author: Lansdon:

text:
    Appeal of THE VISCOSE CO.
    Docket No. 3164.
    Submitted July 16, 1925.
    Decided January 26, 1926.
    Taxpayer is entitled to bave its profits tax computed under the provisions of section 210 of the Revenue Act of 1917 and section 328 of the Revenue Act of 1918.

      Virgil Y. Moore, Andrew T. Smith, and Richard E. Dwight, Esgs., for the taxpayer.

      A. 3. Fast, Esq., for the Commissioner.
    Before SterNhageN, LaNsdoN, and Love.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar years 1911, 1918, and 1919, in the aggregate amount of $536,126.92. The two issues involved are, (1) whether the Board has jurisdiction under the Revenue Act of 1924 to hear and determine the appeal, and (2) whether the taxpayer is entitled to special relief by having its tax liability determined and assessed under the provisions of section 210 of the Revenue Act of 1911 and section 328 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    1. The taxpayer is a Pennsylvania corporation with its principal office at Marcus Hook.
    2. On December 3, 1921, the Commissioner mailed the taxpayer .a letter proposing an assessment of additional income and profits taxes for the calendar years 1917, 1918, and 1919, and granting 30 days from its date within which to protest and appeal from the findings thereof. Before the expiration of such 30 days, and on December 31, 1921, the taxpayer applied to the Commissioner for an extension of time within which to file its written protest and appeal and also asked for an oral hearing. The extension of time was given and an oral hearing was granted and set for January 18, 1922. On January 16, 1922, said written protest and appeal were filed and accepted by the Commissioner. The oral hearing was held on January 18, 1922, and the protest and appeal considered. Prior to January 17, 1922, and at a time when the collection of such tax would not have been jeopardized by delay until after such hearing, and was not believed by the Commissioner to be so jeopardized, the proposed assessment, in the amount of $997,259.74, was made. The taxpayer had no knowledge of such assessment until on or about February 20, 1922, at which time, upon complaint by the taxpayer, the Commissioner directed, the collector of internal revenue for the taxpayer’s district to file his, the said collector’s, claim in abatement of $671,181.59 of such alleged assessment of taxes (the taxpayer at the time paying the remainder thereof, namely, $326,078.15), which the said collector did, and the same was accepted by the Commissioner. The taxpayer did not at that time, nor has it since, filed any claim in abatement of these taxes, or any taxes involved in this appeal. After February 20, 1922, the Income Tax Unit continued to consider the assessment proposed in its letter of December 3,1921, and announced its findings in a letter dated August 29, 1922, which also granted the taxpayer 30 days within which to appeal. On September 7,1922, the taxpayer did appeal to the Committee on Appeals and Review. On March 2, 1923, the Unit forwarded the case to the Committee on Appeals and Review, with an ordinary letter of transmittal, as provided by Treasury Decision 3492, which, at that time, governed appeals or proposed additional assessments. On May 23, 1923, a hearing on appeal was granted to the taxpayer by the Committee on Appeals and Review. On January 19, 1924, a supplemental brief was filed by the taxpayer with the Committee. On January 29, 1924, the Committee granted a further hearing to the taxpayer and its representative. In accordance with the request of the Committee made at the hearing of January 29, 1924, additional information was filed with it on February 11 and 15, 1924. At a hearing on October 15, 1924, before the Review Division of the Solicitor’s office, further information was filed. The taxpayer received a letter dated February 9, 1925, containing the Commissioner’s final determination of the appellant’s tax liability for the years in question. In that letter the Commissioner computed the taxpayer’s excess and war-profits taxes under the normal provisions of the Revenue Acts and denied relief under section 210 of the Revenue Act of 1917 and sections 327 and 328 of the Revenue Act of 1918.

      3. During the taxable years m question, the taxpayer was engaged in the manufacture and sale of artificial silk yarn or Rayon. A brief history of this industry is essential to a clear understanding of the situation from which this appeal arises. Courtaulds, Ltd., of England, was the first successful producer of artificial silk. Since about 1904 this company has been the largest and most successful concern in this industry in the world. About the same time there was operating in the United States the General Artificial Silk Co., which, however, was unsuccessful and went into the hands of a receiver. The Genasco Silk Co., organized as its successor in 1904, operated with indifferent success until 1908, when it sold its assets, including patents and secret processes in the United States, to Courtaulds, Ltd. In 1909, Courtaulds, Ltd., organized the American Viscose Co., hereinafter sometimes designated as the predecessor, or the predecessor corporation, in the United States, which was successful from the beginning. This new company used many patents, secret processes, and refinements and improvements obtained from Courtaulds, Ltd. Its engineers and chemists visited and studied the Courtaulds plant, brought the latest development in the art to the United States from time to time, and carefully guarded all secret processes and machinery for producing artificial silk yarn.
    As a precaution against the disclosure of its processes employed in constructing its machinery, the taxpayer made its own designs, placed its orders for parts, with detailed descriptions, with scattered manufacturers, and then assembled and completed the parts so constructed in accordance with its own secret specifications. Experimentation and development work were continually carried on to better the processes and machinery for production. One particularly striking success was the elimination of fuzz from the yarn. It seems that fuzz and the weakness of the yarn prevented its general use in certain knit goods. The improvements remedying these defects were worked out and developed during 1914, 1915, and 1916, and were first successfully applied during 1916. This enabled the taxpayer to enter the enlarged fields of knit goods and fine needle trade. Increased income resulting from this broadened market, however, was not realized in any large measure until 1918 and 1919. The taxpayer and its immediate successor were by far the largest manufacturers of artificial silk yarn in the United States.
    4. The Viscose Co., hereinafter called the taxpayer, was oi’gan-ized on May 20, 1915, with an authorized capitalization of $10,000,-000, and on that date purchased all the assets of the predecessor corporation. The capital stock of the American Viscose Co. was owned by Courtaulds, Ltd. In consideration of the transfer of the assets of the predecessor corporation to it, the taxpayer issued to the American Viscose Co. $9,999,500 of its capital stock, paid $500 cash, and acquired all the contracts and assumed all the liabilities of the predecessor. The stock so issued was then distributed to the stockholders of the American Viscose Co. in exact proportion to their holdings in that corporation.
    The tangible assets of the predecessor were carried upon its books at $3,731,559.58 and the liabilities at $99,977.31, indicating a net book value of tangible assets of $3,631,582.27. The taxpayer set up the same values upon its books and $500 for cash paid, making the value of its net tangible assets $3,632,082.27. To balance the stock account, this latter sum was subtracted from $10,000,000, the par value of the issued stock, leaving a remainder in the amount of $6,367,917.73, which was entered upon the books of the taxpayer as good will. A comparative statement of assets and liabilities of the taxpayer and its predecessor as of May 20, 1915, as shown upon their books, is as follows:

    The contract of May 20, 1915, hereinafter more fully described, whereby the American Viscose Co. acquired various patents from Courtaulds, Ltd., and issued notes therefor in the amount of $5,000,-000, is not represented in the above statement.
    5. By the purchase of the assets of the American Viscose Co. on May 20, 1915, the taxpayer acquired all the tangible and intangible property owned by that corporation. The principal items of value (in addition to cash, accounts receivable, inventories, etc., over which there is no controversy) were:
    (1) Plant and equipment.
    (2) Contract with Doctor Ernst.
    (3) Contract with Mr. Slater.

      (4) Patents.
    (5) Secret processes and refinements.
    (6) Future patents and processes with Courtaulds, Ltd.
    (7) Good will.

