text:
    Appeal of CONKLIN-ZONNE-HARRISON AGENCY, INC.
    Docket No. 2492.
    Submitted July 1, 1925.
    Decided February 3, 1926.
    Taxpayer was not a personal service corporation during the fiscal year ended April 30, 1921.

      J. Robert Sherrod, Esq., for the taxpayer.

      J. Arthur Adams-and E. G. LaTce, Esqs., for the Commissioner.

      Before Green, Trussell, and MoRRis.
    This is an appeal from the determination of a deficiency of $2,313.06 in income and profits taxes for the fiscal year ended April 30, 1921, arising from the refusal, of the Commissioner to classify the taxpayer as a personal service corporation.'
    FINDINGS OE FACT.
    The taxpayer is a Minnesota corporation, engaged in the insurance agency business.
    For many years prior to 1912 the ConHin-Zonne-Loomis Co., a corporation, was engaged in the management of office buildings, the placing of loans, and the selling of insurance. In September, 1912, this corporation desired to take in one, J. M. Harrison, who had been in the insurance business for 12 years or more, to handle the insurance department. It was later decided to segregate the insurance business, which resulted in the incorporation of the taxpayer, to which was transferred all of Harrison’s insurance business and that of the Conklin-Zonne-Loomis Co., and stock of the par value of $100 was issued therefor as follows:
    Shares.
    J. M. Harrison_I-100
    Conklin-Zonne-Loomis Co-"-200
    In 1918 Harrison received an additional 50 shares of stock, which, ■ together with 35 shares of stock issued to one Sanford prior to that time, resulted in the following stock holdings in the taxpayer during the taxable year in question:
    Shares.
    J. M. Harrison_150
    L. W. Sanford_ 35
    Conklin-Zonne-Loomis Co-150
    Total_ 335
    No cash was paid in for the additional stock issued.
    Harrison and Sanford devoted their entire time to the business. Only one sub-agent was employed, whose activities produced a net income of $25 during the taxable year. A solicitor was also employed in order to give him a chance to pay off his creditors, among whom was the taxpayer. He produced approximately $75,000 worth of business out of $329,806.33. About 15 per cent of the total premium volume was written by outside brokers, who were in the same line of business and transferred insurance to the taxpayer in excess of their writing capacity. Other employees included an office force of 13 or 14, consisting of the usual policy writers, bookkeepers, stenographers, and clerks. The cost of the cashier and switchboard operators was shared with the Conklin-Zonne-Loomis Co. The pay roll of the office for the year ended April 30, 1921, was $20,002.39, in addition to the stockholders’ salaries, amounting to $8,828.12. Uncollected premiums remitted to the insurance companies for two-typical months during the taxable year in question were 9.8 and 13.7 per cent. Its bad debts were nominal. Renewals constituted approximately 75 per cent of the business.
    The balance sheets of the taxpayer as of April 30, 1920 and 1921,. were as follows:

    The accounts receivable included the commissions due the taxpayer, and the accounts payable represented the net amount due the insurance companies at the end of the year. Rotes payable of $310 at the beginning and $10 at the end of the fiscal year represented the unpaid portion of a loan which was made to purchase another insurance agency.
    The stockholders of the Conklin-Zonne-Loomis Co. were as. follows:
    Shares
    A. E. Zonne_124
    G. B. Loomis_• 41
    J. F. Conklin_ 1
    Total_166
    The stockholders A. E. Zonne and G. B. Loomis devoted all their-time to the business of that company. J. F. Conklin, owning one-share, did not take an active part in the business but acted in an advisory capacity. This corporation did not own any buildings or realty, but its main source of income was from commissions received on rentals of office buildings and other properties which were-managed for its customers. In the course of such real-estate business it was instrumental in placing much insurance business with the-taxpayer. Its balance sheets as of April 30, 1920 and 1921, were as follows:

    Its gross income for the fiscal year ended April 30, 1921, was derived from the following sources:

      Income. •

    Year ended Apr. 30, 1921.
    Commissions on rents collected for principals_$49,467.44
    ■Commissions on sales and loans_ 629.00
    •Commissions on coal sales-,- 1, 651.43
    Interest on bank deposits_ 319. 05
    Interest on investments and notes receivable_ 363. 80
    Interest on Liberty bonds- 1, 017. 32
    Rentals_
    Dividends received from:
    Boston Block Trust Co_ 250.00
    Minneapolis Real Estate Associates- 1, 000.00
    Share of net income earned by the Conklin-Zonne-Harrison Agency- 3, 000.00
    Total_$57, 598.04
    The Commissioner denied the taxpayer personal service classification.
   DECISION.

The determination of the Commissioner is approved. Appeal of Medbury-Wilson Co., 1 B. T. A. 963; Appeal of Hanley-Ried & Co., 2 B. T. A. 315. See also Appeal of W. J. Perry Corporation, 1 B. T. A. 788.


source: Caselaw Access Project

author: Steenhagen

license: Public Domain

text:
    Appeal of THE HOME TELEPHONE & TELEGRAPH CO.
    Docket No. 3323.
    Submitted October 13, 1925.
    Decided February 3, 1926.

      Alfred L. Geiger, Esg., for the taxpayer.

      Percy S. Crewe, Esg., for the Commissioner.
    Before Sternhagen, Lansdon, and Love.
    This is an appeal from the determination of a deficiency in income and profits taxes for 1919 and 1920 aggregating $1,404.59. The deficiency is said to be due to the inclusion in taxable net income of an amount of $11,081.99, Federal income taxes paid by the taxpayer for 1918, such amount being alleged to be covered by an obligation of the Postmaster General assumed during Federal control. The appeal was submitted upon the pleadings and exhibits.
    FINDINGS OF FACT.
    The taxpayer is a telephone corporation of Indiana, whose properties were taken over by the Postmaster General, at midnight, July 31, 1918. The taxpayer thereupon made its offer of contract to cover the supervision, possession, control, and operation of its telephone system and the just compensation therefor, and this offer was accepted by the Postmaster General, by direction of the President, on October 25,1918. This contract contained, among numerous other provisions, the following:
    Section 5. * * * (b) The Owner shall, before they become delinquent, pay all taxes, license fees and charges, apd the expense of suits in respect thereof, which can or may be lawfully imposed during the period of Federal control by Federal or other governmental authority upon any part of the property described in paragraph (a) of Section 1 hereof, and also such other taxes, license fees and charges as during the period of Federal control become the obligations of the Owner.
    The Owner shall render bills to the Postmaster General for such taxes, license fees and charges as the same are paid, which bills shall be accompanied by receipts of the proper tax collecting officials, and shall be paid by the Postmaster General within five days after their rendition, except that said bills shall not include and the Postmaster General shall not pay to the Owner, the portion of such taxes, license fees and charges properly apportionable to property not taken under Federal control and to the revenue from said last mentioned property.
    If any such tax, license fee or charge is for a period which began before July 31, 1918, or continues beyond the period of Federal control, such portion of such tax, license fee or charge as may be apportionable to the period of Federal control shall be paid by the Postmaster General and the remainder shall be paid by the Owner.
    Whenever a period for which a tax, license fee or charge is imposed cannot be definitely determined, so much of such charge as is payable in any calendar year shall be treated as imposed for such year.

      Section 7. (a) The Postmaster General shall pay to the Owner for each year and pro rata for each fractional part of a year during the period of Federal control, an amount equal to the sum of the following three items: item (1) One Hundred Thousand Dollars ($100,000.00) ; item (2) the annual charge for interest and dividends and other costs of securing necessary additional capital for such expenditures as may be made at the request of the Postmaster General; item (3) the annual charge for such interest and dividends as the Owner may be required to pay on new securities, obligations or share capital issued for the discharge, conversion or renewal of present obligations, and for additional interest and charges to secure extension of existing securities or obligations. ⅜ * ⅜
    The taxpayer allocated the 1918 Federal income tax as follows:
    Income tax charged to Postoffice' Department_ $4, 617. 50
    Income tax charged to accrued taxes_ 4, 397. 84
    Income tax charged to surplus- 2, 085. 71
    Total_ 11,101. 05
    Less tax adjustment_ 19. 06
    11, 081. 99
    The Commissioner restored this amount to taxpayer’s income for 1919.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Steenhagen

: From the foregoing facts, which are all those in the record in respect of the factors of taxable income, it is utterly impossible to determine the taxpayer’s liability. Briefs have been filed upon the question whether the reimbursement by the Postmaster General of the company’s income tax under section 5 of the contract was taxable income of the company, and whether that issue is controlled by the decision in Appeal of New York, Ontario & Western Ry. Co., 1 B. T. A. 1172. But the facts are inadequate for the consideration of such questions. Did the company pay any taxes, and, if so, what were they, how were they computed, and how were they assessed ? Did the Postmaster General pay the company, and, if so, when and in what amount? The equivocal fact that the taxpayer allocated certain amounts is too uncertain, and we dare not assume its significance.


author: Aettndell:

text:
    Appeal of GEORGE S. MEPHAM.
    Docket No. 1981.
    Submitted October 15, 1925.
    Decided February 3, 1926.
    Value of intangibles determined as of March 1, 1913, as a basis of gain on subsequent sale.

