text:
    Appeal of Seaboard Mills, Inc., (Fleitmann & Co., Inc., Successor).
    Docket No. 5499.
    Decided November 20, 1926.
    Petitioner was not during the year 1918 a personal service corporation.

      Richard E. Dwight, Esq., and Jacob G. Schurman, Jr., Esq., for the petitioner.

      J. Arthur Adams, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1918, in the amount of $51,318.40, arising from the refusal of the Commissioner to classify the petitioner as a personal service corporation and from the increase by him of the net income for the year in the amount of $3,799.21, upon the ground that this amount, representing income and profits taxes for the year 1917, was deducted from 1918 income.
    FINDINGS OF FACT.
    The petitioner was incorporated October 27, 1914, under the laws of New York, to engage in business as selling agent for various cotton mills. In 1914, Fleitmann & Co., a partnership, was engaged in business as factors and commission merchants. In such capacity it made advances against merchandise to various mills for which it acted as sales agent. It had about twenty different departments, including a sales force engaged in selling the product of the various cotton mills and designated as the Cotton Department. One Bich-ardson and one Baldwin were employed as salesmen in this department. In 1914 the partnership was compelled to discontinue acting as factor and sales agent and this left the various mills, the sale of the products of which Henry C. Fleitmann, one of the partners, controlled, without a factor to finance their operation and without a sales agent. Thereupon, Henry C. Fleitmann, one of the partners who held contracts with the various cotton mills for the sale of their entire output, entered into negotiations with the firm of L. F. Dom-merich & Co. and induced that firm to act as factor for the mills. L. F. Dommerich & Co. agreed to the proposition but refused to have anything whatever to do with the selling of the goods produced by these mills. It was stipulated as a condition precedent to its undertaking to act as factor that Henry C. Fleitmann should have entire charge of the sale of the products of the mills which it represented. Fleitmann agreed to this condition, and in order to carry out the agreement organized the petitioner to act as sales agent. About. November 1, 1914, tbe various cotton mills which Fleitmann & Co. had theretofore represented entered into contracts with L. F. Dommerich & Co. of equal import. The contract with the Union Buffalo Mills Co. provided, in part, as follows:
    The Union-Buffalo Mills Co. will discount with and assign or cause to be assigned to L. S'. Dommerich & Co. all the accounts arising from the sale of its entire product from and after the 1st day of November, 1914; the sales are to be made by its own selling agent or agents. All expenses necessary for the business shall be borne by the Union-Buffalo Mills Co., or its selling agent or agents, including the billing and delivery of the goods, and L. F. Dommerich & Co. shall be under no expense except their own office and assume no responsibility or obligation except as hereinafter stated.
    The Union-Buffalo Mills Co. will duly assign or cause to be assigned all accounts which it renders to its customers to L. F. Dommerich & Co., such assignments to be made on a form acceptable to L. F. Dommerich & Co. All bills are to be sent to L. F. Dommerich & Co. for transmission to the customers. L. F. Dommerich & Co. will discount these bills to the Union-Buffalo Mills Co. monthly and make remittances monthly or, if required, oftener, after the goods have been delivered to and accepted by the customers.
    The Union-Buffalo Mills Co. agrees to allow L. F. Dommerich & Co. to retain, when remitting against these bills, an amount commensurate with the volume of business done to cover L. F. Dommerich & Co. against returns, claims, etc. All claims and returns shall be reported to L. F. Dommerich & Co. at once and are to be charged to the Union-Buffalo Mills Co. immediately and all payments made by L. F. Dommerich & Co. thereon shall be refunded to this firm upon demand and the amount of any such claims or of any deductions upon account thereof, made by customers from any payments due L. F. Dommerich & Co. may be deducted by L. F. Dommerich & Co. from subsequent remittances to be made by them to the Union-Buffalo Mills Co. but L. F. Dommerich & Co., (unless it be required for their own protection) shall pass no credits to customers for claims, deductions, returns, etc., without the instructions therefor from the Union-Buffalo Mills Co. The Union-Buffalo Mills Co. will attend to the settlement of all disputes with and claims of customers without expense to L. F. Dommerich & Co. All proposed sales shall be submitted to L. F. Dommerich & Co. and shall not be made unless L. F. Dommerich & Co. approve them in writing, in which case L. F. Dommerich & Co. guarantee to the Union-Buffalo Mills Co. the proceeds thereof after the goods have been delivered to and finally accepted by the customers as to price, terms and quality.
    * * ⅜ # * * ⅛
    L. F. Dommerich & Co. will charge on the 15th of the month in which the sales are made a commission of 4% on the amount of all sales for their services and the services of the selling agents of the Union-Buffalo Mills Co. L. F. Dommerich & Co. will render accounts current semi-annually, in which the interest is figured at the rate of six per cent (6%) per annum, pro and con.
    L. F. Dommerich & Co. agree to loan and advance to the Union-Buffalo Mills Co. in addition to the payments against sales, as provided for in paragraph 3, an amount not over $1,025,000. on open account at any time, but B. F. Dommerich & Co. shall not be required to make such loans or advances to the Union-Buffalo Mills Co. in excess of $100,000. per month but, however, should the sales be less, in any one year ending October 31 than $2,800,000, then L. F. Dommerich & Co. shall only be required to advance during the following year 10/28 of the previous year’s sales and the amount required each month by the Union-Buffalo Mills Co. shall be reduced proportionately.
    The Union-Buffalo Mills Co. agrees that they will not borrow from any banks or anyone other than L. F. Dommerich & Co. for any purpose other than legitimate business and that they will not give security other than cotton purchased in excess of approximately a month’s supply, for any outside loans without the consent of L. F. Dommerich & Co. and that their liabilities will not be increased to the detriment of L. F. Dommerich & Co.; it being understood and agreed that the net debts of the Union-Buffalo Mills Co. shall not be increased. L. F. Dommerich & Co. shall not be compelled to make advances to the Union-Buffalo Mills Co. if the condition of the money market in New York City makes it impossible for them to procure the funds.
    On October 23, 1914, L. F. Dommerich & Co. wrote the petitioner as follows:
    We beg to inform you herewith that we have to-day entered into contracts with the following companies, for the financing of their business:
    Union Buffalo Mills Co.
    Fairmont Manufacturing Co.
    Courtenay Mfg. Co.
    Warren Mfg. Co.
    Orangeburg Mfg. Co.
    Bamberg Cotton Mills Co.
    In consideration of these arrangements we shall pay to you, for the account of each manufacturer, out of the commission collected by us covering your and our services, a commission of 1%% on all sales made by you, except for the account of the Warren Mfg. Co., on whose sales we are to pay you one %.

    You are to act as selling agents for these companies and, as such, assume all responsibilities for the sales towards the manufacturers.
    You may obtain additional agencies for other companies if they are acceptable to us.
    All sales which you make must be made payable to us and cannot be made unless our credit office approves their terms and amounts.
    This understanding is to continue until November 1st, 1919. Either party shall have the right to terminate it on six months prior written notice at any time on or after November 1st, 1916.
    Kindly acknowledge receipt of this communication, thereby accepting all conditions contained therein.
    Upon its organization the petitioner acquired the selling contracts held by Fleitmann & Co. with the Union-Buffalo Mills Co., Fairmont Manufacturing Co., Bamberg Manufacturing Co., Orangeburg Manufacturing Co., Warren Manufacturing Co. and the Santee Mills Co., which was the successor to the Orangeburg Manufacturing Co. In exchange for these contracts the petitioner issued to Henry C. Fleitmann and those persons designated by him its capital stock of the par value of $75,000. Additional stock of the par value of $25,000 was issued for cash, making the total outstanding capital stock of the petitioner $100,000, which remained in that amount throughout the taxable year 1918.

