of rental property.
   FINDINGS OF FACT.

The taxpayer is an individual who resides in and owns the Hotel Plaza Building, in San Francisco.

During the taxable year she expended the amount of $9,795.09 in converting three small store rooms on the first floor of her building into a single large room for the use of one Hirschman, a jeweler. The alterations and improvements were not in the nature of repairs and were made in conformity with an agreement with Hirschman that he would lease the room for a term of 10 years at a rental of $750 per month for the first five years, and of not less than $800 per month for the second five years. The exact amount of the rental for the second five years was to be determined by arbitration. Prior to such rearrangement of the space, the three rooms had been rented from month to month for a total return of $525 per month.

The taxpayer expended the amount of $6,860.91 in altering and reconstructing two rooms in her building that previously had been rented by the Plaza Hotel Operating Co. and used, respectively, as a bar-room and as a club-room for men. The changes in these rooms consisted in the removal of the bar-room and club-room fixtures, the construction of an outside opening of the club-room into the street, and the closing of an arched doorway that had previously connected the two rooms. Before these changes were made, the rooms had not produced any revenue for some time. After the changes the barroom was used as a barber shop by the Plaza Hotel Operating Co., and the club-room was used by a milliner.

The deficiency for 19W is $3,701.58. Order will be entered accordingly.


author: Smith:

text:
    Appeal of CARLISLE GARMENT CO.
    Docket No. 3632.
    Submitted July 13, 1925.
    Decided March 31, 1926.
    1. The taxpayer had on hand at December 31, 1918, raw materials which declined in price during the year 1919. There is no evidence that such materials were sold at a loss during the year 1919. Held, that the decline in price of the raw materials in 1919 is not deductible from the inventory at December 31, 1918.
    2. The taxpayer was incorporated in June. 1913, and acquired in exchange for its capital stock the assets of a going business including tangibles and intangibles. Held, upon the evidence, that the intangibles had no cash value at the time they were paid in for shares of stock.

      Fayette B. Bow, Esq., for the taxpayer.

      Ellis W. Harming, Esq., for the Commissioner.

      Before Trussell, Littleton, and Smith.
    This is an appeal from the determination of deficiencies in income and profits tax for the years 1918 to 1921, as follows:
    1918___1_$4,597.92
    1919_ 7,953. 04
    1920_ 1, 966. 51
    1921_ 65. 23
    14, 582. 70
    The deficiencies result from adjustments made in the taxpayer’s inventories as of December 31, 1918, and January 1, 1919, and from the exclusion from invested capital of certain amounts alleged to have been the value of good will paid for shares of stock.
    BINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation with its principal office at Carlisle, and is engaged in the manufacture of women’s dresses and garments. It was incorporated in June, 1913, with a capital stock of a par value of $81,000, and in July, 1913, this stock was exchanged for the going business of a limited partnership, known as J. I. Plank, Ltd. The taxpayer acquired the assets of the partnership and assumed its liabilities. Subsequently, a stock certificate for $1,000 was canceled, leaving outstanding stock of a par value of $80,000.
    The tangible assets of the partnership were received by the taxpayer at a value of $97,417.01, and the liabilities assumed amounted to $44,097.02. Good will was entered on the books of the taxpayer at $27,620.01, representing the difference between $81,000, the par value of the stock issued, and.the tangible assets less liabilities.
    The profits and losses of J. I. Plank, Ltd., from 1906 to the date of incorporation were as follows:

    From the date of incorporation through 1916 the profits and losses were :

      The taxpayer and its partnership predecessor were engaged chiefly in the manufacture of one-piece dresses for women. The styles adopted were plain and the material used was cotton cloth. A few years prior to the incorporation of the business, the management was changed, the officer then placed in charge procured the services of French designers, and the garments were manufactured on a more elaborate scale. After incorporation the business was reorganized, and in 1914 the design of the dresses became somewhat similar to that used prior to the employment of the French designers.
    At the time of taking the inventory on December 31, 1918, certain goods previously ordered by the taxpayer to cost $3,126.92 were in transit. These goods were not included in the inventory. They were received in January following, and at that time “ Purchases (Merchandise) ” was debited on the books of account and “ Accounts Payable ” was credited. No previous entry with reference to the goods was made on the books. In determining the taxpayer’s income for 1918, the Commissioner added the cost of the goods so in transit to the taxpayer’s closing inventory, but failed to increase merchandise purchases by a like amount.
    The taxpayer’s inventory at December 31, 1918, was taken at cost. During 1919 the market value of goods included in the closing inventory for 1918 was materially decreased. Similar goods were available on the market at a lower price and the taxpayer was forced to accept lower prices for garments ordered in 1918 to be delivered in 1919 than the contract prices of sale. The original prices on these orders were based on cost of materials in 1918. Upon revaluation of the closing inventory for 1918, it was found that none of the goods had appreciated in value, but that certain items of raw material entered in the inventory at $24,207.55 cost price had a replacement value in 1919 of $20,895.60. These items entered into goods manufactured and sold during the year 1919.
    The Commissioner has excluded from the taxpayer’s invested capital for the years involved in this appeal $27,620.01 attributed to good will. He has also increased net income for 1918 by $3,126.92, representing the cost of goods in transit at December 31, 1918, and has reduced net income for 1919 by a like amount. He has also increased the net income for 1918 by $3,311.95, representing the difference between the cost of raw materials included in the inventory at December 31, 1918, and the market price for same in the early part of 1919.
   OPINION.