      Plant and equipment. — The predecessor corporation carried on its books the item “Plant Assets, $2,906,597.61.” This same amount was set up on the books of the taxpayer at the time of the transfer. It was the practice of the predecessor to enter upon its books the bare cost of labor and material used in the construction of its plant and machinery. For the purpose of guarding the secrets of the trade, it would have the parts of the machinery manufactured at different places. These parts would then be finished up at the factory, in accordance with the secret specifications of its own expert engineers, and there assembled into completed machines. The books as kept did not show the actual cost of completed machines. They did not reflect, in connection with the machines, the overhead expenses, such as salaries for supervision and engineering costs, or the increased value of the completed machines. No appraisal of the plant and equipment was ever made by the predecessor corporation, the taxpayer, or the Commissioner,.but the value of such property was in excess of the amount carried upon the books of the taxpayer.

      Gontraet with Doctor Ernst. — Dr. Charles A. Ernst was closely associated with the artificial silk industry from its inception. He was a chemist with the General Artificial Silk Co. in 1904 and was chief chemist and plant manager of the Genasco Silk Co., the successor of that concern, until 1908, at which time was employed by Courtaulds, Ltd., and went to England, where he studied and worked until 1909. He was then sent back to the United States by Courtaulds, Ltd., as chief chemist and general manager of the American Viscose Co. Upon the acquisition of the American Viscose Co. by the taxpayer, he-continued at first in the same position, but later became president. During his employment with the taxpayer and its predecessor he devised, perfected and patented many appliances and processes necessary for the profitable manufacture of artificial silk yarn. He also made numerous inventions and improvements, which were not patented but were held and used as secret processes. He was instrumental in the development of the method of eliminating fuzz from the yarn, which made it usable for knit goods, as heretofore described. A large part of the success of the predecessor and the taxpayer was due to his activities as chemist and plant manager.
    Doctor Ernst’s contract with the predecessor was transferred to the taxpayer. Important provisions of the contract of employment were:

      (1)- He’Should not engage in or carry on any business with any other company but should devote himself and his whole time to the company.
    (2) He should not divulge to any other concern any information as to the processes, machinery, chemicals, etc., used by the company.
    (3) He should at all times endeavor to discover and invent new processes, machinery, etc., and remedies for defects, all of which he was to divulge to the company.
    (4) All discoveries and inventions connected with the business, whether patented by Doctor Ernst or not, should become the property of the company.
    (5) He should not, within four years after leaving the company, directly or indirectly, be identified with any other concern in the same business.
    (6) The contract could be assigned to a successor company.

      Contract with Mr. Slater. — Herbert P. Slater was chief engineer of the American Viscose Co. from its beginning, but, prior to the organization of that concern, he went to . Co'urtaulds, Ltd., in England, to examine and study all the engineering features of that company. During his subsequent employment, he made numerous valuable improvements in the machinery of the taxpayer and its predecessor. All such improvements were turned over to the company without expense, in accordance with the terms of his employment contract. He invented a particularly valuable improvement on the spinning machine, whereby the output per unit was increased 20 to 30 per cent. He was one of the most expert and experienced engineers in this partic'ular business in this country. The provisions of his contract of employment with the American Viscose Co. were similar to those of the contract with Doctor Ernst. This contract was assigned to the taxpayer, and Slater has continued as its chief engineer until the present time.

      Patents. — All the patents owned or used by the predecessor were included in the transfer of assets to the taxpayer. The American Viscose Co. also was using, on a royalty basis, certain specified patents owned by Courtaulds, Ltd. The percentages of profits paid for the use of such patents were: 1913,18 per cent; 1914, 15 per cent; 1915, 14 per cent; and 1916, 12 per cent, and an additional bonus of $2,000,000 was agreed to be paid, in annual installments of $500,000 each. Just prior to the transfer of the assets, this royalty arrangement was canceled and a new contract was entered into by the terms of which the patents were to be transferred outright to the American Viscose Co. for a consideration of $5,000,000. This contract to purchase was transferred to the taxpayer. The patents so acquired,at the time of the transfer were indispensable to the predecessor corporation and the taxpayer in the successful operation of the business.

      Secret processes and refinements. — In addition to patents, the American Viscose Co. developed and used numerous valuable secret processes and refinements in the manufacture of its product, all of which were essential to the profitable operation of its business. Such secret processes and refinements consisted of the adjustment and concentration of chemicals and the regulation of temperatures in different steps in the manufacture of artificial silk. These were all included in the transfer of the assets to the taxpayer and were used by it.

      Future patents and processes of Courtaulds, Ltd. — The predecessor corporation had a contract by the terms of which it was entitled to use all future patents and secret processes obtained or developed by Courtaulds, Ltd., and to have access to the plants of that concern. It frequently took advantage of this provision and sent engineers and chemists to England to study the processes and adapt them to its own use. This right was also transferred to the taxpayer. The pertinent part of the contract was:
    2. Courtaulds agrees that, during the life of such one of the said Patents as shall longest continue, Viscose, or its Nominee, may, in the United States, use all Patents, Improvements, Machinery and Processes in and for the manufacture of artificial silk, which Courtaulds may now or hereafter own, discover, invent, obtain or acquire, and that, during the period aforesaid, Courtaulds will, to the extent of its knowledge, give to Viscose, or its Nominee, the fullest information and disclosure as to all machinery and processes, secret and otherwise, in reference to such manufacture and extend to Viscose, or its Nominee, full inspection from time to time of its factories for such manufacture.
    6. No value was set up upon the books of the taxpayer or its predecessor for any of the assets enumerated and described in the preceding paragraph, and it was impossible on May 20, 1915, or at any time since, satisfactorily to determine such values.

      7. During the year 1916, negotiations were entered into between the taxpayer and the Du Pont interests for the sale of the majority of the stock of the taxpayer. Courtaulds, Ltd., the principal stockholder of the taxpayer, at first fixed the value of all the assets, including both tangibles and intangibles, at $50,000,000, but later this was reduced to $48,000,000. The Du Pont interests took an option at the latter figure. No sale or agreement of sale resulted from such option and negotiations.
    8. Artificial silk yarn is manufactured by four different general processes well known in the trade. All involve the same general chemical processes applied along different lines. The Viscose process is but one of. the four used by a number of manufacturers. The secret processes of the taxpayer, as well as of the other manufacturers, consist of numerous adjustments of chemicals, timing, and temperatures during the various stages in the manufacture of the product, and of designs and specifications used in constructing the necessary machinery. The method of manufacturing mercerized cotton yarn is somewhat similar to that of manufacturing artificial silk yarn. The same raw materials are used and the finished products are similar, except that in the cotton yarn the change producing the luster is upon the surface instead of throughout the entire thread as in the artificial silk yarn. Mercerized cotton yarn and artificial silk yarn are used for the same purposes, seek the same markets, and are in competition with each other.
    9. The net income of the taxpayer, as adjusted by the Commissioner, and the invested capital for some of the years, are as follows:

    10. The Commissioner’s final determination of the excess and war-profits taxes of three manufacturers of mercerized cotton yarn, their invested capital, gross income, net income, and other relevant facts, were as follows:

    A similar statement in respect of the taxpayer, as determined by the Commissioner, is as follows:
    Company. Year. Invested capital. Net profits. Profits taxes credit. Profits t Percentage. Viscose Co. (Commissioner’s computation in deficiency letter dated Feb. 9, 1925). 1917 •1918 1919 $10,916,472.48 17,262,704.40 22,926,296.80 $13,793,428.09 15,175,725.66 29,420,786.12 $985,482.52 3,502,718.17 1,837,103.74 $6,965,480.63 10,635,725.66 10,483,841.82 50.57 68.64 38.00
    DECISION.
    The deficiency, if any, should be computed in accordance with the following opinion. Final determination will be settled on 15 days’notice, in accordance with Rule 50.
   OPINION.