      George H. Moore, Esq., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.

      Before Sterni-iagen, Lansdon, and Arttndell.
    This is an appeal from the determination of a deficiency in income taxes for the calendar year 1919 in the amount of $44,316.51. The Commissioner also found a deficiency for the year 1920 in the amount of $140.92, and for the year 1921 in the amount of $7.57, but no contention is made as to the deficiencies for these two years by the taxpayer. The deficiency for the year 1919 results from the inclusion in income of the alleged profit made by the taxpayer on the sale of his business in that year.
    FINDINGS OF FACT.
    The taxpayer is an individual residing in St. Louis, Mo., and was, during the year 1919, doing business under the firm name of George S. Mepham & Co.
    More than 20 years ago the taxpayer established the business of manufacturing dry color and pigments. The factory was located in East St. Louis, Ill. In connection with the operation of the plant, the taxpayer had trouble with the city authorities and with his neighbors, because, in the burning of sulphate of iron, from which his product was made, sulphuric acid was given out, which prevented comfortable living in the vicinity. In 1903 or 1904 the taxpayer purchased the American rights to certain patented English inventions, which, when adapted and installed in his plant, served to eliminate the fumes. In connection with the installation of the process, there was spent between $40,000 and $50,000 in experiments and in building and rebuilding furnaces. These patents expired in 1909 and, in the years 1912, 1913, and 1914, were written off the books of the taxpayer. However, the process as developed by the taxpayer remained secret from the public and the trade and was secret in 1919 when the business of the taxpayer was sold.
    Some time prior to November 25, 1919, the taxpayer’s health failed. He decided to dispose of his business, as his wife knew nothing about carrying it on and there was no one else to take his place. C. K. Williams, his keenest competitor, had expressed a desire to purchase the business if the taxpayer ever decided to sell. The taxpayer had the utmost confidence in the integrity of Williams and felt that he would be the proper man to carry on the business the taxpayer had built up. He thereupon made known to Williams that the property was for sale and the latter came to St. Louis to investigate it with a view to purchasing the same.
    As a result of the negotiations, the taxpayer and Williams, under date of November 25, 1919, entered into an agreement and contract of sale whereby the taxpayer agreed to transfer and convey to Williams the business known as George S. Mepham & Co., including all of the tangible assets, and by the same instrument conveyed to Williams the personal property of the business. The tangible assets were described in the contract more particularly as follows:
    Inventory (crude and manufactured merchandise)-$70, 072. 27
    Accounts receivable_ 41, 650.62
    Cash_ 13, 391.46
    Heal estate, buildings and machinery- 174, 885.15
    This property was to be conveyed free and clear of incumbrances and outstanding indebtedness. It was further agreed in the contract of November 25, 1919, that the real estate of the taxpayer used in his business in the City of East St. Louis, Ill., should be conveyed by the taxpayer to a corporation, thereafter to be organized in Illinois under the name of George S. Mepham <& Co., or a similar name, which might be permitted by the authorities of that State. The contract further provided that the corporation to be organized should have a paid-up capital stock of $300,000, to be divided into 3,000 shares of the par value of $100 each.
    The price agreed on by the parties in the above-mentioned contract was $300,000, to be paid, $150,000 in cash and the balance in eight promissory notes, all of which were dated November 24, 1919. and payable at the Merchants Laclede National Bank of St. Louis, Mo., on the dates and in the amounts set forth below:
    1. Due January 15,1921_$30,125
    2. Due January 15,1922_,_ 27, 800
    3. Due January 15,1923_ 26, 600
    4. Du,e January 15,1924-,- 25, 400
    5. Due January 15, 1925_ 24,200
    6. Due January 15,1926___ 23, 000
    7. Due January 15,1927_ 21, 800
    8. Due January 15,1928_r- 10, 600
    The face amount of the notes included interest at the rate of 6 per cent to the date of maturity. It was further agreed that- the notes were to be deposited in escrow in the Merchants Laclede National Bank of St. Louis with the entire capital stock of the corporation of George S. Mepham & Co. attached thereto, but that the the full voting rights in the stock were to be exercised by Williams.
    The agreement was carried out substantially as in the contract provided. The corporation was organized and, under date of December 4, 1919, Williams transferred to George S. Mepham & Co., a corporation, the property theretofore conveyed to him by George S. Mepham, and the real estate theretofore owned by George S. Mepham, and used in the business, was also transferred to the corporation.
    On the same date, to wit, December 4, 1919, all of the stock was issued to Williams,' except four' qualifying shares. Thereafter? on the same day, all of the shares theretofore issued to Williams were surrendered and canceled and the same' number that had been issued to Williams were issued to Mepham, who immediately endorsed said shares in blank and attached them to the notes given by Williams, the notes with the stock attached being placed in escrow with the Merchants Laclede National Bank, as provided in the agreement of November 25, 1919.

    The issuance of the stock in the name of the taxpayer was done at the suggestion of counsel for the taxpayer and purely to protect him in case of the death of Williams. The beneficial interest in the stock was at all times in Williams. The escrow agreement provided for the release of a certain portion of the stock with the payment of each of the notes.
    The taxpayer, in making the sale and disposition of the business owned by him and known as George S. Mepham & Co., transferred to Williams not only all of the tangible assets of that business, both real and personal, but also all of the intangible assets, and, for a period of five months after the sale, the taxpayer gave his services without charge to the business of George S. Mepham & Co., a corporation. The value of the tangible assets belonging to the taxpayer during each of the five years prior to 1913 was as follows:
    1908_$203,831.88
    1909_ 215, 635.13
    1910_ 223, 748. 92
    1911- 244,276.04
    1912_ 272, 306.29
    The earnings of the taxpayer during the same period of time were as follows:
    1908- $28, 358. 31
    1909_ 39, 095.21
    1910- 31,132. 59
    1911- 42, 029. 60
    1912-43, 329. 33
    At the time of the sale of the business to Williams, the intangible assets were worth not less than $67,965. The value of these assets on March 1,1913, was not less than $67,965.
    DECISION.
    The deficiencies determined by the Commissioner for 1920 and 1921 are approved. The deficiency for 1919 will be computed in accordance with the foregoing findings of fact and the following opinion and will be settled on 15 days’ notice, in accordance with Bule 50.
   OPINION.

Aettndell:

The Commissioner, in computing the taxable .gain from the sale, depreciated the tangible assets down to the date of sale and refused to allow any value for intangibles owned by the taxpayer, both on the theory that there were no intangible assets of value, and, further, that the sale did not purport to dispose of any intangibles, even if the taxpayer owned any of value. The taxpayer conceded the correctness of the Commissioner’s action in depreciating the tangible assets.

The taxpayer was the sole proprietor of the business of George S. Mepham & Co., which was engaged in the manufacture of dry color and pigments. The business was run on very conservative lines and the accounts were kept in the same conservative way. For a number of years prior to March 1, 1913, the taxpayer had successfully operated his business and had built up a good will of considerable value. The difficulty in the manufacture of his product came from the emission of sulphuric fumes, which caused trouble with his neighbors and the municipal authorities. He had, in the early days of his business, acquired certain American* rights to British patents, which he further developed and adapted to his needs, but the process so adapted was never patented. This secret process served to eliminate the fumes and thus permitted him to carry on his manufacturing while his competitors were in constant difficulties. This secret process was unknown to the trade and to the public at the time of the sale of his property to Williams. The testimony clearly establishes the fact that the taxpayer, in disposing of his business, sold not only ■ the tangible property used in the business, but also the good will and other intangible assets, including the secret process heretofore mentioned. We have found that the intangible assets were, on March 1, 1913, worth $67,965. This amount should be added to the value of the tangible assets as determined by the Commissioner, and the total figure thus obtained should be used in determining the profit, if any, on the sale of the taxpayer’s business to Williams in 1919.


author: Smith

text:
    Appeals of JORDAN MARSH CO. and AVON STREET TRUST.
    Docket Nos. 4458, 4459.
    Submitted October 12, 1925.
    Decided February 3, 1926.
    Tbe taxpayers were affiliated for the fiscal year ended January 31, 1921.

      Henry 8. Richardson, Esq., for the taxpayers.