      Between October 27 and November 2, 1914, the above mentioned mills, with the exception of the Santee Mills, which continued its contract verbally, wrote the petitioner as follows:
    As you know, we have entered into a contract with Messrs. L. F. Dommerich & Co. providing that for the term of the contract our product is to he sold by selling agents, subject to the approval of Dommerich & Co., and the accounts resulting therefrom are to be assigned to L. IP. Dommerich & Co. and guaranteed and accounted for by them. This contract is to continue from November 1st, 1914 to November 1st, 1916, and thereafter subject to termination on six months’ written notice.
    We confirm our understanding with you that for the term of this contract you are to act as our selling agents for the entire product of our mills, the sales to be subject to the approval 'of L. F. Dommerich & Co., and that you are on our behalf to assign the accounts to them and bill the goods through them upon forms which they may approve, thfe bills to be handed to them for transmission to customers in accordance with our agreement. Consignment invoices of the goods will be sent to you as well as customers’ receipts and shipping documents, the latter to be transmitted by you to Messrs. L. F. Dommerich & Co., and it is understood that you are to act for us in adjusting disputes with customers regarding claims, rejections, returns, cancellations, etc., and are to advise Messrs. L. F. Dommerich & Co. of any such adjustment.
    It is understood that all selling expenses, which in the conduct of the business heretofore through Fleitmann & Cp.’s cotton department have been borne by them, shall be borne by you with the exception of such part thereof as Messrs. L. F. Dommerich & Co. under their agreement with us may bear, and to cover your expenses and for your compensation you are to receive such part of the gross commission of four per cent (4%) on all sales charged by Messrs. L. F. Dommerich & Co. under their agreement with us as you may agree upon with them.
    This agreement is to continue until November 1st, 1916, and thereafter from year to year subject to termination on six months’ written notice.
    If this is in accordance with your understanding kindly confirm the same.
    At the time the petitioner acquired the selling agency of Fleit-mann & Co., Richardson and Baldwin were under contract with it for services and the petitioner, as the successor of Fleitmann & Co., paid to them $10,000 each in consideration of the cancellation of the existing contracts.
    During the year 1918 the capital stock of the petitioner was owned by Henry C. Fleitmann, president, in the amount of $60,000, Frank E. Whitman, treasurer, in the amount of $20,000, and Ell-roy Curtis, secretary and salesman, in the amount of $20,000. Each of the stockholders was regularly engaged in the active conduct of the affairs of the corporation. In addition to the stockholders, the petitioner employed two clerks who assisted in the sale of the product of the various mills termed “ seconds,” a telephone operator, two stenographers, an order clerk, a stock-book clerk, a sales clerk, an office boy, and a porter.
    As selling agent the petitioner sold the product of the cotton mills hereinbefore mentioned, advising such mills with respect to the most favorable time to sell their finished product or surplus raw materials and as to the most propitious time to purchase additional raw materials for future use. It secured for certain mills contracts for future deliveries and conferred from time to time with the factor, L. F. Dommerich <⅞ Co., concerning the progress and financial requirements of the various mills. All sales were made under the direct supervision of the officers and the stockholders, and were in the total amounts following:
    Union-Buffalo Mills Co_$6, 857, 447. 32
    Fairmont Manufacturing Co_ 597, 894. 59
    Warren Manufacturing Co_ 1,168, 685. 68
    Santee Mills_ 663, 882.62
    Bamberg Manufacturing Co_ 363, 719. 73
    Total_ 9, 651, 629.94
    Of the above amount, $4,727,327.44 represented sales made direct and $4,924,357.14 represented sales made through brokers, as hereinafter mentioned.
    Ninety-five per cent of the total sales during the year were made by the stockholders, the remaining 5 per cent of sales, representing the product of various mills termed “ seconds,” were made to the East Side New York trade by the two clerks employed by the petitioner, under the direct supervision of the stockholders. Although Fleitmann did not actually go out and take orders, he was the managing head of the business and a greater portion of the income was due to his activities. He supervised all sales and his judgment in all matters affecting the company was controlling.
    A little over one-half of the total sales represented the product of the mills sold by the stockholders of the petitioner through brokers who controlled purchases of this character by certain dealers. In cases where orders were secured by the petitioner through brokers, such brokers acted for and represented the buyers and, pursuant to trade custom, their commissions were paid by the mill making the sale and were deducted from the commission to which the petitioner was entitled upon the sale. The brokers were not at any time in the employ of the petitioner.
    In 1918 the petitioner held as investments, which were not used or employed in its business, the following securities: Liberty bonds in the amount of $7,400 at the beginning of the year and in the amount of $102,000 at the end of the year, 780 shares of the capital stock of the Santee Mills and 1,100 shares of the capital stock of the Warren Manufacturing Co. The 1,100 shares of stock of the latter company were purchased sometime between 1918 and sold in the same year at a net profit of $20,000.
    The gross income of the petitioner for the year 1918 was $174,862.12. Eighty-four per cent of this amount, or $146,552.07, represented commissions on sales, 11½ per cent, or $20,000, represented the profit upon the sale in 1918 of the stock of the Warren Manufacturing Co. acquired in the same year, and 4½ per cent, or $8,309.05, represented dividends received upon the stock of other corporations and Liberty bond interest.
    The balance sheet of the petitioner at the beginning and end of the year 1918 was as follows :

    The accounts receivable represent loans made by the petitioner to the persons named. Henry C. Fleitmann was the president and the largest stockholder of the petitioner and president of the Union-Buffalo Mills Co.; H. B. Jennings was superintendent of the Union-Buffalo Mills Co. Notes payable to the Lincoln Trust Co. and Fleitmann <& Co. represented money borrowed by the petitioner with which to purchase stock of the other corporations.
    The Commissioner increased the net income for 1918 in the amount of $3,799.21, representing income and profits taxes for the year 1917 claimed to have been taken as a deduction by the petitioner in computing its taxable net income.
    On June 7, 1918, this amount of $3,799.21 was charged to profit and loss account on the books of the petitioner, and on the same date a contra-entry was made in a similar amount transferring this charge to the tax account, a reserve account set up on the books in 1917. A reconciliation of the surplus account, as shown by the books for 1918, shows that the net income as reported in the tax return did not include any deduction for the preceding year’s taxes.
   OPINION.

Littleton:

The petitioner contends that its income for the year 1918 was due primarily to activities of its stockholders; that it wa,s not engaged in trading as a principal; and that capital was not used in the business and was not a material income-producing factor.

All of the stockholders were regularly engaged in the active conduct of the affairs of the corporation and 84 per cent of the gross income may be ascribed primarily to their activities. It was not engaged in trading as a principal, but it appears that a portion of its income was produced by capital. Section 200 of the Revenue Act of 1918 provides that the term “ personal service corporation ” means a corporation in which capital (whether invested or borrowed) is not a material income-*producing factor. It appears, as the findings of fact show, that 16 per cent of the petitioner’s gross income was produced by capital, invested or borrowed, and from the sale of stock of another corporation purchased within the year. The statute provides that before a corporation is entitled to classification as a personal service corporation its income must be ascribed primarily to the activities of the principal owners or stockholders, and as was said by the court in the case of Matteson Co. v. Willcuts, 12 Fed. (2d) 447:

Any corporation claiming to be a personal service corporation must bring itself fairly within the requirements of such an organization, as provided by law. Every corporation has full control of its own activities. It knows what the requirements of a personal service corporation are. It may comply therewith and easily keep within the limits thereof if it so choose, or it may not if it otherwise prefers. If it does not fairly observe and keep within the requirements of the law, it should not claim the benefits which the law confers. To nearly comply with the law, or to come within hailing distance thereof, is not enough.

The court in that case denied the claim of the taxpayer that it was a personal service corporation upon the ground that one of the principal stockholders was not regularly engaged in the active conduct of the business, and, with regard to whether capital was a material income-producing factor, the court said:

In this ease a little over 5 per cent, of the income of plaintiff corporation, ■during the year 1919, was derived from interest, discount, and profits on moneys invested. Here again the corporation, being free to elect to comply with the law, has come, at least, dangerously near a violation thereof. If it is to claim the privilege of a personal service corporation, it should keep free from investments which yield interest or profit. The capital here involved was not such as was necessarily incident to carrying on the corporate activities, but was free capital. In view of the rather small amount of the income from interest, discount, and profits, the courts might hesitate to deny personal service classification to the corporation on that ground, if otherwise its right to such classification was fairly shown. Here, where the right to such classification otherwise is not shown, the receipt of such interest, discount, and profits should not be ignored, and may be assigned for what it is worth as a further ground of opposition to plaintiff’s claims.

In the opinion of the Board, it is immaterial whether the income derived from capital is produced by the use of that capital in the business in which the petitioner is primarily engaged. It is income within the definition of section 200 no less because it arises from investments or sale of assets. The Board is of the opinion that it was not the intention of Congress to grant to corporations personal service classification when capital is found to have produced during the year a substantial amount of income. Under the circumstances in this appeal, we believe that capital was a material income-producing factor within the meaning'of the statute and that petitioner is not entitled to classification as a personal service corporation.

Judgment will be entered on 15 days’ notice, wilder Bule 50.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    Appeal of Excelsior Motor Manufacturing & Supply Co., and Arnold Schwinn & Co.
    Docket No. 4686.
    Decided November 20, 1926.
    In the light of the circumstances in this ease, held, that the tax return filed for 1918 was not fraudulent and that the petitioners are not liable to the assessment of the penalty provided by the statute for the filing of a fraudulent return.

      John E. Hughes, Esq., for the petitioners.

      Harold Allen, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1918 in the amount of $44,370.99, plus a penalty of $22,185.50 for alleged fraud in filing a false return. The issues raised by the proceeding are:
    (1) Whether the petitioners’ opening inventory for the calendar year 1918 was understated by the Commissioner in computing petitioners’ tax in the amount of $31,890.39.
    (2) Whether or not the petitioners filed a false and fraudulent return with intent to evade taxes for the calendar year 1918.