Lansdon:

The issues raised in this appeal are (1) jurisdiction of the Board, and (2) the right of the taxpayer to special assessment under the provisions of section 210 of the Revenue Act of 1917 and sections 327 and 328 of the Revenue Act of 1918.

As to the jurisdiction of the Board, we are of the opinion that the facts, as set forth in our findings of fact, put this appeal clearly within the rule laid down in the Appeal of Ormsby McKnight Mitchel, 1 B. T. A. 143, and Appeal of Boston Structural Steel Co., 1 B. T. A. 602. We therefore hold that the Board has jurisdiction.

The provisions of the statutes relating to special assessment under which the taxpayer seeks relief are as follows:

Sections 210 of the Revenue Act of 1917, and 327 and 328 of the Revenue Act of 1918, provide:

Seo. 210. That if the Secretary of the Treasury is unable in any case satisfactorily to determine the invested capital, the amount of the deduction shall be the sum of (1) an amount equal to the same proportion of the net income of the trade or business received during the taxable year as the proportion which the average deduction (determined in the same manner as provided in section two hundred and three, without including the $3,000 or $6,000 therein referred to) for the same calendar year of representative corporations, partnerships, and individuals, engaged in a like or similar trade or business, bears to the total net income of the trade or business received by such corporations, partnerships, and individuals, plus (2) in the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000.
For the purpose of this section the proportion between the deduction and the net income in each trade or business shall be determined by the Commissioner of Internal Revenue in accordance with regulations prescribed by him, with the approval of the Secretary of the Treasury. In the case of a corporation or partnership which has fixed its own fiscal year, the proportion determined for the calendar year ending during such fiscal year shall be used.
Sec. 327. That in the following cases the tax shall be determined as provided in section 328:
(a) Where the Commissioner is unable to determine the invested capital as provided in section 326;
(b) In the case of a foreign corporation;
(c) Where a mixed aggregate of tangible property and intangible property has been paid in for stock or for stock and bonds and the Commissioner is unable satisfactorily to determine the respective values of the several classes of property at the time of payment, or to distinguish the classes of property paid in for stock and for bonds, respectively;
(d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section S28. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, nor (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under section 233 of Title II) consists of gains, profits, commissions, or other income, derived on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
Sec. 328. (a) In the cases specified in section 327 the tax shall be the amount which bears the same ratio to the net income of the taxpayer (in excess of the specific exemption of $3,000) for the taxable year, as the average tax of representative corporations engaged in a like or similar trade or business, bears to their average net income (in excess of the specific exemption of $3,000) for such year. In the ease of a foreign corporation the tax shall be computed without deducting the specific exemption of $3,000 either for the taxpayer or the representative corporations.
In computing the tax under this section the Commissioner shall compare the taxpayer only with representative corporations whose invested capital can be satisfactorily determined under section 326 and which are, as nearly as may he, similarly circumstanced with respect to gross income, net income, profits per unit of business transacted and capital employed, the amount and rate of war profits or excess profits, and all other relevant facts and circumstances.
⅝ sji ⅝ ⅝ $ ⅜ ⅝

The taxpayer has presented a great mass of impressive facts and persuasive arguments in support of its contention that it is entitled to special assessment for the determination of its tax liability for the years involved in this appeal. The Board must base its conclusions on the answers to the following questions to be made from the testimony offered at the hearing:

1. Is the Commissioner unable satisfactorily to determine invested capital?

2. Was there a mixed aggregate of tangible and intangible property paid in for stock of such nature that the Commissioner is unable satisfactorily to determine the respective values of the several classes of property at the time of payment, or to distinguish the classes of property paid in for stock ?

3. During the taxable years in question, were there such abnormal conditions affecting the capital or income of the taxpayer as would work an exceptional hardship, evidenced by gross disproportion between the tax computed without the benefit of the special assessment sections and the tax computed by reference to representative corporations ?

4. Were there available for use as comparatives other representative corporations engaged in a trade or business like or similar to that of the taxpayer and similarly circumstanced?

For answer to the first question, the. Commissioner contends that he is able satisfactorily to determine invested capital. He relies on the figures entered upon the books of the taxpayer at the date of the acquisition of the assets of the American Yiscose Co. as the basis of his determination. The taxpayer was organized with capital stock of $10,000,000. The American Yiscose Co. carried on its books tangible assets at the net book value of $3,631,582.27. The taxpayer transferred the same value for tangible assets, plus $500 cash paid in, to its books. Subtracting this amount from $10,000,000 leaves a remainder of $6,367,917.73, which was charged against stock issued for good will. The parties agree that no actual appraisal of values acquired from the American Viscose Co. was attempted by the taxpayer or the predecessor corporation, and that the Commissioner has never made an appraisal of such tangible or intangible assets.

In controversies involving invested capital, the burden ordinarily is upon the taxpayer to sustain by proof the values set up on its own books. In this appeal, however, it is necessary for the taxpayer to go one step further and to prove that the figures entered on its books did not reflect the true values, which, it contends, were very much greater. There are several outstanding circumstances which support the taxpayer’s contention that the assets had a far greater value than was indicated by the book entries. It is undisputed that the book values for machinery and equipment represent only the actual cost of material and labor. The machinery parts were ordered in rough and unfinished form from different factories and then completed and assembled in secrecy by employees of the taxpayer’s predecessor. No account was taken on the books of the overhead expense incurred in this process, such as' salaries and engineering costs.

Several other facts strongly support the contentions of the taxpayer, noteworthy among them the acquisition of (1) valuable patents, (2) the contracts of employment with Ernst and Slater, (3) the secret processes and refinements acquired from the predecessor, (4) the contract rights to future patents and secret processes developed by Courtaulds, Ltd., and (5) future benefits from developments already under way. No attempt was made to reflect the true value of any of these tangible assets upon the books of the predecessor corporation or the taxpayer. It is not necessary to analyze these assets in detail, but we can not escape the conclusion that such acquisitions were of very great value and were substantial contributing factors in earning the subsequent income of the taxpayer. In this connection, also, the taxpayer points out that, a short time after its acquisition of the property, negotiations were carried on at arm’s length with the Du Pont interests on the basis of a- $48,000,000 valuation. While this is not conclusive evidence of such value, it certainly supports the contention that the capitalization of the taxpayer at $10,000,000 and the issuance of stock in that amount at par value for the assets of the predecessor corporation were not regarded by the taxpayer or its competitors as a reflection of the true values of the assets.

An affirmative answer to the question relating to “mixed aggregate of tangible and intangible property,” as set forth in section 327 (c), also would entitle the taxpayer to relief. Paragraph (c) of section 327 of the Kevenue Act of 1918 provides:

Sec. 327. That in the following cases the tax shall be determined as provided in section 328:
*******
(c) Where a mixed aggregate of tangible property and intangible property has been.paid in for stock or for stock and bonds' and the Commissioner is unable satisfactorily to determine the respective values of the several classes of property at the time of payment, or to distinguish the classes of property paid in for stock and for bonds, respectively.