      P. S. Crewe, Esq., for the Commissioner.

      Before Smith, Littleton, and TRitssell.
    These appeals are from determinations of deficiencies for the fiscal year ended January 81, 1921,'in the total amounts of $110,012.16 and $11,585.22, respectively. The only question presented is whether the taxpayers were affiliated for the fiscal year ended January 31,1921.
    findings of fact.
    The Jordan Marsh Co. is a Massachusetts corporation, incorporated in May, 1901. Its principal place of business is in Boston. Originally there were three stockholders, E. D. Jordan, E. J. Mit-ton, and A. E. Dumaresq, the latter a relative of E. D. Jordan, the percentages of stock owned by each being 50, 30, and 20. About one year after incorporation, Dumaresq transferred one-half of his holdings to George W. Mitton, a son of E. J. Mitton, and one-half to W. F. Watters, an employee of the company. On May 17, 1910, the stockholders entered into the following agreement:
    Agreement between Eben D. Jordan, Edward J. Mitton, Waiter F. Watters, and George W. Mitton.
    Each of the parties hereto agrees with the others that in ease he desires to-dispose of his stock in the Jordan Marsh Company, or any part thereof, lie-will first give to the others who may then be living, or the survivor of them, an option to purchase the shares he desires to dispose of, or any part thereof, for thirty days, in proportion to their respective holdings, or in ease only one is living, such option to the survivor. In case either of the parties fails to-exercise his option by taking all the stock offered thereunder, the other or others shall have the right for thirty days after the termination of such option to purchase the stock not taken as aforesaid, in proportion to their respective holdings, if there are more than one; and in case there should be more than one who have a right to take the stock of the party failing to exercise his option, and either fails to take, within thirty days, all the stock which he is entitled to take of the party failing to exercise his option as aforesaid, then the other shall have the right for thirty days after the termination of the last option to purchase the stock not taken as aforesaid.
    After the giving of such options and the failure to exercise the same as aforesaid, the party desiring to dispose of his stock shall be at liberty to-dispose of the same, or so much thereof as has not been purchased under such options, for a period of one year from the time of the failure to exercise the last option given; but this agreement shall not prevent the parties hereto from disposing by will of any stock owned by them respectively at the time of their death, or prevent the distribution of the same to the persons entitled to the property of a deceased party hereto, but such legatees or distributees shall take said stock subject to the obligations of this agreement, which shall-bind them with the same effect and force as if they were originally parties hereto.
    The price to be paid under said options shall be fixed • by the board of directors of the Jordan Marsh Company, on application of the seller or of any stockholder desiring to purchase. The fact that a stockholder may be a seller or possible purchaser shall not debar him from sitting with the board and taking part in-such determination,- if he is a director.

      The executors or trustees of the parties hereunder or of any stockholder hound by the terms of this agreement may sell the shares of stock of the Jordan Marsh Company held by them to the sons of their testator or testatrix, who are engaged in the business, without first offering the same to the other stockholders, but otherwise subject to the terms of this agreement.
    This agreement shall be binding during the lives of all the parties hereto and shall bind their executors, administrators, legatees and distributees.
    The Avon Street Trust is a common-law trust, taxable as a cor- . poration under the Revenue Acts of 1918 and 1921. It is the owner of certain land and buildings thereon which were constructed for the uses of Jordan Marsh Co. Its property adjoins the main store of that company and is connected therewith by subterranean passages. The property is so situated as to location and ownership that it constitutes a part of a single business consisting of the two companies. Its shares were originally subscribed for by E. D. Jordan and E. J. Mitton and, in the taxable year, they were owned by their estates or their descendants.
    At the beginning and throughout the fiscal year ended January 31, 1921, except for the change hereinafter referred to, the record holders of the stock of the corporation and of the trust, together with a description of the parties holding, were in the percentages indicated in the following table:

    The change which occurred during the taxable year was. occasioned by the death, on November 4, 1920, of May S. Jordan, beneficiary of one-half of the trust estate of E. D. Jordan for life and owner of 4.73 per cent of the stock of the trust, at which time one-half of the stock of both the company and the trust held in trust for her became distributable absolutely to Robert Jordan, as remainderman, and the other half continued in the trustees to be held for the benefit of Dorothy Jordan Robinson, the other beneficiary of the trust estate, and her ownership of 4.73 per cent of the stock of Avon Street Trust passed to her daughter, Dorothy Jordan Robinson, outright.

      During the taxable year the trustee of the estates of E. D. Jordan were Robert Jordan (also a stockholder in his own name), Charles K. Cobb, and William C. Taylor, and the trustees of the estate of E. J. Mitton were George W. Mitton (also a stockholder in his own. right and beneficiary under the will of his father), Robert G. Mitton (also a beneficiary under the will), and Charles E. Barnes.
    George W. Mitton has at all times, in voting the stock owned by the-estate of E. J. Mitton, voted it in the same manner as he has voted the stock owned in his own right. The records of a stockholders* adjourned annual meeting held May 5, 1922, show that those present were :•
    George W. Mitton, representing himself and the estate of E. J. Mitton, Robert Jordan, representing himself and the estate of E. D. Jordan, and Walter F. Watters, the full capital stools: being those represented.
    The records of Jordan Marsh Co. show that there has never been a dissenting vote cast, either at a meeting of the stockholders or at a meeting of the board of directors of Jordan Marsh Co.
    DECISION.
    The deficiency should be computed in accordance with the’ following opinion. Final determination will be settled on 10 days’ notice,, in accordance with Rule 50.
   OPINION.

Smith

: The only question raised by these appeals is whether the taxpayers were affiliated for the fiscal year ended January 31, 1921. They were affiliated if substantially all of the stock of both was “ owned or controlled by the same interests.” Section 240 (c) of-the-Revenue Act of 1921.

It may be deduced from the findings of fact that the shares of stock of the two taxpayers were owned at the beginning of the-taxable year as follows:

The estate of E. D. Jordan was administered by three trustees, one of whom was Robert Jordan, who also was a remainderman of the estate and who came into absolute ownership of his interests in November, 1920. The estate of E. J. Mitton was likewise administered by three trustees, one of whom was George W. Mitton, a son of E. J. Mitton. He was one of five children of E. J. Mitton and had a one-fifth beneficial interest in the. estate of his father. The 10 per cent minority interest in Jordan Marsh Co. was owned by W. F: Watters. He had, in 1920, long been in the employ of that company and his stock was held under the provisions of the agreement of May 17, 1910, the material portions of which are set forth in the findings of fact. The minority interest in the Avon Street Trust from February 1, to November 4, 1920, was owned one-half by May S. Jordan, the widow of E. D. J ordan, and mother of Robert Jordan, and D. Jordan Robinson. The other one-half was owned by D. Jordan Robinson. Upon the death of May S. J ordan, her one-half of the minority interest passed to her executor for the benefit of I). Jordan Robinson.

The record is not satisfactory as to whether Robert Jordan had any actual control over the stock held by the estate of E. D. Jordan or by his mother or sister. It is in evidence, however, that at an adjourned meeting of the stockholders of Jordan Marsh Co. held on May 5, 1922, Robert Jordan represented himself and the estate of E. D. Jordan; at the same meeting George W. Mitton represented and voted the stock held by the estate of E. J. Mitton and, from his affidavit admitted in evidence, it appears that he habitually voted the stock held by the estate. It is further in evidence that the records of Jordan Marsh Co. show that no dissenting vote has ever been cast by any stockholder, either at an annual meeting or a meeting of the board of directors.

What constitutes ownership or control “ by the same interests ” was discussed in Appeal of Rishell Phonograph Co., 2 B. T. A. 229. We have held that blood relationship is a factor to be taken into consideration in determining whether the shares of stock in different corporations are owned or controlled by the same interests. Appeal of Wright Cake Co., 2 B. T. A. 58; Appeal of Midland Refining Co., 2 B. T. A. 292; Appeal of Edward Rose Co., 2 B. T. A. 341. In the instant appeal, 90 per cent of the stock of Jordan Marsh Co. and 100 per cent of the stock of the Avon Street Trust was owned by the Jordans and Mittons.


author: Smith:

text:
    Appeal of WALNUT CREEK MILLING CO.
    Docket No. 2834.
    Submitted July 15, 1925.
    Decided February 3, 1926.
    The claim of the taxpayer that, in the computation of invested capital, its earned surplus, as shown by its books of account, should not be reduced for depreciation sustained in the amount determined by the Commissioner, denied for lack of evidence.