      (3) Whether the Commissioner incorrectly determined petitioners’ invested capital.
    (4) Whether the Commissioner should have assessed petitioners’ profits tax under section 328 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    The Excelsior Motor Mfg. & Supply Co., hereinafter referred to as the Excelsior Motor Co., is an Illinois corporation engaged in the manufacture of motorcycles, with its offices and factory in Chicago. Arnold Schwinn & Co. is a subsidiary company engaged in the manufacture of bicycles and is also an Illinois corporation with its offices and factory located one mile from those of the Excelsior Motor Co. During the year 1918 the former company, in addition to the manufacture of motorcycles, was engaged in the manufacture of airplane engines and Handley Page bombing planes. For the year 1918 the companies filed a consolidated return in the name of the Excelsior Motor Co.
    The petitioners made their income-tax return for 1917 and prior years upon a calendar year basis. The Excelsior Motor Co. took a physical inventory once a year, which was always taken on or as of October 31. The inventory used in computing the profits for the year for the purpose of the income-tax return was obtained by adding to the inventory at October 31 all the purchases for November and December and by deducting from the total the sales for November and December at selling price. In this manner the closing inventory for 1917, which was the opening inventory for 1918, was understated by the amount of the gross profits on the November and December sales. At the hearing the Commissioner admitted error in computation resulting in an understatement of the 1918 opening inventory in the amount of $31,890.39.
    The fraud penalty proposed for assessment by the Commissioner for the filing of a false return for the year 1918 is based upon an understatement of the closing inventory for 1918 by approximately $93,000. This understatement occurred in the following manner:
    When the Excelsior Motor Co. was working on a contract for parts for Handley Page bombing planes, the War Department sent accountants to the plant of the company to audit its books with reference to this work. After the signing of the Armistice the chief of these accountants informed the president of the petitioner corporations that he was leaving the Government service and solicited employment to make out the tax return for the Excelsior Motor Co. He was employed to do so. He inquired of the secretary of the company when the physical inventory was taken for 1917, and when advised that it was taken on October 31, 1917, he assumed that the physical inventory which was taken December 31, 1918, had accumulated over a period of fourteen months and that it was not the correct inventory to use in determining the profits of the corporation for the year 1918. He discussed the problem with other accountants of the accounting firm with which he was employed, and was advised by one of them to go to the office of the collector of internal revenue in Chicago and make inquiry as to how to handle the matter. He went there and was advised to divide the inventory of December 31, 1918, by 14 and multiply the result by 12, and to use this sum in computing the inventory at December 31, 1918. This he did. This method resulted in an understatement of the net income for 1918.
    The reason why an outside accountant was employed to make out the income-tax return of the petitioner corporations for 1918 was that, at about the time the petitioners’ books for 1918 were being closed, the office managers of the two petitioner corporations advised Schwinn, the president of the corporations, that the tax laws were becoming complicated; they suggested that he employ someone to make out the tax return for these corporations. It was about this time that George E. Robertson stated to Schwinn that he was leaving the Government service to enter the employ of an accounting firm, that the firm expected him to bring some business along with him, and that he would like to be employed to make out the income-tax return for these corporations. Schwinn believed that he would be competent to make out their tax return and retained him, paying him $390 for his services.
    After the return had been compiled by Robertson, it was presented to Schwinn for signature. Schwinn was assured by Robertson that the return was correct and in accordance with the law and regulations. Upon Robertson’s assurance that the return was correct Schwinn signed it. The return was also signed by Schwinn’s son, as vice president of the corporation. The son was production manager of the plants and signed the return as an officer upon the assurance of Robertson that the return was correct and at the request of his father.
    Petitioners’ inventories were kept in a loose-leaf ledger system. There was no attempt on the part of Robertson or any other person to change the record of the inventory. The return for the year 1919 shows as the inventory of January 1, 1919, the same inventory as is shown by the inventory record, which is an amount entirely different from that used by Robertson as the inventory at December 31, 1918.
    It was the practice of Arnold Schwinn & Co., prior to 1917, to charge various capital expenditures to operating expenses. For the years 1909 to 1917, inclusive, the Bureau restored to invested capital items totaling $75,849.91, which had been charged to expenses. From the year 1903 to 1909, the bookkeeper of this company itemized on the witness stand capital items charged to expense, which total $9,944.14 as follows:

    The Excelsior Motor Co. was organized in 1900 and incorporated on January 12, 1912. Ignaz Schwinn, president of the Excelsior Motor Co. and Arnold Schwinn <⅞ Co. purchased individually the assets, including the good will, patents and trade-marks, of the Excelsior Supply Co., a corporation that had been manufacturing motorcycles for at least fifteen years prior to 1912. On February 1, 1912, he assigned and transferred to the Excelsior Motor Co., by an instrument in writing, all such assets in exchange for the capital stock of that company in the amount of $500,000. The Commissioner determined that the tangible property turned in to the Excelsior Motor Co. in 1912 had a value of at least $500,000, the full amount of the capital stock of the company.
    Arnold Schwinn t% Co. was organized in 1895. In 1917 and 1918 substantially all of the outstanding stock of the Excelsior Motor Co. and Arnold Schwinn & Co. was owned by Ignatz Schwinn and his immediate family. The statutory invested capital of the consolidated companies for 1918 was determined by the Commissioner to be the amount of $1,026,585.69.
    The following was the amount of borrowed money of the petitioner corporations as shown by the consolidated sheets at January 1, 1918, and January 1, 1919:

    Ignaz Schwinn and his son Frank W. Schwinn owned in their own names certain patents and patent rights, which were used by the petitioners during 1918 without any royalties or compensation being paid to the owners. Among these were the following:
    1. Patent No. 1,243,347, universal joint, applied for January 12, 1917, issued October 16, 1917, to Prank W. Schwinn.

      2. Patent No. 1,215,877, starter lor' internal-combustion engines, applied for February 19, 1916, issued February 13, 1917, to Frank W. Scbwinn.
    3. Patent No. 1,190,956, cycle stands, applied lor March 24, 1915, issued July 11, 1916, to Ignaz Schwinn.
    4. Patent No. 1,198,669, motorcycle frames, applied for March 24, 1915, issued September 19, 1916, to Ignaz Schwinn.
    5. Patent No. 1,268,501, kick-starter mechanism, applied for February 6, 1918, issued June 4, 1918, to Frank W. Schwinn.
    All of these patents were used during 1918, and the manufacture of the Excelsior motorcycles depended largely on their use. No depreciation for the patents was ever claimed by the corporation.
    Registration of the trade-mark of the Excelsior Motor Manufacturing & Supply Co. was applied for December 23, 1912, and letters of registration issued April 29, 1913. The trade-mark has been used by the company on all manufactured goods up to the present time. Excelsior motorcycles are one of the well known standard makes and are sold in practically all parts of the world.
    During the year 1918 there were only three other concerns in the United States engaged in the manufacture of motorcycles and motorcycle parts. These were the Hendee Manufacturing Co., later known as the Indian Motor Cycle Co., the Cleveland Motor Cycle Co., and the Harley-Davidson Motor Co. The Harley-Davidson Co. was granted special assessment by the Commissioner under section 328 of the Revenue Act of 1918. In determining the tax liability of the Hendee Manufacturing Co. for 1918 and 1919, the Commissioner used the following computation:

    The returns of the Hendee Manufacturing Co. were made out on a fiscal year basis ended August 31. For the Cleveland Motor Cycle Co. the following computations were used:
    Net income_ $4,125.60
    Excess profits tax_ None.
    Gross sales_ 548,619.15
    Cost of goods sold- 452, 502.30

    Capital stock outstanding_ 208, 850.00
    Capital stock issued for patents_ 50, 000. 00
    Balance sheet_ 51,259.55
    Invested capital allowed___ 158,850.00

      Depreciation on patents was allowed by the Commissioner in computing net income but no allowance for patents was made in invested capital. The 1918 return was made out on a calendar year basis.
    The consolidated gross sales of the petitioners for 1918 were divided as follows:
    Motorcycles -$1,422,189.89
    Motorcycle parts_:_ 380,066. 64
    Henderson motorcycle parts_ 10, 639.94
    Side cars for motorcycles_ 96,353.71
    Parts for Handley Page airplanes_ 298,743.00
    Lawrence motors_ 295,562.10
    Bicycles- 682,164.70
    The Handley Page airplane parts and the Lawrence motors were manufactured under Government contracts. The companies had no cost-plus Government contracts.
   OPINION.

Smith :

At the hearing of this appeal it was agreed between counsel for the petitioners and counsel for the Commissioner that the opening inventory of the petitioners for the taxable year 1918 was understated in the amount of $81,890.39.