How is it possible for the Commissioner to determine the respective values of the several classes of' tangible and intangible property acquired by the taxpayer in exchange for stock? The values set up on the books of the taxpayer for tangible property represent only the bare cost of material and labor for plant and equipment and do not include either the actual cost of the complete equipment or the increment in value resulting from such construction. The book value of the tangible property acquired from the predecessor corporation is the basis or starting point for the Commissioner’s computation of invested capital. It is clear to us that he has reasoned from wrong premises. Neither the Commissioner nor the taxpayer has made any attempt to determine or distinguish the respective values of the patents acquired, the contract rights to future patents and processes of Courtaulds, Ltd., or of the plant and equipment as completed. The taxpayer, through its officers who are in a position to know, contends that it was and is impossible satisfactorily to appraise or compute those values, except to ascertain that, in the aggregate, they are several times the amount of the original capitalization of $10,000,000. We are convinced ‘from the testimony that the values of these elements, however indistinguishable as to their respective proportions and classes, were in the aggregate far in excess of the values determined by the Commissioner.

Now, as to abnormalities, we believe the facts speak for themselves. Our attention is called to the large net income of the taxpayer, as found by the Commissioner, and also to the small proportionate amount of invested capital allowed for the same years. The net income of the taxpayer and the invested capital, as computed by the Commissioner for some of the years, ⅛ as follows:

A high rate of profit upon a normal invested capital, of course, is not in itself an abnormality, but, taken in connection with the facts and circumstances of this case, the computation of tax liability without the benefit of the relief sections certainly would work an exceptional hardship upon the taxpayer. What are abnormalities in this case? The situation, viewed as a whole, strikingly impresses us as an unusual and abnormal condition. It is so unusual and different from the ordinary course of business organizations that, aside from the commercial aspects, it is highly interesting as the history of a successful industry. Here is pictured the early struggles of the artificial silk industry in the United States; the organization, unsuccessful operation, and failure of the preceding pioneer corporations, the American Artificial Silk Co. and the Genasco Silk Co.; the organization of the American Viscose Co. by Courtaulds, of England, which purchased the Genasco Silk Co., and then the rapid development and final and complete success of the American Viscose Co., which became the leading manufacturer in America of artificial silk yarn. During all this time there were constant developments and improvements in the industry. Specialists were employed, many patents were acquired from time to time, and numerous secret processes and refinements were added to reduce manufacturing costs and improve the product.

There are a number of conditions affecting the capital and income of the taxpayer which seem to differentiate it from corporations the taxes of which are computed without the benefit of the relief sections.. We will mention a few. The stockholders and stockholdings of the predecessor corporation and the taxpayer were identical. There was no necessity for appraisal or valuation of the assets transferred at the date of reorganization. The taxpayer was in fact trading with itself, not at arm’s length with strangers, and therefore made no attempt to reflect the value of the acquired assets on its books. This is substantiated to some extent by the fact that the Commissioner computed the invested capital for 1917 at approximately $11,000,000, while, during the preceding year, negotiations were had with the Du Pont Co. on a basis of a $48,000,000 valuation. Another abnormal condition, reflected in the income, resulted from the successful elimination of fuzz from the artificial silk yarn and the strengthening of the yarn so that it was suitable for the knit-goods trade. As shown in our findings of fact, this development was well under way in the years of 1914 and 1915, during the régime of the predecessor, and it was finally completed in 1916. Some time was required to develop new markets made possible by this improvement, so that the resulting income was not realized until 1918, 1919, and subsequent years.

A number of other circumstances are called to our attention as abnormalities, upon which we have touched in discussing other ‘ points, such as the plant account as shown on the books, the large income, and the inconsistent results of determining the tax by statutory computation. There is no doubt in our minds that all of these circumstances, taken together, put the taxpayer in the abnormal class, within the meaning of the statute.

Before the statutory provisions under which the taxpayer seeks relief can be applied, it is necessary to identify proper comparatives. Are there other representative corporations engaged in a trade or business like or similar to that of the taxpayer which may be used as comparatives? The Commissioner contends that the unusual conditions proved herein are the result of a monopoly and that there are no other corporations similarly circumstanced. The testimony discloses that there are at least four methods of manufacturing artificial silk yarn, of which the Viscose process is but one. There are a number of other concerns in the United States which are manufacturing artificial silk yarn by the Viscose process, all of which have their own secret processes and refinements. However, none of these approaches the taxpayer in the magnitude of output, volume of earnings, or command of markets. The' taxpayer contends, therefore, that it is not a monopoly, but is in direct competition, not only with the producers of artificial silk yarn, but with the manufacturers of mercerized cotton yarn, of which there are several who are similarly circumstanced to the taxpayer with respect to gross income, net income, etc. It has proved that its product is used in the same class of articles and sold to the same customers, and that the prices it obtains rise and fall with the prices of mercerized cotton yarn. We are convinced thafeethe taxpayer was not a monopoly | and that there are proper comparatives, within the meaning of the j statute. Mere superiority of product and success in manufacturing ,; and marketing do not constitute a monopoly. It is an extremely I1 I difficult task for any taxpayer to present conclusive evidence of suitable comparatives, because such information is peculiarly within the knowledge of the Commissioner. In this appeal, however, the taxpayer has succeeded in presenting the data necessary to identify a few representative corporations, within the meaning of the statute.

In the light of all the evidence, the taxpayer has convinced us that the book entries assigning values to the tangible and intangible assets acquired by the taxpayer from the American Viscose Co. were not intended to reflect and did not reflect the true value of such assets; that it is impossible to determine the values of the mixed aggregate of tangible and intangible property, acquired in exchange for stock on May 20, 1915, and that, during the years in question, many abnormal conditions affecting capital and income of the taxpayer existed and resulted in exceptional hardship in the computations of tax liability without the benefit of the special assessment provisions of the statute. We are of the opinion, therefore, that the taxpayer is entitled to have its tax computed under the provisions of section 210 of the Revenue Act of 1917 and section 328 of the Revenue Act of 1918.

The taxpayer in its brief, after reciting the information available to the Commissioner for the purpose of comparatives in the determination of the tax, says:

We shall not go further for the present than to ask Tour Honors, after making the findings of fact hereinbefore requested, to refer this case back to the Commissioner for a determination of the tas liability of the taxpayer under the provisions of Rule 50 of this Board’s Rules of Practice.

The tax should be computed as follows: The Commissioner should select comparatives and determine the amount of the deficiency after the computation of the tax under the provisions of section 210 of the Revenue Act of 1917 and section 328 of the Revenue Act of 1918, and notice of such computation should be served as provided in Rule 50, the right being reserved to the taxpayer to object to said computation and to show cause at a hearing had thereon why the computation of the Commissioner should not be adopted as a basis of final settlement.

On reference to the Board, James, LittletoN, Smith, and Trtjs-sell dissent.

ArttNdell not participating.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Appeal of GUARANTY TRUST CO., Executor, Estate of CLAIRE LOUISE BURTON.
    Docket No. 3272.
    Submitted June 29, 1925.
    Decided January 26, 1926.
    Tbe decedent received from tbe administrator of tbe estate of ber deceased husband, wbo died less than five years prior to tbe date of ber own decease, $127,035 in settlement of certain lawsuits. Tbe evidence does not show whether such receipt was a gift, bequest, devise, or inheritance from tbe estate of the deceased husband.

      Irving Gordon, Esq., for tbe taxpayer.