      P. J. Barnes, O. P. A., for the taxpayer.

      F. 0. Graves, Fsq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This appeal is from the determination of a deficiency in income and profits tax for the year 1919 in the amount of $2,751.10. The Commissioner disallowed $3,262.19 of a total deduction of $14,417.39 for depreciation taken in the tax return, and reduced the earned surplus for invested capital purposes by the amount of $30,896.69, on account of insufficient depreciation charged off in prior years.
    FINDINGS OF FACT.
    1. The taxpayer is a Kansas corporation, with its principal place of business at Great Bend. It was organized in 1877. It is engaged in the grain and flour milling business.
    2. In 1915, a tornado or windstorm destroyed a large part of the company’s then existing plant and many of its records. Its mill proper was complete in 1916. At the time little adjustment was made upon its books to reflect the proper cost of the new plant.
    3. The physical assets employed in the taxpayer’s business, which are subjected to wear and tear arising out of such employment, are as follows:
    12 elevators, frame.
    1 elevator, concrete.
    1 office building, brick stucco.
    1 power plant building, stone and concrete.
    1 mill building.
    1 power plant, boilers and engine.
    4. The taxpayer claimed a deduction in its return for 1919 in the amount of $14,417.39, on account of wear and tear with respect to the above assets. The Commissioner allowed a deduction in the sum of $11,155.20 and disallowed the remainder, or $3,262.19.
    5. In years prior to 1917, the taxpayer accrued no depreciation on its books of account. It figured that the expenses of maintaining the plant covered the depreciation.
    6. For 1917 and subsequent years, the taxpayer has annually accrued on its books a depreciation reserve at uniform rates, and additions, renewals' and replacements have been charged against such reserve.
    7.The schedule of depreciation for 1919, taken from the deficiency letter, reads as follows:

    8. In lieu of the depreciation reserve shown by the taxpayer’s books at January 1,1919, the Commissioner has substituted a reserve of a greater amount, which he has computed by going back to the date of original acquisition of each asset and computing the reserve with respect thereto on a .straight-line basis.
    9. The Commissioner has reduced the earned surplus at January 1, 1919, as shown by the books, for invested capital purposes, by the excess of the depreciation reserve as computed by him over the reserve as shown by taxpayer’s books.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Smith:

The questions presented by this appeal are indicated in the preliminary statement. The taxpayer has furnished little information for the determination of the amount of depreciation sustained during the years prior to 1917, or for the determination of the depreciation sustained during the year 1919. The evidence is to the effect that, prior to 1917, no reserve was set up for depreciation. The cost of repairs was charged to expense, but it is impossible to state the amount spent for repairs or to state whether depreciation was sustained ln‘excess of the amount spent. In its original tax return for 191*9, the taxpayer claimed the deduction from gross income of $14,417.39 for wear and tear of property, and in its brief claims a deduction of $18,431.49. The Commissioner has determined deductible depreciation of $11,155.20. The taxpayer has furnished no information as to when its assets, other than its mill building proper at Great Bend, were acquired. From the meager evidence of record, we can not determine whether the rates used by the Commissioner are more reasonable than those now claimed by the taxpayer. In the absence of material evidence, the appeal of the taxpayer for the deduction of a greater amount for depreciation than that which has been allowed by the Commissioner must be denied.

Little evidence has been furnished as to whether the taxpayer’s book surplus at January 1, 1919, more accurately reflects its true surplus than do the amounts found by the Commissioner. .At January 1, 1919, the taxpayer had been organized for a period of more than 40 years. Prior to 1917 it had never set up a reserve for depreciation. It had spent certain money for repairs and, presumably, for replacements, but the amount so spent is not in evidence. It is in evidence that major additions to the plant were properly capitalized. We have held, in Appeal of Cleveland Home Brewing Co., 1 B. T. A. 87, that depreciation is a question of fact. In any case where the amount of the depreciation determined by the Commissioner is challenged, evidence must be furnished to this Board which will enable it to determine the depreciation sustained. In the absence of competent evidence, the decision of the Commissioner must be sustained.


author: Tkammell

text:
    Appeal of HARRY W. BOCKHOFF.
    Docket No. 3206.
    Submitted November 6, 1925.
    Decided February 3, 1926.
    Determination of tlie rate of exhaustion of a patent.

      Lcuwrence Baker and R. L. P. Wallace, Esgs., for the taxpayer.

      Ward Loveless, Esq., for the Commissioner.
    Before Tkammell and Love.
    This is an appeal from the determination of a deficiency for the year 1919 in the sum of $887.17. The deficiency arises from the refusal of the Commissioner to allow a deduction for the exhaustion of a certain fractional interest in a patent.
    FINDINGS OF FACT.
    1. The taxpayer on June 30, 1917, acquired by. gift, a one-fifth interest in a certain patent No. 1,012,024, and, for the year 1919, received $27,163.20 as royalties, the same being his share of a 10 per cent royalty on net sales of the product manufactured under the patent. The Commissioner has refused to allow any deductions for exhaustion of the patent.

      2. The circumstances of the acquisition of the interest in the patent were as follows:
    The patent in question was originally issued December 19, 1911, to one J. It. Stephenson, an employee of the National Automatic Tool Co., an Ohio corporation. He assigned this patent to the corporation. In 1913 another corporation of the same name was formed under the laws of Indiana, which took over the assets of the Ohio corporation. All the assets of the Ohio corporation, with the exception of the patents, were transferred to'the new corporation. This left the ownership of the patent in question in the Ohio corporation. William F. Bockhoff was the sole stockholder of the old corporation and, upon its dissolution, became the sole owner of this patent. William F. Bockhoff then made a contract or royalty agreement with the new corporation, by the terms of which the corporation was granted the exclusive right to manufacture under said patent, for which it was to pay 10 per cent on the sales of the machinery manufactured under this patent. Subsequently, as of June 30, 1917, the said patent was transferred as a gift by William F. Bockhoff to his wife and four children — one fifth to each. The taxpayer, Harry W. Bockhoff, was one of the children and, in 1919, received $27,123.20 as his share of the royalties.
    3. The patent was on a certain machinery device known as a “ Variable Speed Multiple Drill.” The ordinary unpatented drills had but one speed, while, under the patent, drills were enabled to be operated at two or three rates of speed. It gave the choice of two or more independent changes of speed to each drill at the will of the operator, permitting the simultaneous drilling of different sized holes at different speeds in the same operation. This feature excited great interest in the tool industries and at once caused an increasing demand for this type of machine. There were several types of this machine, with prices ranging from approximately $1,000 to $4,000, and weighing from 3,000 to 10,000 pounds, depending upon the number of sizes of drills in each machine. The additional cost of a variable-speed machine over a single-speed machine ranges from $35 to $50, while the difference in selling price was approximately $160. The principal market of the device consisted of the manufacturers of automobiles, automobile parts, electrical equipment, heavy cast-iron parts, textile-making machinery, and auto-repair shops. By 1917 the advantages of the variable drills were well known in the tool industry and among the manufacturers requiring drilling machinery. The product had long passed the experimental stage and had become the standard equipment of leading manufacturers and was rapidly replacing the one-speed drill. Its market and usage had become established in the machinery trade. The said National Automatic Tool Co. manufactured-both the single-speed and the variable-speed drills, but the greater-portion of the demand was for the variable-speed machine. The relative sales of the single-speed and the variable-speed models, for the period 1913 to 191V, were as follows:

    It will be noted that the total sales of the variable-speed model for the fiscal year ended June 30, 191V, was $658,35V.43 and constituted 86.6 per cent of all types of drills .‘sold.
    4. As of June 30, 191V, the National Automatic Tool Co. could reasonably anticipate and expect, for the remaining life of the patent (11 years, 5 months, and 19 days) sales of the patented device of the average annual sum of at least $600,000, and an annual income of $60,000 to the owners of the patent.
    5. The taxpayer claims a value of $525,628.20 for the patent at the date of his acquisition, that his one-fifth interest was worth $105,155.64, and that the annual deduction for exhaustion of his interest should be $9,556.8V. The Commissioner refused to allow any deduction, for exhaustion of the patent, from the gross income of the taxpayer.
    6. The total value of the patent as of June 30, 191V, the date of acquisition by the taxpayer, together with the contract, was $33V,000, and the value of the taxpayer’s one-fifth interest was $6V,400. The annual deduction for exhaustion of the taxpayer’s interest in the patent over its remaining life of 11 years, 5 months, and 19 days, is $5,8V9.V9.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, in accordance with Rule 50.
   OPINION.

Tkammell

: The sole question involved in this appeal is whether the taxpayer shall be allowed a deduction from his gross income for the year 1919, for exhaustion on his one-fifth interest in a patent acquired by gift as of June 30,1917. Section 214 (a) (8) of the Revenue Act of 1918 provides:

Sec. 214. (a) That in computing net income there shall be allowed as deductions :
(S) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

This Board has already held that deductions for exhaustion of patents are allowable under this statute. Appeal of Union Metal Manufacturing Co., 1 B. T. A. 395. The fact that it was a gift to the taxpayer and that he owned but a fractional part of the patent does not deprive him of the right to a deduction on account of the exhaustion thereof. The real question in this appeal is the determination of the value of the patent at the time of acquisition by the taxpayer and the proper rate of exhaustion.

It is very apparent that the patent had a substantial value at the time of acquisition. By means of the patent, the corporation manufacturing thereunder was able to create increasing sales in a practically unlimited market. In 1919 it paid the taxpayer $21,123.20 royalty, which represented but one-fifth of 10 per cent of the sales for that year. The question now is whether there is sufficient evidence to find a value for the patent from which the proper amount of exhaustion can be deducted. We must find a value as of June 30, 1911, the date of acquisition by the taxpayer, using the factors available at that time. The evidence is convincing that sales in the sum of at least $600,000 per year could have been reasonably anticipated under the circumstances. Witnesses familiar with the machinery market, and particularly this patented machine, who took into consideration the fluctuation of the market, possible business depressions, etc., testified that the minimum average of sales per year for 11 years should be well over $600,000. Although figures of sales in subsequent years have not been given us, it-is evident that, since in 1919 the taxpayer received $21,123.20, representing one-fifth of 10 per cent royalty, the 1919 sales were greater than the estimate we are asked to accept.