The income-tax return of the petitioners for 1918 was incorrect. We are convinced, however, from the evidence of record that the officers of the corporation who signed the return were ignorant of any error in it and innocent of any fraud in connection with verifying the return. In this situation we are of the opinion that no fraud penalty is collectible from the petitioners. Possibly, the petitioners were negligent in not detecting an understatement in the closing inventory and laid themselves liable to the imposition of the 5 per cent penalty for negligence provided for in section 250(b) of the Kevenue Act of 1918. But the Commissioner has not asserted this penalty and the question of the liability to it is not before the Board.

The third allegation of error on the part of the petitioners is that the Commissioner incorrectly computed invested capital for the year 1918. There are three allegations of error upon this point:

(1) That the Commissioner failed to include in invested capital for 1918 the understatement of the opening inventory in the amount of $31,890.39.

(2) That there should have been included in invested capital the depreciated cost of capital expenditures made during the years 1903 to 1909, in the amount of $9,944.14.

(3) That the Commissioner deducted from 1918 invested capital taxes for prior years which became due during the year 1918, which is erroneous under the decision in the Appeal of Guarantee Construction Co., 2 B. T. A. 1145.

The contention of the petitioners relative to the item of $31,890.39 and the depreciated cost of improvements made during the years 1903 to 1909, costing $9,944.14, is sustained. The contention of the petitioners upon the third point is denied under the authority of the decision in Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

The petitioners claim that there was such an abnormality in invested capital for the year 1918 as entitles them to have their profits tax computed in accordance with the provisions of section 328 of the Revenue Act of 1918. They further contend that, inasmuch as the Commissioner has refused to submit data of comparative corporations in response to a subpoena issued by this Board, and inasmuch as the petitioners have submitted evidence as to certain concerns engaged in the manufacture of motorcycles, such concerns must be held to be representative concerns in the industry, and that, in accordance with the data submitted, the profits tax of the petitioners should be determined to be not more than 10.66 per cent of the total net income.

We are of the opinion that the evidence adduced before the Board, warrants a finding to the effect that the petitioners are entitled to have their tax computed under the provisions of section 328 of the Revenue Act of 1918 and that any relief to which they may be entitled thereby should be accorded to them. The Board can not find, however, as a fact, that the Hendee Manufacturing Co. and the Cleveland Motor Cycle Co. are representative corporations within the meaning of section 328 of the Revenue Act. One of the petitioners had Government contracts for bombing planes. It does not appear that either of the claimed comparatives had any such contracts. In this situation the selection of the comparatives must be left to the Commissioner, whose determination of whether the petitioners may be given relief under section 328, and the amount of such relief, if any, will be accepted as final. Appeal of H. T. Cushman Manufacturing Co., 2 B. T. A. 39.

Judgment will he entered on 15 days’ notice, under Rule 50.


author: SteRNhagen :

text:
    J. E. Siebel Sons’ Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 1130.
    Decided November 23, 1926.

      Edward E. Gore, C. P. A., for the petitioner.

      L. C. Mitchell, Esg., for the respondent.

      This proceeding involves a deficiency of $2,886.36, income and profits taxes for the fiscal year ended April 30, 1918, arising from the partial disallowance by the respondent of a deduction for depreciation of equipment, and from his refusal to compute the petitioner’s profits tax for that part of the fiscal year falling within the calendar year 1917 under section 209 of the Revenue Act of 1917. The respondent admits error in the computation of the profits tax, leaving only the question of depreciation.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation with its principal place of business in Chicago. Its business consisted of giving instruction in brewing and malting and acting as analyst and counselor to the brewing industry. For the purpose of instructing students in the practical application of the scientific principles of malting, brewing .and bottling, it had acquired during the years from 1902 to 1907 actual working brewing equipment at a total cost of about $19,000. This equipment had been replaced and renewed to such an extent that it was in satisfactory condition in 1917. This equipment was not in use during the fiscal year ended April 30,1918. The company discontinued its instruction courses in 1917, for the reason that students were not solicited and could not be secured, due to the general agitation for prohibition, legislation against the manufacture of beer, and the conservation of cereals during the war.
    When not in use brewing equipment deteriorates much more rapidly than when in operation.
   OPINION.

SteRNhagen :

The difficulty with this case is that the testimony is so vague that there is no way of determining what the correct depreciation was during the taxable years in question. The purchase of equipment over a period of five years from 1902 to 1907 at an approximate cost of $19,000 does not of itself indicate anything in respect of its probable life. If a 20 per cent rate were applied as the petitioner’s witnesses testified in respect of the taxable year, the property was of little or no depreciable value long prior to 1917. If there was any depreciation in the intervening years, the record is silent on the subject and we must assume that the Commissioner had the facts. Without such information there is no basis upon which to compute the annual deduction. It was testified that in the taxable year in question the equipment was in disuse and that, instead of the normal rate of 10 to 16 per cent, a rate of 20 to 25 per cent would be proper. Obviously, this can not be adopted as a general principle and there is nothing more specific which can be applied to the particular property here in question.

Judgment will be entered on 15 days’ notice, under Bule 50.


author: Morris:

text:
    Long Beach Improvement Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3184.
    Decided November 23, 1926.
    A corporation is subject to tax upon its net income for 1920 although such income is not sufficient to wipe out a pre-existing deficit.

      B. 0. Bub for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetertoination of a deficiency of $1,524.70 in income tax for the calendar year 1920. The question presented is whether a corporation is subject to tax upon its net income for a calendar year when such income is not sufficient to wipe out a pre-existing deficit.
    FINDINGS OF FACT.
    The petitioner is a California corporation with principal office at Long Beach. For several years prior to 1919 it operated at a loss and as a result its balance sheet at the beginning of 1919 showed a deficit. Assessments were levied against and collected from its stockholders in prior years. During 1919 a net profit was earned but such net profit was not sufficient to result in tax liability. The deficit, as shown by the books at the end of 1919, was reduced by the amount of the profits earned during 1920 but there was still a deficit at the end of such year. The net income for 1920, as disclosed by the books, was $25,631.60, against which deductions of $8,383.97 were allowed by the Commissioner. The petitioner’s net income for 1920 was $17,247.63.
   OPINION.

Morris:

It was stipulated that the petitioner had a deficit at the beginning of 1919 which was reduced by a profit for that year and further reduced at the close of 1920 by the profit realized in that year. It contends, however, that such profit is not net income as it can have no net income while there is an operating deficit and that the gain realized in 1920 can not be construed other than as a return of capital. Although it was stipulated that the net income for the taxable year in question was $17,247.63, the petitioner contends in its brief that the reduction of the deficit existing at the close of 1919 eliminates any possibility of net income and that the use of the words “ gain, net gain, profit, net profit ” mean something entirely different, when applied to a corporation, than net income.

Section 232 of the Revenue Act of 1918 provides that in the case of a corporation, net income means the gross income as defined in section 233, less the deductions allowed by section 234, and that the net income shall be computed on the same basis as provided in subdivision (b) of section 212. This subdivision provides for the computation of the net income on the basis of the taxpayer’s annual accounting period, which in the instant case is the calendar year. It therefore follows that the petitioner’s gross income for 1920, less the deductions authorized by law, is its net income for that year and such net income is subject to tax under section 230, unless the organization is exempt from taxation under section 231, a question which is not in issue. Petitioner offered no evidence that the net income as adjusted by the Commissioner is incorrect. The Commissioner’s determination must therefore be approved.

Judgment will he entered for the Commissioner.


author: Littleton:

text:
    Weil-McLain Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3413.
    Decided November 23, 1926.

      P. J. O'Connor, C. P. A., for the petitioner.

      Arthur H. Murray, Esq., for the respondent.
   Littleton:

The petitioner claims that the Commissioner’s determination of a deficiency of $11,533.48 for the period commencing February 1, 1918, and ending December 31, 1918, was erroneous in so far as the same resulted from the disallowance of a deduction of $23,423.94, an account of the Seltzer Heating Co. alleged to have been determined to be worthless and charged off prior to December 31, 1918.

FINDINGS OF FACT.

In 1907 the Seltzer Pleating Co., of Washington, D. C., was indebted to the petitioner, then known as the J. H. McLain Co., of Indiana, in the amount of $4,875, for heating material purchased. Urish D. Seltzer of the Seltzer Heating Co. owned, as trustee for Hess & Booth of Lebanon, Pa., certain real property located at Washington, D. C., known as Alta Park. Under the terms of his trusteeship he was to have for his services one-third of whatever profit might be realized upon the sale of this property. P. L. McLain was treasurer of the J. H. McLain Co., now Weil-McLain Co., and was its principal stockholder. It was arranged between McLain and Seltzer that, if Seltzer would assist McLain in purchasing the real property held by Seltzer, as trustee, at as low a price as possible, he, McLain, would assume the debt of the Seltzer Heating Co. to the J. H. McLain Co. Seltzer assisted McLain in the acquisition of the property for $60,000 and McLain assumed the debt of the Seltzer Heating Co. to the J. H. McLain Co. The debt of the Seltzer Heating Co. was continued upon the books of the J. H. McLain Co., and subsequently upon the books of the Weil-McLain Co., in the amount of $4,875, and, after McLain had purchased the Alta Heights property, he continued to charge to the Seltzer Heating Co.'s account upon the corporation’s books interest paid by him upon the unpaid purchase price of the Alta Heights property, together with taxes upon the property, revenue stamps, etc. As a result of these charges, the account of the Seltzer Heating Co. standing upon the books of the corporation at the beginning and end ' of the taxable period here in question amounted to $23,423.94.