      J. G. Swayze, Esq., for tbe Commissioner.
    Before Sternhagen, Lansdon, Love, and Smith.
    Tbis is an appeal from tbe determination of a deficiency in estate tax in the amount of $7,630.06. The issue is whether there should be deducted from the gross estate of the decedent, under the provisions of section 403 (a) (2) of the Revenue Act of 1921, $127,035 claimed to have been received from the estate of the decedent’s husband, who died less than five years from the date of the death of the taxpayer decedent.
    FINDINGS OF FACT.
    Frank Vincent Burton, the husband of Claire Louise Burton, died March 11, 1922. His estate paid a Federal estate tax, levied under the provisions of the Revenue Act of 1921, upon the sum of $127,035, which sum was paid to Claire Louise Burton, as hereinafter mentioned. Claire Louise Burton, hereinafter referred to as the decedent, died August 30, 1923. Prior to the date of her death, or on or about May 24, 1923, the decedent received from the administrator of the estate of Frank Vincent Burton, in settlement of certain law suits then pending, the sum of $127,035. This sum was placed to the credit of the decedent on the books of the Guaranty Trust Co. on May 24, 1923. On the day previous the decedent’s balance in the Guaranty Trust Co. was $16,045.77. On June’26, 1923, the decedent purchased 100 shares of Union Pacific Railroad Co. common stock at a cost of $13,420 and 100 shares of American Car & Foundry common stock at a cost of $16,620. On June 29, 1923, she purchased 100 shares of United States Steel Corporation common stock at a cost of $9,315 and 100 shares of American Telephone & Telegraph stock at a cost of $12,115. The total cost of these shares of stock was $51,470. The cost of the purchases was charged against the decedent’s personal account in the Guaranty Trust Co. A transcript of the account of Mrs. Claire Louise Burton in the Guaranty Trust Co. from May 1,1923, is as follows:

    On June 20, 1923, the decedent, Claire Louise Burton, stated to D. B. Crocker, assistant to the trust officer of the Guaranty Trust Co. of New York, that there had recently been received by her a sum in excess of $100,000. On or about June 23, 1923, the decedent requested Crocker to purchase for her the following securities at certain prices:
    One hundred shares American Car & Foundry common.
    One hundred shares American Telephone & Telegraph common.
    One hundred shares Union Pacific Railroad Co. common.
    One hundred shares United States Steel Corporation common.
    The above-named securities were purchased by the Trust Co. and the cost was charged to decedent’s cheeking account in accordance with her instructions. The decedent was ill at the time and it was not until several weeks had elapsed that the question of investing the balance was mentioned. Some time in July, 1923, the decedent told Crocker that she expected to invest the balance of the money which she had received as soon as she felt better.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Smith:

In the estate-tax return filed by the Guaranty Trust Co. of New York for Claire Louise Burton, deceased, there was deducted from the gross estate $121,035, upon the ground that this amount was received by the decedent from the estate of her husband, who died less than five years prior to the date of the death of the decedent. The deduction was disallowed by the Commissioner, apparently upon the ground that the $127,035 could not “ be identified as having been acquired in exchange for property ” received from the estate of the decedent’s husband.

The law applicable to the issue involved is section 403 (a) (2) of the Revenue Act of 1921, which permits the deduction from the gross estate of a decedent, in the determination of the net estate, of “ an amount equal to the value of any property forming a part of the gross estate situated in the United States of any person who died within five years prior to the death of the decedent where such property can be identified as having been received by the decedent from such prior decedent by gift, bequest, devise, or inheritance, or which can be identified as having been acquired in exchange for property so received.”

In the instant appeal the decedent received from the administrator of the estate of Frank Vincent Burton, in settlement of certain pending lav/ suits, the sum of $127,035. The Board is not informed of the character of these law suits, or whether the amount constituted a “ gift, bequest, devise, or inheritance ” received from the estate of her deceased husband.

On reference to the Board, James did not participate.


text:
    Appeal of SHEET METAL CONSTRUCTION CO., INC.
    Docket No. 5089.
    Submitted November 10, 1925.
    Decided January 26, 1926.

      Samuel Y. Markley, Esq., for the taxpayer.

      M. N. Fisher, Esq., for the Commissioner.
    Before James, Littleton, Smith, and TRussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1919 in the sum of $771.46. The deficiency arose from the refusal of the Commissioner to permit the taxpayer to file a consolidated return with the Masters Waterproof-ers, Inc., an alleged affiliated corporation.

      BINDINGS OB BACT.
    1. The taxpayer is a New York corporation, organized in July, 1919. It issued 60 shares of cajiital stock of a par value of $100 each as follows: Monroe S. Goldberg, 20 shares; Arthur D. Hyman, 20 shares; Max Kestenbaum, 20 shares.
    2. The Masters Waterproofers, Inc., was also a New York corporation, of which the sole stockholders were the above-named Monroe S. Goldberg and Arthur D. Hyman, who owned 340 shares each. In July, 1919, the stock and interest of the said Goldberg and Hyman in the taxpayer were purchased by and turned over to the said Masters Waterproofers, Inc. The remaining 20 shares of the taxpayer were still held in the name of Kestenbaum, who was employed by the taxpayer, as hereinafter set forth. Kestenbaum paid for his 20 shares of stock by turning over to the taxpayer a small sheet-metal plant and equipment, at a valuation of $1,200, and giving a note for $800 secured by the stock as collateral. The pertinent parts of the instrument evidencing the sale of'the sheet-metal plant are as follows :
    Know all men by these presents: that Max Kestenbaum, of No. 741 JDeKalb Ave., in the Borough of Brooklyn, City and State of New York, hereinafter designated as the vendor, for and in consideration of the sum of One Dollar to him in hand paid before the ensealing and delivery of these presents, by the Sheet Metal Construction Co., Inc., hereinafter designated as the vendee, the receipt whereof is hereby acknowledged, and for other valuable consideration, has bargained and sold and by these presents does grant and convey to the said vendee, its successors and assigns, the business now and heretofore conducted by him at No. 741 DeKalb Ave., in the Borough of Brooklyn, City and State of New York, including the good will thereof, stock in trade, machines, fixtures, appurtenances and contracts on hand for work to be performed by him, to have and to hold the same unto the said vendee, its successors and assigns forever.
    The Masters Waterproofers, Inc., was engaged in the contracting business, and purchased the plant of the said Kestenbaum for the purpose of operating it as a branch or a department. The stock was purchased as above set forth and the said Kestenbaum was employed as manager of this plant. The pertinent parts of the contract of employment between the Sheet'Metal Co., Inc., and Kesten-baum were as follows:
    . 1. The party of the First Part hereby employs and the party of the Second Part agrees to be employed by the party of the First Part, and diligently and faithfully apply himself to the business of the party of the First Part, as its factory superintendent and manager, and that he will diligently, faithfully, lawfully and honestly serve the party of the First Part in such capacities, pursuant to and in accordance with the orders of its Board of Directors, for a period of two years from .⅜1⅝ 19, 1919, and that he will at all times obey the orders and instructions of the Board of Directors of the party of the First Part, and will devote his time, exclusively, and he will not engage in any other business, endeavor or effort at any time during the continuance of this employment, except such duties as he may be compelled to perform as an officer and director of the party of the First Part.
    2. The party of the First Part agrees to employ the party of the Second Part in the capacities aforementioned, and to pay him for his services Seventy-Five Dollars ($76) per week, payable weekly, during the term of this contract, in addition to such salary as may be voted to him by the Board of Directors.
    3. The party of the First Part will have the right to terminate this contract at any time prior to the expiration of the term aforementioned, upon the institution of proceedings of the dissolution thereof.
    In order to retain control of the stock, a written agreement was entered into by and between Kestenbaum and the said stockholders of the Masters Waterproof ers, Inc., whereby they agreed to purchase Kestenbaum’s stock on demand and they were to have the first right to purchase said stock. The pertinent parts of this agreement were as follows:
    Now, therefore, in consideration of their several contributions to the capital of the Sheet Metal Construction Co., Inc., and for other valuable considerations, the parties of the first part have agreed to and with the party of the second part that they will, at any time during the continuance of the Sheet Metal Construction Co., Inc., purchase from the party of the second part when offered by him for sale such capital stock of the company as he may then own at a price representing the actual value of such stock, based upon a valuation of the property of the company, without any allowance for good will, and they hereby obligate themselves to purchase and pay for such shares of stock on demand, and all the parties hereto agree with one another that they will not sell any of their stock of the Sheet Metal Construction Co., Inc., without first affording each of the other parties to this agreement the opportunity to buy such stock at a value represented by the actual value of the property of said company, without any allowance for good will.
    Thereafter, the taxpayer was operated as a branch or department of the said Masters Waterproof ers, Inc., which assumed liability for all bills of the taxpayer, met its obligations, and furnished the necessary capital to run the business. During the year 1919, it held all of the 20 shares of stock of Kestenbaum as collateral for the said note of $800, and said stock was not voted during that time by Kestenbaum, nor did he take part in any stockholders’ meetings. Subsequently, in 1921, his stock was purchased by the Masters Waterproof ers, Inc. The taxpayer and Masters Waterproof ers, Inc., were, during the period from July to December, inclusive, 1919, affiliated corporations.
   DECISION.