Smith:

1. The net result of the Commissioner’s adjustment, as set forth in his deficiency letter to the taxpayer from which the appeal was taken, was to increase income for the. year 1918 in the amount of $3,126.92 and to decrease income for 1919 in a like amount,, upon the theory, apparently, that the goods in transit as of December 31, 1918, should have been taken into the closing inventory of that year, and, if this had been done, would have resulted in increasing income for the year 1918. The Commissioner however, overlooked,, the fact that if no entries were made in respect of such merchandise, or if complete entries were made, the result, so far as concerns 1918- or 1919 income, would be identical. In other words, if goods in transit were not charged into cost of merchandise for the year 1918 and were not included in closing inventory, cost of goods sold would be unaffected, since merchandise purchases would be understated, as would the closing inventory. Cost of merchandise purchased enters into the computation of cost of goods sold by the process of adding the inventory at the beginning of the year to the cost of merchandise purchased during the year, and deducting therefrom the closing inventory. It is manifest that, if a like amount is omitted from merchandise purchased and from closing inventory, the same result, so far as the cost of goods sold is concerned, is arrived at as if two like amounts were included in cost of merchandise and closing inventory. Consequently, the Commissioner was in error in transferring $3,126.92 from income in 1919 to income in 1918, irrespective of whether he was right in principle in requiring the taxpayer to include goods in transit in inventory as of the close of 1918.

2. With reference to the losses claimed in connection with the 1918 inventory on account of decreased values of raw materials in 1919, the taxpayer relies on the provisions of section 234 (a) (14) of the Revenue Act of 1918, which provides as follows:

(14) (a) At toe time of filing return for toe taxable year 1918 a taxpayer may file a claim in abatment based on toe fact that he has sustained a substantial loss (whether or not actually realized by sale or other disposition) ' resulting from any material reduction (not due to temporary fluctuation) of the value of the inventory for such taxable year, or from the actual payment after the close of such taxable year of rebates in pursuance of contracts entered into during such year upon sales made during such year. In such case payment of the amount of the tax covered by such claim shall not be required until toe claim is decided, but the taxpayer shall accompany his claim with a bond in double the amount of the tax covered by the claim, with sureties satisfactory to toe Commissioner, conditioned for the payment of any part of such tax found to be due, with interest. If any part of such claim is disallowed then the remainder of the tax due shall on notice and demand by the collector be paid by the taxpayer with interest at the rate of 1 per centum per month from the time the tax would have been due had no such claim been filed. If it is shown to the satisfaction of the Commissioner that such substantial loss has been sustained, then in computing the taxes imposed by this title and by Title III the amount of such loss shall be deducted from toe net income, (b) If no such claim is filed, but it is shown to the satisfaction of toe Commissioner that during toe taxable year 1919 toe taxpayer has sustained a substantial loss of the character above described ■then the amount of such loss shall be deducted from the net income for the taxable year 1918 and the taxes imposed by. this title and by Title III for such year shall be redetermined accordingly. Any amount found to be due to the taxpayer upon the basis of such redetermination shall be credited or refunded to the taxpayer in accordance with the provisions of section 252.

The above section provides that there may be deducted from income in the year 1918 a loss sustained by a taxpayer resulting from any material reduction of the value of the inventory. A material reduction of the value of an inventory is not, in itself, sufficient to sustain a claim for a loss under this section. The material reduction must result in a substantial loss. The substantial loss, moreover, must he one resulting from any material reduction of the value of the inventory. In other words, the material reduction which results in a loss must relate to the value of the entire inventory and not to the value merely of isolated portions thereof. Upon this latter point the taxpayer has introduced evidence to the effect that some portions of the inventory declined at some time during 1919 and that no portions of the inventory showed an increase. It may, therefore, be accepted that there was a material reduction at some time during 1919 in the value of the inventory taken as at the close of 1918. This reduction in value, as measured by the possible replacement of the materials at a lower cost during 1919, amounted to approximately $3,300, or some 12 or 13 per cent of the original cost of the materials showing such decline. It appears further that the taxpayer manufactured the goods in-its inventory at the close of 1918 and sold them during the year 1919. It does not appear that any loss whatever was sustained by the sale of these inventoried articles, nor does it appear that they were on hand at -the close of 1919, in-eluded in the inventory of that year, or that the raw material content at that time of such inventoried goods, even if they were on hand at the close of 1919, could have been inventoried at a market value •of less than cost. Under these circumstances, there is no evidence that the taxpayer has sustained a substantial loss resulting from any material reduction in the value of the inventory as taken at the close of 1918, and it is therefore not entitled to deduct the amount of the loss claimed for that year.