After McLain had acquired the Alta Heights property, he organized a corporation and received certain of its stock. He then borrowed on his personal note from the Canton National Bank, of Canton, Ohio, $22,000, and placed the stock with the bank as collateral. The interest paid upon this indebtedness was charged to the Seltzer Heating Co.’s account from the books of the McLain Co. On June 23, 1910, there was executed the following written instrument:

I hereby assign to the J. H. McLain Company, all my right, title and interest in the equity to be derived from the sale of the Alta Heights Realty Company, located at Washington, T>. C., until amount of the Seltzer Heating Company’s claim, as it stands on the books of the J. H. McLain Company, is satisfied.
[Signed] P. L. McLain.

About September, 1918, Isadore Weil acquired the stock of the McLain Company owned by P. L. McLain and thereby became the owner of the majority of the stock of the company, and McLain thereafter had no connection with the company. Previous to the purchase of the stock in September, Weil was not connected with the company and knew nothing about its affairs or accounts, and McLain did not explain the account of the Seltzer Heating Co. to him. Some time after Weil had purchased the stock of the company he inquired of McLain concerning the Seltzer Heating Co.’s account, and McLain informed him that, if he would take up his, McLain’s, note for $22,000 at the Canton National Bank and get the stock of the Alta Heights Realty Co. that he had put up as collateral for the loan, he, 'Weil, could probably recover the amount shown in the Seltzer Heating Co.’s account on the books of the company. Weil did not desire to do this and charged off the amount of $23,-423.94 charged upon the books to the Seltzer Heating Co., of Washington, D. C.

In filing the return for the period February 1 to December 31, 1918, the amount of $23,423.94 was claimed as a deduction from gross income as a debt ascertained to be worthless and charged off. The Commissioner disallowed the deduction.

No one for the petitioner made any investigation, at or prior to the time that this account was charged off as worthless, to determine whether it was in fact without value. No inquiry was made to determine whether the Seltzer Heating Co. or P. L. McLain was liable to the company for the amount, nor was any investigation made to ascertain whether the amount, or any portion thereof, could be collected from either of these persons.

Judgment will be entered redetermining a deficiency of $11,533.18 for the period February 1 to December 31, 1918.


author: Littleton :

text:
    Samuel Pond, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 19558.
    Decided November 23, 1926.
    IF. F. Gibbs, Esq., for the respondent.
   Littleton :

On August 25,1926, the petitioner, a resident and citizen of California, instituted this proceeding for the purpose of contesting the correctness of the Commissioner’s determination of a deficiency in income tax for the calendar year 1924 in the amount of $5,549.62.

The deficiency notice mailed to the petitioner on June 28, 1926, discloses that the deficiency is due to the decision of the Commissioner that the petitioner and his wife, Dorothy A. Pond, were not entitled to report each one-half of the income for 1924 upon the community property basis. The deficiency notice further discloses that the petitioner reported in his return a net income of $30,204.14 and that his wife reported in the return filed by her a net income of $30,204.14. The Commissioner held that the total of these two amounts was taxable to the petitioner.

The petitioner alleges that the Commissioner was in error in denying him the right to file his return upon the community property basis and to report only one-half of the income of the community. No facts other than those set forth in the preceding sentence were alleged by the petitioner in support of his claim.

On September 20, 1926, the Commissioner filed a motion asking that the proceeding be dismissed, upon the ground that the petitioner’s assignment of error was insufficient to show that the Commissioner’s determination was erroneous and that the statement of facts contained in the petition is a conclusion of law. He further asks the Board to make a redetermination of the deficiency upon the basis of the allegations contained in the petition.

The decision of this case is governed by the Board’s decision in the Appeal of D. Cerruti, 4 B. T. A. 682. For the reason stated in the Board’s decision of that appeal, the Commissioner’s determination of the deficiency against this petitioner must be approved.

Judgment wül te entered for the Commissioner of a deficiency of $5,549.62 for the calendar year 1924.


text:
    Appeal of Alice M. Clemson.
    Docket No. 6256.
    Decided November 23, 1926.
    Tbe evidence is insufficient to show that the Commissioner’s valuation of property acquired by inheritance in 1918 was erroneous.

      R. Lester Moore, Esq., for the petitioner.

      Bruce A. Low, Esq., for the Commissioner.
    The deficiency involved is $2,747.89. The petitioner acquired certain real estate by inheritance on August 5, 1918. The Commissioner determined its value at that time to have been $83,000. This property was sold in 1920 for $123,863. The petitioner claims that the value of the property in 1918 was in excess of the amount for which it was sold.
    FINDINGS OF FACT.
    The petitioner is the widow of Balph E. Clemson, who, at the time of his death on August 5, 1918, was a resident of Pittsburgh, Pa. Balph E. Clemson died testate, leaving surviving him his widow and one child, a son. The pertinent part of his will, so far as this case is concerned, is as follows:
    FIRST: I give, devise and bequeath all my estate, real, personal and mixed, of whatever kind and description and wheresoever the same may be situated, unto John G. Clemson, Gibson D. Packer and Hallock C. Sherrard, their sue-cessors and assigns, in trust nevertheless to hold, manage, invest, re-invest and keep invested the same and pay out of the net income therefrom, without deduction for any tax, the sum of one hundred dollars ($100) per month during her life to Edith G. Smith, who has cared for my son, Richard E. Clemson; the balance of said net income, to an amount not exceeding twelve thousand dollars ($12,000) per annum shall be paid by said Trustees, without deduction for any tax, to my wife, Alice M. Clemson, quarterly during her life or so long as she remains my widow * * *.
    EIGHTH: Said Trustees shall have power to make and change investments from time to time, and full power and authority is hereby given to them to sell, and convey any of my real estate upon such terms as they deem proper, and to make, execute, acknowledge and deliver a deed or deeds therefor without liability on the part of the purchaser to see to the application of the purchase money.
    NINTH: I nominate and appoint John G. Clemson, Gibson D. Packer and Hallock C. Sherrard executors of this my last will and testament, and full power and authority is given unto them to sell and convey any real estate of which I may die seized, and to make, execute, acknowledge and deliver a deed or deeds therefor, without liability on the part of the purchaser to see to the application of the purchase money. * * *
    On January 3, 1919, the petitioner elected under the laws of Pennsylvania to take against the will of her husband, and claimed one-half of the estate under the Wills and Intestate Acts of Pennsylvania in lieu of the annuity of $12,000 provided for her in the will. Her written election, under oath, to take under the intestate laws was filed in the Orphans’ Court of Allegheny County, Pennsylvania, and is as follows:
    I, Alice M. Clemson, widow of Ralph E. Clemson, late of Allegheny County, deceased, do hereby waive, the devise and bequest to me by his last will and testament, and do elect to take my share of his estate under the intestate laws of the Commonwealth of Pennsylvania.
    Section 23 (a) of the Wills Act of June 7, 1917, P. L. 403; Pa. St. 1920, section 8335, is as follows:
    When any person shall die testate, leaving a surviving spouse who shall elect to take against the will, such surviving spouse shall be entitled to such interests in the real and personal estate of the deceased spouse as he or she would have been entitled to had the testator died intestate: Provided, That nothing herein contained shall affect the right or power of a married woman, by virtue of any authority or appointment contained in any deed or will, to bequeath or devise any property held in trust for her sole and separate use.
    Section 1 (a) of the Intestate Act of June 7, 1917, P. L. 429; Pa. St. 1920, section 8342, provides as follows:
    The real and personal estate of a decedent, whether male or female, remaining after payment of all just debts and legal charges, which shall not have been sold, or disposed of by will, or otherwise limited by marriage settlement, shall be divided and enjoyed as follows; namely,—
    Where such intestate shall leave a spouse surviving and one child only, or shall leave a spouse surviving and no children, but shall leave descendents of one deceased child, the spouse shall be entitled to one-half part of the real and personal estate.
    The deceased, Ralph E. Clemson, at the time of his death owned considerable property, real and personal. Included in such property was a country home on Woodland Road, near Pittsburgh, known as “ Oak Gables,” acquired by him in 1909, which was valued for Federal estate-tax purposes, as well as for State inheritance tax purposes, at $83,000. The Commissioner determined that the value of the property on August 5, 1918, was $83,000. This property was sold in 1920 for $123,863 net, and this petitioner under her election to take against the will received one-half of the proceeds thereof. The Commissioner held that petitioner’s one-half interest was acquired under her election on August 5, 1918. He determined that, upon the sale in 1920 for $123,863, the petitioner realized a taxable profit.
   OPINION.