The deficiency should be computed in accordance with the foregoing findings of fact. Final determination will be settled on 15 days’ notice, under Rule 50.


author: Littleton:

text:
    Appeal of PEERLESS ENGRAVING CO.
    Docket No. 3626.
    Submitted October 20, 1926.
    Decided January 26, 1926.
    Taxpayer was not, during 1919 and 1920, a personal service corporation.

      Charles B. Lawson, Esq., for the taxpayer.

      J. Arthur Adams, Esq., for the Commissioner.
    Before James, LittletoN, Smith, and Trussell.
    This is an appeal from the determination of deficiencies in income and profits tax for the years 1919 and 1920 in the amounts of $6,154.20 and $5,104.07, respectively, arising from the refusal of the Commissioner to classify taxpayer as a personal service corporation.
    FINDINGS OF FACT.
    Taxpayer is a New York corporation, engaged in photo engraving, with principal office in New York City. It was organized in 1904 and, during the taxable years, its entire capital stock of the par value of $8,200 was owned by Henry J. Roes, president and treasurer, who, during the taxable years, devoted his entire time to the business. He determined the policies of the corporation and supervised the manufacture of its product. The taxpayer’s entire net income was derived from the manufacture of photo engravings, both halftone and line, upon orders secured by the principal stockholder and salesmen employed by taxpayer. The cost of all material and labor was borne by the taxpayer and the price charged customers for the engravings was determined by taxpayer upon completion of the work contracted for. Taxpayer leased the building in which it carried on its business and, in addition, had equipment consisting of cameras, lenses, and etching, routing, and blocking machines, and various tools.
    The gross income and deductions for the year 1919 were as follows:
    Gross income from operations_$139,642.28
    Interest- 544.14
    Gross income from other sources_ 5. 82
    Total_$140,192.24
    DEDUCTIONS.
    Ordinary and necessary expenses_$101,880. 62
    Compensation (H. J. Roes)_ 14,000.00
    Taxes___ 86. 95
    Bad debts_ 717.50
    Exhaustion, wear and tear_ 693. 79
    Total. 117,378.76
    Net income. 22, 813.48

      The item of ordinary and necessary expenses, amounting to $101,' 880.52, consisted of the following:
    Cost of materials_$16, 389.58
    Salaries:
    5 gallery employees:_ 10,225. 07
    3 negative turners_ 5, 549.68
    4 etchers_-i_ 7,249.70
    8 finishers- 21,087.11
    2 routers_ 6, 535. 04
    1 Ben Day employee_ 2,931. 52
    Factory rent_ 1, 840. 64
    Factory insurance_ 307.30
    Electric service_ 1, 266.36
    Plant expense- 155.01
    Compensation insurance_ 417. 59
    Gas-,_ 291. 73
    Water_ 109. 85
    Rent-,___ 460.00
    Office salaries, bookkeeper, and stenographers_ 9,369.99
    Office expense_ 272. 70
    Telephone- 309. 72
    Insurance_ 49.70
    Stationery and supplies_ 20. 00
    Repairs- 98.00
    Auditing and legal- 225. 00
    Advertising- 10. 00
    Salaries, 3 salesmen- 8,733.33
    Commissions to salesmen_ 1, 857. 50
    Management expense_ 4, 975.00
    Photo Board of Trade_ 1,144. 00
    Total-i- 101, 880. 52
    The gross income and deductions for the year 1920 were as follows:
    Gross income from operations_$144, 066.00
    Interest- 650. 51
    Gross income from other sources_ 503.14
    Total $145, 219.05
    DEDUCTIONS.
    Ordinary and necessary expenses_ 121, 618. 79
    Taxes- 1, 245. 87
    Bad debts- 421.97-
    Exhaustion, wear and tear_ 624.41
    Total 123,911.04
    Net income. 21, 308.61

      The item of ordinary and necessary expenses, amounting to $121,-618.79, consisted of the following:
    'Labor_$60, 2S4. 81
    Rent_,-. 2, 850. 04
    Insurance- 496.94
    Electric service_ 1,404.15
    Gas_ 438. 60
    Water_ 308. 71
    Repairs- 107.45
    Plant expense--- 464.10
    Office salaries_ 12, 421.06
    Office expense_ 659. 82
    Telephone_ 257. 92
    Stationery_ 123. 25
    Legal and auditing- 221.07
    Advertising_ 325. 00
    Light_ 42. 90
    Salesmen’s salaries and commission- 11, 083.00
    Photo Board of Trade_ 1,218.32
    Materials- 12, 911. 65
    Management expense_ 4, 500. 00
    Management salaries_ 11, 500. 00
    121, 618. 79
    The number of employees, their duties, and the wages paid them during 1920 were substantially the same as during 1919, and are included in the item of “ Labor ” in the above statement.
    The balance sheets at January 1 and December 31, 1919, and December 81, 1920, were as follows:

    DECISION.
    The determination of the .Commissioner is approved.
   OPINION.

Littleton:

From the evidence before ns, we are of the opinion that the taxpayer is not entitled to classification as a personal service corporation. It is true that the principal and only stockholder was regularly engaged in the active conduct of the business, but it can not be said that the taxpayer’s income was due primarily to his activities. Both capital and the activities of other employees were material income-producing factors.


text:
    Appeal of GREEN OIL SOAP CO.
    Docket No. 3574.
    Submitted August 16, 1925.
    Decided January 28, 1926.
    1. Regular compensation specifically for prior years, formally authorized, paid in 1919, may not be deducted under section 234 (a) (1) of the Revenue Act of 1918 as an ordinary and necessary expense for 1919.
    2. Loss on account of abandonment and sale of equipment determined.