3. With reference to the item of good will, the taxpayer has attempted to show that there was a certain amount of good will in the business at the time of incorporation. There appears to be no good reason why good will was entered on the books of the corporation at $27,620.01. The taxpayer submitted a statement as to profits and losses of the business for the years 1906 to 1916. The periods just prior and subsequent to incorporation were unprofitable, and losses were sustained. It is contended that these losses were the result of gross mismanagement prior to incorporation. Witnesses testified that designers were employed who did not understand the taxpayer’s class of trade, and that unsuitable materials were purchased, resulting in heavy losses. But even though it be conceded that the business was mismanaged during the period in question, that is not sufficient to show that there was good will in the business; or, conceding that there was good will, that such good will had the value claimed for it by the taxpayer. The contention of the taxpayer, in short, is that the value of good will can not be computed on the basis of earnings of the business because gross mismanagement prevented normal profits from being made. Conceding this, there is no other evidence upon which a value for such good will as might exist could be based, and we are of the opinion that the amount attributed by the taxpayer to good will was properly excluded from invested capital.

Order of redetermination will he entered on 15 days’ notice, under Rule 50.


author: Love:

text:
    Appeal of CONNECTICUT NATIONAL PAVEMENTS, INC.
    Docket No. 3448.
    Submitted September 26, 1925.
    Decided March 31, 1926.
    The taxpayer in 1920 expended $25,000 for certain patent rights which it alleged became worthless in 1921. Helé, the said patent rights were in fact worthless in 1921 and the cost thereof is deductible as a loss for that year.

      Edward B. Burling and H. O. Kilpatrick, Esqs., for the taxpayer.

      A. H. Fast, Esq., for the Commissioner.
    Before MaRquette, Geeen, Moeeis, and Love.
    This is an appeal from the determination of a deficiency for the year 1921, in the amount of $9,281.77. The deficiency arose from the refusal of the Commissioner to allow a deduction in the sum of $25,000, expended for certain patent rights alleged to be worthless.
    FINDINGS OF FACT.
    The taxpayer is a Connecticut corporation with its principal place of business at New Haven. It was organized in the yéar 1920 for the purpose of engaging in the paving business.
    On April 19, 1920, the taxpayer entered into a contract with the Franklin Contracting Co., whereby the latter granted to the taxpayer the right to manufacture and lay within the States of Connecticut and Rhode Island a certain kind of pavement, the manufacture of which was protected by patents owned or controlled by the Franklin Contracting Co., known as “ National ” pavements, and for this right the taxpayer paid the sum of $25,000. The principal ingredient, in the making of this pavement was a peculiar kind of clay known as “ 15 per cent bitumen ” clay. The officers of the taxpayer knew nothing of the manner of making “ National ” pavements, nor of the necessary materials, but it was represented to them that there was plenty of such clay in Connecticut and Rhode Island, and they relied upon and believed such representations when making the purchase.
    During 1920 the taxpayer secured two or three paving contracts for the “ National ” pavement, but discovered that the type of clay required could be found only in small quantities in Connecticut and Rhode Island. Early in 1921 the taxpayer took on one more small paving job for this pavement, but, owing to the difficulty of obtaining the proper clay, refused to take or apply for more contracts for this kind of pavement. The taxpayer made diligent search for this clay throughout Connecticut and Rhode Island, but found that it could not be obtained in commercial quantities. The nearest point from which such clay was obtainable was in the State of New Jersey, but the expense of transportation prohibited its commercial use. The taxpayer abandoned the special machinery used for this pavement and continued to lay only unpatented pavements.
    The taxpayer thereupon, in the fall of 1921, abandoned the manufacture and laying of pavement under such patents and charged the cost of the patent rights from its books as worthless, and has never since manufactured nor offered to manufacture under said patent rights.
    The taxpayer, in its income-tax return for 1921, deducted said sum of $25,000 from its gross income as a loss not covered by insurance or otherwise, but the Commissiqner refused to allow the same.
   OPINION.

Love:

The Commissioner disallowed the amount in controversy as a loss on the sole ground that there had been insufficient evidence to establish the fact that the patent rights to manufacture were worthless. At the hearing, however, the evidence was convincing that the patent rights for which the taxpayer had expended $25,000 were in fact worthless and useless to the taxpayer, and that it had discarded such assets permanently from use in the business within the taxable year 1921.

Order of redeterrmnation will he entered on 15 days’ notice, under Rule 50.