Littleton:

The evidence before the Board in support of the claim of the petitioner that the residence in question had a value on August 5, 1918, in excess of the amount for which it was sold in 1920 consisted of the testimony of four witnesses.

A member of the firm which constructed the building in 1909 and 1910 testified that, with the exception of electric work, plumbing, heating, finishing hardware, painting, glazing, furnishings and decorating, and title work, the building cost $53,366.31.

Another witness, an officer of a construction company, testified that in his opinion, from the measurements of the cubical contents of the house, the cost of reproduction new in 1920, less depreciation at 2 per cent per annum, was $127,624, and that this cost was considerably in excess of such cost in 1918.

Another witness, an employee of the appraisal company which had made an appraisal on April 23, 1913, of the personal property in the house at that time, such as furniture, carpets, tapestries, clothing, etc., upon the basis of replacement cost, identified the appraisal as one made by that company. He had nothing to do with the making of the appraisal. The appraisal was not offered or received in evidence.

The petitioner testified that a portion of the personal property in the house in 1918 and 1920 was sold with it.

This evidence is insufficient to warrant the Board in finding that the Commissioner’s determination of value was erroneous.

Judgment will be entered for the Commissioner..


author: MoRRis:

text:
    Loyd H. Wilbur, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5636 and 10611.
    Decided November 23, 1926.
    1. Husband and wife, domiciled in the State of California, may not file separate returns, each reporting one-half of the community income.
    2. Depreciation on prune orchard and vineyard determined.

      Lawrence ScMllig, Esq., for the petitioner.

      George E. Adams, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income tax of $4,664.08, $2,925.43 and $2,254.68 for the calendar years 1920, 1921 and 1922, respectively. The questions presented are the right of husband and wife, domiciled in California, to file separate returns, each reporting one-half of the community income, and the amount of depreciation allowable on certain assets.
    FINDINGS OF FACT.
    The petitioner is a citizen of the United States and a resident of Yuba City, Calif. During the years 1920, 1921 and 1922, he was a married man, his wife’s name being Ethel E. Wilbur. All the property shown by the petitioner’s income-tax return is community property of himself and wife, except an interest in a piece of rented land which returned about $32.50 a year. .
    The petitioner is a vineyardist and orchardist, having been engaged in such business about twenty-seven years. During that time he planted, bought and sold vineyards and orchards.
    It cost about $400 an acre to bring a prune orchard into bearing. A French prune orchard will bear at the fifth year and the Robe Sergeant and Imperial orchards, at the sixth year. The petitioner’s prune orchard had a bearing life of about 20 years.
    The petitioner’s vineyard consisted of Thompson seedless grapes. Prior to 1924 there was a series of dry years during which phylloxera flourished and destroyed the vines more than during wet periods. The average bearing life for such vineyard in the vicinity in which the petitioner’s vineyard was located was seven years.
    The Commissioner determined that the cost of bringing petitioner’s prune orchard into bearing was $200 an acre and that such orchard had a bearing life of 33½ years. He therefore allowed depreciation thereon for 1921 of $6 per acre. He determined the cost of petitioner’s vineyard to be $200 per acre and that it had a bearing life of 10 years, thus allowing depreciation for the years 1920 and 1921 of $20 per acre. At the hearing counsel for the Commissioner moved that the deficiency for 1922 be computed by allowing the same depreciation rates as those used by the Commissioner for 1920 and 1921.
   OPINION.

MoRRis:

The question of the right of husband and wife, domiciled in the State of California, to file separate returns, each reporting one-half of the community income, has already been decided adversely to the petitioner and the determination of the Commissioner in that respect is therefore approved. Appeal of D. Cerruti, 4 B. T. A. 682.

The petitioner alleges, for the years 1920 and 1921, that the Commissioner erred in allowing depreciation at the rate of 10 per cent, instead of 20 per cent, on a truck and raisin stemmer, but no evidence was introduced to sustain the allegation of error. The determination of the Commissioner on these two items is therefore approved.

The next question involves the amount of depreciation to which petitioner is entitled on his vineyard and prune orchard. We are satisfied from the evidence that the petitioner’s vineyard had a life of 7 years and that depreciation should be computed for the years 1920, 1921, and 1922 on that basis on a cost of $200 per acre.

The evidence also convinces us that the cost to the petitioner of bringing his prune orchard into bearing was $400 per acre, instead of $200 as determined by the Commissioner, and that its bearing life is 20 years. A depreciation deduction of $20 per acre should therefore be allowed for the years 1921 and 1922.

Judgment will 5e entered on 15 days' notice, under Rule 50.


author: Moeeis:

text:
    Modesto Lumber Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3971.
    Decided November 23, 1926.

      J. M. Walthall, Esg., for the petitioner.

      George E. Adams, Esg., for the respondent.
    This proceeding is for the redetermination of a deficiency of $1,632.74 in income and profits taxes for 1920. The question involved is whether certain expenditures were ordinary and necessary expenses or additions to capital.

      FINDINGS OF FACT.
    The petitioner is a California corporation located at Modesto, Calif.
    Due to the increase of business during 1917, 1918 and 1919, the petitioner found it necessary to enlarge its office building. This was done by moving out the exterior walls four or five feet, both as to length and width. At the same time new flooring was put in, new partitions were installed in place of old ones, and additional partitions were added; new counters and office equipment were installed, windows and doors were changed, new wooden sills, joists and footings were substituted for old, and general repairs made where needed. The alteration and remodeling resulted in a 10 per cent increase in office space and in a more convenient and efficient operation. During the remodeling and repairing the petitioner continued to occupy the building.
    The office building was located on property leased on a 30-day basis from the Southern Pacific Railroad Co. It was erected in 1910 at a cost of approximately $3,000. It had been repaired and added to prior to 1920. The building is 40 feet by 50 feet, and is of frame construction. After the altering and remodeling, the petitioner had one additional private office and additional rooms for stenographers and clerks.
    The planing mill was located about a block from the office. The building was of frame construction, 90 feet by 105 feet, and had been acquired some twenty years previous at a cost of approximately $5,000. The building had been used constantly and was in need of some repairs in 1920. Leaks in the roof were repaired, and in certain sections the old roof was torn off and replaced with new shingles. About one-third of the roof was replaced and leaks were repaired. New trusses and rafters were added as well as sheathing and gables. The roof was not a continuous surface but was a series of roofs with gables. In the interior of the mill partitions were torn out and braces substituted. The alterations made w'ere to secure additional floor space.
    On its return for 1920 the petitioner took as a deduction for repairs $6,954.78. The Commissioner allowed a portion of this amount but disallowed $2,770.87 as repairs to the office and $712.92 as repairs to the mill, upon the ground that these amounts represented capital expenditures.
   OPINION.

Moeeis:

There is no question in our minds but that some of the expenditures made by the petitioner in the taxable year and disallowed as deductions by the Commissioner were for ordinary and necessary repairs, the cost of which is deductible. Appeal of Illinois Merchants Trust Co., 4 B. T. A. 103. On the other hand, certain of the expenditures were for replacements, alterations and improvements, which are additions to capital investment the cost of which should not be applied against current earnings. Appeal of Blanche Burbank, 3 B. T. A. 1118. See also Appeal of Simmons & Hammond Mfg. Co., 1 B. T. A. 803. In the absence, however, of any segregation in the record of the costs disallowed by the Commissioner, we are unable to determine what amounts are deductible and what amounts should be added to capital investment. The determination of the Commissioner is therefore approved.

Judgment will be entered for the Commissioner.


author: Steenhagen:

text:
    Appeal of Gilchrist Company.
    Docket No. 5397.
    Decided November 23, 1926.
    Value; Opinion. — Since value implies both a purchaser and a seller, it is not enough that he who would be a seller expresses a categorical opinion as to value. Held, value not proven.

      Frank J. Albus, Esq., for the petitioner.