      E. B. Wilkinson, Esq., for the taxpayer.

      Blount Ralls, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of deficiencies in income and profits tax for the calendar years 1919 and 1920, in the amounts of $2,783.64 and $170.37, respectively, arising from the action of the Commissioner in denying a deduction for 1919 of $7,825, representing salary for prior years, in denying a deduction totaling $1,193.46 for 1919, on account of losses alleged to have been sustained through abandonment or sale of equipment, in denying a deduction of $196.64 for 1920, on account of equipment discarded or sold, and in computing taxpayer’s income upon the accrual basis.
    FINDINGS OF FACT.
    Taxpayer is an Illinois corporation, engaged in the manufacture and sale of soap, with principal office at Chicago. It was organized in May, 1904, under the name of Monohan Antiseptic Co., which was changed in 1920 to Green Oil Soap Co. At the date of organization the principal stockholders, who were, at that time, also the directors and officers, were W. J. Monohan, president; W. M. Kelso, vice president and treasurer; and George W. Hicks, secretary and factory manager. In determining, at that time, the amount of compensation to be paid to themselves, the directors, without formal resolution, agreed that they should each be entitled to the same compensation. Due to the financial condition of the company, Hicks, being in such a financial position that it was unnecessary for him to draw his entire salary, agreed with the other directors that he would forego doing so until such time as the company was in a position to pay it. Thereupon, the directors agreed that Kelso and Monohan should be paid full compensation, and that Hicks should draw a lesser amount for the time being, the difference between the amount drawn in each year subsequent to 1904 and the amount paid to Monohan and Kelso to be paid to him at a later date. No formal resolution of this agreement was adopted at the time. On June 19, 1919, however, the following resolution was adopted:
    The board of directors recognizing the valuable services rendered by George W. Hicks as secretary and factory manager and purchaser for the pást fourteen years, hereby grant to him the same compensation as the president and treasurer received during the past fourteen years. The sum of -this amount shall be the difference between the amount withdrawn by Mr. Hicks and that withdrawn by the president, Mr. Monohan, or that of the treasurer, W. M. Kelso. In lieu of cash being paid, to Mr. Hicks, by mutual consent the board hereby authorizes the officers to issue to George W. Hicks the balance of the unsold treasury stock, being 313 shares of the common stock of the company, in full settlement of the compensation rightfully due him for services rendered.
    With the exception of the reference to the payment of the salary in treasury stock in lieu of cash, the above resolution embodied the agreement entered into by the directors in 1904. The difference between the salaries paid Monohan and Kelso and that drawn by Hicks during the 14 years from 1904 to 1918, inclusive, was approximately $10,000. In full settlement thereof, Hicks received on June 19, 1919, 313 shares of treasury stock of the taxpayer of the par value of $1,825. No entry was made upon the books in any year prior to 1919 of the amount to which Hicks was entitled on account of salary.
    During the years 1919 and 1920, such records as were maintained by the taxpayer were upon the accrual basis. These records consisted of a cash book showing cash received and disbursed and the source from which received and the purpose for which disbursed, and a loose-leaf invoice book containing the invoices of purchases and sales. In addition,, there were a daily memorandum of accounts payable and accounts receivable, and, at the end of each year, an inventory of merchandise on hand on the basis of cost, or cost or market, whichever was the lower. The returns for the-years 1919 and 1920 were rendered upon the accrual basis.
    During the latter part of 1914 taxpayer equipped a drying room, at a cost of $1,500, which, in 1919, had become obsolete owing to the adoption of an improved method of drying. The depreciated cost of the drying room in 1919, at which time it was torn out and discarded, was $984.15. In 1914, it purchased an electric motor at a cost of $110, which had a depreciated cost in 1919 of $72.17. This was turned in at a value of $40 as part payment for a new motor. During 1914, certain soap-drying frames were constructed, at a cost of $120. These frames were discarded in 1919, at which time they had a depreciated cost of $78.78. A steel tank was installed in 1914 at a cost of $150, and discarded in 1919, at which time it had a depreciated cost of $78.41. In 1914, five open tanks were acquired at a cost of $200. These tanks had a depreciated cost in 1920 of $118.10 and were sold in that year for $25. During the year 1914, two typewriters were purchased at a total cost of $205. In 1920, one of these typewriters was discarded and the other turned in as part payment on a new machine at a credit of $17.50. The depreciated cost of the two machines in 1920 was $121.04.
    The Commissioner reduced the taxpayer’s invested capital for 1919 in the amount of $143.90, on account of a tax of $340.50 for 1918 prorated. He also reduced invested capital for 1920 in the amount of $1,245.48, on account of a tax of $2,955.58 paid in that year upon the income for the year 1919.
    DECISION.
    The deficiencies should be .computed in accordance with the foregoing findings of fact and the following opinion. Final determination will be settled on 15 days’ notice, under Rule 50.
   OPINION.

Littleton:

Taxpayer contends that its records were kept upon the cash receipts and disbursements basis and that its income for the years involved should have been computed by the Commissioner upon that basis; also, that the item, of $7,825, salary for prior years, paid on June 19, 1919, in treasury stock, was a proper deduction from gross income as an expense in that year; and that it is entitled to certain losses in each of the years on account of abandonment and sale of obsolete and worn-out equipment.

No evidence is furnished as to the basis upon which the books were kept for prior years. The president of the corporation testified that, prior to 1919, the corporation had a complete double entry set of books installed but that, due to difficulty with the bookkeeper, these books were not kept up. We have found, however, that such records as were kept during the years involved were upon the accrual basis, and the Commissioner’s computation of the income upon that basis is therefore approved. The amount of $7,825 paid to Hicks, pursuant to the agreement of the directors in 1904 and the formal resolution on June 19, 1919, was specifically for salary for prior years. Section ‘234 (a) (1) of the Kevenue Act of 1918 provides that, in computing the net income of a corporation, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. In the opinion of the Board, this section permits of the deduction in any taxable year by a taxpayer on the accrual basis, of only the salary incurred, during such year in carrying on the trade or business. Consequently, a payment during the year 1919 of an amount specifically as salary for prior years, unrelated to the compensation for services for the year in which paid, is not within the allowable deductions in 1919. Appeals of H. T. Cushman Manufacturing Co., 2 B. T. A. 39; Melrose Granite Co., 2 B. T. A. 113; Delaware Electric & Supply Co., 2 B. T. A. 403; Columbia Textile Co., 2 B. T. A. 472; Van De Kamps Holland Dutch Bakers, 2 B. T. A. 1247. No part of the deduction claimed was incurred in 1919, and the Commissioner correctly disallowed the deduction as ordinary and necessary expense for that year.

Taxpayer should be allowed a deduction of a total of $1,193.46, as losses sustained during the year 1919, on account of the equipment discarded and sold, and a deduction for 1920 of a total of $196.64 as losses sustained on account of equipment discarded and sold in that year.


text:
    Appeal of SCHULZ BAKING CO.
    Docket No. 2074.
    Submitted May 11, 1926.
    Decided January 28, 1926.
    Tbe selling prices of corporate stock immediately after incorporation, held, in tbe circumstances of tbe appeal, to be a proper basis for measuring tbe value of property, including good will acquired for stock.

      Alfred H. Goe, G. P. A., for the taxpayer.

      ETlis W. Manning, Esg., for the Commissioner.
    Before James, LittletoN, Smith, and Trussell.
    This is an appeal from the determination of deficiences in income and profits tax for the years 1919 and 1920 of $3,488.61, only a portion of which, however, is here in controversy. The only issue presented for our consideration is the elimination by the Commissioner from invested capital of any amount predicated upon the value-of good will acquired for stock.