Having established that $600,000 a year in sales could reasonably have been anticipated for the remaining life of the patent, the owners of the patent would then be assured of an income of at least $60,000 per year. The total return for 11 years would be $660,000.

In consideration of all the facts and circumstances of this appeal, we find that the value of the patent at the time acquired was $337,000. The taxpayer’s interest therein would be one-fifth of this sum, or $67,400. The annual deduction for exhaustion of the taxpayer’s interest in the patent over its remaining life of 11 years, 5 months, and 19 days, is $5,879.79. We are of the opinion that the taxpayer is entitled to a deduction of $5,879.79, as exhaustion, from his gross income for the year 1919.


author: Teammell

text:
    Appeal of DAVID GIBSON CO.
    Docket No. 2458.
    Submitted October 22, 1925.
    Decided February 3, 1926.
    On the evidence, held,, that the taxpayer is not entitled to a greater deduction in 1918 on account of abandoning or discarding manuscripts than that allowed by the Commissioner.

      Paul Potter, Esq., for the taxpayer.

      W. Frank Gibbs, Esq., for the Commissioner.
    Before Phillips and Trammell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1918. The petition states, and the Commissioner’s answer admits, that the taxes in controversy amount to $1,599.22. The letter from which the appeal is taken states an additional tax of $1,711.45, less an overassessment of $202.75, or a net additional tax of $1,508.70, to be due for 1918.
    The error alleged is the disallowance by the Commissioner of part of a claimed deduction on account of obsolescence of manuscripts.
    FINDINGS OP FACT.
    The taxpayer is an Ohio Corporation, with its principal office at Cleveland. It was organized in June, 1908, with a capital stock of $10,000.
    About one-third of the capital stock was issued to David Gibson in exchange for some 375 or 400 manuscripts, which had been written by Gibson, covering: general editorial matter, such as economic and business subjects, short sketches and stories, and biographies. R. E. Evans turned in to the corporation certain contracts for the publication of magazines, in which it was proposed to use the Gibson manuscripts, receiving in exchange about one-third of the capital stock of the taxpayer. The remainder of the stock was issued to R. E. Gammel for cash in the approximate amount of $8,300.
    The manuscripts acquired from Gibson were entered on the books of the taxpayer as an asset, at a cost of $3,000, or $8 per manuscript. Thereafter, Gibson and one Feather, who became an officer of the company in 1916, prepared numerous manuscripts for the taxpayer, and some were purchased by it for amounts ranging from $10 to $25 each, about 2,000 being acquired by these methods to and including the year 1918. Gibson and Feather were paid salaries for their services, which included the preparation of manuscripts. The cost of the manuscripts purchased was originally entered on the taxpayer’s books as a capital expenditure, but was later charged to expense.
    The manuscripts acquired from Gibson upon organization of the taxpayer had an average fair market value as of March 1, 1913, of at least $8 each.
    The taxpayer, in some instances, rented out its manuscripts, and, in others, used them in what it termed “ house organs,” that is, by surrounding the text or editorial taken from the manuscripts by advertising and selling the publication thus prepared to the advertisers.
    Some of the manuscripts were used regularly by the taxpayer in its business from 1908 to and including 1916. In 1917, it considered that about 100 of them had become obsolete and could no longer be used, and it accordingly charged off on its books the sum of $800. In 1918, the taxpayer deemed the remaining original manuscripts, about 275 in number, to have become obsolete and charged off $2,200 to cover the claimed loss.
    It was considered by the taxpayer that the manuscripts had become obsolete, due partly to the fact that the subject-matter of the writings had been used frequently and to the point where it was no longer of interest to the public, and partly to the changes over a period of years, and particularly during the war period, in theories underlying certain of the subjects treated in these writings.
    The company has made no use of, nor has it offered to sell, any of the manuscripts since 1917 and 1918, when it charged them off, although it still retains them in its files.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Teammell

: The Commissioner, in adjusting the tax liability by allowing a deduction on account of the abandonment of 66 manuscripts, on the basis of a value of $8 each, did so on the theory that, with the exception of those used in 1918, the others had become obsolete prior to that time. A tabulation of the years in which the manuscripts were used, submitted by the taxpayer, shows that no use of a great many of them was made after the first few years following their acquisition, while others were used several times during the entire period of 1908 to 1918. Some were used only once, and others a number of times. The testimony of the former secretary-treasurer and editor is to the effect .that the manuscripts were not discarded .prior to 1918, for the reason that they had a potential value. However, a number of the writings were not used after the first few years of the organization of the taxpayer company. Others were discarded later, and we are of the opinion that those manuscripts became obsolete prior to the year 1918. A deduction may be allowed in 1918 with respect only to those manuscripts which were abandoned or discarded in that year. We believe from the evidence, however, that those manuscripts which the taxpayer had ceased to use prior to 1918 were abandoned and became obsolete prior to that year.


text:
    Appeal of L. M. and ANNA R. MAUS.
    Docket No. 1322.
    Submitted September 21, 1925.
    Decided February 3, 1926.

      L. M. Mans for the taxpayers.

      B. O. Bimpich, Esq., for the Commissioner.
    Before Marquette, Green, and Loto.
    The taxpayers have appealed from the determination of a deficiency in income tax for the year 1922 in the amount of $78.
    FINDINGS OF FACT.
    The taxpayers are husband and wife, living together at Hot Springs, Ark. They filed a joint return for the calendar year 1922. During the year 1922 they were the owners of two houses, one a brick structure, situated on Kalorama Road, Washington, D. C., the other, of frame construction, situated in Frankfort, Ky. These houses are rented by the taxpayers and are among the taxpayers’ chief sources of income.
    The Kalorama Road house was purchased in 1920 for a consideration of $18,500, and a reasonable allowance for the exhaustion, wear and tear thereof is 2 per cent per annum. Through error the purchase price of this property was reported as $6,000, and depreciation at 2 per cent was allowed on that amount.
    The taxpayers made contributions during 1922 to the following corporations and funds operated exclusively for religious purposes, no part of the net earnings of which inured to the benefit of any private stockholder or individual:

      1. Southern Presbyterian Church, Frankfort, Ky_$75. 00
    2. Northern Presbyterian Church, Frankfort, Ky_ 75. 00
    3. Presbyterian Church, Rockville, Md_100.00
    4. Washington Heights Presbyterian Church, Washington, D. C_ 62.00
    5. The Missionary Cause, Emboni, Africa_ 50.00
    6. The Missionary Cause, Hankow, China_ 20.00
    382.00
    During 1922, Maus had two sisters, one a widow aged 81, and the other a spinster aged 71. Both were entirely dependent upon and received their chief support from him, and were incapable of self-support because of physical defects due to age.
   DECISION.

The deficiency should be computed in accordance with the foregoing findings of fact. Final determination will be settled on 10 days’ notice, under Bule 50.


author: Phillips

text:
    Appeal of MAXWELL E. BESSELL.
    Docket No. 4971.
    Submitted October 27, 1925.
    Decided February 3, 1926.
    A partner is required to return as income only the share of the partnership profits which he is entitled to receive.

      Edward F. Dalton, Esq., for the taxpayer.

      Ellis W. Manning, Esq., for the Commissioner.
    Before GeatjpneR, Trammell, and Phillips.
    This is an appeal from the determination of a deficiency of $427.97 income tax for 1919, due to an increase in the amount of income alleged to have been received from the partnership of Bayne, Hine & Co.
    FINDINGS OE FACT.
    On January 1, 1918, taxpayer became a partner in the firm of Bayne, Hine & Co. Prior to that date taxpayer had been an employee of a partnership doing business under the same name and consisting of the same individuals who, with taxpayer, formed the new partnership.
    The capital originally invested in the preceding partnership had been impaired and it was provided in the partnership agreement that, except for salaries, no profits should be distributed until this impairment of the capital of the other partners had been replaced. Taxpayer had no interest in such capital. It was further agreed that, after payment of salaries and the restoration of the capital investment of the other partners, taxpayer should receive 10 per cent of the profits.
    During 1918 and 1919, taxpayer withdrew his salary, but the partnership profits were all used to restore the capital of the other partners, and no part thereof was paid or credited to taxpayer. Taxpayer’s membership in the firm ceased on December 31, 1919, and he never received from the firm any profits other than such salary. No part of the partnership assets was contributed by the taxpayer.
    In his 1919 income-tax return, taxpayer returned the salary as income. Upon an audit of the return, the Commissioner increased this income by 10 per cent of the profits of the partnership, after deducting salaries.
    DECISION.
    The deficiency determined by the Commissioner is disallowed.
   OPINION.