      F. 0. Graves, Esq., for the Commissioner.
    Deficiency of $360.05, income and profits taxes for the fiscal year ended July 31, 1920, arising from the disallowance of a deduction covering the exhaustion of leaseholds owned on March 1, 1913. At the hearing the Commissioner amended his answer so as affirmatively to allege an overstatement of invested capital. No proof, however, was offered to substantiate the allegation.
    FINDINGS OF FACT.
    The petitioner conducts a department store at the corner of Washington and Winter Streets, Boston, Mass.
    On March 31,1900, the petitioner became the lessee of the premises at 417-425 Washington Street, Boston, at an annual rental of $58,626, plus the annual taxes levied against the property. On November 5, 1904, the petitioner renewed this lease for a period of fifteen years from 1910, at an annual rental of $71,000, plus annual taxes, plus 5 per cent of any assessment against the property for betterments.
    On July 24, 1911, the petitioner became the lessee of the premises at 1-7 Winter Street, and 431-439 Washington Street, for a period of 30 years from the completion of the building being constructed thereon. The building was completed in October, 1912. The annual rental was $95,000, plus 5 per cent of the cost of the building, and 5 per cent of assessments against the property for betterments, plus tases and insurance.
    On February 16, 1910, the petitioner became the lessee of the premises at 413-415 Washington Street for the period from January 1, 1910, to September 3, 1921, at an annual rental of $19,250.
    The leases of November 5, 1904, and July 24, 1911, were not recorded in the office of the registry of deeds.
    The above leases cover adjoining properties at the intersection of Washington and Winter Streets, an important and valuable business locality.
    By March 1, 1913, the commercial value of the properties covered by these leases had been enhanced by the construction of subways, the terminals of which are close to petitioner’s store, by the proposed construction of other subways, and by the erection by other merchants of large stores in the vicinity.
    On August 1, 1912, the petitioner by a vote of its board of directors made an entry on its books of account setting up $150,000 as the value of its leases and making a credit to surplus of a like amount.
   OPINION.

Steenhagen:

The petitioner claims that its leaseholds were, on March 1, 1913, worth the amount of $150,000, entered upon its books in August, 1912, in excess of the value represented by the rentals and other terms of the leases. This amount it seeks to have recognized as the basis for exhaustion deductions within the taxable year. Grosvenor Atterbury, 1 B. T. A. 169. It has introduced in evidence the oral depositions of several witnesses who expressed their opinion that the leaseholds were of greater value on March 1, 1913, than was reflected in the rentals, and that this alleged increase in value was attributable to the completion of the subway near by, as well as the construction of large commercial buildings in the vicinity. The testimony of these witnesses is, however, not sufficient to indicate the measure of any enhancement in value which might have taken place. Their testimony indicates that their opinions were not the result of careful consideration but were mere casual expressions upon which no prospective willing purchaser would have acted on March 1, 1913. Bearing in mind that value implies both a purchaser and a seller, it is not enough that he who would be a seller expresses a categorical opinion as to value. Unless it is also shown that such an opinion represents the common point of dealing with a willing buyer, it does not prove value.

Judgment will be entered for the Commissioner,


text:
    Appeal of Commercial Truck Company of America.
    Docket No. 3300.
    Decided November 23, 1926.
    1. Petitioner did not possess a patent on March 1, 1913, and is not entitled to ascribe any value to a patent subsequently issued as of that date.
    2. Opinions of value upon the hypothesis that a patent existed on March 1,1913, based upon estimated royalties from the patented article, are insufficient to enable the Board to determine the fair market price or value, if any, of the application for letters patent

      John T. MeOraclcen, Esq., for the petitioner.

      John D. Foley, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes for 1918 in the amount of $45,287.53. The issue involved is the value, if any, on March 1, 1913, of a patent issued June 24,1913, for which application was made in 1909.
    FINDINGS OF FACT.
    The petitioner is a Pennsylvania corporation engaged in the manufacture of electrically propelled motor trucks in Philadelphia. Prior to 1909 and subsequent thereto E. ft. Whitney, an engineer, was in the employ of the petitioner, and there existed between them an oral agreement to the effect that all devices perfected and patented by him during his employment should become the property of the petitioner in so far as such devices related to automobiles.
    On February 26, 1909, Whitney filed an application for United States letters patent on an invention entitled “ Improvement in Motor Vehicles,” known as a “ Worm Drive Axle.”
    On November 22, 1912, the United States Patent Office notified Whitney that all claims set forth in his application for the patent had been allowed, with the exception of claim three, to the wording of which objection was interposed. Following receipt of such notice, and on December 23, 1912, the wording of this claim was changed to conform to the suggestions of the Patent Office. On March 8, 1913, formal notice of the allowance of the patent was forwarded to Whitney. On April 19, 1913, Whitney executed an assignment of the patent to the petitioner, which was received aDd recorded on the 22nd day of April in the Patent Office, in Liber 92, page 192, of Transfer of Patents. Letters Patent No. 1,065,413 were issued by the Patent Office June 24,1913.
    In the year 1918 petitioner sold this patent to a syndicate of automobile manufacturers for the sum of $50,000, reserving to itself the right to manufacture, use and sell axles embodying the invention.

      In determining tlie deficiency the Commissioner regarded as income all of the $50,000 received on the sale of the patent except an amount of $1,530.41, the cost of procuring the patent, and increased petitioner’s net income in the amount of $48,469.59, the amount by which the selling price of the patent exceeded the cost thereof.
   OPINION.

Littleton :

E. ft. Whitney agreed under a contract of employment with the petitioner that all devices perfected and patented by him during his employment should become the property of the petitioner so far as such devices related to automobiles. He perfected a device known as the “Worm Drive Axle,” for which application for patent was pending from 1909 to June 24, 1913, when the patent was issued. The device, however, had been manufactured, used and sold by the petitioner for several years prior to the issuance of the patent. At least two other automobile manufacturers made and used the device before that time.

The petitioner takes the position that the invention was perfected and the application for letters patent had, with one exception, been allowed prior to March 1, 1913, and the only thing which remained to be done was the issuance of the patent; also, that title to the patent related back to the date of the application which was prior to the basic date. The claims set forth in the application were not allowed in full until March 8, 1913, and the patent was not issued until June 24, 1913. Petitioner had no monopoly on the invention until the patent was issued and, furthermore, title by relation does not meet the requirements of the statute that the property must have been acquired before March 1, 1913, in order that the fair market price or value, as of that date, may be used as a basis for determining gain or loss on the subsequent sale. Appeal of Gity Bank Co., 1 B. T. A. 210. It is further contended that the application for the patent created a valuable property right on March 1, 1913, and that the value thereof was at least equal to or in excess of the sale price of the patent in 1918. We agree that an application for a patent is property and is subject to valuation. Individual Towel & Cabinet Service Co., 5 B. T. A. 158. The evidence submitted consisted of the testimony of engineers familiar with the petitioner’s invention. Their opinions of value were upon the hypothesis that petitioner owned a patent on March 1, 1913, and were based upon the estimated royalties from the patented article. This evidence is not sufficient to enable the Board to determine what value, if any, should be ascribed to the application for letters patent, which application was all that the petitioner owned on March 1, 1913.

Judgment will be entered for the Commissioner.


author: Sternhagen:

text:
    Cadillac Automobile Company of Illinois, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2657.
    Decided November 23, 1926.
    An amount withdrawn írom a corporation by its sole stockholder as a loan and carried on the corporation’s books and balance sheets as an account receivable upon which credit has been secured, there being no evidence oí a dividend, is within its invested capital.

      Henry W. Wales, Esq., for the petitioner.

      A. H. Fast, Esq., for the respondent.
    Deficiency of $9,276.51.'. income and profits taxes for the calendar year 1918, arising from the reduction of invested capital (1) by a prorated amount based on a tax for 1917 said to be greater than the true amount, (2) by excluding the amount of an account due the corporation on December 31, 1917, from its sole stockholder, and (3) by excluding one-half of the increase of this stockholder’s indebtedness during 1918.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation with its principal place of business in Chicago. In 1918 it was the distributing agent for Cadillac automobiles.
    C. H. Foster was the president and, with the exception of those holding qualifying shares, its sole stockholder. For several years Foster’s personal account had been carried on the books of the petitioner. This account was charged with withdrawals made by Foster and credited with various items, including dividends. On August 1, 1913, the debit balance due the corporation was $50,898.05. On August 1, 1916, the debit balance was $9,443.44; on December 31, 1917, it was $80,736.72; and on December 31, 1918, it was $86,575.04.
    In 1919 the Cadillac Motor Car Co. served notice that the agency contract would be canceled, effective August 1, 1919, as it intended to establish a direct factory branch. On August 1, 1919, the petitioner ceased doing active business and it is now in process of liquidation. Foster’s present debit balance is substantially as large as it was during 1918. The petitioner’s surplus is at the present time and always has been more than sufficient to take care of Foster’s indebtedness.
    The principal cause of Foster V indebtedness was his withdrawal of funds to purchase a vacant piece of property required for the petitioner’s use in the storage of cars brought in for repairs. Petitioner paid no rent for this property in 1917 and 1918. In 1919 a credit was carried to Foster’s account which included $21,000 to cover three years’ rent at $7,000 a year.