      FINDINGS OF FACT.
    The taxpayer is a Delaware corporation with its principal place of business at Pottstown, Pa. It has been engaged in the general baking business since its organization on April 14,1913, when it took over the business which theretofore had been conducted by John L. Schulz, as an individual proprietor.
    Schulz began business in Pottstown in 1902. By 1906 his total output amounted to only 2,000 loaves of bread per week. During that year he acquired the right to manufacture and sell “ButterNut ” bread in Pottstown and vicinity, and by 1908 his business had increased to 17,000 loaves of bread per week. In 1912 the plant was enlarged and shortly thereafter the weekly output was 70,000 loaves. The improvements cost approximately $20,000. From 1912, and after the taxpayer was organized, the business increased steadily, and in 1918 the plant was again enlarged by the construction of two additional ovens.
    The taxpayer had an authorized capitalization of $150,000, divided into $75,000 preferred stock and $75,000 common stock — 1,500 shares of each at $50 a share.
    When the taxpayer was organized the total authorized issue of stock was transferred to Schulz for his plant, equipment, and business, allocated as follows:
    Net tangible assets_$13,996.16
    Formulas_ 580. 00
    Good will_ 135,423. 84
    Total_ 150,000.00
    The amount allocated to formulae represents the amount of cash paid by Schulz for the formulae and right to manufacture and sell “ Butter-Nut ” bread in Pottstown and vicinity.
    On April 19, 1913, Schulz turned back into the treasury preferred stock in the amount of $40,000 and common stock in the amount of $10,000. During the year 1913, 121 shares of preferred and 81 shares of common stock were sold from the treasury stock as follows:

      Of tbe amount received from these sales, $3,110 was paid in cash, $1,400 in promissory notes, and $1,540 was charged against accounts payable. In each instance, the preferred stock was sold at par and common stock was given as a bonus. These sales were made to willing purchasers who were members of the general public. They were acquainted with the business and knew the amount for which the business was capitalized. In the two cases where stock was accepted by creditors in satisfaction of claims against the taxpayer, the stock was taken by choice of the creditors and not from necessity.
    On March 3, 1917, there were outstanding 1,840 shares of stock of a par value of $92,000, of which amount $35,200 was common stock and $56,800 was preferred stock.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days’ notice, pursuant to Rule 50.
   OPINION.

Littleton:

The only matter presented for determination by this appeal is the amount of the taxpayer’s invested capital for the years 1919 and 1920. There is no question concerning the net income for either of these years.

The taxpayer was organized on April 14, 1913, for the purpose of taking over the general baking business, which was owned and operated by John L. Schulz. For the assets of this business, the taxpayer issued its total authorized capital stock amounting to $150,000. This stock was divided into 1,500 shares of preferred stock and a like number of shares of common stock with a par value of $50 a share.

In computing the tax for the years 1919 and 1920, the Commissioner excluded from invested capital the total amount allocated to good will. This action was based on the ground that no satisfactory estimate as to the cash value of good will, as of the date it was exchanged- for stock, was adduced. From this determination the taxpayer appealed, claiming that the good will was of value and that the amount thereof should be included in its invested capital.

With reference to the proper method for determining the value of good will, the court, in the case of Von Au v. Magenheimer, 115 App. Div. 84; 100 N. Y. S. 659, said:

No rigid and unvarying rule can be laid down by tbe courts in this class of cases. Each must be considered and determined in the light of the facts surrounding and connected with it. Within proper limits the determination of such question must be left to the jury, but their conclusion must rest upon evidence legitimately tending to establish value and supporting their verdict.

In Moore v. Rawson, 185 Mass. 264; 70 N. E. 64, the court said:

While no rule can be laid down by which the good will of a trading partnership in all cases can be ascertained and its value fixed with mathematical precision and accuracy, yet, if it be assumed that a firm has been in existence for a time long enough to establish a business sufficiently permanent in character to include not only its customers, but the incidents of locality, and a distinctive name, these advantages constitute a going business enterprise; and it may then be said that the name and what is done under it go together, and a good will exists which forms an asset of commercial value in a winding up between partners. The fact that such an asset may be difficult of appraisement is no legal reason for denying to the retiring partner an appraisal, if it be proved that he is entitled to it. * * * The length of time the firm had been in existence, the nature and character of its business, the fact whether it had been successful or unsuccessful, the average amount of net profits, the probability of the continuance of the business under the same name without competition in any form from a retiring partner, are some of the elements that may enter into such an inquiry.

The valuation of good will is a question of fact and must be determined on the evidence in the record. The evidence presented by the taxpayer in support of its appeal must therefore be considered to determine whether or not the taxpayer has submitted facts sufficient to show the value of the good will as of the date it was acquired for the stock of the corporation. The record discloses that the business was started as an individual enterprise by John L. Schulz in 1902, but that his business did not exceed 2,000 loaves of bread per week until 1906, when he obtained the formulae to make and sell “ Butter-Nut ” bread. Within two years after that date his business had increased to 17,000 loaves a week, and in 1912 it became necessary to enlarge the plant. Shortly thereafter the business was more than trebled, the weekly output being 70,000 loaves per week. These facts indicate that the taxpayer acquired a thriving, growing business. They indicate that Schulz had built up a reputation among the people of Pottstown and that the number of customers was both large and constant. They show that the taxpayer, in taking over the business, acquired a value greater than that attributable to the tangible assets. No evidence was submitted showing the profits of the business during the time that it was operated as an individual enterprise, and the facts outlined above are not sufficient for determining the value of the good will of the business. The facts mentioned do show, however, that good will was a large factor in the success of the business.

There is further evidence which shows the sale of stock during the year 1913 immediately after incorporation. On April 19, 1913, five days after the taxpayer corporation was organized, Schulz turned in to the treasury preferred stock in the amount of $40,000 and common stock in the amount of $10,000, leaving outstanding $35,000 par value of the preferred stock and $65,000 par value of the common stock. During the nest few months the taxpayer sold 121 shares of the preferred stock at par and 81 shares of common stock were distributed among the purchasers as a bonus.

The Commissioner rejected this evidence upon the ground, first, that the block of stock sold was so small in proportion to the total left outstanding that the sales furnished no reliable criterion as to the value of the stock issued for property; and, second, that the transactions were subsequent to the organization of the corporation. These sales took place almost immediately after the organization of the taxpayer, and, in view of this fact and the further facts as to the established business existing at the time of the incorporation of the taxpayer, there is little merit in the latter position taken by the Commissioner. The Commissioner’s position on the first point rests on the weight to be attributed to the sales in question and to the values which would result mathematically from the application of the price received in these sales to the entire block of stock issued for property — that is, to $35,000 of preferred stock and to $65,000 of common. A further difficulty arises from the fact that the common stock was given as a bonus with the preferred. This, of course, does not mean that bonus stock so given is without value or that preferred stock sold with common as a bonus is sold for par. It does mean that for a block of common and preferred together a certain price is received. In this case $6,000 was received for a block of 201 shares of preferred and common. Upon this basis — that is, upon the basis of $6,000 for 120 shares of preferred and 81 shares of common — $35,000 of preferred would carry with it as a bonus $23,625 common. There having been issued, in effect, for tangible and intangible property, $65,000 of common in addition to the $35,000 of preferred, our next problem is to determine whether any value should be assigned to the remaining lot of common stock. No evidence was submitted showing sales of common stock separately from preferred stock, and, as set forth above, the total stock shown by the evidence to have been sold immediately after the organization of the taxpayer was small in proportion to the total amount of stock issued, particularly to the total amount of common stock issued for property. Under all the circumstances we are of the opinion that no more than $35,000 can be accepted as the proven value of tangible and intangible property issued for stock upon the organization of the taxpayer. Taking from this amount of $35,000 the value of $13,996.16 applicable to tangible property, leaves a value of $21,003.84 for the intangible property paid in for stock, which value of $21,003.84 should be included in computing the taxpayer’s invested capital.