Phillips

: It is apparent from the findings of fact that the Commissioner has charged taxpayer with income which is properly chargeable to the other members of the partnership. The senior members of the partnership had originally contributed capital in the business which had been impaired during the continuance of the previous partnership. One of the conditions of the new partnership was that all profits in excess of salaries should be credited to such senior partners until the original capital invested was restored, and this disposition was made of the profits for 1919.


author: Sternhagen:

text:
    Appeal of SHARPSVILLE BOILER WORKS CO.
    Docket No. 1873.
    Submitted August 8, 1925.
    Decided February 3, 1926.
    1. Upon the evidence, held, tbe taxpayer did not file a false or fraudulent return with intent to evade tax. Fraud penalty disallowed.
    2. Amount authorized in 1917 as retroactive compensation for 1916 to officer-stockholders disallowed as ordinary and necessary expenses of 1917. Reasonable amounts as salaries for 1917 and 1918 determined.
    3. Amount of deduction for depreciation and obsolescence determined.

      Hugh Satterlee, Esq., for the taxpayer.

      E. G. Smith, Esq., for the Commissioner.

      Before Sternhagen, LaNSdoN, Green, and Love.
    This is an appeal from the determination of a deficiency of $77,-325.38 in income and profits .taxes for the years 1917, 1918, and 1920, and fraud penalty in connection with the taxes for 1917.
    The errors assigned are:
    (1) The inclusion in net income for 1917 of $49,100, deducted as accrued officers’ salaries.
    (2) The wrongful determination of a fraud penalty of $37,073.38 for 1917.
    (3) The inclusion in net income in 1918 of $4,333.32, deducted as officers’ salaries.
    (4) The inclusion in net income for 1918 of $4,275.89, deducted by the taxpayer for exhaustion, depreciation, and obsolescence.
    (5) The inclusion in net income for 1920 of $9,651.05, deducted by the taxpayer for exhaustion, depreciation, and obsolescence.
    The Commissioner in his answer alleges that the sum of $49,100, which was disallowed as a deduction for officers’ salaries in 1917, was in fact a reserve for the contemplated distribution of profits of the business to its officer-stockholders. The charge of fraud rests upon the contention that this sum was charged to expenses and was so reported by the taxpayer, falsely and with intent to evade the tax.
    The Commissioner further alleges that the amount of the deficiency asserted in the notice mailed to the taxpayer, viz, $77,325.38, should be increased by the amount of tax which will result from adding to net income for 1918 additional sums which he claims should be disallowed as deductions from income. These claims are: (1) that the amount disallowed as officers’ salaries in this year should be $18,530.64, instead of $4,333.32, as heretofore asserted, the increase being $14,197.32; and (2) that the amount of depreciation disallowed should be $11,871.89, instead of $4,275.89, the increase being $7,596. The Commissioner abandoned the last-mentioned claim at the hearing.
    FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation, engaged in the business of manufacturing steel-plate work at Sharpsville. It was incorporated in 1907 with the name “ Sharpsville Boiler Works.” For some time prior to December, 1915, the company had not been prospering. In that month and year the plant was leased to Hugh J. Garvey and John L. Considine for a period of six months from January 1,' 1916, and they, at the same time, obtained an option to purchase for $4,000 all of the outstanding capital stock, amounting to $11,000 par value. Garvey and Considine took into association with themselves Francis W. King, who had been connected with the taxpayer as a stockholder and officer since its incorporation. They engaged James P. Keene, who had been employed by the taxpayer as manager since October, 1915, and Charles D. Fagan, to run the plant. It was operated by Garvey, Considine, and King in partnership until June, 1916, when they exercised the option to purchase the outstanding stock. On June 28, 1916, the name was changed to “ Sharpsville Boiler Works Company,” and the authorized capital stock was increased from $15,000 to $50,000 par value. The three purchasers then paid in to the company $4,000 in cash, and there was issued or transferred to each of them $5,000 par value of stock.
    On February 10, 1917, the following officers were elected:
    Hugh J. Garvey, president; John L. Considine, vice president; Francis W. King, treasurer; Charles D. Fagan, secretary; and James P. Keene, general manager.
    These men continued in the respective offices mentioned during 1917 and 1918, with the exception that Considine resigned as vice president on July 1, 1918.
    On June 29, 1916, Garvey, Considine, King, Keene, Fagan, and W. C. McGaffic were elected directors. McGaffic served as a director until December 8, 1916, when he resigned. The others continued as directors and constituted the board during 1917 and 1918, with the exception that Considine resigned on August 1, 1918, and R. F. Sawyer was elected a director in his place.
    Keene and Fagan were given the right to, and each did, purchase $5,000 par value of stock for the sum of $2,666.67, this sum being the cost to each of the other three men of the same amount of stock. In March, 1916, W. C. McGaffic was employed and given a similar right to purchase stock. McGaffic left the employ of the taxpayer on December 8, 1916. A settlement was made with him at that time under which he was paid $2,514, and he released all right to or interest in stock of the company under the agreement mentioned above.
    On May 23, 1917, the board of directors, at a special meeting, adopted a resolution providing for the transfer of the property, assets, and contracts of the copartnership consisting of Garvey, Considine, and King, which operated the property between January 1 and July 1, 1916, and an assignment accordingly was executed on May 23, 1917.
    The following were introduced as minutes of the corporation:
    Annual meeting, February 10, 1917:
    As verbally agreed between the Directors last month, it was resolved that James P. Keene, General Manager and Charles D. Pagan, Secretary, be allowed a drawing account of «$200.00 per month each for the first four months of this year.
    It was further agreed that all of the officers receive same compensation for their services as heretofore, but in order to allow the Company the advantage of Raving all possible working capital, that no other Officers take out any cash at present, their salaries however to be credited on the books to them and payable on demand, as well as the balance of salary due Messrs. Keene and Fagan.
    Special meeting, April 24, 1917:
    The Secretary stated further, that Mr. Keene and he were of the opinion that their drawing account should be increased, as they had been drawing only a nominal amount to date, in fact much less than they felt they were entitled to for the services rendered, and as the business now appeared in condition to pay them a salary in cash, they would like to have an expression from the Directors.
    The matter was discussed at length. Messrs. Garvey, King and Considine, who are also Officers of the Company expressed the opinion that they also, in view of the business being in better position to take care of its obligations, felt that they too should be entitled to a drawing account as they had received no salary in cash from the Company since its reorganization.
    The following drawing' accounts were decided upon for the remainder of the year, subject to change by the Directors at any time the business appeared to be in need of additional working capital or when it was the consensus of opinion that it would be for the good of the business for the drawing accounts to be reduced.
    James P. Keene and Charles D. Fagan:
    For May, June and July $250.00 per month, August $400.00, balance of year $650.00 per month, each.
    Hugh J. Garvey, J. L. Considine and F. W. King:
    For June and July $100.00 per month, August $250.00, balance of year $500.00 per month, each.
    Meeting, May 24, 1917:
    As stated in previous minutes James P. Keene and Charles D. Fagan were given a certain drawing account and balance of April 30th, 1917 shows that account of James P. Keene is overdrawn $344.16 and account of Charles D. Fagan overdrawn $386.55. The Directors of the Company hereby authorize the Treasurer to pay to the above named parties, James P. Keene and Charles D. Fagan the sum of $344.16 each as a bonus, balancing Keene’s account to April 30th, 1917 and leaving a balance of $42.39 in Charles D. Fagan’s account. Charles D. Fagan to reimburse the Company with this amount.
    Special meeting, August 5 [year not stated] :
    On motion it was unanimously resolved that Hugh J. Garvey, President, receive a salary of Five Hundred Dollars ($500.00) per month, John L. Considine, Vice President, receive a salary of Five Hundred Dollars ($500.00) per month; Francis W. King, Treasurer, a salary of Five Hundred Dollars ($500.00) per month; Charles D. Fagan, Secretary, a salary of Six Hundred Fifty Dollars ($650.00) per month and James P. Keene, General Manager, a salary of Six Hundred Fifty Dollars ($650.00) per month.
    It was further resolved that this action be retroactive and that said salary date back to January 1st, 1916.
    It was further resolved that only the General Manager, Mr. Keene and the Secretary, Mr. Fagan, draw any salaries in cash for the present and that whatever amount they draw be nominal only, and that these amounts be fixed from time to time by the Board of Directors. In every instance salaries not paid or part of salaries not paid to be entered on the books of the Corporation as a debit against the Company. These entries to be made from time to time as the Directors may elect. Back salaries not to draw any interest from the Company.
    It was further agreed that drawing account of $125.00 per month drawn by Messrs. Keene and Fagan from January 1st, 1916 to be in effect until October-1, 1916 and that they be permitted to draw $150.00 per month for balance of the year, subject to change at pleasure of the Directors.
    Annual meeting, February 11, 1918:
    The following salaries were agreed upon for the year 1918, it being understood, of course, that the Directors reserve the right to change same at their pleasure should conditions necessitate such action:
    Hugh J. Garvey, $500.00 a month.
    John L. Considine, $500.00 a month.
    Francis W. King, $500.00 a month.
    James P. Keene, January to July inclusive $650.00 a month, balance of year $800.00 a month.
    Charles D. Fagan, January to July inclusive $650.00 a month, balance of year $800.00 a month.
    After the reorganization, the minutes of directors’ and stockholders’ meetings were kept in typewritten form in a loose-leaf book, until the end of 1916. Objection was made by Keene to having the stenographer know the content of the minutes. Fagan thereupon acquired a bound book and commenced recopying into it in handwriting the minutes that had already been typewritten. Thereafter, Fagan kept memoranda of meetings and would copy them into the bound book as he found time. In 1922 the taxpayer had negotiations with a banking house relative to a bond issue, and Fagan was advised by the bankers to put the minutes in good shape because an audit was to be made. He thereupon obtained a loose-leaf book and had all of the minutes recopied therein, dictating those which he had still in memorandum form, and this book is the present minute book of the company. The recopied minutes were checked by Sisk, then secretary, and Fagan, and were signed by Garvey and Fagan. The two other books were lost.
    The following table shows the amounts of salaries for 1916 and 1917 specified in the resolutions set forth above and the years and amounts in which they were paid:

      The taxpayer’s books were kept and its tax returns were made on the accrual basis. The salaries not paid in 1916 were not entered on the books in that year.
    In April, 1917, a public accountant made an examination and report on the financial position of the taxpayer. He set up the capital account; up to that time no capital entries had been made. There were then no charges on the books, and no reserves had been created, for unpaid officers’ salaries. On or about December 31, 1917, and before the closing of the books for 1917, the following entries were made in the journal:
    General Expense (a/c Operating Expense)_$47,600.00
    a/e Payable_$47, 600.00
    Eor salaries due officers. Eor detailed explanation see adjustment sheet of Dec. 31, 1917, in possession of Auditor.
    General Expense_ 1, 500. 00
    a/c Payable_ 1, 500. 00
    Reserve for salaries due King, Oonsidine and Garvey for Dec. a/c and not paid until January, 1918.
    On September 26, 1918, the above item of $47,600 was debited to accounts payable, and the accounts of the several officers were credited as follows:
    Payment of stock H. J. Garvey_$9, 550.00
    Payment of stock E. W. King_ 9, 500.00
    Personal account J. L. Oonsidine_ 9, 500.00
    Payment of stock Charles D. Eagan_ 9,475.00
    Payment of stock James P. Keene-1- 9,475.00
    This entry was made on the advice of a public accountant then examining th.e books.
    The officers in their personal-tax returns for 1917 reported the amounts received as salaries. The accountant told them, when he was there in September, 1918, that they should have reported the total amount credited to them, and he recommended filing amended returns. Later, Fagan consulted a man in the office of the collector of internal revenue at Pittsburgh, who expressed the same view. In June, 1919, he filed an amended return, reporting a salary of $14,025; the original return showed $4,550. Fagan’s original return was made on a cash basis; he did not keep any books. Each of the officers, except Keene, filed an amended return, reporting the amount of salary credited to him.
    In the summer of 1918, an agreement was made between Garvey and Fagan for the purchase of the interest of the latter for $20,000. It provided for the sale by Fagan of 50 shares of stock and a “right to back salary due him by the company” amounting to $9,475. Garvey paid Fagan $10,000 on account of the purchase price. The agreement was later rescinded and the $10,000 was returned. In December, 1918, Keene, for a consideration of $20,000, agreed to sell his interest to Garvey, who was acting for himself, King, Sawyer, and Fagan. Keene executed a bill of sale and release for 100 shares of stock and a claim “ for back salary due ” amounting to $4,475.
    We find that the return for 1917 filed by the taxpayer was not false or fraudulent with intent to evade taxes.
    Keene was general manager and had charge of production and erection. He also assisted on estimates. He was in the shop- during the daytime and spent evenings in the office. Fagan assisted Keene in the shop, helped purchase materials, and worked on estimates. As secretary, Fagan kept minutes of the meetings. He also had charge of the accounting books; the first entries were made by him, and thereafter he directed the bookkeeper. He handled such of the correspondence as was not taken care of by Garvey, Consi-dine, or King. Keene and Fagan were the only operating men, aside from the ordinary labor. During 1916, 1917, and 1918 it was their custom to go to work about 6 or 7 in the morning, to work all day, and to come back in the evening; they also worked nearly every Sunday. *
    Garvey and King were regularly employed by another concern in Sharpsville, which was engaged in making ingot molds. Consi-dine was vice president of a steel company at Sharon, Pa., and was regularly engaged there. All three spent many evenings and Sundays at the plant during 1916, 1917, and 1918. It was their custom to have meetings in the evenings to. go over the affairs of the taxpayer. Garvey or King, or both of them, were at the plant at some time during the day, and Keene and Fagan frequently would go to their offices for advice. Considine was not there as much as the other two, but he was consulted over the telephone. Garvey, King, and Considine, in consultation with Keene and Fagan, decided on the methods of conducting the business and how to employ the capital; they assisted in getting orders, and through their connections obtained steel that was essential to the operation of the business.
    Garvey enabled the taxpayer to get steel plate on credit. He was able to obtain freight cars when there was a shortage. He usually came to the plant at noon and in the evenings after he had finished at his other place of employment. Garvey or King signed all the checks.
    King had lived in Sharpsville 25 years and knew conditions there. He assisted in starting operations after the plant was leased; established plant records; secured new employees; found living quarters for them; obtained concessions on city property; assisted in purchasing additional property; secured water and sewer connections; and helped to get railroad crossings through. He endorsed notes; arranged with banks *for credit; arranged terms with customers ; got credit for materials, and secured extensions of credit.
    Considine rendered valuable services in obtaining steel and securing credit. Owing to the war it was difficult to get steel during this period and often it could not have been obtained without Con-sidine’s assistance. Some of it was bought through the purchasing department of his company,' and the taxpayer was thereby given the benefit of a low contract price. He also obtained inquiries from prospective customers. He guided the others on costs and selling prices, and he had drawings and designs made. Through his assistance four or five months’ credit was obtained.
    The net income returned by the taxpayer for 1917 was $20,036.81; for 1918, $16,662.51.
    The following tabulation shows the amounts of salaries for the years 1917 and 1918, either paid or accrued in those years, respectively, the amounts allowed by the Commissioner, and, in the case of 1918, the amounts which the Commissioner in his answer alleges are proper:

    We find as a reasonable allowance for salaries the following amounts for 1917 and 1918:

    Considine resigned as vice president on July 1, 1918. Sawyer commenced his service with taxpayer on July 1, 1918; he was not with the taxpayer in 1917. Keene resigned on December 4, 1918.

      The following table shows the figures used and depreciation found by the Commissioner for 1918:

    The taxpayer in its return deducted a total of $14,391.04.
    For 1920 the Commissioner found depreciation as shown by the following tabulation:

    The amount deducted by the taxpayer was $22,018.51.
    In arriving at the depreciation on the additions, the Commissioner took 50 per cent of the cost as representing the average for the year.
    The Commissioner adopted for factory buildings a rate of 10 per cent; for machinery and fixtures 10 per cent; and for motors and wiring 15 per cent. In 1918, however, the rate for factory buildings was increased 50 per cent, because of the effect on the buildings of fumes from surrounding plants; the rates for machinery and fixtures and for the additions to motors and wiring were each increased 50 per cent, because of overtime work.
    The taxpayer claims the Commissioner has failed to take into account property that became obsolete in 1918, amounting to $2,-138.42, and in 1920, to $8,391.15. It contends that the depreciation (including obsolescence) originally taken by it should be allowed, or, if the Commissioner’s figures are adopted, the obsolescence should be added; or, in the alternative, that its depreciation should be revised for the years 1918, 1919, and 1920, in accordance with the following statement:

      The following is a comparison of the taxpayer’s original claim, the Commissioner’s allowance, and the revised depreciation contended for as an alternative:

    The property named below became obsolete and was scrapped without salvage in 1918 and 1920:

      Obsolescence, 1918.

      The following statement shows the depreciable costs claimed by the taxpayer:
    1918.
    Factory buildings:
    Cost to Jan. 1, 1918_$20, 299. 77'
    Additions in 1918—
    Oct. 31-$7, 000. 00
    Dec. 31- 1, 500. 00
    3, 504. 30 2, 400.00
    - 14,404.30i
    Sept. 30-1_ 351.00
    Oct. 31_ 700.00
    Nov. 30- 300. 00
    16. 26 136.00
    Dec. 31 _ 482. 24
    100. 00
    -' 2, 085. 50
    36, 789. 57
    Office building: Erected in 1918_ 10, 332. 54
    Machinery and fixtures:
    Cost to Jan. 1, 1918_ 20, 553. 67
    Additions in 1918_$25,309. 20
    1, 336. 58
    - 26,645.78
    Motors and wiring:
    Cost to Jan. 1, 1918_ 1,432. 00
    Additions in 1918_ 6,179. 77
    Automobiles:
    Cost to Jan. 1, 1918_ 2, 358.70
    Additions in 1918—
    Jan. 31_._ 675. 00
    July 31, credit, property sold_ 250. 00
    1920.
    Factory buildings:
    ---$37,417. 74 Cost to Jan. 1, 1920.
    Additions in 1920-
    _ $600.00 Dec. 30_
    _ 397.29 31_
    -- 997.29-
    Office building: Cost to Jan. 1, 1920_ 10,332.54
    Machinery and fixtures:
    Cost to Jan. 1, 1920_!_ 65,854.26-
    Additions in 1920_■_ 8,285. 96
    Motors and wiring:
    Cost to Jan. 1, 1920_ 9, 298.10-
    No additions.
    Automobiles:
    Cost to Jan. 1, 1920_ 2, 784. 50-
    No additions.