      A dividend of $30,000 was paid in 1917. It was credited to Foster’s account under date of September 6, 1917.
    On August 30, 1917, the following certification was made by Foster to accountants who were auditing the petitioner’s books:
    I hereby certify that the amount to the debit of my account, namely $54,935.37, at June 30, 1917, is the correct amount of my indebtedness to the Cadillac Automobile Company of Illinois at that date.
    On July 31, 1918, a similar certification was made, as follows:
    I hereby certify that the amount to the debit of my account, namely, $84,450.93, at July 31, 1918, is the correct amount of my indebtedness to the Cadillac Automobile Company of Illinois at that date.
    In 1917 and 1918 balance sheets were prepared by the accountants as of the same dates as those certified to by Foster, in which Foster’s indebtedness was included as a part of the assets of the petitioner. These balance sheets were presented to the National City Bank of Chicago, and based thereon credit of $200,000 was extended to the petitioner in each of those years. The petitioner borrowed sums of money from the bank; in the latter part of 1917 owed it in excess of $170,000; and at various times in 1918 owed it in excess of $190,000.
    The respondent reduced the petitioner’s invested capital for 1918 by prorating $28,815.46 as the amount of income tax for 1917. The correct tax for 1917 as finally determined is $25,595.12.
   OPINION.

Sternhagen:

1. The Commissioner admits the first error and hence the invested capital should not exclude for prior year’s tax more than $25,595.12, properly prorated. Russel Wheel & Foundry Co., 3 B. T. A. 1168.

2. The only evidence we have is to the effect that Foster borrowed some $80,000 and promised to pay it back. The corporation gave him the use of it with the full right to reclaim it. Foster, so far as the evidence shows, was solvent and able to pay the amount, and upon the strength of his promise as an account receivable the corporation, to some extent, secured credit at the bank. By its balance sheet it held out to third persons that Foster’s indebtedness was part of its assets, and Foster certified to this. We know of no authority for saying that Foster or the corporation could have contended for his or its own advantage that this belonged to Foster by way of dividend. Irrespective of whether Illinois law permitted such a dividend, we can not find any evidence that one was intended. When, in the future, either in the ordinary course or in final liquidation, Foster is relieved of the indebtedness, it will be necessary to consider whether he then realizes income. Meanwhile, what is for all other purposes a loan is not to be construed as a dividend solely to support a tax. See Pictorial Review Co., 5 B. T. A. 416. Like other accounts receivable, the amount is within the petitioner’s invested capital, and the Commissioner’s determination is reversed. This makes the petitioner’s third assignment of error unnecessary to consider, as it was raised only in the event of an adverse decision of the second.

Judgment for the petitioner in accordance with this opinion will he entered on 15 days' notice, under Rule 50.


author: GReen:

text:
    Arthur A. Cocke and wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 809.
    Decided November 24, 1926.

      Arthur A. Coche, Esq., for the petitioners.

      B. H. Saunders, Esq., for the respondent.
    The deficiencies involved in this proceeding are, in the case of each of the petitioners, income taxes for the year 1922 in the sum of $3,492.19. The petitioners are husband and wife, residing in Texas. The income involved herein was reported, and treated by the Commissioner, as community income.
    The petitioners allege eight errors in the computation of the net income:
    (1) The inclusion in net income of the amount of $82,500, which it is alleged never became income to either.
    (2) The disallowance of a deduction of $6,191.90, the amount of loss which it is alleged resulted from the surrender of 71½ contracts in the United Home Builders of America.
    (3) The disallowance of a deduction of $5,707.30, the amount of an alleged loss arising from an investment in the White Banking System.
    (4) The disallowance of a deduction of $5,910, claimed as interest accrued in 1922.
    (5) The disallowance of a deduction of $1,734.30, being the amount of taxes which it is alleged accrued upon a certain warehouse property prior to its acquisition by the petitioners. This item the Commissioner treated as a capital expenditure, treating it as a part of the cost of property purchased.
    (6) The disallowance of a deduction for taxes in an amount not stated in the petition, which it is alleged accrued after the acquisition of said warehouse property in 1922.

      (7) The disallowance of a deduction of $8,305.10, which it is alleged was a loss sustained upon 45 contracts in the United Home Builders of America.
    (8) The disallowance of a deduction of $16,453.95, being the amount of a loss which it is alleged resulted in 1922 from an investment in the Community Mausoleum.
    BINDINGS OP TACT.
    The petitioners are residents of Dallas, Tex. Prior to January 24,1922, the petitioner, Arthur A. Cocke, had an interest — the nature of which can not be determined from the record — in the United Home Builders of America, an association operating under the laws of the State of Missouri. He was, at the same time, one of the managing trustees of the association. The association had been seeking to purchase a building within which to conduct its business. The managing trustees (the petitioner, Arthur A. Cocke, and another whose name is not material) found that one Sachs, of St. Louis, was offering for sale a building in that city. The managing trustees, on behalf of the association, purchased the building from Sachs for $200,000.
    On January 24,1922, that being the same time as, or shortly after, the purchase of the building above referred to, the petitioner, Arthur A. Cocke, sold his interest in the association to Sachs for $100,000.
    Certain persons interested in the association — whether as owners of an actual interest or as contract holders, does not appear — brought suit against the petitioner in the courts of Dallas County, Texas, alleging that the association did not have in its expense fund an amount sufficient to pay the purchase price of the building, and that there had been expended in the purchase thereof funds which were the property of the contract holders. It was alleged that the amount received by the petitioner herein did not rightfully belong to him; that the interest sold could not be disposed of by him as trustee, to his own benefit; that the sale inured to the benefit of all contract members and that the $200,000 paid for the building came out of the loan or trust fund; and that therefore the $100,000 received by the petitioner herein was impressed with a trust and could be followed as such fund by the interested parties. A writ of attachment and garnishment was issued and there was attached thereunder, among other things, the petitioner’s bank account in which had been deposited the $100,000 received from Sachs.
    The petitioner filed his answer in the suit and a trial was had at which the jury disagreed. The suit was still pending at the date of the hearing of this proceeding and the petitioner herein still contends that the $100,000 is his and that it is not impressed with a trust.

      During the taxable year the petitioner owned or held 116½ contracts in the association above referred to. Of these contracts 71½ were pledged to a bank as collateral security for a loan. These contracts had a cash surrender value. Some time prior to the 25th day of December, 1922, the petitioner went to the office of the association and arranged with it for the surrender of the contracts and the payment to the bank of the surrender value thereof. The bank surrendered the contracts and received their surrender value, but we can not determine from the record how or when this was done. The evidence does not disclose the costs of the contracts or the amount received on their surrender.
    The remainder of the contracts were not surrendered and they became involved in the receivership proceeding and are in that condition today. The petitioner charged “ them ” off as a loss.
    One Charles H. White organized and put into operation what was known as the White Banking System. The principal feature of its business was what were described as “ cooperative loans.” The petitioner invested $5,707.30 in this organization in the year 1922 — ■ whether as a stockholder or in some other capacity, does not appear. White maintained his office in the offices of the petitioners. During the taxable year some disagreement arose between the petitioner, Arthur A. Cocke, and White as to the operation of the banking business and the petitioners refused to allow White to office with them. The amount of the investment in the White Banking System was charged off as a loss. On December 26, 1923, White gave the petitioner his note for $4,850, which note is still unpaid. The petitioner, during the year 1922 and a part of the year 1923, was one of the trustees of the White Banking System.
   OPINION.

GReen:

We are convinced that the petitioner’s sale to Sachs was not an advantageous one, but we are equally convinced that he derived a gain thereon and that that gain was properly included in gross income. The payment was deposited in the petitioner’s bank account and the proceeds thereof lay for thirty days unincumbered by either attachment or garnishment. The plaintiffs in that suit may establish a trust — and as to this we express no opinion — or they may establish a liability on the part of the petitioner herein which will be satisfied by an execution levied upon, the funds garnisheed. This disposes of the first allegation of error.

In regard to the second allegation of error, it appears that the petitioner, shortly before Christmas of 1922, made a trip to St. Louis and there arranged for the payment to the bank of the cash surrender value of the 71½ contracts belonging to him and held by it as collateral. The evidence is that the bank did surrender the contracts and receive their value, but whether in 1922 or 1923 we can not ascertain, and therefore affirm.the Commissioner. Likewise, the cost of the contracts and the amount received on their surrender is not in evidence.

The White Banking System, another cooperative loan organization, had interested the petitioner to the extent of investing $5,707.30 therein and becoming a trustee thereof. White officed with the petitioners. A disagreement arose, friendship ceased, and White moved his office elsewhere. The petitioners were dissatisfied with White’s management of the business, of which one of them was a trustee. Some time in 1923 White gave the petitioner a note for $4,850. The proof of loss is lacking and we must affirm the Commissioner.

The proof, if any, in support of the remaining allegations of error, is wholly inadequate and makes their further consideration unnecessary.

Judgment will be entered for the Commissioner.

KoeneR, Littleton, and Milliken not participating.