      We find these cost figures should be revised as indicated below, and that, as so changed, they are correct.

      Factory buildings. — The cost to January 1,1918, should be reduced by $1,669.29, being the cost of property which became obsolete and was charged off in 1918. There should be eliminated from the additions made during the year the expenditures made on December 31, 1918, and on December 30 and 31, 1920.
    In ascertaining depreciation on the other additions, it should be computed from the dates on which the expenditures were made, respectively.'

      Office building. — There is no evidence of expenditure in 1918. The books show an entry of $9,332.54 in 1919. This amount should be used for 1920.

      Machinery and fixtures. — The January 1, 1918, cost should be reduced by the cost of property scrapped and charged off in this year which was acquired prior thereto, amounting to $1,069.70. The January 1, 1920, cost should be reduced $7,768.65 for property scrapped in 1920. The additions in 1918 should be reduced by the amount of $467.38, and additions in 1920 by $1,910, being the cost of property acquired and scrapped in the same year.
    We find that the rates of depreciation used by the Commissioner are reasonable, except that the rate of 22½ per cent for motors and wiring in 1918 should apply to the property acquired prior to January 1, as well as to that added during the year.
    In addition to depreciation ascertained as above set forth, there should be allowed deductions for obsolescence as follows:
    1918.
    Factory buildings-$1, 035.24
    Machinery and fixtures_ 1, 052. 23
    1920.
    Machinery and fixtures. $8, 371.15
    DECISION.
    The deficiency should be recomputed in accordance with the findings of fact and opinion, and settled on 10 days’ notice, under Bule 50.
   OPINION.

Sternhagen:

There are three main subjects of controversy between the parties: (1) Fraud, (2) salary deductions, and (8) depreciation deductions. The fraud penalty is based entirely upon the taxpayer’s salary deduction and most of the evidence was directed to these two related issues. Throughout a prolonged hearing there was much conflicting evidence, from which it is extremely difficult to conclude with certainty what the facts in many respects actually were. The recollections of the numerous witnesses were at variance, sometimes as to details and sometimes as to matters of primary significance. Some of the witnesses had long since quar-relled and their testimony was unmistakably affected by their personal feelings. During the early history of this business things were moving rapidly and it was apparently difficult to ascertain clearly what happened or why. But the Board is charged with the duty of making findings of fact as the basis of its decision, and therefore, out of varying and conflicting evidence, wé have sought to find the preponderance and base our findings thereon.

(1) Fraud. — The Commissioner has asserted that there was a fraudulent return with intent to evade tax, and hence he has determined that the normal deficiency should be augmented by a penalty of $37,073.38 for 1917. This is based upon the view that the taxpayer’s deduction in 1917 of $49,100 in officers’ salaries was knowingly false because no such obligation existed during the taxable year and that the officers signing the return knew that there was no such liability, j While there is some substantial conflict in the evidence as to whether and when this liability arose, and while the impression which we gather is not free from doubt, we can not sanction an assessment of a fraud penalty on mere suspicion or because the memories of witnesses may falter or conflict. Upon its face, the transcription of the minutes from one book to another and the disappearance of the old book and of the intervening supporting memoranda, the cutting out of pages of the journal and repasting, the pencil and pen interlineation of dates and substituted words, are unquestionably sufficient to give rise to suspicion of fraud. They justify careful investigation, but such investigation as was made in the present instance is not sufficient to transform suspicion into conviction. The cutting of the journal pages and repasting were satisfactorily explained to remove all doubt. The date of the meeting purporting to fix the salaries is still in great confusion. Circumstantially, it appears to have taken place in August, 1917, although there are witnesses who recall no such meeting whatever. Keene, the principal witness for the Government, a former officer and director, said that no such meeting took place, but we can not resist the impression that Keene’s testimony was largely influenced by what he regarded as the necessity of self-protection from a personal deficiency, as we shall explain.

None of the officers included in his return more than the salary actually received, believing as they did that, upon the cash basis, this was a correct return. They were thereafter poorly advised, by both an outside accountant and a Government employee in the collector’s office, that they were required, although on the cash basis, to return and pay tax upon the full amount credited to them on the books of the corporation and deducted by the corporation upon its return on the accrual basis. Several of the officers acted upon this advice, filed amended returns, and paid additional tax. The Government then officially called upon Keene to do likewise. Keene refused to make an additional payment and stated that the alleged salary credited on the books and deducted by the corporation was unauthorized and did not represent a liability. Thus the Government’s suspicions were aroused, which resulted in the penalty.

It is, however, not without significance that an internal revenue agent twice investigated the affairs of the corporation, once before Keene’s alleged disclosure and again thereafter, and in neither of his reports did he suggest fraud or recommend a penalty as he regarded it his duty to do had he believed that fraud existed. It may be, of course, that this revenue agent was fooled, but he adhered to his position up to the time he left the witness stand at the hearing before the Board.

Four members of the Board heard all the persons who were familiar with the facts and observed them on the witness stand testifying either for the taxpayer or the Government, and after considering all the evidence we can not conclude that there was fraud. The penalty therefore is disallowed.

(2) Salaries. — The returns of the taxpayer were made upon the accrual basis, and for 1911 it included in its deductions for expenses the amount of $49,100, which was entered in the journal for 1917 as a closing entry. This amount was arrived at by applying the salaries set forth in the resolution of August 5 to the period back to January 1, 1916. We must examine this deduction and determine from the evidence whether it represents an accrued ordinary and necessary expense consisting of a reasonable allowance for salaries. In this connection much has been said as to whether the meeting took place August 5, 1916, or August 5, 1917 — assuming that it took place at all. This latter assumption we think is warranted. We are inclined to give credence to the several witnesses who testified that the meeting took place and that this was a correct record of the proceedings. It seems to us, however, from the circumstances, that the meeting probably occurred in 1917. Affairs in 1916 were too uncertain to make it probable that salaries at that time were fixed so greatly in excess of the amounts actually paid. The omission of salary to McGaffic is also some indication that the resolution was not made in 1916; for McGraffic was with the company in August, 1916, and quit in December. Furthermore, the resolution fixes salary for Considine as vice president, although there is no record of his election to this office until February 10, 1917. In an audit of April, 1917, by outside accountants, no mention is made of accrued salaries or of any obligation then outstanding or possible claims. And, moreover, the other minutes of 1917 lead one quite naturally to place this meeting in August, 1917. It was not until May, 1917, that the partnership property was transferred to the corporation, and it is not likely that this would be neglected by officers who were foresighted enough to determine a schedule of salaries for the distant future. We are therefore of the opinion that the meeting took place on August 5, 1917, when for the first time the obligation for salaries arose.

Thus we have the recognition in August, 1917, of the monthly value of the services and an entry at the close of that year applying this rate. But this entry included not only the application of the rate to 1917 but also to 1916, and it is contended by the taxpayer that this was an accrued obligation of 1917 and therefore properly deductible from gross income in that year. We are of opinion, however, that the argument goes too far. The statute permits the deduction of ordinary and necessary expenses, including a reasonable allowance for salaries, and, to the extent that an accrued expenditure goes beyond these statutory qualifications, it may not be deducted. By the resolution the parties have agreed upon the compensation for services rendered, and thus they have fixed what we may properly regard as the ordinary and necessary expense and the reasonable allowance for salaries. While it may be proper, and in this proceeding can not be questioned, that the corporation should recognize past services by making the new salaries retroactive and thus incurring a fixed obligation therefor, this is not conclusive that such an obligation represents a reasonable allowance for salaries for the taxable year or in other respects an ordinary and necessary expense for the taxable year. In view of the necessity of reaching a fair and practical disposition of these issues from a confused record, we are of opinion that the salary deduction for the years 1917 and 1918 should not exceed the amounts, heretofore set forth, aggregating $33,600 for 1917 and $32,311.68 for 1918.

(3) Depreciation. — The issue with respect to the deduction of a reasonable allowance for the exhaustion, wear and tear and obsolescence of the taxpayer’s property during the taxable years 1918 and 1920 is so much a question of detailed fact that discussion of our findings would serve no useful purpose. We have considered all of the evidence, including the exhibits. The taxpayer’s deductions have not been uniform, because the circumstances during the years in question were not uniform, and we can not therefore approve entirely the Commissioner’s computations. Nor, on the other hand, would we be justified in approving the deductions taken by the taxpayer; for in some instances they seem to involve duplications — depreciation being deducted upon property abandoned as obsolete during the year. We have therefore reached our independent conclusions, all of which are set forth in our findings of fact.